The Short-Economics behind the Conflict Government vs. Rural Sector in Argentina

Other than any political reasons—that I won’t discuss here—the conflict government-rural sector in Argentina results mainly from an economic inconsistency. Of course, there are additional important issues. I want to focus on what I understand is one of the basic origins of the problem.

As already reported before, Argentina has a high inflation bias generated by the over-use of the different policies (monetary, fiscal, and exchange rates) to keep demand higher than in equilibrium. Argentina also claims to be free of any effect of the current international financial crises due to strong fiscal and current account surpluses. I do not agree with this. Especially when dealing with the fiscal surplus.

The main source of the current primary surplus is essentially based on

1.The high prices of some of the key Argentine exports: soy, corn, etc. The problem is that these high prices are essentially temporary shocks. Even though there might have some permanent component due to the China, India effect (and thus related to the “decoupling” effect, something that I do not believe to exist), the speculative component is probably bigger. I see the latter as if a big share of the so-called savings glut was driven to commodities’ markets.

2. The increase in aggregate demand (through a standard multiplier process) derived from the consumption but mainly investment that the rural sector is generating—the sector internalizes that this is a transitory shock and thus invest now, anticipating the future correction (to long-run equilibrium prices) in commodities’ markets.

3.The inflation tax that result from (1) and (2) above plus the huge level of government expenditures (reflected, e.g., through VAT and profits tax revenues).

4. Although probably of second order, the consumption-credit expansion—as opposed to an investment—credit expansion.

The government tries partly to control the high inflation rate by an immense and increasing amount of crossed-subsidies. I would also expect that, unless the government seriously sits down to control inflation using the appropriate polices, these subsidies are likely to increase at an increasing rate.

A second element of the government inflation strategy is the flow primary fiscal surplus. The government is forced to have this surplus. The more so as time goes by. Why? Notice that Argentina was almost out of international financial markets in the last couple of years, when the global economy was expanding and there was plenty of international liquidity. Currently things in international markets are becoming more stringent and this phenomenon is likely to remain with us for some time.

Thus, for all of the above Argentina does not have other choice than keeping a high fiscal surplus—whether they like it or not. Then it either increases taxes or reduces expenditures. There is no doubt that the latter would be the sensible way to do it. It would increase the surplus at the same time that it would reduce the intertemporal fiscal fragility that I posted on several times before. It would contribute to reduce long-term inflation expectations. It would even contribute in a non-inflationary way to depreciate the real exchange rate. It would even potentially allow for expansionary fiscal polices if the international financial crises ends hitting hard on Argentina—something that although with still low probability can not be disregarded yet. Why not saving in good times for a rainy day?…And the list goes on.

But the latter would go against the whole economic philosophy of the Kirchners’ administration—and it would imply reckoning the multiple mistakes that they have incurred in. I would presume that the administration will not be willing to do it.

Therefore, the government is forced to increase taxes. Based on its (mis)understanding of the economy, it is then pushed into trying to increase export taxes further up. This is quite risky, though.For it is using transitory positive shocks to increase its permanent sustainability needs—and erroneously thinking that this will anchor inflation expectations.

So, this is my short-version of the economics that triggered the conflict. Let me conclude by highlighting that I think that this conflict is currently a political issue. But my understanding is that the roots of the problem lie on an incorrect reading of the economy, especially trying to sustain long-term growth based on temporary shocks—and without using them (or letting them be used) to invest in long-term productivity. As a result the administration prefers to increase taxes instead of reducing expenditures in still relatively (temporarily) good times—which it would allow for higher degrees of freedom if things get worse in the future. It thus implies that the government is not anticipating rainy days in the near future…

3 Responses to "The Short-Economics behind the Conflict Government vs. Rural Sector in Argentina"

  1. ewulf   March 31, 2008 at 4:29 pm

    I would add that the main focus in Argentina economic policies like many other Latin America economies,these days ,is not economic growth but distribution which is strongly tied to tax increases.Lower expenditures, means better chances for growth as long as additional resources goes to finance private invetment projects.On the other side ,the real dilemma on the Argentina ´s policies is the new role of the State, but with an old philosophy,that one of price controls,and subsidies which we all know where is headed to.Economic literature and empirical evidence,suggest this is the wrong policy mix.However,will be accepted that way by current authorites,after the collapse of 2001?.-

  2. Aw   April 3, 2008 at 10:50 am

    Nicolas,Great piece! I fully agree. I just have one technical question. You say:”The increase in aggregate demand (through a standard multiplier process) derived from the consumption but mainly investment that the rural sector is generating—the sector internalizes that this is a transitory shock and thus invest now, anticipating the future correction (to long-run equilibrium prices) in commodities’ markets.”If they believe it is a temporary shock, and thus long term prices are lower, shouldn’t they invest less, not more, today? In other words: why invest now if prices are going to be lower in the future? Could you please clarify your reasoning?Thanks

  3. Nicolas Magud   April 3, 2008 at 1:10 pm

    Thanks for your comments. 1. I agree on the comment on the role of the state. I would personally prefer a smaller rather than a larger one.2. Regrading the temporariness of the shock, my view is as follows. As far as a producer will keep on being an agricultural producer, it is intertemporally relatively cheaper to buy today when your income is (relatively) high, as opposed as investing when you are kind of “tightened” by lower income–when the price of your commodity returns to its long-run value. Also, at least in the medium run, I would be tempted to think that although commodities’ prices should return back to their trend, this trend might me for some time not as low as in the past decade. This is based on the “structural” effect, so to speak, from the growth in China, India and the like. My expectation is that the reduction is prices should be mostly based on the correction due to the speculative component of these prices.Thanks one more time,Nicolas