NS4540 Winter Term 2019 Argentina: Reverse Convergence Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

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.

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 and 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

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

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.

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 there were sharp redistributions of income and wealth. Between 1975 and 1991, GDP per capita dropped 22 percent Worst period in Argentina’s economic history

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

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

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

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

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

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