Guest Authors: Pablo Schiaffino (head of research studies at the University of Palermo) and Jose Luis Machinea (dean of the school of government at the University Torcuato Di Tella and former governor of Argentina’s central bank and minister of the economy of Argentina). The University of Torcuato Di Tella and the University of Palermo are located in Buenos Aires.
A previous version if this article was published Monday 29 November 2010 at The Guardian under the headline “Argentina’s hard lesson for Ireland.” The sub-title was: “Failure to meet the IMF’s conditions had dire consequences, but Argentina’s real problem was that its bailout wasn’t big enough.”
From an economic practitioner’s point of view, Argentina in 1999 and Ireland in 2010 are quite similar. Both countries face a lack of competitiveness as a consequence of an appreciation of the exchange rate, a recession and a large fiscal deficit (Argentina’s was -4.7% of GDP and Ireland was 14.6% in 2009). Like Argentina 11 years ago, Ireland is now suffering the consequences of the lack of international financing related to the uncertainty about the sustainability of its debt.
The obvious answer to deal with these issues would be a depreciation of the exchange rate. But this is not an option in the case of Ireland, since it is tied in to the European currency. Similarly, at that time in Argentina, currency depreciation did not seem a conceivable option.
Throughout the nineties, Argentina had maintained a convertibility programme which tied the peso at a 1:1 rate to the US dollar. Under this arrangement, most contracts were denominated in dollars, meaning that everything from account balances to deposit, bonds, loans and rents were all established in dollars. To abandon convertibility meant breaking all contracts and generating instant economic, social and political upheaval.
Wage and Price Deflation
If currency depreciation is not an option, then the bad news for Ireland is that wage and price deflation, combined with structural reforms, are the only way to restore external competitiveness. So, getting out of the crisis will take time and generate an unpopular political agenda.
Austerity and Default
If successful, the economy will be set on the path to recovery. However, the short-term issue is to get access to financial markets at both the public and private level. In order to maintain the very functioning of government, urgent measures are required. Since these measures imply a drastic reduction in the fiscal deficit, they will not help to move the economy out of the recession; but without them, there is a risk of debt default and even deeper recession.
The option of seeking financial help from the IMF, at least in theory, would reduce pressure from the financial markets. Usually, however, support by the Fund comes with tough restrictions and goals – as Milton Friedman famously put it, “There is no such a thing as a free lunch.” The last European example was Greece, where the stand-by arrangement, according to the IMF press release, includes:
“1) Restoring confidence and fiscal sustainability (this is to bolster confidence, regain market access and put the debt-to-GDP ratio on a declining path); 2) Restoring competitiveness (the programme includes nominal wage and benefit cuts and structural reforms to reduce costs and improve price competitiveness, which would help Greece transition to a more investment and export-led growth model); and 3) Safeguarding financial stability.”
Generally speaking, the IMF tends to lend conditionally on these terms. The difficulty with these goals and economic objectives is that they can be hard to achieve. Greece has the onerous task of trying to reduce its fiscal deficit from the 2009 level of -8.6% of GDP, to a surplus of 3.1% in 2013. In addition, it is expected to make a reduction of the current account deficit from 11.2% to 4.0% in the next three years.
What if IMF Withdraws?
Similar cases from the past are easy to find, and this is where the Argentine case sheds light on the issue. During 2000 and 2001, Argentina failed to satisfy IMF conditions and support was withdrawn. Previously, the quarterly goals and corresponding revisions had generated day-to-day uncertainty that impacted adversely on the financial markets. In the end, those markets virtually ground to a halt. Investors feared Argentina’s inconsistent ability to satisfy IMF demands and decided to stop lending. The economy then fell into debt default and recession, with immediate consequences for ordinary Argentines. Social chaos ensued as the rate of unemployment and poverty rose dramatically, while the number of presidents in one week scored a record five.
Argentina had Many Problems
It is fair to mention that the problem did not come strictly from IMF demands, as the economy had suffered from other internal problems, as well as a tough external environment. At that time, Argentina faced record low commodity prices; close to record appreciation of the dollar; a devaluation of the real (the currency of Brazil, which was Argentina’s largest trade partner); and high international interest rates.
But there are significant differences in the present case. The IMF is showing more flexibility than it did in the past, at least in Latin America; and Ireland is not Argentina. As part of the EU, the relationship between Ireland and the IMF should, in theory, be more “friendly”. In Ireland’s case, the European club might persuade the Fund to relax some of its targets – the conditions of IMF assistance.
Comparisons to Greece
Greece’s experience, however, suggests that EU membership does not necessarily confer special privileges – as Greece’s stand-by arrangement looks even more draconian than the traditional IMF programme, like the one applied to Argentina (although, it should be noted, the Greek situation is substantially worse).
Besides, if Ireland has to go back to the financial markets in the very short term, the “good will” of the EU and the Fund will not be enough, because the markets themselves are setting tough conditions. Although these demands strike us as excessive, there are no other options for Ireland in the near future. If “good will” alone will not do it, the IMF/EU must bale Ireland out with enough money for Ireland to survive without going to the markets for several months, perhaps for one year. If not, the short-term support will only delay the inevitable – and the real problem will be far from over.
What are the alternatives, if any? One possibility is debt restructuring. In a case where the EU does not support this option, the consequences would be costly. It might also cause a domino effect across different European countries. Equally, debt restructuring is not a solution for the competitiveness problem, even if this is not so severe an issue in Ireland as in Greece.
Leave the Euro?
The final option would be for Ireland to abandon the euro and regain control over the monetary policy. This option would probably also be associated with debt restructuring. Without the support of the European Community, though, quitting the euro would come at extraordinarily high political and economic cost – including, almost certainly, being dismissed from European club membership. At least in the short run, this choice would be disruptive, recessive and would further rock the markets with adverse sentiments.
The Best Option
More advisable would be a joint venture between the IMF and the European Union, establishing manageable objectives combined with sufficient financial assistance. If the measures demanded are too restrictive, the most likely outcome would be to suppress growth in the economy, as aggregate demand is severely constrained. Excessively harsh conditions imposed on Ireland’s economy could hamper economic recovery – as was the case in Argentina. The difference in Argentina was that a lack of sufficient IMF funding at the beginning of the programme was a more severe constraint than the conditions imposed to reduce the deficit.
Finally, if enough financial help is provided, Ireland will have the chance to restore confidence without issuing new debt in the coming months. As part of the agreement, the Irish authorities must commit to the established measures, avoiding discretionary decisions. But even everything goes according to plan, the road to regain confidence will be long, very long.