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Currencies, Compensations, and Coalitions: The Politics of Exchange Rate Valuation in Argentina, 1963-2007* David A. Steinberg Ph.D. Candidate Department of Political Science Northwestern University [email protected] Work in Progress: Comments Welcome Abstract: This paper develops a political explanation of exchange rate valuation choices, and applies the theory to Argentina between 1963 and 2007. Both ideational theories and existing interest group models miss important features of the politics of exchange rate valuation in Argentina. This paper argues that Argentina has typically maintained an overvalued exchange rate because private support for undervaluation has been limited. The coalitional theory I develop suggests that tradable industries often support overvalued exchange rates because they favor expansive macroeconomic policies and stable nominal exchange rates, which typically coincide with currency overvaluation. I hypothesize that undervaluation is only likely to occur in the rare instances when it can be combined with these compensatory policies; this requires idle capacity in the domestic economy and high commodity export prices. The case study shows that most of the Argentine policymakers responsible for maintaining overvalued exchange rates actually believed that undervalued currencies are preferable to overvalued currencies. The only times where Argentine policymakers successfully maintained an undervalued currency (1963-66 and 2003-06) were during periods in which the Argentine economy had considerable unused productive capacity and high prices for their commodity exports; these conditions allowed undervaluation to be combined with expansive fiscal policy and a stable currency. I also demonstrate that overvalued exchange rates received political support not only from nontraded sectors but also from exporters and import-competing industries. * Prepared for presentation at the 2008 meeting of the IPE Society. This research has been funded by the Social Sciences and Humanities Research Council of Canada and Northwestern University’s Buffett Center for International and Comparative Studies. I am very grateful to everyone in Argentina that took the time to participate in interviews. Diego Finchelstein and Sebastián Etchemendy deserve special thanks for providing extensive support and advice while I was in Argentina. Jesús Monzón’s help with research at the CESPA archives is also gratefully acknowledged. Thanks to Alejandro Bonvecchi, Peter Gourevitch, Sebastian Karcher, Lucas Llach, James Mahoney, and Ben Schneider for providing helpful comments on earlier drafts of this paper. Undervalued exchange rates are believed to have many beneficial economic effects, including faster economic growth (Easterly 2001; Rodrik 2007), lower unemployment (Frenkel 2004), and less risk of capital flight and currency crises (Crystal 1994; Kaminsky et al 1997). However, the majority of developing states have kept their real exchange rates at overvalued levels for most of the postwar period (Huizinga 1997; Edwards 1989; Todaro and Smith 2003: 571). This raises an interesting puzzle: why, despite the harmful economic effects of this policy, have many developing countries spent most of the time with overvalued exchange rates? And, under what conditions, can countries avoid currency overvaluation? This paper develops a political explanation of exchange rate policy. I argue that many politicians maintain overvalued exchange rates because the combination of policies that generate currency overvaluation are typically supported by powerful domestic political coalitions. I then show that this theory helps explain the evolution of Argentine exchange rate policy since 1963. Argentina serves as a useful case-study for testing theories of exchange rate politics because overvalued currencies have had disastrous consequences for Argentina, including a major crisis in 2002 during which the economy contracted by 11.8% and the country had five different presidents in less than two weeks (Chudnovsky and Lopez 2007). Exchange rate valuation policies in Argentina defy many of the predictions of existing theories. One common argument is that policymakers’ ideas influence their exchange rate policies (McNamara 1998; Kirshner 2000; Helleiner 2005). The ideational argument predicts that policymakers will supply undervalued (overvalued) currencies when they themselves believe that undervaluation (overvaluation) is the most appropriate policy. This paper will show that, despite the fact that nearly all Argentine policymakers have 1 favored undervaluation, they constantly adopted overvalued currencies. Second, interest group theories argue that governments keep their exchange rates overvalued to improve the purchasing power of nontraded sectors (Frieden 1991), such as urban workers in uncompetitive industries (Bates 1981; Sachs 1989; Kaufman and Stallings 1991; Huizinga 1997), or the financial sector (Shambaugh 2004; Woodruff 2005; Walter 2008). By contrast, politicians are expected to keep the currency undervalued when tradable producers are more politically powerful than nontradable industries (Frieden 2002; Frieden et al 2001; Blomberg et al 2005). The case of Argentina challenges this logic because Argentina’s manufacturing sector is the largest in Latin America (Blomberg et al 2005: 211), and they are also well-organized and have had close contacts to many governments (see below). Rather, the following case-study will demonstrate that Argentina’s tradable industries have not been a force for undervalued exchange rates because they lack a strong preference for undervaluation. The theory developed in this paper builds on existing interest group arguments (especially Frieden 1991), and follows their assumption that policymakers will maintain undervalued exchange rates when there is a strong political coalition that favors undervaluation. However, I argue that currency undervaluation has fewer private-sector advocates than has been previously believed. Many tradable producers do not lobby for undervaluation because they dislike the spending cuts and nominal currency instability that are required for undervaluation even more strongly than they oppose an appreciated real exchange rate. Even though exporters benefit from a competitive currency, they will often support overvalued exchange rates because they favor the “compensatory policies”—particularly expansive macroeconomic policies and currency pegs—that are 2 typically coupled with an overvalued currency. My coalitional theory implies that overvaluation is often politically attractive not (only) because it increases purchasing power, but because overvalued exchange rates are compatible with a variety of desirable side-policies, including subsidies and a stable nominal exchange rate. Building on this logic further, the second section argues that support for undervalued exchange rates will be strong only when undervaluation can be made compatible with these compensatory policies. Undervaluation is most likely when commodity export prices are high and there is idle capacity in the domestic economy, as these economic conditions make it possible for policymakers to combine an undervalued currency with both a stable nominal exchange and expansive macro policies.1 Section III examines the political-economy of exchange rate valuation in Argentina since 1963. This case study supports several of the theory’s hypotheses. First, I show that private support for appreciating or overvalued real exchange rates came not only from nontraded groups but also from export and import-competing industries that were attracted to currency stability and high government spending. This was clearly the case in the periods of 1967-72, 1973-74, 1991-98, 2005-07, and to some extent between 1976 and 1980. Policymakers kept the exchange rate overvalued in these periods because the alternative policy mix—undervaluation with fewer compensatory policies—was opposed by some powerful tradable industries. I also show that undervalued exchange rates have 1 My theory builds on previous research (Gowa 1988; Frieden et al 2001; Woodruff 2005; Walter 2008) showing that other trade and monetary policies influence exchange rate valuation politics. I argue that these side-policies have more inescapable and systematic influences on currency valuation choices than most have previously recognized. My emphasis on the importance of the policy mix also draws inspiration from Bearce’s (2007) approach to open economy macroeconomic policy in industrial countries. 3 only persisted in Argentina during periods in which resources are underemployed and commodity prices are high (1963-66, 2003-05). I. Exchange Rate Valuation Preferences: The Role of the Policy Mix Exchange rate over/undervaluation relates to the real exchange rate (RER). The RER is defined as the nominal exchange rate (e), the price of foreign currency, multiplied by the ratio of foreign to domestic prices (q = ePF/PD). A rise (fall) in the RER is a real depreciation (appreciation), meaning that domestic goods have become cheap (expensive) relative to foreign goods. Overvaluation refers to situations where the RER is below its equilibrium rate: when a given bundle of domestic goods can purchase a larger quantity of foreign goods than with a market-determined exchange rate. When the exchange rate is undervalued, domestic goods and exports are cheap relative to foreign goods and imports.2 Policymakers only influence exchange rate valuation indirectly, primarily through the exchange rate regime and domestic macroeconomic policy though also via capital controls and sterilized foreign exchange interventions (Rodrik 2007; Hinkle and Montiel 1999; Edwards 1989). Given the interconnections between the exchange rate’s level and these other polices, it is essential to take the “policy mix” into consideration when examining the coalitional bases of over- or undervalued exchange rates (see also Bearce 2007). The starting point of this analysis is that actors support the combination of exchange rate and macroeconomic policies that is most beneficial. Policy mixes can be compared along two dimensions: whether the exchange rate is overvalued or undervalued; and whether these 2 Although currency valuation is a continuous concept, I often treat it as dichotomous for the sake of simplicity. 4 policies are “compensated”, by which I mean that actors receive stable nominal exchange rates and/or expansive macroeconomic policies. Doing so leads to the conclusion that cleavages over the exchange rate level will not necessarily pit tradable against nontradable producers. The key argument of this section is that tradable producers will support overvalued exchange rates when they receive compensatory policies. Table 1 summarizes the preference rankings of three sectors over these four different policy combinations. a. Tradable Industries Compensated undervaluation should be tradable producers’ preferred outcome, as this policy mix provides them with all three policies that they want: undervaluation, expansive macroeconomic policies, and a stable currency. Despite the fact that traded sectors benefit from undervaluation, they will not always advocate undervalued currencies. By contrast, these tradable producers are likely to favor “compensated overvaluation” over “uncompensated undervaluation” because the benefits of compensatory policies often exceed the benefits of undervaluation. It is beyond doubt that most tradable-goods producers will find an undervalued currency more attractive than an overvalued one. Undervaluation enhances external competitiveness, which protects import-competing firms and promotes exports. However, undervalued exchange rates often provide only limited benefits to tradable industries. Import barriers, such as quotas, tariffs or antidumping duties, improve the competitiveness and profitability of import-competing industries in analogous ways to an undervalued currency (Gowa 1988; Woodruff 2005). Exports of specialized products are often insensitive to exchange rate valuation because they typically compete in world 5 markets on quality rather than price (Broz and Frieden 2001; Shambaugh 2004; Helleiner 2005). Furthermore, since exporters often import production inputs from abroad, real depreciation raises exporters’ costs along with revenues, and undervaluation therefore has more ambiguous effects on profits (Frieden et al 2001: 34; Ross 1999: 307). The policies that accompany overvaluation are highly beneficial to many tradable industries. A stable nominal exchange rate benefits tradable producers because this increases predictability and financial stability, and hence encourages investment. Some exporters, such as those that rely on imported inputs or participate in global production networks, are “very sensitive to currency volatility”, and strongly prefer fixed exchange rates (Broz and Frieden 2001: 332). Thirdly, expansive macroeconomic policies are highly attractive to most tradable producers. High government spending increases domestic demand for tradable goods. Lower tax rates directly increase producers’ profitability. Furthermore, expansionary fiscal and monetary programs, such as low taxes, cheap credit, and export subsidies, directly benefit the specific producers that receive these targeted measures (Horowitz 2001; Bearce 2007).3 In sum, tradable sectors may receive fewer benefits from undervaluation than from pegs and high spending. The only exception to this may be exporters of very pricesensitive goods that rely on few imported inputs. In general however, tradable producers are expected to prefer compensated overvaluation to uncompensated undervaluation when forced to choose between these policy mixes. Compensated undervaluation is the most attractive policy mix for much of this sector. Overvaluation without compensations is the least-preferred policy combination for tradable producers. 3 Since export subsidies often take a large proportion of budgets (Kurtz and Schrank 2005), they “can be understood as a simple extension of fiscal policy” (Bearce 2007: 58). 6 b. Nontradable Producers The combination of overvaluation with expansionary macroeconomic policies is highly attractive to producers of nontraded products, such as services and construction. These industries are “highly concerned about domestic macroeconomic conditions” and strongly prefer expansive fiscal and monetary policies (Frieden 1991: 445). Furthermore, they benefit from overvalued exchange rates because it cheapens imported inputs and increases the relative price of nontraded goods. However, the exchange rate only indirectly affects nontraded industries, and “matters little to them” relative to the stance of domestic macroeconomic policy (Frieden 1994: 85; Henning 1994: 33). These industries benefit most from compensated overvaluation. Given that their priority is domestic macroeconomic policy, this sector should prefer undervalued currencies combined with high spending over “uncompensated overvaluation” policies of overvaluation with tight macroeconomic policies. c. Financial Sector Financial sectors in developing countries strongly oppose exchange rate devaluations because this increases the domestic-currency value of their foreign debts, which contributes to banking failures (Woodruff 2005; Walter 2008). Bankers also prefer the stability and credibility of fixed exchange rates (Frieden 1991; Shambaugh 2004; Broz 2002). The financial sector prefers low government spending since they favor low inflation, are relatively unaffected by macroeconomic conditions, and benefit little from fiscal assistance (Posen 1995; Broz 2002). Their favored policy mix is thus an overvalued peg with contractionary macroeconomic policy. 7 II. When Will Politicians Adopt Undervalued Exchange Rates? Since most politicians want to remain in power (Ames 1987), they usually try to avoid policies that are unpopular or that are supported by only a very narrow segment of the population. This should especially be the case when policymaking authority is less-thanfully centralized: leaders will face strong incentives to build coalitions with a variety of social groups when power is spread across different regions or branches of government (Bates 1997). Most politicians will seek out macroeconomic and exchange rate policy mixes that will win them the support of a variety of interest groups. Since few groups favor “uncompensated undervaluation” (see previous section) politicians will typically try to avoid this policy mix.4 By contrast, compensated undervaluation—undervalued exchange rates combined with a stable nominal exchange rate and expansionary macroeconomic policies—is popular with exporters, importcompeting industries, and some nontraded industries. I expect that policymakers will be more willing to keep their currencies undervalued when they can combine undervalued exchange rates with these other compensatory policies. In other words, undervaluation is likely only when the policy mix of compensated undervaluation is feasible. The problem is that this policy mix is typically infeasible. Stable nominal exchange rates combined with expansive macroeconomic policies typically generate RER appreciation (Edwards 1989; Hinkle and Montiel 1999). Budget deficits and expansions of domestic credit typically increase inflation, and when the nominal exchange rate does not depreciate to offset this increase in domestic prices, the RER becomes overvalued. It is often 4 The most likely exception should be if exporters are politically dominant and state power is so concentrated that the export lobby can capture the state (Steinberg 2008). 8 impossible to reconcile undervaluation with stable exchange rates and high government spending. It is easier to combine undervaluation with expansionary macroeconomic policies and currency stability under two conditions: when there is idle capacity in the domestic economy and when commodity prices are high. When factors of production (labor, land and capital) are under-employed—in other words, when the economy’s pre-existing productive capacity is not being fully utilized—expansive macro policies increase investment and resource utilization without contributing to large price increases. Fiscal expansion tends to be more inflationary when the economy is at or above its capacity level because it is more expensive for firms to increase output.5 Price levels and the RER should be much less responsive to macroeconomic policies when the economy is operating below its full employment level. Since expansive macro policies are not inflationary when there is high underemployment, governments have an easier time keeping a stable nominal exchange rate and expansive macroeconomic policies without appreciating the RER. The combination of nominal exchange rate stability, RER undervaluation and expansive fiscal policy becomes easier to reconcile when the economy is operating below capacity. The prices of commodity exports, or the terms of trade (TOT), are a second factor that can influence policymakers’ ability to combine undervaluation with compensatory 5 This follows from simple textbook models of the macroeconomy, which typically assume that aggregate supply curves are positively sloped (increases in output typically raise production costs and prices) but have increasing (steeper) slope. Since the aggregate supply curve is flat when there is excess capacity, increases in aggregate demand increase production but prices do not change. As the supply curve becomes steeper, an equivalent increase in aggregate demand produces more inflation. Lipsey et al (1997: 551-559) provide a useful discussion. 9 policies. Strong terms of trade benefit national governments in several ways. Most directly, domestic economic conditions tend to greatly improve when export prices are high (Kose 2002; Broda and Tille 2003; Wibbels 2006). Tax revenues tend to increase when the terms of trade are strong because there is more wealth to tax in a growing economy, and also because it becomes easier for the government to tax primary exports when their external prices are high. Governments can use this revenue to compensate and subsidize more industries. Alternatively, governments can use this revenue to increase the budget surplus and reduce inflationary pressures. Both results—larger budget surplus or more government spending—mean a greater degree of compensations can be compatible with undervaluation when there are high terms of trade than when the prices of commodity exports are weak. In sum, “compensated undervaluation” policy mixes are most feasible when two economic conditions are present: there is idle capacity in the national economy and the prices of commodity exports are high. I thus expect that exchange rates are most likely to be undervalued when terms of trade are strong and there is idle productive capacity. In such circumstances, undervaluation does not require giving up other attractive policies, and political support for undervaluation will be strong. In most other conditions, the coalition favoring undervaluation will be narrow and politically weak because proponents of high spending and advocates of currency stability will oppose uncompensated undervaluation. Compensated overvaluation will usually garner broader support than undervaluation. 10 III. Exchange Rate Valuation Politics in Argentina, 1963-2007 This section examines the political economy of exchange rate valuation in Argentina since 1963. Since it is impossible to provide a comprehensive historical account in this brief case study, I primarily focus on those historical facts that are useful for evaluating the rival theories. Table 2 summarizes some of the key features of each period of exchange rate policy between 1963 and 2007. a. 1963-73: Failed Attempts at Competitive Exchange Rates During ISI According to conventional wisdom, states using ISI development strategies intentionally keep their exchange rates overvalued to improve the purchasing power of protected sectors (Crystal 1994; Kaufman and Stallings 1991). Contrary to this assumption, several Argentine governments tried to maintain a competitive currency during the ISI era. The biggest obstacle to undervaluation in Argentina’s ISI period was not demands for purchasing power, but an unwillingness to sacrifice other policy goals in order to maintain undervaluation. Arturo Illia’s Radical government was the most successful at maintaining a competitive exchange rate during this decade. When Illia became President in October 1963, the economy was in poor condition: a deep recession left considerable excess capacity in the economy, inflation was high, and the budget was in deficit (Mallon and Sourrouille 1975: 26; Guadagno 1991).6 The one fortuitous factor was that the terms of trade were on the rise. The political situation was not much better. Illia was elected with only 25.4% of the vote but almost as many votes (24.5%) were cast blank, presumably for the Peronist Party, which was banned from contesting the election. The Radicals 6 Labor-market unemployment was nearly 9%, and 45% of industrial capacity sat idly (Tudero 1990: 76). 11 realized that future political success required gaining support from the pro-Peronist working class. To do so, Illia’s priorities were overcoming recession and reducing inflation while improving workers’ real wages (Tudero 1990). In a major break with past practice, the Radicals adopted a crawling peg exchange rate that devalued the nominal exchange rate at regular intervals to maintain a stable and competitive RER. As a result, the RER depreciated mildly between 1964 and 1966. In the economic context of high unemployment and rising commodity export prices, the trade-offs of keeping an undervalued exchange rate were more limited than is typically the case. These economic conditions enabled the government to keep expansive fiscal, monetary, and wage policies along with undervaluation. However, given the difficult economic situation, it was not possible for undervaluation to be fully compensated, and the currency was unstable, inflation was high, and exchange controls were extensive. Partly as a result, the Radicals were never capable of expanding their political coalition. The financial sector was predictably opposed to many of Illia’s abovementioned monetary policies (Mallon and Sourrouille 1975: 28; O’Donnell 1988: 50). Since investment remained relatively weak in nontradable sectors, such as energy, transportation and communications, (Tudero 1990: 81), the lack of backing from nontradable sectors was comprehensible. However, even the main beneficiaries of economic policy remained hostile to the Radicals (Mallon and Sourrouille 1975). Production and exports in agriculture and industry grew strongly in 1964-65, yet representatives of tradable sectors, such as the Unión Industrial Argentina (UIA) and Sociedad Rural Argentina (SRA) remained discontented (O’Donnell 1988; Tudero 1990; Smith 1990; de Palomino 1988). Government policies also clearly improved the lot of 12 workers in many ways— unemployment fell and real wages rose, for example—but unions were angered by the Radicals’ excessively transparent political efforts to interfere with and divide the unions (O’Donnell 1988).7 When the terms of trade began falling in 1965-66, the government reacted by adopting more contractionary macroeconomic and wage policies (di Tella and Braun 1990). The implementation of more restrictive macroeconomic policies and the slowdown of economic growth angered industrial firms, and increased their support for a military coup that brought General Onganía to power in June 1966 (Mallon and Sourrouille 1975). The objective of maintaining a stable and competitive RER was an important continuity between the Illia and Onganía periods (Guadagni 1991: 148; di Tella and Braun 1990). When Economy Minister Krieger Vasena devalued the peso 40% in March 1967, he proclaimed with “certainty that there will not be monetary overvaluation” (Krieger Vasena 1990: 91). The government was particularly concerned with promoting nontraditional exports, and to do so they imposed taxes on traditional exports and subsidized manufacturing exports. Although the exchange rate was to remain pegged, export taxes and import duties were to be adjusted to offset inflation and maintain a constant effective exchange rate. Krieger Vasena’s successors, first Pastore and then Moyano Llerena, copied Krieger Vasena’s policy of undervalued pegs with export taxes (O’Donnell 1988: 222; Smith 1989: 166-167).8 7 The lack of support from these groups also reflected their perception of the government as illegitimate and aloof. 8 In Pastore’s own words: “as Economic Minister I basically followed the economic guidelines set by my predecessor, Krieger Vasena”. In addition, he claims that undervalued exchange rates with export taxes is “more appropriate” than overvalued exchange rates with high import duties (Pastore 1990: 104, 109). 13 Despite their preference for undervaluation, the RER appreciated under each of these three ministers because inflation remained well-above international level. For example, the RER was more overvalued at the end of the 1968 than it was prior to Krieger’s March 1967 devaluation (Mallon and Sourrouille 1975: 32; di Tella and Braun 1990). Krieger Vasena’s economic program was supported by a broad capitalist coalition spanning nontraded and traded industries alike. The financial sector benefited from large capital inflows, which were attracted by the stable and convertible currency (O’Donnell 1988: 109-115). Producers of nontradable goods were another big winner in large part because massive government investments generated a construction boom. Despite the RER appreciation and the reduction of tariff protection, large manufacturing firms strongly supported the economic program. Industrial producers benefited from a variety of economic policies, including expansive monetary policies, the subsidization of machinery and equipment purchases, and export subsidies (O’Donnell 1988; Chudnovsky and López 2007: 36; Smith 1989). Support for the government was weaker for tradable producers that were not compensated: although agro-exporters initially supported the government and its policy of devaluation, this sector stagnated and became increasingly unhappy because of RER appreciation combined with additional taxes on agricultural exports (Smith 1989; O’Donnell 1988). The promise of avoiding currency overvaluation was broken because RER stability was a lower priority to the government and its capitalist coalition than were currency stability and expansive macroeconomic policies. Although Pastore and Moyano Llerena adopted similar policies to Krieger, the exchange rate became even more overvalued during their tenures due to inflation and a currency peg (Smith 1989: 145; O’Donnell 1988: 181). The stronger real appreciation 14 reflected changed economic conditions. Since the economy was reaching its full capacity level in 1969 (O’Donnell 1988: 179; Smith 1989: 143; Machinea 1990: 9), government spending became more inflationary. Furthermore, Argentina’s terms of trade were falling at this time (di Tella and Braun 1990: 15), which reduced revenues from export taxes; this increased the budget deficit and stoked further inflation. Nonetheless, the small- and medium-sized manufactured producers represented by the Confederación General Empresario (CGE) continued to support the government as they were pleased with protectionist policies and other industry-promotion schemes, such as subsidies, state investments and favorable bank credit (O’Donnell 1988: 213, 251; Smith 1989). To summarize, although many of the policymakers between 1963 and 1973 had no intention of appreciating the currency, this often resulted from the combination of a stable nominal exchange rate and expansive macroeconomic policies. This policy mix was supported by a coalition that included both nontraded and traded sectors. Maintaining a competitive exchange rate proved most politically feasible when economic conditions, such as a deep recession, made it possible to combine undervaluation with expansionary macro policies. While the government’s preference for undervaluation changed little, the RER became increasingly appreciated over this period as the economy went from underemployment to full capacity and, eventually, overheating. b. Peronists, 1973-76: Extreme Overvaluation Results from Multiple Motives Peronist economic policies during this period were the archetype of ISI and macroeconomic populism, and included a strongly overvalued currency (Kaufmann and Stallings 1991). The typical assumption that populist governments adopt overvalued 15 exchange rates in order to increase workers’ real wages (Kaufmann and Stallings 1991; Bates 1981; Sachs 1989) is partially correct for this episode. However, concerns with the working class’ purchasing power cannot alone explain the extent of overvaluation. When the Peronists’ entered office in May 1973, their priority was reducing inflation, which was over 50% per year. A freeze of wages and prices succeeded at stopping price rises over the next few months, and, with a constant nominal exchange rate, generated RER depreciation. In reaction to the loss of purchasing power, the Confederación General de Trabajo (CGT), the Peronist-dominated labor union, and some businesses began lobbying for a revaluation of the fixed exchange rate. In December 1973 Perón complied with this request and appreciated the exchange rate for imports (di Tella 1983: 116; Sturzenegger 1991: 99). The exchange rate remained fixed during the remainder of Peron’s tenure owing to his fear that devaluation would lead to economic contraction and reduce real wages. The Peronist governments’ desire to maintain strong real wages helps explain why the exchange rate was not undervalued. However, purchasing power considerations are insufficient for understanding why the exchange rate became grossly overvalued in 1974. The nominal exchange remained unchanged, but the real exchange rate appreciated considerably because Argentine inflation more than doubled U.S. inflation.9 The inability to keep a lid on inflation was due to the highly expansive monetary, fiscal and wage policies aimed at maintaining a booming domestic economy (Ayres 1976). The government targeted these expansionary policies, such as subsidies and cheap credit, to manufactured exporters and small- and medium-sized enterprises. In spite of the overvaluation of the currency, these 9 Argentine inflation was 23.5% and US inflation 11.0%. (WDI). 1974 was the highest degree of overvaluation in Argentina for all data recorded by Easterly (2001). 16 compensatory policies helped generate an export boom and ensured that various tradable producers, such as the manufactured export sector, small firms, and the CGE business group, stayed within the government’s support coalition (Leyba 1991; Sturzenegger 1991: 85; di Tella 1983: 92). The exchange rate would have been much less overvalued if the government’s only concern was preserving purchasing power. The massive overvaluation of the peso reflected the desire to combine a stable nominal exchange rate with expansionary and compensatory policies. There were two major negative shocks in 1974: Perón’s death, which brought his unpopular wife Isabel into the Presidency; and a sharp fall in the terms of trade that made the previous compensated overvaluation policy mix no longer tenable. Painful devaluations in 1975 strengthened opposition, contributing to another military coup. c. Military, 1976-82: The Importance of Political Coalitions in NonDemocratic Regimes The military, led by Jorge Videla, entered into office in March 1976 with the backing of capitalists from a variety of sectors. José Alfredo Martínez de Hoz, a member of the agro-export community and an opponent of overvalued exchange rates, was put in charge of economic policy with the aims of lowering inflation and making the economy more open and efficient (see Martínez de Hoz 1960, 1990; Schvarzer 1986). Businesses were very content with initial policies. The banking sector benefited from financial liberalization. Reductions in workers’ salaries and lower taxes on agricultural exports increased profits for industry and agriculture, respectively. Devaluation and the maintenance of a competitive exchange rate throughout 1976 helped boost exports of both manufactured and agricultural goods (Schvarzer 1986). 17 Despite the initial devaluation of the currency, the RER appreciated strongly between 1977 and 1981 and soon became massively overvalued (Calvo 1986; Crystal 1994; Schvarzer 1986). Exchange rate overvaluation was not an intentional government strategy (Interview, Ricardo Arriazu, 08/01/07). On the contrary, the strong appreciation of the currency was a matter of “high concern” for the government (Interview, Avila, 09/19/08). Martínez de Hoz (1991: 170) himself described the overvaluation as a “sacrifice” that was “acceptable” in order to attain other goals. The exchange rate became overvalued because the policies that would have been required to reduce real appreciation—such as nominal devaluations, controls on capital inflows, or more restrictive fiscal and monetary policies—would have alienated key constituencies. External monetary policies—a fixed exchange rate and capital account liberalization—contributed to real overvaluation. Capital openness along with the overvalued peg enticed capital inflows and these policies were integral for maintaining the support of financial capital (Schamis 1999: 258-9; Díaz-Bonilla and Schamis 2001: 82; Frieden 1991b: 209; Gibson 1996).10 These policies also helped maintain support from national industry. The tablita exchange rate based stabilization program was used to reduce inflation because “the economy would have suffered a general and more costly recession” under the alternative money-based stabilization program, and “the Junta said they were absolutely against general recession” (Martínez de Hoz 1990: 173, 169).11 Although overvaluation could have been avoided with a money-based stabilization, One illustration of this sector’s influence comes from Martínez de Hoz’s (1990: 154) confession that, even though he “did not like the idea”, the state fully guaranteed bank deposits because “the whole financial sector…was applying great pressure”. 11 Exchange rate-based stabilization is often more politically attractive than money-based stabilization (Schamis and Way 2003). 10 18 which lowers inflation by shrinking the money supply, the regime felt that domestic recession more problematic than overvaluation. Large manufactured firms’ ability to borrow cheaply from international capital markets was another important tool that helped them remain profitable (Schvarzer 1986: 180). Capital liberalization and the currency regime benefited two important supporters of the military—bankers and industrialists. Budget deficits were responsible for inflation staying above 100%, and fiscal policy intensified the extent of real appreciation (see Martínez de Hoz 1990: 171). Government spending, in the form of subsidies and investments, was targeted towards a number of heavy industries, such as iron and steel, chemicals and aluminum (DíazBonilla and Schamis 2001: 78). “Thanks to special compensations paid for the by the Treasury”, notes Schvarzer (1986: 183), these industries were “cleared of the effects” of the overvalued currency and remained competitive on export markets.12 An equally important source of the budget deficit was the state’s unwillingness to raise agricultural export taxes during this period of high international prices. But, low agricultural export taxes and manufacturing subsidies helped maintain support from these two industries. The combination of a stable but overvalued currency, expansive fiscal policies, and an open capital account enabled the government to maintain the backing of capitalists across nontraded and traded sectors. Nonetheless, as RER appreciation started to exceed compensations, tradable producers became increasingly opposed to the government between 1978 and 1981 (Gibson 1996: 85; Frieden 1991b). The agricultural sector became increasingly critical of the military’s economic policies after 1978 because the benefits of low export taxes increasingly paled in comparison to the costs of 12 Some import-competing industries, including autos, paper, cigarettes, and paper, remained profitable thanks to targeted protectionist measures (Schvarzer 1986). 19 overvaluation (Schvarzer 1986; de Palomino 1988). Furthermore, those manufacturing industries that did not receive compensatory fiscal policies were unambiguous losers in this period (Schvarzer 1986; Frieden 1991b; Schamis 1999). Tradable sectors supported overvaluation when they were well-compensated with other policies. The top economic policymakers during this period opposed overvalued currencies but ended up keeping the currency overvalued nonetheless. Schvarzer (1986: 186) attributes the gaps between what the military initially wanted to do and what they ended up doing to “sectoral pressures”. Indeed, such pressures for subsidies, low taxes, currency stability, and international capital mobility, were responsible for the government’s failure to accomplish its goal of maintaining an undervalued exchange rate. The policy mix of compensated overvaluation allowed the military government to construct a political coalition of banks, agro-exporters and large manufacturing firms. However, this strategy had limits: compensations were unable to keep up with the massive overvaluation of the currency, and opposition steadily grew. The collapse of the terms of trade collapse in the early 1980s more fully exposed the inconsistencies of the policy mix, and brought about several large devaluations between 1981 and 1983. d. Alfonsín, 1983-89: From Compensated Undervaluation to Hyperinflation The 1983 elections took place in a context of a deep recession, high inflation, a large fiscal deficit, and low prices for commodity exports. Virtually all politicians advocated reactivating the economy and using a crawling peg currency regime to maintain an undervalued exchange rate (see Mercado 08/18/83; Cronista 07/28/83). Alfonsín, the Radical candidate, became the first non-Peronist to win an election, and his political 20 objective was, similarly to the Radicals in the 1960s, to win the support of Peronist labor (Schamis 1999: 261; Smith 1999: 12). Alfonsín’s initial economic policies were an attempt to replicate Illia’s mix of expansive wage and macroeoconomic policies with an undervalued currency (Canitrot and Junco 1993; Díaz-Bonilla and Schamis 2001; Machinea 1990; Cronista 01/02/84). However, the economic constraints were much stronger in this period, and Alfonsín’s policies of devaluations and macroeconomic expansion pushed inflation above 600% in 1984. To address the growing inflation problem, the government partially changed strategies. The Austral Plan of 1985 used a fixed exchange rate, along with other contractionary measures, such as a wage and price freeze, and increased export taxes, to reduce inflation. However, since Sourrouille, the Minister of Economy, also attached a high priority to an undervalued exchange rate (see Mallon and Sourrouille 1975: 99-105), prior to pegging, they depreciated the nominal exchange rate strongly to prevent overvaluation (Machinea 1990; Frieden 1991b: 227; Canitrot and Junco 1993: 59; Interview, Frenkel, 10/15/08). Initially, the effects were as desired: inflation fell and the exchange rate remained competitive. This helped the government gain the support of the UIA (Smith 1990), and the voters (Díaz-Bonilla and Schamis 2001). Public approval, however, was ephemeral. Three economic changes—increased overvaluation and the decline in both inflation and export prices—caused business groups and labor unions to demand a switch away from anti-inflationary policies in early 1986 (Clarin 02/16/86). As the threat of hyperinflation waned, workers advocated wage increases and industry advocated demand stimulus (Machinea 1990). In the nine months following the Austral Plan the RER became overvalued owing to the peg combined with 21 residual inflation (Canitrot and Junco 1993: 53; Canitrot 1994; Gibson 1996: 162).13 The sharp fall in international agricultural prices further reduced profits for agricultural exporters, who became highly critical of the overvalued exchange rate and export taxes (Smith 1990; Gibson 1996: 162). In turn, the government modified the Austral Plan in February 1986 to try to better accommodate various interest groups. Wages were increased in “an attempt to widen the political support of the government [by] attracting some labor union leaders” (Machinea 1990: 59). The government shifted to a crawling peg regime and started devaluing the exchange rate in order to—as the Economy Minister himself puts it— “provide an additional stimulus to exporters, in particular exports of agriculture, who are confronting a severe fall of international prices” (La Nacion 04/05/82). In addition, the government reduced agricultural export taxes, and—to the satisfaction of industry groups, such as the CGE—introduced new industrial promotion policies (Tiempo 02/11/86; Somos 02/12/86). Although many industries were pleased with the introduction of such measures, this policy mix generated major economic problems that left most worse off in the end. Lower export taxes increased the budget deficit, which, when combined with currency depreciations, quickly generated inflation.14 Despite a variety of stabilization plans and frequent policy shifts in the late 1980s, Alfonsín was unable to overcome hyperinflation and economic contraction. The government lost control of the economy and inflation over 3000% generated rapid and out-of-control currency depreciation in 1989. The RER appreciated 10% between July 1985 and March 1986 (Fernández 1991: 128) According to Canitrot and Junco (1993), cutting export taxes cost the government fiscal revenues equivalent to 1% of GDP. Machinea (1990: 64) points out that revenue from export taxes was 1.93% of GDP in 1985 but only 0.32% of GDP in 1987. 13 14 22 The Radical government was never able to reconcile its objectives of improving real wages while simultaneously keeping the exchange rate at a stable and undervalued level (Canitrot and Junco 1993; Schamis 1999: 260). Like most others, they felt obliged to comply with demands for high wages and expenditures but low taxes even though they were incompatible with their objectives of a stable and competitive currency. The inconsistencies between exchange rate and macroeconomic policies ended in disaster. e. Menem, 1991-98: Compensating the Losers of Overvaluation After Carlos Menem, the Peronist candidate, won the 1989 Presidential election he implemented several failed stabilization plans. Hyperinflation continued until the Convertibility Law of April 1991 created a quasi-currency board that fixed the peso to the dollar at a rate of one-to-one, established full currency convertibility, and required the Central Bank to maintain foreign reserves equivalent to the entire monetary base. Inflation fell almost immediately but since inflation remained much higher than American inflation the RER appreciated sharply and became considerably overvalued (Baer et al 2002; Wise 2000; Starr 1997; Damill et al 2007). The primary objective of Convertibility was overcoming the immediate problems of hyperinflation, not real exchange rate appreciation and increased purchasing power (de la Torre et al 2003: 46; Interview, Miguel Kiguel, 08/13/07; Interview, Pablo Guidotti, 08/09/07; Interview, Jorge Baldrich, 08/08/07). On the contrary, Economy Minister Domingo Cavallo himself was an opponent of overvaluation (Díaz-Bonilla and Schamis 2001: 86). Cavallo’s academic writings stress the negative impacts that overvalued currencies have had on developing countries, and Argentina in particular (Cottani, Cavallo and Khan 1991; Cavallo and Mundlak 1982). In the words of one administration 23 official, “Cavallo never imagined that Convertibility would have been a lasting system. He didn’t think that it was the sort of regime to be kept for a long time” (Interview, Pablo Guidotti, 08/09/07). For Cavallo, Convertibility was nothing more than a temporary solution to the inflation problem (Levy-Yeyati and Valenzuela 2007: 211). Hence, once the inflation problem was solved, Cavallo’s concern with the peso’s overvaluation led him to try to revise the Convertibility regime early in its tenure. In late 1992, Cavallo attempted a “fiscal devaluation”: increasing tariffs to reduce imports and increasing export subsidies to encourage exports, with effects analogous to changing the rate of currency conversion (Starr 1997: 95). This crushed financial markets’ confidence in the peg, leading to a speculative attack. In order to regain credibility, the government further increased the rigidity of the monetary regime.15 Rather than reverse overvaluation with a devaluation or deflation, Menem implemented side-policies to compensate those hurt by overvaluation (Etchemendy 2005). Through the use of a combination of macroeonomic and more targeted compensatory policies, Menem built a broad political coalition that included voters and interest groups across various sectors (Díaz-Bonilla and Schamis 2001; Starr 1997; Woodruff 2005). Table 3 summarizes the views of three sectors on four facets of government policy—the exchange rate level, financial stability, domestic economic growth, and targeted compensations. For much of the 1990s, this compensated overvaluation policy mix was supported by both nontraded and tradable industries, though for different reasons. 15 More specifically, dollar-denominated bank accounts were legalized (Woodruff 2005). 24 The banking sector, which benefited not only from overvaluation but also from currency stability, low inflation, and capital mobility, were perhaps the most enthusiastic supporters of Convertibility (Baer et al 2002). Nontradable producers supported the economic model because it provided them with price stability and economic growth (Ambito Financiero 07/27/92; Cronista 07/30/96). Most tradable producers were also opposed to devaluation. This support partly reflected the important benefits of the peg, such as credibility and financial stability (Díaz-Bonilla and Schamis 2001; Galiani et al 2003; Starr 1997). Producers that relied on imported inputs strongly favored Convertibility: agricultural exporters, for example, calculated that, devaluation would provide limited gains because they imported many inputs; by contrast, exchange rate and monetary predictability enabled productivity improvements and an expansion of land use (Interview, Urricariet, 10/10/08; Interview, de Freijo, 10/10/08). For many industries, the competitiveness benefits of devaluation paled in comparison to the expected costs of devaluation, such as greater instability, uncertainty, and inflation. Fiscal and commercial policies also helped firms remain profitable. To maintain a booming domestic economy, Menem adopted “over-stimulative monetary and fiscal policies” to maintain growth in nontraded and traded sectors (Díaz-Bonilla and Schamis 2001: 90; Galiani et al 2003).16 Another central feature of this period were neoliberal reforms, which Menem applied strategically in ways that compensated groups hurt by Although Argentina’s fiscal performance was vastly superior to earlier times, fiscal prudence fell fall short of what it should have (Mussa 2002; Machinea 2002; Blustein 2005; Corrales 2002; IMF 2004). Government expenditures steadily grew over the decade, and the government budget, which was in surplus initially, went into deficit in 1994 (Baer et al 2002). Financial policies further magnified the impact of capital inflows on economic growth: for example, rather than issuing bonds to sterilize capital inflows, private banks’ reserve requirements were reduced in the early 1990s (Starr 1997). 16 25 overvaluation (Etchemendy 2005). These compensatory policies caused important tradable-sector interest groups to favor the government. The reduction of export taxes further convinced agricultural exporters to support Menem (Interview, Urricariet, 10/10/08; Interview, de Freijo, 10/10/08; Díaz-Bonilla and Schamis 2001: 90; Bolten 2006). Subsidized credit was provided to the petrochemical industry. Domestic oil firms were assisted with favorable privatization terms and limited deregulation. Steel privatization helped Techint, Argentina’s largest multinational company, to enlarge their domestic market share. Despite the overall reduction of import tariffs, the maintenance of auto tariffs satisfied this sector (Etchemendy 2005). Manufacturing sectors that were not compensated—for example, textiles—were less supportive of the economic program. However, these compensatory policies convinced enough industrial producers to support the government that the UIA—their main lobby group—did not oppose Convertibility (Etchemendy 2005; Bolten 2006). In sum, an assortment of compensatory policies helped create support for the government among both nontraded and traded industries. “The endurance of the convertibility system”, writes Etchemendy (2005: 81) “cannot be understood without considering this matrix of payoffs”. There was widespread support for overvaluation throughout much of the 1990s because the policies required to reverse overvaluation—deflationary macroeconomic policies or devaluation—were even more unattractive than was the loss of exchange rate competitiveness. In addition, Menem had no problem finding other ways of satisfying tradable industries hurt by overvaluation. With such a powerful coalition supporting this policy mix, it is hardly surprising that the “Menem administration did not have a single doubt” about maintaining Convertibility during the speculative attack that followed 26 Mexico’s 1995 devaluation (Interview, Jorge Baldrich, 08/08/07). Although the Argentine economy went into recession in 1995, it recovered from quickly, and growth remained strong in the following two years. f. de la Rúa, 1999-2002: Rising Opposition to Overvaluation Argentina’s luck ran out in 1998-99: capital stopped flowing into Argentina and other emerging markets, and Argentina’s export prices began falling. These exogenous shocks meant that fewer public resources were available to compensate tradable producers. Devaluations by Argentina’s trade competitors, particularly Brazil, further appreciated Argentina’s real effective exchange rate. No longer was it possible to combine overvaluation with currency stability and economic expansion as happened in the past decade. Instead, the Argentine economy started to disinflate and contract in 1999. The business unity of the previous years disintegrated as various sectors grew increasingly hostile towards recessive economic policies (Etchemendy 2005; Woodruff 2005). The financial sector was the only group that remained unconditionally supportive of Convertibility and deflation (Woodruff 2005; Baer et al 2002: 79). The service sector was hurting from both domestic recession and falling relative prices, and began lobbying for reactivation and tax cuts in 1999 (de la Torre et al 2003; Cronista 03/30/99; Clarin 08/09/99). Tradable producers were even more critical, and manufacturing, agricultural and construction sectors formed the Grupo Productivo, which advocated measures such as reduced taxes, subsidies, and trade protection (Woodruff 2005; Bolten 2006). While they did not openly criticize Convertibility, support for devaluation within the manufacturing sector grew from 1999 onwards (Interview, Grasso, 10/17/08; Interview, Anonymous, 09/16/08). In contrast to their previous defenses of Convertibility, some in 27 the UIA now pledged only “conditional support” for the regime, and suggested that the peg was not going to last forever (La Nacion 05/30/99, 09/02/99). One UIA representative, when asked in an interview, whether the next government should leave Convertibility, suggested that this “depends on the international juncture” (La Nacion 09/02/99). The first explicit public criticism of Convertibility from a prominent businessman came in August 1999, from the head of Techint, Argentina’s biggest conglomerate, which is concentrated in the steel sector (Etchemendy 2005: 83). By the time of the October 1999 Presidential election, many within UIA were privately suggesting that the next government should devalue the currency (Bolten 2006; Pagina/12 08/18/99). Opposition to overvaluation began rising when this required recession and deflation. However, Fernando de la Rúa of the Alianza (a coalition between the Radicals and FREPASO), the winner of the 1999 Presidential election, chose not to devalue, and had little success reversing overvaluation. The administration, like previous Radical governments, subscribed to neo-Keynesian ideas, and viewed overvaluation a serious problem (Interview, Bonvecchi, 08/07/07). Upon preparing to enter office, top Alianza officials studied the possibilities for devaluation, but decided that the likelihood of hyperinflation and financial insolvency were too great (Interview Frenkel 10/15/08). The government instead opted for deflationary macroeconomic policies, and in their first year in office they raised taxes, cut spending and lowered public employees’ wages in order to demonstrate commitment to the regime and achieve real depreciation via the lowering of prices. They hoped that such measures would restore confidence, or that commodity 28 prices would recover, and that they would then be able to return to more expansionary macroeconomic policies (Interview Bonvecchi, 09/25/08). Unfortunately, the economy continued to contract. As the number of firms suffering continued to grow, opposition to the status quo became the dominant position within UIA by the end of 2000 (Bolten 2006). In response to these political and economic troubles, two Economy Ministers resigned in March 2001 and de la Rúa brought Domingo Cavallo back to the post, hoping that he would be able to calm the markets. Cavallo experimented with a variety heterodox and expansive measures to try to revive the economy and regain support from the private sector. Limits on the Central Bank’s ability to inject liquidity, a basic element of the currency board, were removed. Reminiscent of his efforts in 1992, Cavallo attempted to devalue while maintaining the Convertibility system by imposing import taxes and export subsidies. He also tried moving to a basket peg. These measures failed to revive the original political coalition, but heightened skepticism of the exchange rate regime’s viability. The fragile system essentially stopped functioning by November 2001, when the government had to limit withdrawals of bank deposits and impose capital controls. Protests and riots led President de la Rúa to resign. Shortly after, on December 21, 2001, UIA announced their proposal for devaluation (Bolten 2006; Woodruff 20005). And then on January 1, 2002, Eduardo Duhalde, a Peronist with close ties to UIA, assumed the Presidency and terminated Convertibility.17 The government also adopted an “asymmetric pesification”, transferring assets at the rate of one peso per dollar but exchanging liabilities at 1.4 pesos/dollar. This transferred the balance sheet effect of devaluation onto debtors, which hurt banks but helped industry (Levy-Yeyati and Valenzuela 2007; de la Torre et al 2003; Blustein 2005). 17 29 The increasingly constraining international environment limited the government’s ability to compensate tradable producers, and in turn, tradable industries became opposed to Convertibility after their compensations were removed. The rising opposition to Convertibility indicates that compensatory policies were integral to maintaining political support for the overvalued exchange rate throughout the 1990s (Etchemendy 2005: 83). g. Kirchner, 2003-07: The Temporary Success of Compensated Undervaluation The 2002 devaluation, where the peso fell by over 300%, created an unprecedented economic contraction of over 10% and pushed unemployment, which had already been high, above 20% (Chudnovsky and López 2007). Fortunately, economic recovery started quickly. Thanks to high unemployment and idle capacity, the devaluation did not produce major wage or price rises, but it did encourage production of tradable goods (Damill et al 2007; Levy-Yeyati and Valenzuela 2007). When prices of Argentina’s commodity exports, such as soy and meat, began rising in 2003, this provided an additional stimulus to investment and exports. When Peronist Néstor Kirchner became President in May 2003 he inherited a favorable economic situation with an undervalued exchange rate, major unused industrial capacity, and rising terms of trade. Two competing economic programs were put forth: the central bank governor advocated a relatively rapid appreciation of the exchange rate and an inflation-targeting regime, while Roberto Lavagna and his team at the Ministry of Economy favored maintaining a more depreciated currency. Kirchner intervened in support of Lavagna, and maintaining a stable and competitive exchange rate remained one of the Kirchner government’s central objectives (Interview, Roberto Frenkel, 30 10/15/08; Frenkel and Rapetti 2006; Levy-Yeyati and Valenzuela 2007: 225; Interview, Pedro Elosegui, 08/16/07). Kirchner’s undervaluation policy helped him win the strong backing of the manufacturing sector, who have loudly advocated for the maintenance of a competitive currency (Coatz and Woyechezsen 2007; Ambito Financiero 08/24/2005; Interview Grasso 10/17/08; Interview Woyecheszen 10/11/08). In spite of the currency’s undervaluation, various nontradable industries strongly support Kirchner, as they have been compensated in other ways. The construction industry lobby claims that the higher costs for imported inputs is not a major problem for them, and they boast that “we are pampered by Kirchner” thanks to Keynesian fiscal policies and expansion of public works (Pagina/12 11/30/03, 11/11/03, 05/04/03). Similarly, bankers and retailers are not concerned about the undervalued currency because the domestic economy has grown rapidly, and they have been able to increase loans and sales to tradable-sector firms (Interview, Wilson, 09/18/08; Fortuna 08/08/05). Labor unions, particularly the CGT, strongly supported Kirchner because undervaluation alongside high public expenditures generated employment gains, while the government also administered notable real wage improvements (Etchemendy and Collier 2007; Tomada and Novick 2007). Another important part of Kirchner’s political strategy includes the use of targeted policies to benefit groups that are hurt by undervaluation. Subsidies for energy and transportation, and taxes on beef exports—which reduce the domestic price of food— lower the cost of living, and improve purchasing power. Such purchasing power improvements provide considerable benefits for workers, such as the large informal services sector that developed in Argentina over the 1990s. 31 The combination of outcomes—increased real wages, undervaluation, domestic economic growth, and low inflation—are rife with tensions and potential incompatibilities that previous Argentine governments have not been able to reconcile. Kirchner’s remarkable success in achieving all these goals, and sustaining this policy mix, relied of the atypical economic context. The presence of idle capacity meant that expansive macroeconomic policies increased production without raising prices much (Interview, Daniel Heymann, 08/07/07). Underemployment thus enabled the government to combine high government expenditures with a fairly stable nominal exchange rate without appreciating the RER away from its undervalued level. High commodity export prices further helped Kirchner achieve his multiple objectives: retenciónes, taxes on traditional exports, are a major source of government revenues that have helped the government avoid fiscal deficits, while also helping fund important fiscal programs, such as the above-mentioned subsidies (Frenkel and Rapetti 2006; Damill et al 2007; Grugel and Riggirozzi 2007).18 According to one government official, these economic conditions “allowed inconsistent policies to survive for a longer time than could be in other instances” (Interview Katz 10/01/08). The ability to couple undervaluation with various compensatory policies would not have been feasible without such favorable economic conditions. The only clear opponents of the government are those that are not compensated, agricultural exporters; they protest against retenciónes, and also disapprove of the less-than-fully-stable nominal exchange rate (Interview, Urricariet, 10/10/08; Interview, de Freijo, 10/10/08). Kirchner’s “compensated undervaluation” policy mix enabled him to construct a broad multi-sectoral political coalition. 18 For example, in 2004, export taxes provided the state with revenue equivalent to 2.3% of GDP (Frenkel and Rapetti 2006: 13; Chudnovsky and López 2007: 155). 32 The tensions in Kirchner’s economic program started to emerge in 2005. Aggregate demand started to reach its capacity levels after several years of solid growth, and inflation thus started to rise, reaching nearly 10% in 2005.19 Lavagna and his advisors became concerned with the emerging inconsistencies between inflation and RER competitiveness, and they believed that increasing the fiscal surplus was required to reduce aggregated demand and inflation (Interview, Frenkel 10/15/08; Interview, Katz, 10/01/08; Interview, Anonymous, 09/24/08). Lavagna announced his new plan for a counter-cyclical fiscal stabilization fund in October 2005, but then one month later, Lavagna left the Ministry, in part over policy differences with Kirchner. The counter-cyclical stabilization fund never got implemented (Interview, Vicenzotti, 10/28/08), and fiscal policies became even more expansive after Lavagna’s departure.20 As the economy approached its full employment level during this period, inflation became increasingly responsive to government spending (Interview, Daniel Heymann, 08/07/07; Interview, Lucas Llach, 08/15/07). Thus, despite the fact that the nominal exchange rate depreciated slightly over 2007, inflation of over 20% meant that the real exchange rate appreciated by at least 12% that year.21 Inflation, largely the result of expansionary fiscal policies, is thus eroding undervaluation.22 19 According to one econometric analysis, in 2003, production was 13.7% below potential GDP; this fell to 3.5% by 2007, suggesting that almost all capacity was being utilized at this time. Thanks to Lucas Llach for sharing his data. 20 For example, fiscal policy was particularly expansionary in 2007, as spending rose by nearly 50% and the budget surplus fell from 3.6% in 2004 to 1.2% in 2007 (Frenkel and Rapetti 2006: 12; Economist 01/05/08, 10/20/07, 11/03/07). 21 The RER appreciated by 12% using the change in nominal exchange rate multiplied by the ratio of U.S. to Argentine consumer price inflation; American CPI is taken from the U.S. Bureau of Labor Statistics and Argentina inflation is 20%. Although official Argentine government statistics place 2007 inflation at 9%, there is widespread agreement that the government has forced the national statistics agency to lie about 33 The recent real exchange rate appreciation is certainly not an intentional government strategy. On the contrary, Nestor Kirchner and Cristina Fernández de Kirchner, his wife who succeeded him as President, continue to prefer an undervalued exchange rate.23 Real appreciation results from the political popularity of compensatory policies, and opposition to spending cuts. Although UIA is unified in favor of an undervalued exchange rate, they also advocate industrial policies, and they argue that tight fiscal policies are inappropriate for developing countries because “development requires a strong state with lots of investments” (Interview, Woyecheszen, 10/11/08). Similarly, ADIMRA, the metal industry lobby, opposes contractionary macroeconomic policies, and want more “sectoral plans” with preferential loans (Interview, Grasso, 10/17/08). Although manufactured exporters are unhappy about inflation, and believe that inflation is reducing their external competitiveness, the combined benefits of undervaluation and strong domestic growth still outweigh the costs of inflation (Interview, Anonymous, 09/16/08). Maintaining expansionary policies was also integral for maintaining the support of the construction lobby: Kirchner continued to court the construction industry, reassuring them that orthodox policies will be avoided and investment in public works will continue; in return, the construction lobby favored Kirchner over Lavagna (Clarin 11/23/05; Pagina/12 08/22/06). The objective of inflation, which is widely estimated to have been approximately 20% (see New York Times, 11/01/07, 12/11/07, and Economist 12/15/07). Argentine economists believe that provincial governments that independently calculate inflation provide more reliable indications of actual inflation. The average inflation for 7 provinces with independent data available for 2007 is 26%, implying a 16.5% RER appreciation. I thank Lucas Llach for supplying me with this data. 22 In anonymous interviews during September/October 2008, central bank and Ministry of Economy officials pointed out that, due to inflation, the RER is much less undervalued than it was recently, and is currently close to its equilibrium rate. 23 See her speech in Santa Fe province, 10/19/07 (accessible at www.cristina.com.ar). 34 maintaining an undervalued exchange rate is being sacrificed because the government’s constituents are intolerant of the measures required to preserve a competitive currency. In sum, Kirchner had more success maintaining an undervalued exchange rate than most previous administrations because the economic circumstances—idle capacity and high commodity prices—reduced the costs of this policy. The low trade-off between undervaluation and other attractive policies meant that fewer private actors were hurt by undervaluation. As a result, an undervalued exchange rate was more politically popular than it was at previous times. However, maintaining an undervalued currency became inconsistent with compensatory policies once the economy reached its capacity. The real exchange rate then started appreciating since the government and its supporters were unwilling to cut spending or reduce nominal exchange rate stability. IV. Discussion and Conclusions Exchange rate politics in Argentina displays several regularities over the past 45 years. One striking finding is that policymakers usually favored undervalued exchange rates but, time and again, were unable to avoid currency overvaluation. Krieger Vasena and Pastore in the 1960s, Martínez de Hoz in the 1970s, the Radical government in 1985-86, Cavallo in the 1990s, de la Rúa at the turn of the century, and since 2006 under Kirchner: none of these policymakers succeeded in their pursuit for undervalued exchange rates. This pattern strongly discredits the argument that policymakers’ ideas can explain exchange rate valuation policy. The fact that overvaluation has been associated with neoliberal governments, such as Menem and Videla, populists on the left like Perón, and pragmatic centrists such as de la Rúa, casts doubt on the claim that ideology influences 35 exchange rate policy. The prevalence of “unwanted overvaluation” also calls into question the hypothesis that overvaluation is purposively selected to increase purchasing power for the benefit of nontradable industries. Another recurring finding was that tradable industries often favor policy mixes that include overvalued exchange rates. Manufacturing producers were strongly supportive of economic programs that included real appreciation/overvaluation during the governments of Onganía, Perón, Menem and Kirchner. Tradable producers did not want undervalued exchange rates at these times because undervaluation would have required abandoning currency pegs, expansive domestic macroeconomic policies, or both. The fact that tradable producers were more opposed overvaluation during the Videla and de la Rúa eras, when compensatory policies were more limited, is also consistent with the theory. Neither beliefs in the benefits of undervaluation nor powerful tradable sectors have contributed to undervalued exchange rates in Argentina. The two moments when Argentine policymakers were able to keep undervalued currencies, 1963-66 and 20032006, were also the only two periods where the Argentine economy had considerable excess capacity and high terms of trade. This likely reflects the fact that these economic conditions make it possible to combine undervaluation with expansive macroeconomic policies and stable nominal exchange rates. Argentine policymakers were only able to keep undervalued exchange rates when this was compatible with compensatory sidepolicies. Argentine governments have typically adopted overvalued currencies because combining overvaluation with pegs and high spending is a useful way to maintain the 36 backing of broad multi-sectoral coalitions. The desire to package expansive macro policies with stable nominal exchange rates was the overriding motivation for exchange rate appreciation/overvaluation at various moments in Argentine history, including under Presidents Onganía, Videla, Menem and towards the end of Kirchner’s term. Even in the cases of Perón and de la Rúa—the only times where purchasing power considerations discouraged the government from undervaluing the exchange rate—opposition to contractionary macroeconomic policy and currency instability were perhaps even more important motives for overvaluation. In sum, the findings suggest that preferences and policies towards the value of the exchange rate are systematically influenced by the availability of compensatory measures. Support for undervaluation is much greater during moments when this can be combined with expansive fiscal policies and currency stability; by contrast, political demands for overvaluation are much stronger when this is not possible. This paper has attempted to clarify the complex relationship between interest groups and exchange rate policy, but more research is clearly required to understand the obstacles that policymakers face in avoiding overvalued exchange rates. Given the harmful effects of overvaluation on economic development and financial stability a better understanding of currency politics is increasingly needed in today’s globalized world. 37 Table 1: Summary of Interest Group Preferences Sector Preference Ranking Tradables UC > OC > UN > ON Nontradables OC > UC > ON > UN Finance ON > OC > UC > UN Legend: U = Undervalued exchange rate; O = Overvalued exchange rate; C = Compensations; N = No compensations 38 Table 2: Exchange Rate Politics in Argentina, 1963-2007 196366 196768 Real Exchange Compensatory Rate Level Policies Undervalued Partial Appreciation High 196972 Overvaluation Overvaluation Unstable/ Depreciation Overvaluation Unstable/ Depreciation Low Limited support Tradable benefit but oppose government Multi-sectoral capitalist coalition Full Capacity & Falling TOT SME Manufacturing Broad Multi-Class Urban Coalition Approaching Capacity & Strong TOT Finance Construction Large Manufacturing Shifting Economic Conditions Idle Capacity & Strong TOT Full Capacity & Rising TOT Labor unions Manufactured Exporters SME Manufacturing Limited Falling TOT Multi-sectoral capitalist coalition Full Capacity & Rising TOT Currency devaluations Spending cuts High 198182 Currency peg Fiscal expansion Monetary expansion Subsidies & cheap credit for exporters Low 197680 Currency peg Fiscal expansion Subsidies & tariffs High 1975 Currency peg Fiscal expansion Monetary expansion Export subsidies High 197374 Fiscal expansion Support Coalition Stable currency Fiscal expansion Capital liberalization Subsidies to heavy industry Finance Heavy industry Limited Falling TOT 39 198390 Unstable Unstable 199198 Overvalued Overvalued 200305 Undervalued Appreciation Currency peg Spending cuts Rising financial restrictions Stable currency High spending Manufacturing subsidies Consumption subsidies High Falling TOT Broad Full Capacity & Strong TOT Finance Manufactured Producers Agricultural exporters Nontraded sectors Limited/Shrinking High 200607 Currency Peg Mild fiscal expansion Targeted subsidies & tariffs Reduced export taxes Low Limited/Shifting Shifting exchange regime Macro policy instability High 199902 Currency devaluations Spending cuts Stable currency Fiscal expansion Manufacturing subsidies Consumption subsidies Finance Broad Idle Capacity & Rising TOT Manufactured Producers Nontraded sectors Labor unions Broad Falling TOT Full Capacity & Strong TOT Manufactured Producers Nontraded sectors Labor unions 40 Table 3: Industry Preferences for Compensated Overvaluation, 1991-98 Overvaluation Financial Stability Domestic Growth Targeted Compensations Finance Large benefit Large benefit Small benefit Small cost Nontradables Small benefit Large benefit Large benefit Ambiguous Manufacturing Small cost Small benefit Small benefit Large benefit Agriculture Small cost Large benefit Small benefit Large benefit Net Effects Positive Positive Positive Positive References Ames, Barry. 1987. 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