Twin Problems

Argentina faces serious challenges in the two spots where, before, it was thought to have strengths, namely, the fiscal and current account balances. While these challenges were made worse by the current global financial crisis, they were not created by it, but by an inconsistent policy model.

On the fiscal side, the challenge is how to close the financing gap of the federal government without aggravating the recession. On the external side, it is how to avoid an impending currency crisis.

A cautionary tale for Argentina is that, for all the fuzz about its “twin surpluses,” these were not nearly high enough to support the heterodox macroeconomic model adopted by the two Kirchner administrations. Such a model called for a depreciated real exchange rate even in the presence of very favorable international conditions, such as the ones that prevailed from 2003 to 2008. The only way in which the government could have done this legitimately would have been by keeping its own spending under control, for this would have resulted in larger fiscal surpluses and lower domestic credit expansion. In turn, less domestic absorption by the public and private sectors would have generated larger current account surpluses and, by extension, a less appreciated currency. But, this is not at all what the government did.

Between 2005 and 2008, the primary spending of the federal government rose by almost five percentage points of GDP, from 14 to 18.7%. Had the share been constant, the primary surplus would have been close to 8% of GDP in 2008, in which case the economy would have been much better prepared to face the global crisis.

Clearly, the Kirchners wanted to “have the cake and eat it, too.” Since fiscal and monetary expansion ran the risk of eroding external competitiveness by increasing inflation, they introduced a host of measures (euphemistically called “income-distribution policies”) that distorted the economy and rarefied the business climate. Worth noting among these measures were: the prolonged freezing of public utility tariffs; the discretionary distribution of government subsidies; the introduction of quantitative restrictions on beef and milk exports; the labor-market-distorting concessions granted to labor union leaders in exchange for “negotiated” wage increases; and the persistent harassment of producers of basic consumption items to limit price increases.

In addition to managing the economy poorly, both macroeconomically and microeconomically, the Kirchners engaged in self-destructive behavior by isolating themselves and the economy from foreign capital markets and institutions, including multilateral and bilateral organizations. In this regard, Argentina followed the steps of Latin America’s “three ugly sisters,” Venezuela, Bolivia, and Ecuador.

This reaction was partly ideological, partly motivated by a belief that opening the economy to foreign capital would automatically raise macroeconomic instability.” Such belief was strongly influenced by the preachings of Aldo Ferrer, a former ministry of finance of Argentina, generally regarded as the intellectual father of the so-called “Modelo K.” The main idea exposed by this economist was that having an open capital account was always a bad idea because it inevitably lead the public and private sectors to over-borrow, hence becoming vulnerable to changes in international financial conditions.

The neglect of foreign investment and credit was such that, in 2007, two years after having completed the largest and, arguably, most controversial sovereign debt restructuring in history, the government began manipulating CPI statistics, effectively debauching 45% of its sovereign debt, which was linked to inflation. When the IMF protested, the government reacted by paying off the debt owed to the institution and kissing the IMF goodbye.

But, in the end, all the government accomplished by alienating foreign investors and the IMF was to replace one form of external vulnerability (excessive reliance on foreign saving) by another (excessive reliance on foreign terms of trade).

Contrast this approach with the one adopted in Latin America by Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. These countries did not have to close their capital accounts or alienate foreign investors and IFIs to keep their economies externally solvent. Rather, they took advantage of improved market conditions to expand capital formation and better the terms at which they borrowed. Furthermore, by introducing exchange rate flexibility, they were able to manage capital inflows more efficiently than Argentina.

Neither did the countries mentioned before incur large fiscal deficits just because there were foreign investors willing to lend to their governments. If previous crises had taught them a lesson, this was that the best way to avoid unsustainable increases in the public debt was to keep government spending under control and borrow in domestic currency.

Having snubbed the IMF, Argentina is now on its own to face the global crisis. At a time when not only the IMF, but also the US Fed could come to the rescue, Argentina is not eligible to receive funds from any of these institutions. So much for “vivir con lo nuestro.”

4 Responses to "Twin Problems"

  1. Anonymous   February 23, 2009 at 8:36 am

    Very good comment Joaquin. It is truly tragic how the K’s mismanaged the years of bonanza. Do you see any way out of this conundrum Argentina is in now?

  2. Guest   February 23, 2009 at 9:11 am

    A very insightful piece. Thanks!

  3. RGBx   February 27, 2009 at 1:58 pm

    Argentina is on it’s own. They have lost all true pride and only have to put out a chin ready to be hit squarely. Hopefully that will result in a shake-up of the gray matter for the good of the country and the Latam region.

  4. Anonymous   March 17, 2009 at 8:52 am

    why wouldn’t Argentina receive loans from the IMF this time around?