Argentina: A Serious Challenge To The Euro And Economic Orthodoxy

Includes: ERO
by: Shareholders Unite

Latin America is supposed to be part of the new emerging world economy, and indeed, countries like Chile (mainly driving on a neo-liberal economic agenda) and more recently Brazil (having more of a social, redistributive market economy) have stolen all the limelight with stellar economic performances. However, the fastest growing economy by far the past decade has actually been another one, Argentina.

After the landslide victory of Christina Fernandez de Kirchner on Sunday, it's instructive to take stock what has happened to the Argentinian economy over the past decade. It's in many ways such a remarkable case study that one can seriously wonder whether Argentina has defied the laws of orthodox economics. The answer seems to be a resounding yes, but the question remains for how much longer it will be able to do this.

Argentina also functions as a sort of beacon for those peripheral eurozone countries that are fed-up having to deflate their economies into the ground.

After a currency peg with the US dollar became untenable, Argentina defaulted on $95B of its debt and let the currency float (which quickly lost 2/3 of its value). The severing of the link with the US dollar left many Argentinians with their savings in tatters as they weren't able to get them out of banks in time (known as the "corralito").

Now, there are numerous remarkable elements in the subsequent phoenix like rise of Argentina from the crisis.

Speed of recovery; Rogoff and Reinhart

By any means, this was a major financial crisis. In fact, before the 2008 financial crisis it was generally considered as 'the mother' of all financial crises, at least since the great depression.

In a seminal work by well known economist Kenneth Rogoff and Carmen Reinhart, "This Time is Different: Eight Centuries of Financial Folly", the authors argue that recoveries from financial crises are way more protracted compared with recoveries from your garden variety recessions (caused by the business cycle). Debt overhang being an important mechanism here.

What's remarkable about the Argentinian recovery that it started just a single quarter after the seismic events of December 2001. The contraction in Q1 2002 was 5%, but the recovery started in Q2, despite many people having lost most of their savings.

Argentina's real GDP reached its pre-recession level after three years of growth in the first quarter of 2005 [Weisbrot et. al.]

These are, well, very enviable figures if one compares them with the economic implosions in Greece, Ireland, Portugal. In fact, the Argentina example might very well become irresistible over time for one or more of these countries if their economies continue to spiral downward.

No Washington consensus here

Does the following quote from a recent Bloomberg article strike as describing a market friendly economic policy?

Fernandez, 58, has tapped central bank reserves to pay debt and steady the peso, nationalized carrier Aerolineas Argentinas SA and fined economists who question official inflation reports since taking office in 2007. She has also kept caps on utility prices, causing Reading, U.K.-based BG Group Plc and France’s GDF Suez to leave the country. Metrogas SA, Argentina’s largest natural-gas distributor, filed for bankruptcy. [Bloomberg]

And this quote is by no means exhaustive. The Heritage Foundation classifies Argentina as the 138th free economy of the world. It is instructive to read the following from that classification:

Recent growth has been driven mainly by the agricultural sector and exports of agricultural commodities. The strength of the economic rebound, however, may be held back by the government’s ongoing expansionary fiscal and monetary policies. [Heritage Foundation]

Below it will be shown that both statements are flat out wrong. If you read the whole Heritage article on the classification, you expect that they're describing a sort of economic waste land, not an economy that grew more than twice as fast as Brazil the past decade.

The Argentine economy has grown 94 percent for the years 2002-2011, using International Monetary Fund (IMF) projections for the end of this year. This is the fastest growth in the Western Hemisphere for this period, and among the highest growth rates in the world. It also compares favorably to neighboring economies that are commonly seen as quite successful, such as Brazil, which has had less than half as much growth over the same period. [Weisbrot et. al.]

It has often been claimed (like the Heritage Foundation above) that this is on the back of rampant commodity exports but closer inspection doesn't show this is the case. in fact:

It can be seen that the role of exports is not very large during the expansion of 2002-2008. It peaks at 1.8 percentage points of GDP in 2005 and 2010, and amounts to a cumulative 7.6 percentage points, or about 12 percent of the growth during the expansion. The story for net exports is even worse, with net exports (exports minus imports) showing a negative cumulative contribution over the period. [Weisbrot et. al.]

It could be that large price increases in export commodities (soy beans!) has masked the contribution from exports, but no:

agricultural exports, as a percent of GDP, fell slightly from 5.0 percent of GDP to 4.7 percent, dipping as low as 3.4 percent in 2006 – again, this is measured by dollar value, so it reflects the large increases in commodity prices from 2005 to 2008. So agricultural exports are clearly not driving growth; and in fact they are too small a share of GDP to have anywhere near the kind of impact that is often attributed to them. [Weisbrot et. al.]

Before we turn to where the growth actually came from, first two other noteworthy items.

Financial sector

The role of financial institutions was considerably curtailed as a result of the corralito. Trust in banks is still quite low, mortgages are only recently reappearing (houses are bought and sold with cash!). Here is the Heritage Foundation on the financial sector:

The Argentinean government has considerable control over financial activities. Argentina’s largest bank is state-owned and may be the sole financial institution in some areas. Since the 2001–2002 debt default and banking crisis, regulation and supervision have become more prudential. The banking sector has expanded faster than the overall economy since 2005 but is struggling to regain confidence and stability. Capital controls remain in place. The stock exchange is active and lists over 100 companies, but the investor base is small. Private pension funds were nationalized in 2008. In mid-2010, the government provided a debt restructuring process for private holders of defaulted bonds in which two-thirds of the private bondholders participated. [Heritage Foundation]

This view is corroborated by:

a large segment of the population remains excluded from the formal financial sector. Although the majority of Argentines live in urban areas where bank branches are highly concentrated, lowincome customers are not taking full advantage of the branch presence. This is partly due to low levels of confidence in banks, which results in a large informal, cash-based economy. [CGAP - pdf]

Yet, a rather regulated and small financial sector doesn't seem to be incompatible with rapid economic development.

International capital

Because of the default and a lingering issue with a minority of creditors (who refused to accept a restructuring agreement in 2005) Argentina has had limited access to the international capital markets and limited FDI inflows, averaging just 1.7% of GDP over the past eight years.

Yet the economy has continued to prosper. This is, well, remarkable. Of course, we do not know how the economy would have fared had there been significant inflows of FDI and/or foreign financial capital. FDI in particular brings new capital, ideas, management practices and the like and can be an important motor of economic growth (Ireland comes to mind).

But apparently it is possible, at least for a decade or so, to snub the international bond markets and be a fairly hostile environment to foreign companies, and seemingly pay little in the way of economic consequences. The relative hostility towards foreign companies was demonstrated yet again on Tuesday:

Argentina ordered oil, gas and mining companies such as Xstrata Plc to repatriate all future export revenue as the government struggles to stem accelerating capital flight from South America’s second-biggest economy. President Cristina Fernandez de Kirchner, in her first move since winning re-election Oct. 23, changed a 2002 decree requiring companies such as Repsol YPF SA, Total SA, Petroleo Brasileiro SA and Pan American Energy LLC to keep at least 30 percent of their export revenue in the country. [Bloomberg]

Where did all that growth come from?

The recovery is driven by consumption and investment (fixed capital formation), which account for 45.4 and 26.4 percentage points of growth, respectively. [Weisbrot CEPR]


As one would expect with such rapid economic growth, employment fared rather well:

Employment fell from 52 percent in 1992 to under half in 1997, briefly rose again to over 50 percent in 1998 and fell back to 46 percent in 2001. By early 2010, it had risen to 55.7 percent, the highest on record. This is not only because of women joining the labor force; men’s employment is also above its 1992 level, at 87.7 percent. [Weisbrot CEPR]

What Weisbrot and company do not mention is how the state was involved in employment creation immediately after the crisis in 2002 via the so called 'Jefes de Hogar' (heads of household) plan:

Just like the New Deal in the 30s, the Jefes plan was up and running in only a few months. In January 2002, the jobs program was signed into law as an emergency measure and five months later it began putting 500,000 people to work. Twelve months after that, it had employed 2 million people, or 13% of the labor force. The program offered a part-time, minimum wage public sector job to any unemployed head of household willing to work in a community project. The price tag of the Jefes plan was less than 1% of GDP. [P. Tcherneva]

What did it do, well:

In a matter of months, Argentina had organized projects at the federal, state, and local levels. These included large-scale infrastructure investments and massive recycling initiatives, water irrigation and soil renewal projects, health care and daycare centers, food kitchens and homeless shelters, public libraries and recreational programs, subsistence farming and elderly care programs, family violence attention centers and many others. Public sector jobs provided employment, income, on-the-job training, and education to participants. [P. Tcherneva]

It has been tapered off as the crisis past (for a more detailed study of the Jefes plan see here). Apparently, the World Bank has classified the program as a success:

According to the World Bank’s reviews (see for example World Bank Report No: 23710-AR), the program has been highly successful in achieving a number of goals. First, program spending is well targeted to the intended population—poor households with children. Second, the program has provided needed services and small infrastructure projects in poor communities, with most projects successfully completed and operating. Third, the program has increased income of poor households, although it has not pulled them above the poverty line (this is not surprising, because of the low monthly income provided through the program). [Wray and Tcherneva, University of Missouri-Kansas City]

Social development

On numerous social indicators, Argentina has seen rather remarkable improvements. Poverty has fallen by over two-thirds from its peak (from almost half the population in 2001). Health statistics have improved (infant mortality has fallen by half, etc.). Income inequality has fallen dramatically

In 2001, those in the 95th percentile had 32 times the income of those in the 5th percentile. By early 2010, this fell by nearly half, to 17. Perhaps more importantly, this change is due in large part to improving incomes among the poor and not just diminishing incomes among the rich. [Weisbrot CEPR]

Role of the state

The role of the state in the economy has increased markedly. Revenue rose from 15% of GDP in 2002 to 23.4% of GDP in 2009, tripling in real terms (as GDP itself almost doubled). Spending on social security increased from 5.5% to 7.5% of GDP and support for various sectors of the economy from 0.43% to 4.1% of GDP over the same period.

As one can read on the Heritage Foundation page on Argentina, the state plays a large and somewhat arbitrary role in the economy. Government has done as it saw fit, proposing large taxes on agricultural exports (which were voted down at 4am by the vice president), raiding the central bank reserves, nationalizing the pension system, pulling noses at the IMF and international bond holders, etc. It is by no means a market friendly regime.

There are widespread accusations of the government favouring certain business interests against others (there is a large standing feud with the Clarin Group, the biggest media group in the country for instance).

More research is warranted but the large reductions in income inequality seem to be largely the product of state intervention (social policies and the like). Does Argentina make a case for redistributive expansionary policies? Since the economic success has been driven mostly by an expansion of the domestic market, we see little other possible interpretations of the data.


The biggest blight on the economic record is the rise in inflation, although a bigger blight is perhaps that the official figures are widely thought to be way off. Official figures suggest an inflation around 10% but private sector estimates put this at 25%. However, like South Korea in the 1960s and 1970s, and Vietnam today, this doesn't seem incompatible with fast economic growth.


The recent measures mentioned in the Bloomberg article are meant to stem widespread capital flight, estimated at $3B per month. It is not a sign of confidence in the economy, and the main source of that is the high inflation rate. Another objection one can have is that despite the economic boom, there has been too little in the way of expanding the productive base of the economy. The education system, once the best of Latin America has also not been improved sufficiently.

So it is difficult to argue whether the path Argentina has chosen is sustainable. Next year, considerably lower growth is expected (although still an admirable 4%+). We have no crystal ball, but we do think Argentina needs more business investment and an improvement in the education system, and more transparent institutions if the party is going to last.

Having said that, the past decade has been nothing short of stunning. Argentina has almost been a textbook case against economic orthodoxy, yet it enjoyed the fastest economic growth by far in Latin America and a growth that rivals that of China. A few observations to finish:

  1. The economic recovery was rapid despite the widely held view that after a financial crisis it will a large financial crisis, against Rogoff Reinhart
  2. The economic development has, contrary to widespread belief, been largely driven by domestic market expansion (and not by exports). Is Argentina a successful case of domestic demand expansion?
  3. Pleasing bond markets and attracting FDI not incompatible with high economic growth (but for how long?)
  4. Inflation not necessarily much of an impediment against growth (again, for how long?)
  5. It is possible to reduce poverty and inequality to a substantial amount and this is not incompatible with rapid economic growth
  6. The state can serve as an important agent of economic development
  7. The greatly diminished role of banks and international capital flows are not necessarily an impediment to economic growth

We are actually quite stunned by the Argentinian example as so much of the boom seems to belie the basic tenets of our economic training, which is why we still remain quite skeptic about how long it can last. But a decade is already quite a long period, we can't close our eyes to that basic fact.

And perhaps one also should wonder how long the likes of Greece and Portugal can keep their eyes closed to this remarkable economic experiment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.