Argentina is recovering

Joseph E. Stiglitz Professor of Economics and Finance Columbia University Project Syndicate

The first glimpses of Argentina's recovery can be seen. To many, what happened, and what is happening there seems a mystery. Abandoning "convertibility," i.e. a fixed exchange rate system, was supposed to be a disaster -- and it was. Output fell and unemployment increased dramatically. Fear of these costs, combined with IMF bailouts, kept Argentina from abandoning its currency board long after it was clear that the system could not be sustained. This stubbornness made matters worse when things finally fell apart.

But what primarily kept Argentines wedded to a system that could not work was fear of hyperinflation. When I asked people, during my visits to Buenos Aires, why Argentina persisted in this economic folly, a single answer came back: "Yes, when Brazil went off its peg, its inflation remained moderate; but Brazil is Brazil, and we are Argentina." There was almost pride in the lack of confidence Argentina's people had in their institutions and their ability to manage without the shackles of convertibility.

The feared hyperinflation, so far, has not materialized. To be sure, there has been the normal inflation associated with large increases in import prices that always follow large devaluations, but rather than setting off a spiral of price increases, inflation rates appear to be dampening. Argentina seems set to join the long list of countries -- Brazil, Korea, Russia, Thailand, and Indonesia -- that managed devaluations without runaway inflation.

To an economist, Argentina's recovery is no surprise. Devaluation incites several restorative forces. Exports are cheaper, and revenues from exports (measured in pesos) are up dramatically. Tourism and related industries are booming. Import substitution takes place before your eyes: A clothing store that last year sold only imported apparel, now sells only domestically produced goods.

As in East Asia after its crisis of 1998, what inhibits these restorative forces is a lack of credit. Foreign ownership of banks was supposed to ensure their stability; it was expected that foreign banks would come to the rescue of their Argentine subsidiaries if they needed money. Deposits in the branches of American banks in Buenos Aires were to be as safe as deposits in Miami. Unfortunately, depositors learned otherwise.

On the other hand, foreign banks were always falling short in assuring an adequate supply of credit to small and medium sized Argentine firms. This lack of credit stifled growth, which contributed to the country's economic woes; and now credit has virtually dried up.

To be sure, some domestic banks continue to provide credit. But if the recovery is to be sustained credit must be expanded, either by creating new financial institutions or by expanding existing ones. Here credit cooperatives may be particularly important, given the seeming lack of confidence in the more traditional banking sector. Revival of trade credit is also urgent -- its importance was recognized early on during East Asia's crisis, where Japan, in a good neighborly gesture, provided $30 billion dollars through the Miyazawa initiative, much of which went to finance trade credit and help restart the economy.

The point is simple: Argentina's real resources, its people, with their enormous talents and skills, its fertile land, its capital goods remain. What the economy needs is reactivation, and government policies must focus on this task. If the private sector cannot improve the availability of credit on its own, and no good neighbor steps forward to help, as Japan did in East Asia, government must take a more active role in restructuring the existing credit institutions as well as creating new ones.

Would government involvement in providing credit create dangerous levels of inflation? Directing credit in order to increase supply of goods need not be inflationary; on the contrary, the increased supply of domestically produced goods may be an effective instrument for combating inflation.

Appropriate accounting, separating expenditures for recapitalizing banks from ordinary expenditures, such as those needed to run hospitals and schools, would make clear that these expenditures are not by themselves inflationary. It is only the credit expansion that such expenditures allow which might be inflationary. In an economy with vast problems, underutilization of resources, and a massive lack of credit, a modest credit expansion would not in fact lead to high inflation.

Centering attention on reactivation makes clear why the focus on IMF credits is misguided. IMF credits will go to repay the IMF, not to reactivate the economy. Supposedly, the IMF credit will "restore confidence" in the economy, but whether it does so depends on the conditions that are imposed. If the IMF imposes fiscal contraction or a misguided strategy for restructuring the financial sector (as it did in Indonesia), then the economy will be weakened and this will lead to a further erosion of confidence.

If, on the other hand, IMF credit is obtained on reasonable terms, it will make a positive contribution. But it will be no panacea. Indeed, IMF credit will do little to address the key economic issues, except to the extent that it frees up money from other international sources and those funds are used to reactivate the economy.

Where the international community can help Argentina is by opening its doors to Argentine goods, taking the rhetoric of free trade seriously and recognizing that trade can be an important instrument not only for long-term growth, but also for economic recovery. Exports will help reactivate the Argentine economy, while consumers in Europe and America will benefit from high quality goods at lower prices. This is one way of making globalization work to benefit those in need.