Make Argentina Crash Again

 

My article for The American Prospect on the Argentina situation was just published online. Argentina is far from being out of the woods. The expectation that the country will stabilize prices, float its currency, and build up reserves, and restart economic growth is a chimera. Despite market support for Milei’s program, the crisis remains unresolved. In my article, I explain why the challenges persist, an why this will end like the previous three neoliberal experiments, with a crash. While an immediate crash may not be on the horizon, it is somewhat inevitable. It's a matter of when, not if. And it may very well be with the next president, if the U.S. continues to financially prop Milei's government.

Note that contrary to the IMF, or Barry Eichengreen, who actually provided the IMF justification for floating rates more generally (as he explains there), I don't think to abandon the dirty float (band in this case) would be a good idea.* On that I think Milei's administration is correct. I even think that some degree, even more I think, of a reintroduction of exchange rate controls (the government reintroduced some controls on individuals, I must add) is necessary. Something that supposedly the IMF also favors. Capital controls as a macro-prudential measure in times of crises.

I also want to make clear that this is mostly about the current macroeconomic circumstances. The point is not to return to a world of Bretton Woods, with fixed exchange rates, and capital controls. It is clear that Brazil, for example, did much better than Argentina, with a dirty float and no capital controls. But, as noted by Fabian Amico, in a talk at Universidad Nacional de Moreno, recently, Brazil accumulated reserves in a different macroeconomic scenario.

Brazil accumulated foreign reserves (see graph), maintaining a positive interest rate differential (the domestic interest rate minus the foreign reference rate, the U.S. one, the expected depreciation, and a measure of country risk). We discussed that with Amico and Serrano a few years back (in Spanish). Note that as capital inflows allowed Brazil's central bank to accumulate dollars, the real appreciated in nominal terms. In Argentina where both left and right of center governments have 'appreciation fear' (and their fear is about the real rate, let alone the nominal one), that would be politically difficult.

Exchange rate depreciation at this point would lead to accelerated inflation, and to contractionary pressures. Of course, there might be a situation (they had more than a few over the years) in which, with low country risk, and high interest rates at home, leading to a higher differential that allows for the profitability of holding peso denominated assets to be higher than holding dollars, we might finally get on the road to stability. That would be orderly macroeconomic policy, and not draconian fiscal adjustment. At any rate, that doesn't seem to be the case right now.

Over the long-term, it is very clear that all the previous experiments with this kind of policy (fiscal austerity, financial deregulation, and trade liberalization) ended up in a crash. There is also little reason to believe that this time it will be different. 

* It goes without saying that I would also be against dollarization, something that Milei promised in his campaign in 2023, and that has been recently floated by Laurence Kotlikoff in the Financial Times. This suggests that the old bipolar consensus has not been completely abandoned in more mainstream circles.

Podcast with about the never ending crisis in Argentina

Podcast with about the never ending crisis in Argentina with Fabián Amico, and myself and interview by Carlos Pinkusfeld Bastos and Caio Bellandi from the Lado B do Rio Revista, and sponsored by the Centro Celso Furtado (Carlos is the director). In Portuguese (but fine if you speak Spanish or at least Portuñol).

Thinking about Inflation: A conversation with Marc Lavoie

The conversation on inflation with Marc Lavoie at the Fields Institute in Toronto. I think that there was an agreement, between us, and most people in the room that the oligopolistic view of inflation does not hold water. I tried to discuss the Argentinean case on the basis of a piece that I co-wrote with Fabián Amico and Franklin Serrano, published in the local version of Le Monde Diplomatique online. A longer version, also in Spanish, here. An English version is in the works, btw.

Webinar on COVID and the Argentinean situation (in Spanish)

For those interested, I suggest listening only to Amico's talk if you already heard a version of my COVID talk.

What to expect from the incoming government in Argentina

The government in Argentina has less than two weeks at this point. It is too early to pass judgment. But we can look at the legacy of the Macri administration, and indicate a few things about the current strategy. A paper I have just received from Fabian Amico, that will soon be published in Circus, will be invaluable for my very brief comments here (the new issue of Circus and his paper will eventually be linked here, in Spanish).

The first thing that should be evident is that the 4 years of the Macri administration, that were supposed to restore economic growth, something that had faltered since 2011, essentially as a result of an external constraint, were a failure. Using IMF data, the average GDP growth in the period was -0.2 percent. Yep, negative. Amico uses a local activity index and the results are visibly not very different (his numbers give an overall decline of 1.7 percent for the whole period).

Macri's administration also lifted capital controls, paid the Vulture Funds more than US$ 9 billion, and open the doors to additional foreign borrowing. The Macri government had put all of their bets on the notion that growth would come from private investment and exports, rather than the combination of government spending and higher wages, which allows for higher consumption. Below you can see how well that worked out for them.

As it should be clear only exports grew (Amico calls, aptly, the Macri period an export-led stagnation one), and not as a result of the real devaluation, since they grew at about 2 percent per year, more or less in tandem with the growth of global GDP. So much for the notion that devaluation provides space for policy, and higher growth. The collapse of government consumption, and the fall in real wages were crucial to explain the poor performance. Investment followed the accelerator and collapses with the fall in GDP.

The real depreciation of the exchange rate, as is well-know, affects negatively the real wages, that fell approximately 30 percent during his government, and as I had noted back in 2015, that was the real objective of his government. In that sense, one can say that his government did achieve its main goal. The participation of wages in total income fell 8 percent, as shown below.

The worst mistake was the increase in foreign debt in foreign currency, of course, the currency crisis and the return of the IMF, which I've already discussed (here and here) so I'll not delve again into this.

The Fernández administration, and the new Finance Minister, Martín Guzmán, are doing what was expected, and what seems reasonable under the current circumstances. The increased the retentions, taxes on exports, mostly of the agribusiness sector, started to tax assets held abroad, and eliminated taxes on assets held domestically in pesos, which are measures to try to increase the reserves in dollars. This will certainly complemented with measures to alleviate hunger, and poverty, including the pensions of the elderly poor. They are most likely in negotiations with the IMF to avoid a default, and that is crucial for the success of the economic program.

As Fernández said, his administration inherited the chaos. But there are reasons for hope in the dark.

How bad is the Argentine crisis?

There is a certain view about current events in Argentina that tends to emphasize the potential effects of the devaluation as the collapse of the economic model, and, and, hence, suggest that the post-default process of economic growth should not be taken as an alternative for other countries in distress, like for example Greece and other Southern European countries. This kind of view, expressed for example by Walter Molano in the Financial Times (subscription required; minus the strange argument that the Argentine problem is "geographical"), suggests that policies should be aimed at pleasing international financial markets since the goal is to promote "confidence in the country’s economic management," and that devaluation is necessary for solving the "unsustainable economic imbalances."

First, it must be understood that the current devaluation, which was of the order of 20% in nominal terms in the last days of last week, is part of a plan that was most likely in the works, since the change in the economic team at the end of last November, when the current finance minister, Axel Kicillof, became the sole commander of the economy displacing Guillermo Moreno, and to a lesser extent Mercedes Marcó del Pont (full disclosure, I worked in the central bank during her tenure as president) in the internal domestic dispute.

In other words, this is not a balance of payments crisis (or a currency one) per se, even though it might become one, since it was actually part of a policy decision, first to accelerate the depreciation of the currency, which started in the last month of 2013 after the new finance minister assumed his position, and that culminated with the renegotiation of the debt with the Paris Club (to regain access to international financial markets), and the gradual liberalization of the exchange market, trying to move the official rate closer to the 'blue,' that is, the black market rate. Note that the current account, as I noted before here, is not in a terrible situation, the Brazilian position has been far worse for a longer period, and the real exchange rate was not more appreciated than in Brazil either.

Before discussing my views of what might happen, it is important to note the New Developmentalist views, which are often associated to Bresser-Pereira and in Argentina to Roberto Frenkel and his co-authors, that the re-alignment of the real exchange rate was inevitable and necessary to promote more competitiveness and growth does not hold water (see my previous critique here, and Fiorito and Amico's here). Bresser has in fact argued that this devaluation is likely to be good for Argentina. In his words (the whole article here):

"the peso retrieved the lost competitive equilibrium; the government declared that the peso had reached the desired level, and, without fearing an increase in the dollar's official price, it suspended several restrictions to the purchase of dollars , in order to draw the parallel down. If this strategy of keeping the exchange rate at the competitive level is successful, profit expectations will rise, business enterprises will invest again, the current account surplus will be restored, and the Argentinian crisis will be over."

Martín Rapetti (a Frenkel co-author) remains more skeptical here (in Spanish), but insists it was inevitable (the exchange rate realignment).

In my view, the devaluation was not inevitable and is not particularly good. First, it will be inflationary, and as I noted a few years back, also might be contractionary, so expect less growth this year. The reduced growth is what will hold the current account in a reasonable situation, by the way. Hence, devaluation will not solve either the inflationary problem, nor the external constraint one. In this sense, the crisis (manufactured as it is) is worse than most people understand, since it won't solve any of the pressing problems in Argentina.

Note that if the government on top of the current measures adds fiscal contraction (monetary tightening is a given, since higher rates of interest will be needed to avoid more capital flight; and the effects of monetary contraction can be compensated by subsidized public credit) as the New Developmentalists wanted (since for them inflation was caused by excess demand) then the slowdown will be significant and even a recession could take place. The Plan Progresar (that gives money to young students without jobs) might indicate the opposite disposition, but the crisis might force the government to slowdown the economy to avoid a more serious current account deficit.

A more benign scenario would be that the Central Bank manages to control the depreciation, and stabilize the real exchange rate, likely at a somewhat depreciated rate (how much will depend on wage resistance, and how much inflation we get; my guess is that some real depreciation will take place, and lower real wages will follow, which also will add a contractionary force in domestic demand), but this does not turn into a run on the currency.

As I noted before, there are good reasons to believe that lack of growth in advanced economies and low rates of interests in the center will preclude outflows of capital, if higher real rates of interest are imposed in Argentina (they are still negative now) like Brazil has done. Also, the plateau of commodity prices indicates that the balance of payments will not worsen immediately, so there will still be space to solve the long-term problems associated with excessive dependence on the export of commodities, and to pursue the difficult but necessary process of import substitution.

In short, the default and the process of growth (which was possible because of favorable external conditions, but NOT caused just by that; as I noted several times terms of trade improved less in Argentina than in Brazil, and the former grew far more during the commodity boom period), which was based on fiscal expansion and income redistribution is an alternative to Neoliberal policies. And the way to deal with the limits to the model (which are associated to the external constraint) are not related to the exchange rate, but to industrial policy.

PS: Here a video in which Fabián Amico provides a similar analysis (in Spanish).

Natural Resource Nationalism and Fiscal Revenues

One of the relevant points made by Amico and Fiorito for the case of Argentina, that apply to many countries in the region, is the increase in fiscal revenue that was associated to the higher national participation in the gains from exports of primary goods. This has been, in part, associated to the left of center governments and the so-called Natural Resource Nationalism. The table below shows the evidence.

It can be seen that, with the exception of Mexico and Venezuela, where State revenue from oil was already high, in all other countries there was a significant increase in State revenues. Governments have appropriated primary export earnings and turned them into fiscal resources by taking a share of operating earnings, either through public enterprises (which included nationalization in some cases) or through equity holdings, more stringent requirements on the payments of royalties, and by levying taxes on export earnings.

Read more on the fiscal situation in Latin America in ECLAC's report here. For more on Natural Resource Nationalism read the following paper by Carlos Medeiros (h/t Revista Circus).

The mysterious case of the optimism about the relation between depreciation and growth

By Fabián Amico and Alejandro Fiorito* (Guest Bloggers)

The current debate about economic growth in Argentina, has accepted as dogma that the fast rate of economic growth between 2003 and 2011 had as its primary cause the devaluation in 2002, and the maintenance of a Sustainable and Stable Competitive Real Exchange Rate (SSCRER). Several economists attribute the current deceleration of economic activity to the real exchange rate appreciation.

The most analyzed economic variable is the real wage in dollars: between 2009 and 2011 the official exchange rate was devalued in 12.6%, while nominal wages in the private sector increased by 68%. In other words, the dollar value of wages increased almost 50%. In 2012 this was partially reversed.

How would a more competitive (devalued) real exchange rate stimulate growth? First and foremost it would lead to higher exports and lower imports, and then it would stimulate investment, and would generate more output and employment. The implicit assumption is that all the other components of demand would not change with the devaluation. But that is highly unlikely.

For at least 60 years it has well known that in Argentina devaluation have been contractionary. All available empirical evidence suggests that the sensibility of external trade (exports and imports alike) to variations of the exchange rate is extremely low. Yet, the inflationary and regressive on income distribution (associated to lower real wages) is considerably stronger, and, as a result, the global effect of a depreciation is contractionary. Worse even when devaluation is accompanied by fiscal austerity. The reduction of the level of economic activity has a depressing effect on investment compounding the negative effect.

Some economists suggest that the way in which devaluation generates an increasing demand for labor domestically – for a given level of activity – is related to the reduction in the relative price of the labor ‘factor’ with respect to capital. In other words, if a persistent reduction in the relative price of wages to capital goods (in dollars) were to take place, then the level of employment would increase irrespective of the rate of growth of the economy.

The devaluation of the exchange rate is, in this case, analogous to the neoclassical logic according to which a downwardly flexible real wage would eliminate the unemployment (and why wouldn’t one continue to devalue until full employment is reached?). But, in general, there is more rigid (technically) relation between capital and labor; ergo, even if relative prices change, the employment to output relation may not change significantly.

Surely, a SSCRER might have a positive role – together with other policies – in the maintenance of the external sustainability of the long term growth strategy to the extent that it contributes to export diversification and facilitates import substitution. Yet, this is a different proposition than suggesting a simple positive relation between real devaluation and growth: it really implies an exchange rate policy that is nuanced enough to maintain competitiveness, while not reducing real wages, which are the real locomotive pushing Argentinean economic growth. In sum, a ‘horizontal’ devaluation (without any type of differentiation in types of exchange rates or compensations for losers) produces an improvement in the profitability of exporters, a small effect on the volume of exports, and a contraction in the level of economic activity.

It is fairly clear that Argentina has a structural tendency to external disequilibrium between imports and exports, associated to the over dependency on primary exports, the low diversification of exports, and the composition of imports (which are entirely determined by domestic investment, and not by the real exchange rate). Domestic growth leads to increasing investment and this requires higher demand for imports of capital and intermediary goods, while exports grow at a lower pace. In other words, the propensity to import of the economy is incompatible with the countries’ export platform.

The counterpart to these arguments is that, contrary to what many defend, real exchange appreciation is expansionary, since is the other side of the coin associated with higher real wages. Note that in 2008 several economists already argued that the real appreciation was a matter of concern and that growth would stall immediately. Several argued that the time of ‘Chinese’ growth rates was over. Yet, after the 2009 crisis, in a context in which the real exchange rate had already achieved the late 1990s levels, the economy grew at record levels (9.2% in 2010, and 8.9% in 2011), while the industrial output grew even more (9.8% in 2010, and 11% in 2011). Something similar happened in Brazil and the result was, in both countries, the result of expansionary fiscal policy.

Clearly, other than the increase in real wages, it was the increasingly expansionary fiscal policy that explains the Argentinean recovery since 2003. This was for the most part unacknowledged since the government had a significant fiscal surplus since 2003, suggesting incorrectly that fiscal policy was contractionary. However, the most important component in the fiscal surplus was the increase in the tax revenues levied on exports. The government was able to use the revenues of the taxes on exports to pay the obligations on the external debt re-structured in 2005, increasing significantly its fiscal space. At the same time, the main categories of primary spending (public investment, social transfers, and wages) grew at a fast pace.

Nonetheless, there are deeper reasons for looking down on the role of fiscal policy. There is an almost complete consensus that expansionary policies in the context of an economy with an external restriction are by definition unsustainable. Instead of this ‘populist’ policies, the argument goes, it is suggested that a SCRER would be a more ‘serious’ alternative. However, the Argentinean economy, even if the main restriction to growth is given by its capacity to import, grows – as it did in the past, and as most medium and large countries do – pushed by the expansion of domestic demand. It is a structural feature, and not a policy option.

Another aspect – more circumstantial – that led to the misplaced optimism on the effectiveness of a nominal devaluation to become a real one, was the very low wage resistance exhibited by the working class back in 2002 (in the context high unemployment and labor flexibility). In the past, nobody would have accepted that proposition, since a maxi-devaluation would easily translate into a virulent wage-exchange rate spiral, with unpredictable results. And in this respect, it is possible that now, with lower unemployment, Argentina is back to its traditional situation.

The last aspect that favored the optimist views about the relation between the SSCRER and growth is the uncritical acceptance that the import substitution strategies, in general, and the processes of industrialization led by the State, in particular, were exhausted and disreputable. In this context, exchange rate policy looked like a suitable alternative in a world in which the State should have limited intervention in the economy and the process of development. Put simply, exchange rate policy (horizontal) is market friendly. Sadly, the effects of exchange rate policy are not the ones suggested by this optimistic new macroeconomic developmental consensus.

In sum, the feasible development strategies for Argentina (and for Latin America) do not simply change with the whims of fashion. The attempt to promote development by getting the prices right (the exchange rate in this case), is a vain utopia, that might have undesired consequences. The more it takes to return to the old wisdom and realism of the old Structuralists, the longer it will take to begin the practical reconstruction of a viable development strategy. This would necessarily require the intervention of the State in the difficult tasks of inducing selective import substitution, diversification of exports, modernization of infrastructure, and policies that promote technological change, within the context of high and sustained growth levels. It is not possible to leave all of these tasks to be performed by the change of one single variable.

* Researcher at CEFID-AR and Professor at UNLU, respectively.

PS: Originally published in Spanish in El Economista here, and also here. A similar view was discussed here before.

Okun's Law at 50

The IMF has written a good paper on Okun's Law (here), suggesting (from the abstract) that: "Okun’s Law is a strong and stable relationship in most countries, one that did not change substantially during the Great Recession [and] accounts of breakdowns in the Law ... are flawed." nothing new really; I have said so a few months ago (here). Bill Mitchell has good post (here), which suggests correctly that the problem with the recoveries is not Okun's Law, but excessive fiscal austerity. I would add one more thing, not only Okun's Law works well in developed countries (advanced economies according to the IMF paper), but also in developing countries. Figure below is a crude representation of the Law for Argentina.

Note that the coefficient is more or less the same as in the US or other advanced economies. An increase in GDP growth of 1.87% reduces unemployment in 1%. Close to the 2 to 1 ratio. A more sophisticated and better estimatimated version that takes into account trend issues associated with Kaldor-Verdoorn, by Fabián Amico, Alejandro Fiorito and Guillermo Hang is available here (but in Spanish).