Cry For Argentina

ARGENTINA’S economic collapse has brought the usual but bogus warnings about the ill-effects of free-market policies and the Washington Consensus. The same warnings were issued when Mexico went bust in 1995, and again when East Asia, Russia and Brazil went bust in 1997-98.

But all those regions recovered subsequently without abandoning economic openness. Argentina has not gone bust through over-eager adoption of Washington’s tutelage. Quite the contrary. The Washington Consensus stresses fiscal discipline, whereas Argentina has been borrowing from abroad to finance its fiscal deficit. The Washington Consensus typically forces devaluation on countries, not a fixed dollar peg.

The accompanying table shows that Argentina’s trade (exports plus imports) as a proportion of GDP is one of the lowest in the world at just 21 per cent. Mexico’s ratio is 63 per cent, Malaysia’s 218 per cent. Lower ratios are typical in large, diverse countries like the United States, Brazil or India, but not in a country of 37 million like Argentina.

Clearly its traditions of strong labour unions and inflexible labour practices have prevented it from becoming a really open economy, let alone a laissez-faire one.

If left-wing policies were really superior, Argentina should have fared excellently under Juan Peron and his successors. In fact, it went steadily downhill. A century ago it was the second richest country in the world. Today it ranks only 58th.

Its top economists like Raul Prebisch believed that outward looking policies would convert it into a dependency of the West, and so opted for self-sufficiency behind tariff barriers, cheered on by trade unions and populists like Peron. Crooked generals and politicians combined with a feudal landed aristocracy and powerful trade unions to produce economic stagnation.

Argentina’s riches a century ago flowed from agricultural exports to Europe. But in recent decades the European Union shut out Argentinian agro-exports. It has not been able to adjust. Citizens have cut savings rather than consumption to maintain living standards.

Argentina has a relatively low savings rate of 17 per cent. This would matter less if it was fiscally prudent, but fiscal orthodoxy has been anathema in Argentina’s populist politics. It borrows from abroad to finance its fiscal deficit, a recipe for disaster.

Argentina’s debt service as a percentage of exports of goods and services has risen relentlessly from 37 per cent in 1990 to 75.6 per cent in 1999. In the same period, Mexico’s debt service ratio has risen from 20.7 per cent to 25.1 per cent, and India’s declined from 32.7 per cent to 15 per cent. The East Asian countries that went bust in 1997 today service their debts comfortably. Brazil still has a very high debt ratio, but has become an aggressive exporter aided by repeated devaluation.

Argentina has proved unable to export its way out of trouble. A major reason has been its currency board, linking the peso to the dollar. The old tradition of self-sufficiency in Argentina came to an apocalyptic end in the 1980s with a hyperinflation that wiped out the savings of the middle class. Carlos Menem, despite heading the Peronist party, went for a dramatic change towards a more open economy. To quell fears of inflation and capital flight, he adopted a currency board that made devaluation theoretically impossible and inflation less likely.

For some years, the formula worked. Inflation fell dramatically, capital flight was reversed, privatisation attracted billions of dollars. But Argentina remained a country living beyond its means. It could not raise either its savings or exports enough, and needed foreign borrowing to balance its trade and fisc. This proved unsustainable.

Other Latin American countries like Brazil and Mexico also depended heavily on foreign borrowing and suffered earlier. So did East Asian borrowers in the 1997-98 financial crisis. But all these countries were able to cut borrowing and raise exports so that debt servicing was no longer a problem. Argentina failed to do so.

It was a special case, not a typical one. That is why its failure has not caused a run on other currencies. Its problems are its own, not a general one of liberalising economies.

A fixed dollar peg has risks and benefits. It provides stability for citizens, investors and lenders, and so can be a blessing. Estonia, Hong Kong and Ecuador operate currency boards without strain, and Panama has long been totally dollarised (it has no local currency). Why, then, did Argentina’s currency board fail?

For three reasons. First, unlike the other currency board nations, Argentina has failed to keep inflation at around US levels. So its exports, long hamstrung by EU protectionism, have further been hit by the rise of the dollar. Second, Argentina is in a free trade area called Mercosur in partnership with Brazil and Paraguay, and while its partners have devalued, its own currency has appreciated leading to a terrible mess. Third, unlike other countries Argentina has resorted to unsustainable foreign borrowing at ever-rising interest rates.

Argentina has now devalued and defaulted on foreign debt, but this brings more problems. Citizens and companies have dollar debts but assets designated in devalued pesos. So, many may go bust. Devaluation will not prove a lasting solution unless the underlying fiscal imbalance is tackled.

Russia bounced back from its default in 1999 because oil prices shot up. No such stroke of luck seems likely to rescue Argentina. Its high income level frustrates its attempts to adjust to Europe’s agricultural protectionism. Other developing countries can diversify from agriculture into industry using cheap labour. But Argentina’s labour is costly: its per capita income ($7,500) is almost double that of Latin American neighbours. Brazil is far more advanced technologically, yet has much lower wages.

Ideally, Argentina should cease to be corrupt and feudal, and increase savings and exports. But then it would not be the Argentina we know. More feasible, though some way off, is WTO action to open up world agriculture. That will enable Argentina to once again harness its great comparative advantage in agriculture.

What do you think?