Ar­gentina’s eco­nomic ‘big bang’

Financial Mirror (Cyprus) - - FRONT PAGE -

Last week, the gov­ern­ment of newly elected Ar­gen­tine Pres­i­dent Mauri­cio Macri launched a bold plan to re­vi­talise a bruised and be­lea­guered econ­omy plagued by high in­fla­tion. At a time of daunt­ing cri­sis con­di­tions, one should not un­der­es­ti­mate the im­por­tance of this move not just for Ar­gentina, but also for other coun­tries, where lead­ers are watch­ing closely for clues about how to deal with their own eco­nomic woes.

Thanks to years of eco­nomic mis­man­age­ment, Ar­gentina’s econ­omy has been badly un­der­per­form­ing for decades. Pre­vi­ous gov­ern­ments sought to avoid dif­fi­cult pol­icy choices and ob­fus­cate fun­da­men­tal is­sues by im­ple­ment­ing in­ef­fi­cient con­trols that grossly mis­al­lo­cated re­sources and un­der­mined Ar­gentina’s abil­ity to gen­er­ate the for­eign-ex­change earn­ings needed to cover its im­port bill, re­sult­ing in do­mes­tic short­ages. The re­cent drop in com­mod­ity prices has ex­ac­er­bated the sit­u­a­tion, de­plet­ing what lit­tle growth dy­namism the econ­omy had left, while fu­el­ing in­fla­tion, deep­en­ing poverty, and spread­ing eco­nomic in­se­cu­rity and fi­nan­cial in­sta­bil­ity. In the­ory, gov­ern­ments in such a sit­u­a­tion have five ba­sic op­tions to con­tain cri­sis con­di­tions, pend­ing the ef­fects of mea­sures to rein­vig­o­rate growth and em­ploy­ment en­gines:

- Run down the fi­nan­cial re­serves and wealth that were ac­cu­mu­lated when the econ­omy was do­ing bet­ter.

- Bor­row from for­eign


do­mes­tic lenders.

- Cut pub­lic-sec­tor spend­ing di­rectly, while cre­at­ing in­cen­tives to in­duce lower pri­vate-sec­tor ex­pen­di­ture.

- Gen­er­ate rev­enues through higher taxes and fees, and earn more from abroad.

- Use the price mech­a­nism to ac­cel­er­ate ad­just­ments through­out the econ­omy, as well as in trade and fi­nan­cial in­ter­ac­tions with other coun­tries.

Through care­ful de­sign and se­quenc­ing, th­ese five mea­sures can help not only to deal with i mme­di­ate eco­nomic and fi­nan­cial prob­lems, but also to cre­ate the con­di­tions for higher growth, job cre­ation, and fi­nan­cial sta­bil­ity in the longer term. In this man­ner, they can con­tain the spread of eco­nomic hard­ship among the pop­u­la­tion, pro­tect the most vul­ner­a­ble seg­ments, and put fu­ture gen­er­a­tions on a bet­ter foot­ing.

In prac­tice, how­ever, gov­ern­ments of­ten face com­pli­ca­tions that un­der­mine ef­fec­tive im­ple­men­ta­tion of th­ese mea­sures. If pol­i­cy­mak­ers are not care­ful, two prob­lems, in par­tic­u­lar, can re­in­force each other, po­ten­tially push­ing the econ­omy over the precipice.

The first prob­lem arises when spe­cific fac­tors, real or per­ceived, block some op­tions from the ad­just­ment menu. Some mea­sures may al­ready have been ex­hausted: the coun­try may not have any wealth or re­serves left to tap, and there may be a short­age of will­ing lenders. Other mea­sures, such as fis­cal ad­just­ment, must be im­ple­mented very care­fully, in or­der to avoid tor­pe­do­ing the growth ob­jec­tive.

The sec­ond prob­lem is tim­ing, with gov­ern­ments strug­gling to en­sure that the mea­sures take ef­fect in the right se­quence. Ef­fec­tive im­ple­men­ta­tion re­quires un­der­stand­ing key fea­tures of eco­nomic and fi­nan­cial in­ter­ac­tions, in­clud­ing not just feed­back ef­fects, but also the be­hav­ioral as­pects of pri­vate-sec­tor re­sponses. And all of this must be closely co­or­di­nated with the pur­suit of sup­ply-side re­forms that pro­mote ro­bust, durable, and in­clu­sive growth.

Here is where the Macri gov­ern­ment’s ap­proach is an his­tor­i­cal ex­cep­tion. Macri took over the pres­i­dency with a bang, launch­ing an au­da­cious – and highly risky – strat­egy that places ag­gres­sive price lib­er­al­i­sa­tion and the re­moval of quan­ti­ta­tive con­trols front and cen­tre, ahead of the five mea­sures re­lat­ing to de­mand man­age­ment and fi­nan­cial as­sis­tance. Al­ready, most ex­port taxes and cur­rency con­trols have been scrapped, in­come taxes have been cut, and the ex­change rate has been freed up, al­low­ing for an im­me­di­ate 30% de­pre­ci­a­tion of the peso. His­tor­i­cally, few gov­ern­ments have pur­sued this type of se­quenc­ing, much less with such fer­vour; in­deed, most gov­ern­ments have hes­i­tated, es­pe­cially when it comes to full cur­rency lib­er­al­i­sa­tion. When gov­ern­ments have taken sim­i­lar steps, they usu­ally have done so af­ter – or at least along­side – the pro­vi­sion of fi­nan­cial in­jec­tions and ef­forts to re­strain de­mand.

The rea­son is clear: by tak­ing time to set the stage for lib­er­al­i­sa­tion, gov­ern­ments hoped to limit the ini­tial spike in price in­fla­tion, thereby avoid­ing a wage-price spi­ral and curb­ing cap­i­tal flight. They wor­ried that, if th­ese prob­lems emerged, they would de­rail re­form mea­sures and erode the pub­lic sup­port needed to press on.

To re­vive the Ar­gen­tine econ­omy in a durable and in­clu­sive man­ner, Macri’s gov­ern­ment needs to act fast to mo­bilise size­able ex­ter­nal fi­nan­cial as­sis­tance, gen­er­ate ad­di­tional do­mes­tic re­sources, and im­ple­ment deeper struc­tural re­forms. If it does, Ar­gentina’s bold eco­nomic strat­egy will be­come a model for other coun­tries, both now and in the fu­ture. But if the ap­proach fal­ters – whether be­cause of in­cor­rect se­quenc­ing or a surge of pop­u­lar dis­sat­is­fac­tion – other coun­tries will be­come even more hes­i­tant to lift con­trols and fully lib­er­alise their cur­ren­cies. The re­sult­ing pol­icy con­fu­sion would be bad for ev­ery­one.

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