Global Crisis, Local Effects: How does the financial crisis affect Argentina and other developing countries?

Note: this post was originally written for the World Business Dialogue official blog (not online yet, but I'll let you know when it is). That's why you may find it a little longer and more technical than usual posts.

We are all aware of the fact that the current crisis (probably the worst since the
Great Depression) started in the US financial market which is the center of a network of interconnected financial systems. As a consequence, the crisis spread rapidly and became global in nature. Nevertheless, the impacts and effects of the crisis vary from country to country because they have different institutions, economic structures, idiosyncrasies and histories which condition the macroeconomic outcomes. Today, I will discuss a little bit how the crisis affects developing countries in general and Argentina in particular.

To begin with, there is a fundamental difference in the way financial crises arise in developed and developing countries. In developed countries, they follow a classical Minskyan boom-and-bust cycle governed by endogenous recurring elements which are the agents’ risk perceptions and expectations (this model successfully explains how the current crisis was originated in the US). On the other hand, in developing countries, there is an important differentiating aspect which is that the booming cycle is not triggered by internal financial innovations. Instead, it is driven by macroeconomic policies that promote speculation and arbitrage between domestic and foreign assets. A typical example of these policies is the predetermination of exchange rates which triggered the Argentinean financial crisis in 2001. Nevertheless, we have already stated that the current crisis was originated in the US. As a consequence, this point is not strictly relevant for the current analysis but should definitively be taken into account when adopting measures towards global sustainability.

Another crucial aspect to analyze is the way the current crisis was transmitted from US to developing countries. Probably the main transmission channel for developing countries that specialize in manufacturing and services was the contraction of the world trade volume. Other countries that specialize in primary industries (such as Argentina with its cattle farming and agriculture) were strongly affected by the decreasing trend of commodities’ prices particularly since the end of the commodity price boom in the middle 2008. In the financial field, we have the combined effect of the clash of multinational companies that bring down stock prices all over the world plus the rapid spread atmosphere of uncertainty created by the partial failure of big investors’ portfolios. A last transmission channel for the crisis (not important in Argentina but with some relevance in smaller countries of Latin America) are the remittances. With this I mean that with a less active US economy, the money that immigrants can send to their families in their home countries decreases, consequently affecting these countries’ economies.

In addition, there is an essential difference between developed and developing countries concerning governments’ capabilities to conduct stabilization policies once the financial crisis is made evident. In developed countries, the crisis generally entails an increase in the demand for money and public bonds which are considered safer assets than risky banks, shares or stock options. Hence, the financing of public expenditure towards economic reactivation is promoted. Whereas in developing countries, the people do not consider their domestic public bonds and money as safe assets, so they demand developed countries’ money and bonds. Thus, the recent financial crisis led to an outflow of capital from developing to developed economies.

Particularly in Argentina, this decrease in domestic capital for economic reactivation and other public expenditures with more political objectives, led the government to take a set of decisions which exacerbated the effects of the crisis to fields outside the economic and financial ones. To start with, an increase in the withholding taxes to the agro industry provoked a massive strike causing the exportation of the national main industry to cease for months, entailing unfavorable effects for the whole economy and some social tension as well. Moreover, the public office in charge of statistics lied about the inflation index in order to maintain the virtual value of the domestic money but instead brought a popular disbelief in the official information. In addition, these policies and others were taken directly by the executive power (because they were considered “emergency measures”) and did not follow the conventional legislative path. This brought unreal division of powers, causing an institutional crisis and a regulatory environment too unstable to attract foreign investors.

In the near future, Argentina and many other developing countries have to work really hard on different aspects if they want to emerge in a relatively favorable position from this crisis. Among the most important aspects to work on, I would highlight the need to improve the external image by serious long term political planning and solid institutions that will attract foreign investors. Furthermore, in a world were the Keynesian concepts in contexts of uncertainty are regaining prominence, economies should rethink the relevance of domestic markets and regional integration (such as Argentina in the MERCOSUR). Nevertheless, in order to reach an effective integration, regional political conflicts must be overcome once and for all.