NS4053 Winter Term 2015 Argentina: Reverse Convergence

1. NS4053 Winter Term 2015Argentina: Reverse Convergence

2. Overview Miguel Kiquel, Argentina: A Case of Reverse Convergence, Brookings, November 2014 Main Points • Argentina’s growth performance over last century unique • Country has • moved from being a prosperous developed country at beginning of 20the century to • Joining the group of emerging countries 100 years later • Possibly a case of reverse convergence Main lesson, • Convergence does not occur naturally, but • Requires supporting policies to take advantage of opportunities opened up by openness and capital inflows.

3. Argentine Economic History I • Argentina’s successful period largely between 1880s and the 1920s • Country was integrated into the world economy • One of the major suppliers of food and raw materials to the world • Magnet for foreign direct investment for poor workers leaving Europe and searching for opportunities in the new world • Depression in 1930s marked a turning point • Drop in commodity prices • Trade barriers were imposed on Argentina exports • Sudden drop of capital flows from advanced countries

4. Argentine Economic History II • Conditions resulted in a change in the development paradigm • World economic order in 1930s was that of protectionism in Europe and the U.S. • First -- policy response in Argentina – shift towards industrialization and import substitution • Prebish thesis – terms of trade go against primary producers therefore need to industrialize • New policy shift created tensions between • traditional export sectors (mainly agricultural/beef sectors) that were efficient and main suppliers of foreign exchange and • Infant industrial sector that needed foreign exchange to import intermediate and capital goods

5. Argentine Economic History III • Second change in the economic paradigm was a relaxation of fiscal and monetary discipline • A trend that became more pronounced since the mid-forties during Peron administration • Beginning of the era of inflation and the stop and go macroeconomic cycles • Typically an expansionary phase stimulated by fiscal and monetary policies • Always ended in balance of payments crisis due to lack of reserves and an overvalued exchange rate • Cycles became more intense over the years • Inflation hit triple figures in 1970s • Devaluations in these cycles resulted in unsound banking system and led to debt restructuring or outright defaults.

6. Argentine Economic History IV • Since mid-1970s Argentina suffeed a large crisis approximately every seven years • Widespread bank failures and sovereign debt defaults • In 1989 country experienced hyperinflation. • These were distributive episodes in which thee were sharp redistributions of income and wealth. • Between 1975 and 1991, GDP per capita dropped 22 percent • Worst period in Argentina’s economic history

7. Argentine Economic History V • Hyperinflation marked a new turning point • Triggered a new change in economic polices and • Put the economy back on a growth path • Between 1992 and 2013 economy grew at an average rate of around 4 percent • Faster than that of most Latin American countries • However there was a deep crisis in 2001 • Since then there has been some sifting of policies and a return to inflation • Some concerns about the near-term outlook as the country is again in default with large fiscal deficits and balance of payments problems • Still the post-hyperinflation period suggests Argentina may be on a new secular cycle that is simply on a pause due to macroeconomic problems.

8. Lessons from History I Lessons from Argentina’s growth patterns • First – Argentina grew faster in periods in which • It was more open and more integrated with the world economy • When it followed an export oriented strategy as opposed to those in which it adopted import substations. • Second – The abuse of stimulus policies – fiscal deficits primarily financed by printing money in an environment of fixed exchange rates • Started a new era characterized by high inflation and business cycles closely tied to an abundance or scarcity of reserves • Typical stop go cycle – expansion driven by macroeconomic policies leading to higher imports and inflation • Currency strengthened, balance of payments deficit often caused massive devaluation and further inflation • Produced significant volatility and reduced the trend rate of growth

9. Lessons from History II • Third – exchange rate policy matters • Most crisis occurred following a period in wich currency became overvalued • When devaluation occurred it was recessionary because it affected domestic income • Negative balance sheet effect that affected the ability of government and banks to service foreign currency debt • Created a link between devaluations and financial crises • Fourth macroeconomic financial crisis were very disruptive to growth

10. Reasons for Optimism I Some cause for optimism at the present time • First, although country is in default – this time clearly related to legal and political issues as opposed to the ability to pay • Once new government takes office at the end of 2015 and debt resolved, country risk should drop • Would open up way foreign capital inflows that should help reignite growth • Second – Argentina has a sound banking system that this time is not the source of vulnerability – few foreign currency liabilities • Third key macroeconomic imbalances: • The fiscal deficit • Overvaluation of currency • Have increased but not reached unmanageable levels as in previous crisis

11. Reasons for Optimism II • Solving macroeconomic imbalances will be critical if country wants to take full advantage of growth opportunities • During Kirchner years a shift towards interventionist policies • New trade restrictions – import substitution • Directed credit lines • Subsidized interest rates • Numerous controls to access foreign exchange and • A near freeze on utility rates • Brought to a halt investment in energy generation transmission and distribution

12. Assessment • Country needs large investments in infrastructure and many sectors – mining, oil and gas, and agriculture • If new administration does not address the incentives to invest in infrastructure and in key sectors, the macroeconomic improvements will • Provide short-term relief but • Not foster long-term growth • Big question is whether • The next government will be willing and able to attract investment and external financing to develop major projects or • The country will again get trapped in domestic politics