Monday, 21 May 2012

The Argentine example isn’t helpful to Greece

Or to anyone else for that matter.

A lot of times during the past months I came across the idea that Greece should follow the Argentine 2001 example and devalue its currency. This would imply leaving the euro and returning to Drachma, followed by a series of bank runs and capital controls to prevent capital flight. But, crucially, the currency devaluation would cause a boom in Greek exports and sustain an investment-led growth.

I covered this fallacy in a text on currency devaluation earlier in November, claiming that no devaluation will help the Greek economy, as it won’t address the structural problems this country is facing. Here’s an excerpt of what I wrote back then:
"...there are many other indirect effects that are likely to completely crowd out any positive effects of currency devaluation...The Greek people and businesses were, just like the Greek government, running high debts and used them to fuel their consumption previous to the crisis. An increase of the exchange rate would imply higher interest payments in drachmas for all those with outstanding loans with the banks, leaving the households and businesses with less disposable income. As a response to this effect the labour unions may negotiate higher domestic wages in terms of foreign currency (the euro) which will crowd out the devaluation effect and yield an inflationary effect of roughly the same size as the devaluation, thereby undermining the increase in competitiveness. Besides, Greece needs to completely change and restructure its labour market and labour market conditions if it wants to make its workers more competitive on the international market. No currency devaluation will resolve the deep structural problems of the labour market, no matter how competitive they may seem to appear due to cheaper currency.

Concerning the export increase (due to lower export prices), if the labour unions do increase the wages and spur an inflationary effect over the economy, this will increase the prices of domestic goods further offsetting positive devaluation effects. Besides, currency depreciation can work only in countries which have high production levels and a huge industry such as Japan or China."
Nevertheless, many pundits claim (the latest one I noticed on the VoxEU portal) that devaluation is the only possible way to a full recovery, citing the evidence from Argentina’s rapid growth recovery in 2003 and 2004. Here’s what Kretzmer and Levy (2012) from Bank of America claim: 
"In December 2001, Argentina defaulted on its debt...and abolished its currency board and US dollar peg, and the Argentine peso depreciated approximately 75%. The depreciation foment generated a temporary spike in inflation...that reduced real wages and income, but stimulated exports (exports rose 52% in the first five years of recovery). This fuelled a near 300% surge in business investment, which fed back into modest increases into jobs and domestic consumption..."
However, they (and a lot of others stressing the benefits of devaluation) tend to overstate what really happened with the depreciation of the peso in Argentina and the real effects of the Argentine Corralito. For those who don’t know, the Corralito was the name for a series of measures initiated in Argentina in 2001 to prevent capital flight and bank runs. It allowed for small sums of cash to be withdrawn on a weekly basis, but only in pesos (all dollar denominated currency could only be withdrawn if converted into pesos). When the depreciation was made, the peso-dollar exchange rate dropped from 1:1 to 1:4. But, while the new exchange rate was in place the people could only exchange their dollars for pesos for an old exchange rate, meaning that in one go Argentina reduced the nation's savings by three quarters! Anyone with a $100 in savings all of a sudden found themselves with $25. Needless to say this helped debtors but at the expense of savers, private companies and taxpayers. It made a huge negative impact on the nation's wealth. 

Luckily the former Governors of the Bank of Mexico and Bank of Argentina, Mario Blejer and Guillermo Ortiz, recognized the devaluation threat and called for Greece to stay in the euro. They stress the same problem with the Argentine Corralito and claim that in Greece things could get even worse:
"The end of Argentina’s currency board was harrowing. It led to endless violations of contracts that left an enduring stain on the investment environment. But reintroducing an abandoned currency is even more difficult. Argentina never stopped using the peso, but Greece discarded the drachma. To generate confidence in the drachma in the midst of a crisis would be very challenging. Convincing potential investors to commit to projects denominated in a reintroduced currency is an almost unachievable task."
What Argentina needed then and what Greece needs now is a proper institutional reform based on, above all, achieving political stability. I’ve made this case repeatedly in a series of texts, including in the VoxEU, Institute of Economic Affairs, and my own blog. This will be excruciatingly hard to do, but in the case of Greece there are no easy short-term answers – only long term ones. 

Besides, focusing on depreciation to reduce real wages and stimulate exports is a temporary measure that will only hide the need for institutional reform in Greece, just as it hid the need for institutional reform in Argentina. And, last time I checked, the Argentines are still suffering. So no, Argentine depreciation is no case study for Greece or for anyone for that matter. 

Finally, back in 2004, The Economist did an analysis of Argentina’s recovery and what steps are needed further to continue on the positive momentum created. They concluded their article with the following:
"If Argentina is to make the most of its opportunity, Mr Kirchner will have to take swift, perhaps unpopular, action to clear up the unfinished business left over from the collapse. But above all he will need to draw the right lessons from its travails. A good place to start is the rule of law."
Exactly my point.

Note: This post was also published at the Institute of Economic Affairs blog, on 18th June 2012. For all my other IEA articles, see here


  1. Even though I agree with your point that what happened in Argentina wouldn't be applicable to Greece, I still feel that what happened there was good for Argentina. It's not a universal solution but for them, in that particular moment it did make a difference. They needed someone like Kirchner and he got them out of trouble.
    Greece is in a different situation since it's part of a wider political and economic union with different consequences of a default. Otherwise, they would have done the Argentina scenario a long time ago.

  2. Last I heard, Argentina was still pretty much a basket case with an economy in the dumpster.

    1. that's because things got out of hand with Mr&Ms Kircher for a while, but the fact is the economy recovered really well after the chaos of 2001/2002

  3. Devaluation did help Argentina. It led to a short-term boost in exports and investments which fueled growth for the next few years making it easier for Kirchner to consolidate his rule. The reason why it didn't carry on was first of all the recent crisis and declining levels of trade.

    Even if we assume that it was Kirchner's fault for letting growth slow down in the second part of the decade, the fact remains that devaluation did help. And if cyclical economic policy followed this initial rapid growth, Argentina would have gotten out of it very rapidly. The main reason why it didn't was the spillover from the US financial crisis.

    So, yes, the Argentine example could be applicable to Greece. Greece can even learn from them and continue supporting this initial growth and hope that the world doesn't fall into another double-dip recession.
    But it's first step should be to leave the euro.

    1. Devaluation only hid the need for deeper reforms in Argentina. If it weren't for the contagion of 2009, sooner or later they would have faced severe problems again.

      Besides, the devaluation itself based on what happened in the corralito isn't something I would recommend to anyone. Particularly not to a country already in deep turmoil.