Unlike in 1910, when the Republic commemorated its 100th birthday with pride and optimism for, at the time, it was one of the most promising nations on earth, this time round there is little to cheer about.
For the best part of the last hundred years, Argentina’s economic performance was abysmal relative to the expectations that existed at the beginning of the period. Back in 1910, the country seemed perfectly fit to catch up with US per-capita income in a matter of a few decades or, at a minimum, grow as much as the other “Western offshoots,” i.e., Canada, Australia, and New Zealand. But, as the chart below shows, this was not the case.
Long-term Performance of Argentina vis-à-vis Australia, New Zealand, and Canada
(GDP per capita adjusted for PPP)
Source: Angus Maddison, “The World Economy: Historical Statistics.”
According to the long-term data estimated and compiled by the late English economist Angus Maddison, Argentina’s GDP per capita, when adjusted for differences in purchasing power, was not too different from that of Australia, New Zealand, and Canada in the early 1930’s. Fifty years later, it represented less than a half. A similar conclusion can be reached by looking at the data published by the IMF in the WEO, which also adjusts GDP for PPP, even though the absolute figures differ in both cases because the base year is not the same.
Recent Performance of Argentina vis-à-vis Australia, New Zealand, and Canada
(GDP per capita adjusted for PPP)
Source: IMF, World Economic Outlook, April 2010.
In more recent times, the gap in per-capita GDP continued to grow and, today, Argentina’s income per person represents less than 40% of Australia, New Zealand, and Canada’s combined. Notice that this trend has not been affected by the post-Convertibility recovery in Argentina since, just as Argentina grew more than in previous years during this period, so did the other countries, evidencing that the recovery was not a local, but a global phenomenon. Notice, in addition, that, in pure dollar terms (namely, without adjusting for PPP), the widening of the income gap is much more pronounced due to the sustained appreciation of the AUD, NZD, and CAD relative to the ARS (itself a sign of economic strength in those countries relative to Argentina). Thus, while this year Argentina’s GDP per capita is going to be less than US$9,000, that of the Australia, New Zealand, and Canada taken together will exceed US$45,000, more than five times higher!
GDP per Capita in Current US dollars
(Not Adjusted for PPP)
Source: IMF, World Economic Outlook, April 2010.
The question is: will the gap diminish going forward? Depressingly, nothing indicates this will be the case. The reason is that, unlike Australia, New Zealand, and Canada, whose macroeconomic conditions and market incentives are rock solid, Argentina’s macroeconomic stance has deteriorated and its market incentives are deplorable.
Charting the Future with a Broken Compass
Acolytes of the current regime like to trumpet the view that, whatever the mistakes of the past, everything is fine now that the “old vices” (e.g., an overvalued exchange rate, current account deficits, and a bloated external debt) have been removed. So, suppose for a minute that someone had paid us to convince you the reader that this is, indeed, the case using for such purpose a comparison between Argentina and a composite of Australia, New Zealand and Canada (AusNZCan), whose historical performances were analyzed in the previous section. This is what we would say (assuming we were corrupt, which of course we are not):
Consider the following table in which several economic indicators are presented using data of 2008, the year before the global recession occurred. Thanks to a competitive exchange rate and a solid external and fiscal situation, Argentina was able to grow at 6.5% during a difficult year, which was marred by a global financial crisis, while AusNZCan grew only by 1.2%. Argentina accomplished this despite the fact that investment as a share of GDP, though having recovered significantly from the trough of 2001-02, was still 2 percentage points of GDP lower than in AusNZCan, evidencing that, despite criticism from the neoliberal camp, active government intervention in Argentina did not impinge negatively on total factor productivity, but quite the opposite, it improved it. Another favorite neoliberal diatribe, that Argentina’s economy exhibits a strong bias against foreign trade and in favor of big government, is also far from true. Both the degree of openness (exports plus imports divided by GDP) and the share of public sector expenditures in GDP are not significantly different in Argentina than they are in AusNZCan, an area regarded by the Washington consensus as an example of free trade and small government. The only performance criteria that do not stand out in Argentina by comparison with AusNZCan are: inflation, dollar interest rates, and dollar GDP per capita. But, why should anybody worry about these? Higher domestic inflation is the price Argentina must pay for attaining higher growth (and a low price at that since, by Argentina’s historical standards, current inflation is not that high). On the other hand, the fact that interest rates on internationally traded sovereign bonds are still relatively high in Argentina is irrelevant now that the country is embarked on a process of “desendeudamiento” (sovereign debt reduction). And, as for GDP per capita, what matters is not the dollar measure (which, in the 1990s, was inflated by a grossly overvalued exchange rate) but the real (i.e., constant prices) measure, which has been growing steadily since 2002 after a new economic paradigm was adopted.
Argentinaand AusNZCan: Selected Economic Indicators (2008)
Source: Own elaboration based on IMF, Mecon, and MacroVision databases.
Back to Reality.
What is wrong with the picture presented before? More than one thing, to be sure, the most obvious one being that inflation was not 7.9% in 2008, but 20.7% (and is going to be at least 25% in 2010). But, allow us to discuss more substantive issues, starting with the real exchange rate. When it comes to this variable, the question is not whether the RER is competitive or not, but where it is situated relative to equilibrium. The equilibrium RER is not a policy variable, but an economic outcome. In AusNZCan, where the RER is, in all likelihood, not too far from equilibrium, the relative strength of the local currency is consistent with that of the economic fundamentals, macro and micro. By contrast, in Argentina, where the RER has been manipulated via price controls and distortionary taxes since 2002, the peso is still undervalued (although, as shown in the table below, the degree of undervaluation has been falling on account of high domestic inflation).
Argentina: Selected Economic Indicators (2008-2010)
Source: Own elaboration based on IMF, Mecon, and MacroVision databases
The correct alignment of the RER (namely, its closedness to the equilibrium level that would prevail in the absence of distortions) and its flexibility in response to external shocks are extremely important considerations to judge how the small-open economies of Argentina and AusNZCan will perform in the future (the next decade or so). Particularly if, as it appears to be the case, the world economy, which is still dominated by the US and Europe despite the rapid growth of Asia, becomes less hospitable than it has been in the last two decades. In this sense, the current turmoil in the Eurozone finds AusNZCan in an enviable position. Inflation is low and the real exchange rates are strong implying that the Aussie, Kiwi, and Canadian dollars have ample room to depreciate if needed to facilitate the adjustment of their economies to a decrease in global demand and capital inflows. This room does not exist in Argentina where the RER is already overly depreciated and inflation has become a serious problem.
How about the alleged solidity of fiscal and external fundamentals? On the former, let us simply say that, aside from the fact that there has been a sharp deterioration in the budget balance over the last two years (the consolidated balance of the federal government and the provinces now registers a 3.5% of GDP deficit, down from a 1.5% surplus in 2008), there are three other factors that complicate the fiscal situation. First of all, the size of the public sector (as measured by the aggregated expenditures of the Nation and the provinces) has ballooned, from 25% of GDP ten years ago to 36.5% now. Besides posing an additional burden on the private sector, which must pay higher taxes, fiscal vulnerability has increased going forward, particularly since, once spending increases, reducing it as revenues fall becomes virtually impossible except through a maxi-devaluation.
Second of all, the government’s access to voluntary credit, foreign or domestic, is practically inexistent meaning that the deficit has to be financed almost entirely by the Central Bank, either by printing money (which ignites inflation in the short run) or by “lending” reserves (which raises expectations of devaluation and inflation in the medium run).
A third fiscal problem is that, notwithstanding the government’s rhetoric, there has been no real reduction in the public debt as a share of GDP. All there has been is a reshuffling of the gross debt owed by the Treasury from the private to the public sector, mainly due to the nationalization of the AFJPs. But, unless the government is planning to renege on its pension obligations, the liabilities are still there. Meanwhile, the net debt outstanding (namely, the one that needs to be repaid each year as opposed to being automatically rolled over with the public agencies) continues to grow as holdouts, the Paris Club, and other unpaid creditors are incorporated.
Going now to the external fundamentals, our view is that the only reason Argentina runs a current account surplus is that it needs it to finance capital flight. This may sound like a cynical interpretation but, actually, it is not. Among other things, it explains why, now that the RER has started to appreciate, the government has been forced to introduce direct restrictions on imports despite retaliation by China (which banned imports of soybean oil) and angry complaints by Brazil and the European Union.
Simply put, the dilemma the authorities face is as follows. Capital flight has declined, but it has never stopped. In a good month, it can be US$500-600m, and in a bad one, US$1.5bn or more. On average, it is US$1bn/month. Thus, if the private sector is able to generate, via trade and trade financing, US$2bn/month, the Central Bank can give the government US$500m to service the external debt, let people have US$1bn, and accumulate US$500m in reserves, without devaluing the peso. At AR$4/US$, this implies an AR$2bn monetary base expansion (roughly, 2% per month), enough to lubricate the monetary system without creating inflation. But, what if capital flight (“dollarization” in the Argentine lexicon) increases to US$2bn? Then, the Central Bank loses reserves and the money supply contracts causing economic activity to fall. The government can react by sterilizing in reverse (e.g., buying Lebacs for cash) but, over time, this reduces the dollar-backing of the monetary base increasing the pressure for devaluation, hence inflation. If faster depreciation is ruled out for fear of exacerbating inflation, there is no alternative for the government but to raise import restrictions.
What the government does not seem to understand is that, by doing this, it sooner or later ends up hurting exports. If so, it is not clear how the current account surplus can be maintained. In other words, there is no free lunch. The government’s novel paradigm has placed it in a Catch-22 situation. Can this be called a solid external position? One has to look no further than at Brazil to understand that it cannot. Brazil has a deficit in its current account (of about 3% of GDP) but, unlike Argentina, it has foreign direct investment in abundance. Despite the strength of the BRL (o, perhaps, because of it) Brazil’s external position is stronger than Argentina’s.
In closing, let us say a few words about Argentina’s seemingly elevated degree of openness. Is this not a puzzle considering the long array of export and import taxes, quotas, and prohibitions the government has introduced? Actually, more than a puzzle, a statistical mirage is what it is. For if the ratio of exports plus imports to GDP is measured at constant prices of 1993 rather than at current prices, the figure for 2009 drops from 37% to 28%, which is essentially the same as 10 years ago. Hence, the reason is not that Argentina trades more, but that both commodity prices and the value of the dollar in terms of pesos are higher.
Short versus Long Run
As argued in previous reports, Argentina’s economic outlook presents a clear (and odd) dichotomy between the short and the long run. Anything that goes beyond the next presidential election is here regarded as “the long run.”
The political objective of the Kirchners is either to win the election or come close to winning, preferably the latter. For this, they have to get to October 2011 without crashing the economy. If they win, they will worry later about what to do. If they come close, they will try, from the opposition, to blame the new government for anything that happens after they leave.
How high are the chances that the economy crashes before the election? Not very high, in our view. In all likelihood, the fiscal situation will worsen (a consolidated deficit of 5-6% of GDP?), inflation will be higher (an annualized rate of 30-40 or even 50% in some months?), but there will not be a recession and the unemployment rate will not be significantly higher than the one we are observing now (10%?).
Foreign reserves will be lower (US$30bn?), domestic interest rates will be higher but even then money demand will drop, and there is a distinct possibility that the exchange rate will split into a dual system with a comercial rate of AR$4-4.5/USD and a parallel, free or financial rate of AR$6-7/USD. But, there will not be a financial crisis. In particular, commercial banks will remain liquid and the government will not default, except by continuing to cheat on the inflation index.
Come January of 2012 and all hell will break lose. Inflation and devaluation will rise and the economy will go into a deep recession. If the Kirchners are in power, they will get a taste of their own medicine. But, even if they are not, contrary to their wishes, they will still suffer some of the consequences.
The author is a Local Partner of GlobalSource Partnersand a Managing Partner at DFC Associates, LLC.