Download I - Niehaus Center for Globalization and Governance

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 = ePF/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
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