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What would a healthy economy look like after the global crisis?

August 2, 2013
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What caused the economic crisis and what are the biggest problems currently facing the developed economies? Years of over-investment and the uncontrolled explosion of exotic financial instruments in the boom years created a surge in personal and corporate debt – the latter mostly accrued by banks and financial institutions.

The whole process was facilitated by historically low interest rates, over-dependence on the financial sector and intimate links between Europe and US banks, which meant that when one stumbled, entire economies were dragged down. A decline in real wages over the past five years against the backdrop of a long-term decline in the wage share of the economy has supressed demand.

Rich-country governments have been forced to socialise socialised the fallout from these private-sector calamities and maintained spending during the downturn to compensate for the slump in demand, raising public debt. Contrary to the idea that austerity is reducing the need to borrow, government debt in every advanced economy has increased since 2009, according to the Bank for International Settlements.

What would be an example of a healthy economy, one which was poised to recover well from the global crisis? Well, one which was growing, for a start, and which has expanded in recent years — unlike the UK economy, which is still smaller than it was in 2008. A steady 3.5% GDP growth, for example, would be nice this year. An unemployment rate of, say, 7.2% would suffice, especially if living standards were maintained as wage increases kept pace with inflation.

But growth and a relatively high employment rate would be no use if public debt was strangling the economy. A public debt ratio of about 35% of GDP would be lovely – around a third of the ratio in the UK. A healthy economy might have to run a temporary deficit to maintain demand in a sluggish global economy, but it could probably be tolerated if this were its first since the mid-nineties, and if  the economy were growing fast enough to maintain revenue growth.

Foreign debt can be particularly destabilising, as Italy, Ireland, Spain and Portugal have found out. Probably better to keep it low to reduce the influence of the bond vigilantes. A rate of 14% of GDP would be the envy of many governments.

An additional sign of health would be an economy which was diversified and which had a manageable financial sector. A lack of dependence on the rest of the world would reduce exposure to overseas wobbles. A country lucky and big enough to produce lots of stuff at home wouldn’t have to trade as much, boosting the prospects of a trade surplus.

As you might have guessed, this healthy economy isn’t fictional. Unlikely as it might seem, it’s Argentina, a country which outperforms most European countries and the US on almost every critical macroeconomic indicator – public debt, foreign debt, GDP growth, unemployment and the budget deficit (which was recently reported at 3.2% of GDP).

The economy runs a trade surplus, and trade in goods and services is a small proportion of GDP even though the country is a major agricultural exporter. The country has a small but functional financial sector featuring some foreign banks, although finance is a far smaller part of the economy than in a country like the UK, which Nicholas Saxson and John Christensen have described as being cursed by finance.

During the last decade Argentina enjoyed its fastest ever period of economic expansion, at a real annual average of 7.3% according to World Bank figures, one of the highest rates in the world during that period.

Given all this positive data, particularly on debt, you’d think the economy was better placed than most to deal with the aftermath of the crisis.

Yet the foreign press and the International Monetary Fund are far from satisfied. The government is constantly slated over inflation.  In February Argentina became the first country ever to get a rap on the knuckles from the IMF for allegedly faking its price numbers. An official rate of 10% is far lower than the 25% calculated by private-sector economists.

Debt-holders are suffering as the value of their future repayments is eroded. Inflation presents a big problem for the poor, and the government has tried to combat this effect by negotiating a deal with the major supermarkets to keep prices on hold for most of 2013.

Partly as a result of worries about Argentina’s fiscal situation, benchmark interest rates have been driven to very high levels, currently 13.25%. But this is slightly less important than in a country with a big debt pile. Strict controls have also been brought in to stem capital flight.

In no way is this to suggest that Argentina’s economy is a stellar performer – it’s got a history of financial mismanagement and political instability. Hyperinflation hit 12,000% in 1999. A lot of the numbers are so positive now simply because the economy sank to such a catastrophic low in 2002 after the debt default.

President Kirchner has yet to find a way of taking full advantage of the massive natural reserves of oil and gas, not to mention agriculture. Productivity has risen in the last 10 years but it still lags competitors, and investment, particularly in infrastructure, is generally low as political instability deters long-term players.

But undue attention is placed on inflation. As a recent OECD report puts it: “the risk of repeating another episode of hyperinflation is low in Argentina, at least in the short-run. Previous episodes of hyperinflation were associated to [sic] high government deficits that were monetized and to capital flight that forced a sharp reduction in the value of an overvalued Argentine peso. This is not the case today.”

The inflation-mania of the international business press is partly to do with its unstinting orientation toward finance. Rather than analyse the economy as a network of transactions for the provision of welfare to the people who live in it, these institutions tend to view economies only as places to conduct short-term investment – and short-term investors generally don’t like inflation.

Using a standard formula which sees anything that is bad for investors as bad for the economy, the business press panics at any sign of deviation from the Washington Consensus. Anything other than total private ownership of business, current-account and capital account liberalisation is anathema.

So the nationalisation of oil company YPF last year, for example, was greeted with jeers from the foreign media and yet more derision when the government sold part of the company to Chevron last month for a sum big enough to bring state finances back to supportable levels. Capital controls are slated, even when they work. Import tariffs and the promotion of domestic production are likewise seen as poison to the international financial class.

Wall Street is still smarting from the late 1990s when the emerging-market debt boom made Argentina a place of unheralded money-making opportunity, followed by the inevitable burnt fingers when the boom ended. The largest public default in history hurt a lot of investors, and they appear reluctant to forget it.

Yet Buenos Aires does have a strategy, one of growth, industrialisation, a degree of import-substitution and the protection of certain sectors from foreign competition. Unlike previous governments the Kirchner administrations have paid attention to the poor, bringing the official poverty rate down from a half of all families a decade ago to around a tenth now. Whether or not the strategy will work in the long run is unknown, but at least it’s a strategy that’s proved viable since 2003.

Given the travails affecting the rest of the world, you’d think that an economy with Argentina’s economic fundamentals had a chance of weathering the storm. It’s at least possible to construct a moderately positive story about the economy, although this rarely happens. You might even go as far as to draw conclusions about finance and debt for the developed economies of Europe and for the US.

Could it even be that the ultra-liberal, finance-dominated economic model of Europe and the United States is bust, and that a more statist, egalitarian model has a better chance of success in the post-crisis world?

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