Themes > Current Issues

24.10.2008

Jayati Ghosh

The world’s attention is riveted on the United States economy, as the financial crisis in the global superpower promises a depression within that country and threatens economic growth everywhere else. But as crisis management in the US comes into play with the huge proposed government bailout of troubled banks, it is interesting to look at how other financial crises in less powerful countries have been managed. The details of the plan to contain the financial turmoil in the US are still emerging, but it is clear that it will involve a very large draft on US taxpayers, both present and future, and rely on resources from other countries, including developing Asia.

But most other countries that have financial crises are not so fortunate as to be able to make the rest of the world pay for their problems. Especially in developing countries, a financial crisis is usually a double whammy, as internal bank failures and stock market collapses are compounded by the external flight of capital and associated collapse of the currency. And then (once again unlike the US at present) the governments of these countries in the throes of financial crisis have to put up with (largely mistaken) advice from the IMF and similar organisations, who insist on ramming down more free market medicine on economies that have been destroyed by reckless liberalisation.

Argentina was one such country in 2001, as one of the most severe financial crises to hit any emerging market caused a precipitate decline in output and employment, doubled poverty rates within a year and caused huge political instability such that no fewer than six governments were installed over two years. The policies imposed by the IMF only served to accelerate the economic decline and push the country into an apparently endless downward spiral. By 2002, half of the population was living below the official poverty line.

Yet, after the government of Nestor Kirchner came to power in 2003, there has been a remarkable recovery, which made Argentina the fastest growing economy of the developing world after China in the past four years, with annual rates of real GDP growth in excess of 8 per cent. The recovery was all the more noteworthy because it was based on very different economic principles from the neoliberal model that had governed Argentine policy making in the 1990s, and which continued to be supported by the IMF and the major external creditors.

The IMF plan was for Argentina to go in for further privatisation of public assets and more deregulation, along with maintaining very high real interest rates, in the hope of “restoring investor confidence” and once more attracting foreign capital into Argentina. Instead, the Kirchner government stopped bothering about placating foreign investors, and directed its attention to domestic producers. It used a stable and competitive exchange rate regime to ensure that domestic production revived and grew. It focussed on improving the consumption of ordinary people and reducing poverty. It sought to provide basic (but privatised) services at a more accessible rates, often through renationalisation or controls on pricing of utilities. Significantly, the government also took a hard line – which ultimately proved very effective – with Argentina’s external creditors, forcing a majority of them in 2005 to accept a debt write-off agreement that effectively cancelled 65 per cent of the value of their outstanding debt.

The neo-liberal perception, widely touted in the international press at the time, was that this would spell complete doom for the economy in international markets. The new policies – according to the proponents of the “Phoenix Plan” group that emerged after the crisis - envisaged a renewed role for the state in re-structuring the economy in the direction of greater transparency and efficiency, moving towards a welfare state even in the much more difficult context of contemporary capitalism. Obviously all this was anathema to those wedded to the neo-liberal model, as well as to its beneficiaries in international finance, who predicted continuing and even more devastating economic collapse in Argentina as punishment for the move away from economic orthodoxy.

Yet this did not happen, and if anything the economy went from strength to strength. It is true that the government could not borrow from international bond markets, but it was able to find other investors (including the Bolivarian Republic of Venezuela) to hold its public debt. Foreign direct investment also started coming back in as the economy grew, and amounted to about $4 billion a year, around the same level as in the market-friendly 1990s. And most important of all, the continued growth in output was also associated with employment growth and diversification.

How did this miracle come about? The conventional wisdom is that this was all due to exports of agricultural commodities, and that Argentina simply benefited from the boom in global primary commodity prices. It is certainly true that Argentina is a major exporter of wheat, beef and now soya bean, and that these exports soared in both quantity and value. But exports have accounted for only around 13 per cent of the economic growth of the past four years, and cannot be held solely responsible for the recovery.

Rather, it was the government’s ability to manage the boom to diversify the economy and direct investible resources to other domestic sectors that was the key. Throughout this period, the exchange rate was maintained at a level that not only encouraged exports but – more importantly – discouraged imports and allowed domestic producers to sell in the home market. This produced a revival of many labour-intensive traditional industries that were badly affected by the earlier high currency regime, such as textiles and metal machinery. It also led to the emergence of newer activities, including services such as tourism and Spanish software delivery, which benefited from the cheaper peso.

Meanwhile, the government was able to gain at least some part of the rents from the sharp increase in world agricultural prices by imposing an agricultural export tax of 25 per cent. This tax has to be seen in the specific context of Argentine agriculture, which is dominated by large farmers who are either themselves landholders or corporate businesses who cultivate with the help of hired labour on land taken on lease from small owners. A tax on agriculture (which is otherwise untaxed) in this context, in the form of the export tax, therefore is a means of income redistribution. The revenues from this tax in the period of high world prices allowed the government to increase its own spending in important areas such as education, health and anti-poverty programmes, and still maintain a primary fiscal surplus.

This very heterodox economic approach paid rich dividends until early this year. Cristina Fernandez, wife of Nestor Kirchner and herself a noted Senator, easily won the Presidential election on the basis of widespread public support for these economic policies. And the impressive success of this strategy was underlined by the fact that the growth was accompanied also by relatively stable inflation rates, rising employment rates and a dramatic reduction of poverty.

Yet the recent past has been much more troubled. Two major problems have emerged in the past few months, creating some amount of political instability and resentment against the government, despite all its other successes. The first is the battle with farmers, as the government attempted to introduce a variable export tax rather than a flat rate. Since this unfortunately coincided with the global decline in agricultural prices since March, there was very vociferous protest from farmers who are a strong and powerful lobby. Ultimately this variable tax, which is otherwise a good policy in Argentina’s specific economic context, had to be withdrawn.

The second problem is one that directly affects much greater segments of the economy, including the ordinary people who have been beneficiaries of the boom. Inflation has been running high especially for the past year, but the official rate of inflation has been suppressed through statistical jugglery. Thus, while the official rate is now about 9 per cent, unofficial estimates suggest that in actual fact both wholesale and consumer prices are rising at the very high annual rate of 25 per cent.

This attempt to conceal the actual rate of inflation is both bizarre and wrong-headed, since it obviously cannot succeed it preventing people from realising what prices they are paying, and because it then distorts all the other measures that the government itself uses for its economic policies. Thus, those workers who are able to negotiate on the basis of the higher perceived rate are able to maintain their real wages, but public sector workers whose wages are calculated on the basis of the official consumer price index suffer declines in real wages. The holders of inflation-indexed bonds also suffer. Most of all, of course, such a strategy reduces the credibility of the government not only in the eyes of some possibly unreliable investors, but for its own citizens.

But this is a problem that can be relatively easily dealt with, if the government decides to recognise the true inflation and then do something about it. It is clear that subsequent inflation control will require other measures, such as an incomes policy, but for this is likely to be much political support among ordinary people.

So the current problems in Argentina are tractable, especially in the context of the still growing economy. This is worth noting, because not only did the economy recover fairly quickly from a very severe crisis, but it did so by implementing heterodox measures that involved controlling capital and improving the consumption of the poor. This is likely to be an instructive contrast to both the unfolding crisis in the US and the measures that the Bush regime will take to deal with it.