Argentine Crises: A Model to Promote Chinas Fiscal and Monetary Reform - Example

Argentine Crises: A Model to Promote China’s Fiscal and Monetary Reform By Devangini Mahapatra Chauhan As many economists put it, fiscal crises are blessings in disguise being situations by which strong economic policies may be initiated in order to promote stability and growth in a particular state. Accordingly, it is through the examination of the major causes of the crisis in the economy that policymakers may re-evaluate and rectify unsound economic practices and policies. In this regard, being at the very core of the modern global economy, China has become the manufacturing hub of the world with its sheer magnitude of the working class and the scope for the fulfilment of the needs that emanate from the same. Thus, it has become an important part of the wish list of every multinational and is now enjoying the latest innovations from the world of information technology. Provincially, Argentina has been compared with China on account of the fact that it has the same capacity as far as the size of the working class is concerned as well as a plethora of resources at its disposal. (Paolera et al, 2003)1 In this context, this paper will seek to devise a plan for financial and economic reform for China based on the plan followed by Argentina. This paper will study the areas where this application may take place effectively. Argentina – An Economic Overview With agriculture and minerals as its foremost contributors to the economy, the Argentinean Economic analysis looks like this: GDP (purchasing power parity): $599.1 billion (2006 est.) GDP (official exchange rate): $210 billion (2006 est.) GDP - real growth rate: 8.5% (2006 est.) GDP - per capita (PPP): $15,000 (2006 est.) GDP - composition by sector: agriculture: 9.5% industry: 35.8% services: 54.7% (2005 est.) Labor force: 15.35 million (2006 est.) Labor force - by occupation: agriculture: NA% industry: NA% services: NA% Unemployment rate: 10.2% (3rd quarter, 2006 est.) Population below poverty line: 31.4% (June 2006) Household income or consumption by percentage share: lowest 10%: 1% highest 10%: 35% (June 2006) Distribution of family income - Gini index: 48.3 (June 2006) Inflation rate (consumer prices): 10% (November 2006 est.) Investment (gross fixed): 22.6% of GDP (2006 est.) Budget: revenues: $52.1 billion expenditures: $47.6 billion; including capital expenditures of $5.4 billion (2006 est.) Public debt: 62.2% of GDP (2006 est.) Agriculture - products: sunflower seeds, lemons, soybeans, grapes, corn, tobacco, peanuts, tea, wheat; livestock Industries: food processing, motor vehicles, consumer durables, textiles, chemicals and petrochemicals, printing, metallurgy, steel Industrial production growth rate: 8.2% (2006 est.) Electricity - production: 93.94 billion kWh (2004) Electricity - production by source: fossil fuel: 52.2% hydro: 40.8% nuclear: 6.7% other: 0.2% (2001) Electricity - consumption: 90.93 billion kWh (2004) Electricity - exports: 4.143 billion kWh (2004) Electricity - imports: 7.7 billion kWh (2004) Oil - production: 745,000 bbl/day (2005 est.) Oil - consumption: 470,000 bbl/day (2004 est.) Oil - exports: 470,000 bbl/day (2003) Oil - imports: 39,000 bbl/day (2003) Oil - proved reserves: 2.116 billion bbl (2006 est.) Natural gas - production: 44.88 billion cu m (2004 est.) Natural gas - consumption: 37.85 billion cu m (2004 est.) Natural gas - exports: 7.83 billion cu m (2004 est.) Natural gas - imports: 800 million cu m (2004 est.) Natural gas - proved reserves: 612.5 billion cu m (1 January 2005 est.) Current account balance: $5.81 billion (2006 est.) Exports: $46 billion f.o.b. (2006 est.) Exports - commodities: edible oils, fuels and energy, cereals, feed, motor vehicles Exports - partners: Brazil 15.8%, US 11.4%, Chile 11.2%, China 7.9% (2005) Imports: $31.69 billion f.o.b. (2006 est.) Imports - commodities: machinery and equipment, motor vehicles, chemicals, metal manufactures, plastics Imports - partners: Brazil 35.9%, US 14.1%, China 7.8%, Germany 4.5% (2005) Reserves of foreign exchange and gold: $30.24 billion (November 2006 est.) Debt - external: $106.8 billion (30 June 2006 est.) Economic aid - recipient: $0 (2002) Currency (code): Argentine peso (ARS) Currency code: ARS Exchange rates: Argentine pesos per US dollar - 3.0543 (2006), 2.9037 (2005), 2.9233 (2004), 2.9006 (2003), 3.0633 (2002) Fiscal year: calendar year (Source: www.cia.gov)2 The domestic and fiscal market has seen an increasing trend towards liberalization with growing links between the financial markets in various countries, which have in turn opened up the rapid growth of international flows for developing and industrial countries. In this regard, China and Argentina are similar. To follow in China’s footsteps, Argentina needs a more concerted effort to be focused on liberalization. China: An Economic Overview In the recent years, China has been engaged in the reformation of its economic policy. It is a current member of the World Trade Organization (WTO) and APEC. Agriculture has been the primary occupation in China which involves 50% of the country’s total population although areas in the north with high terrain limit the agricultural viability of the country. Even with the given fact, agriculture in China only comprises 20% of the nation’s gross national product (GNP). Farming has however been made unprofitable by taxes and fees which the government extracts from the farmers. Agricultural production is limited to the east. (www.cia.gov)3 China is known to be the largest producer of rice and wheat in the whole world and marked as a great producer of millet, sorghum, peanuts, corn, barley, soybeans, and sweet potatoes. China ranks first in cotton and tobacco cash crops. It is also recognized as a significant maker of silk, oilseeds, ramie, tea, jute, hemp, sugar beets and even sugarcane. (www.cia.gov) In terms of the world’s production of red meat, China also ranks first. China is one of the largest producers of minerals ranking as number 1 in the production of coal. Its coal is its most important source of energy accounting 70% of its electric power. (www.cia.gov) Chinese economy’s privatization has lead to conflicts in the countryside as the land on which peasants have long lived and worked for decades become the subject of sale by local authorities. Each year, as many as 2 million small farmers are being displaced majority of whom are the victims of the hukou system of household registrations which limits their rights to move in to the cities for work. The obvious income gap between urban and rural China has been the meat of speeches of leadership in the place. In the past few decades, China has seen a more centralised scheme of operations on the economic front due to a fiscal system that has been centrally planned to combat specific problems like low wages, unemployment and trade deficits. (www.cia.gov) The 1980’s economic crises: Background Argentina has suffered for almost twenty years till the end of the 1980’s poor negative GDP growth, hyperinflation. Low levels of capital investment and even huge lack of trust in its Central Bank and its National Government were also evident. Inflation reached its peak in 1989 which was estimated to be 3,000 % per annum. The GDP Per capita was said to be lower than 10% in 1980. There was also a serious deterioration of social indicators. Moreover, the fiscal deficit reached 7.6% of GDP. Several reasons were pointed out behind the long period of hyperinflation which would include among other things, unsustainable growth of the money supply to cover up the large deficits incurred yearly by successive governments. Argentina’s lack and deficient ability to participate in the world capital markets is greatly evident because of great investment risk. The financing of these fiscal deficits through their monetization is the only recourse that needs to be done. This involves the levying of the government with an inflation tax to pay the fiscal deficits. (Hausmann, 2001)4 Another reason for the instability of its currency is the domestic financial institution’s fragility and weakness. The said problem was emphasized by Argentine banking crisis of 1980. In such crisis, the Central Bank moved to confiscate the deposits from commercial banks in order to overcome problems in its liquidity to gain a breathing room. (Hausmann, 2001) Fluctuations in interest rates were also one of the significant external factors that cause more of the crisis in currency. This became evident when the United States of America imposed strict monetary policy and discipline upon its own institutions. The imposition of strict policy made it more difficult and expensive to borrow money from it made more difficult by the fact that the commercial banks had fewer reserves in the monetary market. Moreover, at other instances, interest rates were lowered by less restrictive monetary policy in the developed economies. Such less restriction resulted in capital flows to developing countries, consequently producing real exchange rate appreciation, increasing current account deficits that eventually gave rise to severe currency crises. (Hausmann, 2001) Evolution of Economy Strong nationalistic policy protected Argentina’s industry which was developed during the World War I. The said policy virtually made the country self-sufficient in terms of consumer goods production and production of many types of machinery. The United States of America, Italy and members of the European Union countries are said to be its trading partners. Both inflation and recession hurt the economy of Argentina in the past decades. However, in the early 1990’s the country has experienced unprecedented economic growth through privatization and other economic reforms but problems still existed due to rampant tax evasion and freehand government spending. In the late 1990’s Brazil’s recession and currency devaluation also affected the economy of Argentina. These combinations of circumstances lead to its economic collapse. Factors affecting the economic downturn of Argentina The following are the apparently conceived causes of economic downturn of Argentina in 1980’s and onwards: 1. Mistakes in the implementation of the pegging of the currency board; 2. Fewer economic freedom that paves way to corruption in the public and private sectors; 3. Privatization of economy hurting farmer tenants of agricultural lands; 4. Mismanaged borrowing leading to fluctuation of interest, hence the inability to pay Satisfactory results of the currency board Although the currency board has its flaws, it has nonetheless good results which may be a basis for a sound economic policy. Argentina commences its own execution of the currency board in April of 1991. After its implementation, its main achievement was in controlling inflation, a dramatic change from 3,000% in 1989 to 3.4% in 1994. (International Financial Statistics, 2006)5 Renewed economic growth is one of its major gains. The system was made to enjoy the high world prices of primary products in the form of Argentina's main exports. The Gross Domestic Product or GDP also went high at a yearly rate of 8% from 1991 until 1995 during the said Tequila Effect. The annual growth rate was even 6% until the 1998 Mexican crisis. Therefore, growth is evident. (Hausmann, 2001) International trade reflected the growing degree of the country’s liberalization. Imports and exports increased in billions of US dollars from 1991 to 2000. The negative effects of the currency board The existence of impressive result would not however warrant the non-existence of social setbacks of the currency board which included among others, increased unemployment and poverty levels and unequal income distribution. Unemployment can be traced to the extraneous effort of the local firms to invest in advance technologies because of foreign price competition, hence the requirement of less labour and higher productivity. (Hausmann, 2001) There was also no showing of any improvement on income distribution. This is shown when the participation to the national income of the bottom 20% of the population decreased from 4.6% in 1991 to 4.1% in 2000, while 20% of the upper top of the population accordingly increased its share in the national income from 50.4% to 51.4%. (Hausmann, 2001) Initial reactions to inflation tax were good as the hyperinflation receded, but after the Mexican crisis came into picture, the trend turned turtle. Overall wage increase did not benefit equally all the workers since managerial and professional income groups earned far behind both the skilled and unskilled workers. (International Financial Statistics, 2006) As a result of the above problems, the debt of the government went high rapidly. The government’s not being able or unwillingness to raise taxes, and prevented from printing money as a policy of the currency board system, its remaining recourse is the funding of its budget scarcity by issuing debt tools and means in the open markets. As a consequence, a quick raise of the public debt from 29.5% of GDP in 1993 to 50.3% in 1999 emerged. (Hausmann, 2001)The debt is in the figure of foreign money since local reserves are noticeably low in spite of the large inflows of income and profit from the proceeds selling of the formerly-owned state companies. Accompanied with the swelling in public debt was also the soaring in the debt service ratio, accounting from 22% in its exports in year 1993 to 35.2% in the year 1999 paving way to an escalating current account deficit. (International Financial Statistics, 2006) Limited economic freedom leads to corruption in the public and private institutions Economic freedom, according to The Heritage Foundation/Wall Street Journal annual Index of Economic Freedom, is "the absence of government constraint or coercion on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty itself."(Eiras, 2003) 6 The economic freedom index measures contain fiscal load of the government, the economy is intervened by the government, monetary policy, trade policy, banking and finance, property rights, wages and prices, informal market and regulation. Studies have shown a great correlation between economic freedom and corruption. As economic freedom vanishes, corruption flourishes. (Eiras, 2003) In the case for instance of Argentina, under its labour laws, an employer must grant several employee benefits which include vacations, sick leave, holidays, health insurance, an annual bonus, paid overtime, and back pay. This only shows that whether or not an employee performs well in his job, he shall get the benefits provided for by law. This in turn will promote reluctance and leniency on the part of the employee in performing his job which encourages corruption (i.e. deduction in the amount of time of work or wanton disregard of the efficiency required by the nature of the work). Moreover, the bureaucratic form of government of Argentina encourages its subjects not to abide with the stringent rules of processing papers or documents but to proceed with the shortcut method by simply bribing public officers to expedite their respective transactions with the government. In addition to such bureaucratic processes, the stringent and excessive imposition of taxes poses a restriction on economic freedom of the subjects of the State thereby inducing the same to create illegal mechanisms to avoid paying taxes. Hence according to a study, 75% of Portenos who lived in Buenos Aires do not pay the correct bus toll, 70% have illegal cable connection or that 90% pay their way out of traffic tickets. (Eiras, 2003) Survival in a corrupt country requires a citizen to develop a scheme to cope with such, which scheme develops a corrupt practice itself, for it is said that a person who fails to act corruptly in a corrupt country will end up poor. Thus the government must impose such measures as to give more economic freedom to its subjects and lessen the bureaucratic form of legal processes and licensing. To this view, for corruption and informality to decrease in all possible areas of the economy, countries must advance economic freedom with particular emphasis on regulations affecting small and medium business. Privatization of economy hurting farmer tenants of agricultural lands The recent privatization of previously state-owned lands has led to some commotions on the part of tenant farmers of these agricultural lands. Since Argentina is an agricultural country, the livelihood of many tenant farmers has been affected by the massive privatization of the agricultural lands, which hurt their income hence, contributing to their poverty and misfortune. This has a strong nexus with the fact that land owning is still dependant on a subtle system of feudalism where the super rich get to enjoy ownership. In case of China, the factors of production lie more or less with the individuals due to a more equitable sharing of the land and other factors. This has evolved due a more centralised system of economic and fiscal planning. Mismanaged borrowing leading to fluctuation of interest, thus the inability to pay The issuance of money of the Argentine government to cover its fiscal deficits for the past few years resulted in rampant inflation. This has leaded the government to borrow money from foreign nations to finance its deficits. However, the borrowing went uncontrolled resulting in the fluctuation of interest. As a member of the World Trade Organization (WTO), Argentina has reaped benefits in the form of attracting foreign investors or foreign markets which significantly contributed to its liquidity. Conclusion: Applicability to China The previous pages have exhaustively discussed the major causes of the economic downturn of Argentina. The concepts thus discussed above apply to China in a sense that China possesses the same geographical qualities as Argentina (i.e. being primarily an agricultural country). China also possesses a bureaucratic government and is currently in the process of privatization of its agricultural lands. Hence, to avoid the ills that the Argentine government has experienced, China must establish a currency board which has no restriction on capital account transactions or current account transactions. More importantly, such currency board must abide strictly with the rules on currency pegging. Moreover, it must make sure that its currency be pegged with a stable currency and/or that currency which reflects its major trading partners. It must not seek to privatize agricultural lands to the prejudice of the tenant farmers leading the same to incur opportunity cost and restricting them with their means of livelihood, thus reducing their income. China must also develop economic freedom on almost all sectors of its economy to avoid and lessen the evil of corruption and must manage its foreign borrowings to avoid fluctuation on interest on loans. It is said that China, being a member of the WTO has experienced benefits there from by attracting foreign investors and foreign markets. China is now being courted by the major economic nations for investment. All of these methods may improve or strengthen China’s fiscal and monetary reform and all must always be coupled with a pure heart of implementers to achieve the desired success. References: 1. Gerardo della Paolera, Alan M. Taylor, (January 2003) Working Paper 9457, URL: http://www.nber.org/papers/w9457, NATIONAL BUREAU OF ECONOMIC RESEARCH, 1050 Massachusetts Avenue, Cambridge, MA 02138 2. The World Fact Book – Argentina. URL: https://www.cia.gov/cia/publications/factbook/print/ar.html 3. World Fact Book – China. https://www.cia.gov/cia/publications/factbook/geos/ch.html#Econ 4. Hausmann, Ricardo. (October 30, 2001). A Way Out for Argentina: The Currency Board Cannot Survive Much Longer. Financial Times. 5. International Financial Statistics. URL: http://library.ust.hk/info/db/ifs.html 6. Eiras, Ana Isabel, (2003) Ethics, Corruption and Economic Freedom. Heritage Foundation. Read More