Although the media has steadily turned its attention away from the country’s high levels of drug violence, recent developments show the situation has experienced a further deterioration in relation to the already bloody first half of this year, and more so in relation to the previous year.

According to statistics from newspaper Milenio, this October registered 840 drug-related executions (DREs), becoming the second deadliest month in the country’s history of drug violence after a record high of 854 DREs set in July 2009. The total DREs registered this year from January to October (6,714) represents a 55.2% increase over the same period in 2008 with only 4,325 DREs. In fact, the number of DREs counted this year has already surpassed the total DRE’s registered last year by 1053.

The execution of law enforcement has also experienced a notable increase during this year in relation to 2008. Security authorities report 1,221 policemen and 111 soldiers executed during the first 10 months of the year. The majority of these DRE’s have taken place during the second half of the year.

Unusually violent methods

In this new wave of violence, drug cartels and their hired guns are using more violent methods against their rivals, including law enforcement. Although torture is a common experience in many DREs, the number of executions displaying signs of torture has dramatically increased to 1,312 cases registered during 2009. Similarly, cartels have become more violent in their message to authorities and their rivals, leaving severed bodies and their limbs in public sight with increased frequency.

Hotspots and spikes of violence

Despite noticing a slight descent in DREs during this month, Chihuahua registered again the highest number of DREs across country with 388 deaths. The bulk of these executions have taken place in Ciudad Juarez—the country’s most violent city for a long time.

High numbers of DREs continued in the usual hotspots of Baja California, Durango, Guerrero, Michoacan, Nuevo Leon, Sinaloa, and Sonora and Tamaulipas. DREs in these states along with Chihuahua represent 81.2% of the country’s total through 2009. Other states with usually low levels of violence, notably Guanajuato and Morelos have registered important spikes in DREs during the last two months.

Analysis

These trends have defeated even some of the more pessimistic projections about the levels of violence. According to a number of hypotheses, a steady reduction in DREs was expected as a result of increased military deployments in different states—particularly in Chihuahua, but also because of an underlying belief that drug violence had already reached a peak and therefore would follow a pattern of descent.

The increased presence of the Mexican army in the usual hotspots has rarely been accompanied by a sustained reduction in the levels of violence. In March of this year, the Calderon administration deployed 7,000 additional soldiers and federal police to contain the spiraling violence in this northern state. Subsequently, in June another 2,000 soldiers were sent to reinforce security in Chihuahua, while the Ministry of Defense announced a change in strategy whereby the army would do more intelligence work—to no avail. Needless to say, the military influx has not shown the desired results, but it actually seems to have led to more violence.

On November 12th, a group of business representatives from manufacturing and other industries located near Ciudad Juarez stated their intention to request the presence of the United Nations’ Blue Helmets in the region. According to the businessmen, the high levels of violence have forced many businesses to close down or move to other regions which offer better protection to its citizens. While the UN has already discarded the possibility of sending its peace corps to the region because this is only applicable to war zones, the latter is a fair indication of the gravity of the situation in the border city and the incapacity of the state to guarantee security for the average citizen in this violent region.

Drivers of Violence

The escalation of violence is a common phenomenon associated with growing drug activity and competition among cartels. Yet the main factor behind the dramatic increase of late in the levels of violence is directly linked to the government’s decision to wage a full war on the drug cartels.

By striking the cartels and invading their zones of influence, the Mexican army has forced a large-scale restructuring of the cartels. This strategy launched by the Calderon administration also diminished any existing “understanding” between cartels and state or local governments, and the criminal organizations can no longer rely on local protection.

At the same time, cartels have continuously tried to exploit setbacks of their rivals by venturing into their zones of influence. The weakening of the previously established rules and structures has actually brought more violent groups into the fray that are trying to increase their share of the market, and which rely on increasingly cruel methods as a way to inflict fear among its rivals—including the Mexican state.

Media’s Soft Coverage

Several sources explain the Mexican government has tacitly asked media conglomerates to soften their coverage on the subject of spiraling drug violence, namely to protect the country’s image and tourism-related industries.

The government’s request is not without legitimate reason. Drug violence was indeed being reported in a sensationalist manner by national and international media, particularly earlier this year. On the other hand, the same type of media coverage is not given to dangerous cities in the US with historic levels of gang violence. However, In compliance with this request, it seems like the media has shifted from sounding alarms to relative indifference.

This strategy to underplay drug violence carries a series of implicit risks. First, it reduces pressure on the Mexican government to diminish drug violence and related criminal activity, but also to pursue strategies other than direct confrontation (i.e. seizing financial assets, improving intelligence). Secondly, this strategy might provoke a backlash whereby the sustained escalation of violence suddenly gets more attention and disqualifies the government’s strategy and efforts against the cartels. In this case, international media coverage would resurge to expose the failure of the government to reduce the levels of violence.

Weakening of la Familia?

Since the clash between La Familia and the federal government that left 13 federal policemen and two soldiers dead in Michoacan last August, security elements have intensified their hunt for the leaders of the Michoacan-based cartel and its cells around the country.

This effort has achieved relative success. While the government has successfully disarmed many of the cartel’s cells operating outside of Michoacan and some cartel lieutenants in the state, authorities have not been able to capture the key leaders of the cartel.

In a separate yet interconnected development, on October 22nd the US government announced the arrest of 403 members of La Familia operating in the US, as part of a large-scale operation across 19 states in the US. According to the US government, the recent arrests completed a total of 1,200 arrests against members of La Familia operating in the US territory over the last 4 months. These cartel’s main activity was the distribution of amphetamines across the US.

These recent developments suggest the structure of the Michoacan-based cartel has been substantially weakened after more than three months of consecutive blows. The operation in the US resulted in the confiscation of nearly US$33.0 million in cash as well as drugs, arsenals, and other property.

Lack of Finance Intelligence Persists

At this time, the celebrated arrests in Mexico have not resulted in the major confiscation of financial assets that could inflict deep pain in the Michoacan-based cartel. As discussed in previous reports, the cartel’s power resides in its strong financial resources.

Without inflicting damage on this end, cartels quickly recover from the arrests and confiscations of merchandise. This is the case of the Tijuana Cartel, which after substantial blows during 2007-2008 has undergone an impressive recovery and perhaps strengthened its sway in its territory.

Although the government has no other choice but to wage a war on the cartels, the recent blows to La Familia are likely to bring about increased violence in Michoacan, Guerrero, Morelos, Guanajuato, and Mexico City—the states where the cartel operates. This will happen as a result of other cartels wanting to exploit La Familia’s temporary weakness and invade its zones of influence.

Outlook: Levels of Violence To Escalate Further

Considering the trends observed in recent months, we foresee DREs staying at very high levels, potentially surpassing the 800 mark before the year ends, and certainly surpassing this mark in the first quarter of 2010. Overall, we don’t see violence descending throughout 2010. The latter will be a topic of an upcoming report.

For the Mexican government, the sustained escalation of violence observed during the second half of 2009, along with the increased cruelty of cartels, poses a very serious challenge regarding the effectiveness of its strategy. As we have suggested before, as long as the current strategy of confrontation is not accompanied by the necessary financial intelligence that allows authorities to strip cartels of their financial assets, the ongoing trends of violence are poised to continue.

Finally, just as it happened during the first months of 2009, the persistence of high levels of violence might catapult the Calderon Administration in the coming months into a field of massive criticism—sending waves of alarm around the world about the security situation in the country. Yet, this time around, such criticism would be more justified.

Editors Note: The Following RGE premium content, "Latin American CDS: Fully Recovered, What are the Risks?" is available to paid clients.

Bertrand Delgado, Elisa Parisi-Capone and Alejandro Rivera, take a close look at Latin America’s 5 year CDS fundamental and counterparty risk dynamics.  They examine the extent to which counterparty risks explain the sharp movement in CDS spreads both during and after the crisis.  

In this year of global recession, fiscal policy has been able to play a supportive role in some countries of the Latin America and Caribbean (LAC) region.  Even as the downturn caused fiscal revenues to fall, many governments were able to avoid cutting expenditure, and some were able to provide a sizable positive fiscal impulse, actively raising expenditure to provide a boost to domestic demand and GDP.   

This is especially clear among the group we call “commodity exporting, financially integrated countries” (see Figure). Fiscal policy is also playing a countercyclical role in a number of other countries in 2009.  In contrast, some of the region’s other commodity exporting countries—which in general had implemented a procyclical fiscal policy during the previous years of expansion—continue to do so in 2009, with negative fiscal impulses.

And most of the LAC region’s tourism intensive countries are also implementing a procyclical policy, again similar to their previous record.

The different fiscal policy responses this year are not a surprise, but relate to differences in the conditions and policies prevailing in more favorable times. Countries implementing countercyclical fiscal policies in 2009 are those that have the ability to do so.

This is the notion of fiscal space, related to the availability of financial buffers, and the ability to access international capital markets even during bad times, a privilege associated with stronger track records of fiscal discipline—including by having achieved larger fiscal surpluses in the pre-crisis period, when revenues were booming.

Countries with larger debt ratios, lower debt ratings, lesser access to financing or their own financial buffers have less space to conduct countercyclical fiscal policies. In some cases, these restrictions are related to past patterns of rapidly increasing expenditure when rising commodity export prices deliver revenue windfalls.

This year’s experience highlights the value of strengthening fiscal policy frameworks in the future, so that all countries can be better prepared for future episodes of unfavorable conditions.  For a discussion of these policy issues, and a detailed analysis of policy responses to the global crisis, see the October 2009 edition of the Regional Economic Outlook for Latin America and the Caribbean.

Other blogs in this series:

The Commodity Connection: Rising Commodity Prices and the Outlook for Latin America and the Caribbean

Latin America and the Caribbean During the Global Crisis: Better than the Past, Better than Other Regions

Why Did Latin America Do Better in This Crisis? The Benefits of Being Prepared

Spanish versions (Version en español):

La recuperación de los precios de las materias primas y su impacto en las economías de América Latina y el Caribe América Latina y el Caribe durante la crisis: Mejor que en el pasado y que otras regiones ¿Por qué América Latina tuvo un mejor desempeño en esta crisis? Los beneficios de estar preparado

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.         

Event

On the night of October 11^th, the federal police surrounded the headquarters and power plants of Luz y Fuerza del Centro (LFC), the decentralized supplier of electricity. The move was part of a takeover plan ahead of the Oct 12^th announcement regarding the elimination of the state-owned electricity company.

The reason for a surprise takeover by federal police was to prevent any resentful workers from barricading inside the building in an effort to resist the decision. More importantly, it prevented unionized workers from interrupting service, as they had often recurred to this threat in order to negotiate their yearly salary increases. The takeover was strategically planned to catch LFC workers unprepared as they celebrated Mexico’s soccer victory over El Salvador, which granted the national team its pass to the 2010 World Cup in South Africa.

Subsequently, President Calderon published a decree in the official journal listing the considerations behind the decision to close down LFC. The Executive’s decree provided a summary of the company’s economic inefficiencies, managerial discrepancies, and failure of the union to abide by the series of agreements signed with the government to improve its competitiveness. The latter constituted the legal case against Luz y Fuerza:

“The Law of State-Enterprises establishes a cause for extinction of a decentralized agency created by the federal government, if this agency stops fulfilling the goals for which it was created, or its functioning is no longer viable from the point of view of the national economy and the public interest.”

In conclusion, the decree stated the effects of the global financial crisis have left the Mexican government with few options to avoid a further deterioration of public finances, and it was imperative for the government to make the right decisions to ensure an efficient use of public resources.

Needless to say, the decision to close down LFC was repudiated by the Sindicato Mexicano de Electricistas (SME), the company’s union. Martin Esparza, the union’s de facto leader, immediately began organizing a resistance movement while exploring other alternatives to challenge the Executive’s decision and exert pressure on the government of Felipe Calderon.

On October 13^th, the Ministry of Energy confirmed it would be the Federal Electricity Commission (CFE), also a state-owned enterprise (SOE), that will take over the operations of Luz y Fuerza in Mexico City and other serviceable zones.

Significance

The closing down of Luz y Fuerza is no doubt one of the boldest if not most difficult political decisions taken by President Calderon during his term. Successive administrations have failed to reform LFC, given the threat of a frontal clash with its powerful union and the political and economic ramifications.

For more than two decades, LFC was Mexico’s worst performing state-owned company. While the CFE has become a world-class electricity company, LFC increasingly deteriorated. In spite of this, LFC was able to maintain one of the most advantageous collective contracts, given the constant danger of a clash with the union and the possibility of interrupted service.

Regardless of any political benefits for President Calderon, the decision opens a battle front of social discontent which could instigate political instability.

Early Timing

Although there were rumors about the closing down of LFC a few weeks before it actually happened, these had been dismissed by the union’s leadership as a government strategy to induce fear among the SME, as it was believed the government of Felipe Calderon would not dare to take such action given its background of yielding to unions. As such, the decision to take over the headquarters was received as a big surprise nationwide.

Background

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This week we are offering another preview of our global economic outlook for Q4, which will be released to RGE’s clients later this month. The following is a sample of our analysis on Latin America. The full version of the outlook goes into greater detail and includes RGE’s country-by-country projections for economic growth and several major indicators.

RGE maintains the position we took in our July outlook: Latin America will recover in 2010, but its expansion will likely be below potential. Given aggressive foreign and domestic policy responses in Latin American countries, the region is stabilizing in H2 2009 after having contracted severely in H1 2009. Although global and regional economic and financial conditions will likely improve in 2010, RGE expects the pace of external and local demand revival to be measured. Commodity prices will stay on hold in the middle ground between record highs and recent lows, mainly because of below-potential recovery in the U.S. and advanced economies, as well as in China. Though global liquidity will remain elevated in the upcoming quarters, favoring LatAm asset classes, market anxiety about the timing of exit strategies around the world represents a significant risk. Miscalculations in exit strategies and disappointing economic results pose the main risks to LatAm market dynamics in 2010.

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The Mexican army’s increasing role in the war against drug cartels has prompted concerns about a potential overstretching of its deployed troops and the impact this could have on morale as well as the army’s capabilities for traditional responses, including natural disaster relief and stationary deployments for guarding strategic facilities and infrastructure such as oil pipelines.

During the Calderon era, the number of soldiers assigned to antinarcotics operations has almost doubled from 23,000 to 45,000. At the same time, the number of soldiers deserting the army has increased to unprecedented levels, without the Federal Government taking meaningful steps toward reversing this trend or making the army more efficient.

The army’s reputation as a professional, well-disciplined force is being eroded as respected watchdog groups, such as Human Rights Watch and Amnesty International, document escalating allegations of human rights abuses by the Mexican military.

Background

According to statistics from the Ministry of Defense (SEDENA), between January 2002 and December 2006, more than 140,000 soldiers deserted the Mexican army. Although to a lesser degree, this trend has continued into the Calderon era with at least 48,000 soldiers deserting between in 2007-2009, despite improvements in salaries and fringe benefits during this era. While the majority of desertion has taken place among low-ranking troops, the number of army specialists deserting is on the rise—a previously unseen phenomenon.

The first part of this report looks into the causes of desertion and the impact this might have on the army’s capabilities for traditional responses as well as in the war against drug cartels. The second part of this report takes a broad view of the army’s structural problems and other emerging factors, which will be obstacles for the army’s performance in the long run.

Causes of desertion, low morale, and corruption

Sources interviewed for this report concur this is rooted in the army’s low salaries and poor working conditions, which are particularly acute for low-ranking troops with a poor educational background. Another related factor is distance from family; it is not being far away from family per se that discourages the troops, but the fact that travel expenses paid by the army are minimal (often less than 15% of total). Thus, the farther a soldier is stationed away, the more expensive it is for him to visit his family.

Sources cite the principal reasons for low morale are the many sacrifices imposed by the army’s involvement in the war against drug cartels. During the Calderon era, the number of soldiers assigned to antinarcotics operations has almost doubled from 23,000 to 45,000; plus 5,000 navy and 5,000 transferred from the army to the federal police.

Army rotation as a cause of desertion and low morale

The rotation of deployed troops is yet another disincentive to be in the service. Deployed soldiers could spend from three to eight months in particular areas, depending on the risk of becoming corrupted. However, sources agree that rotation itself is not the core problem, but rather the places where soldiers are deployed, as well as the conditions in which soldiers are forced to live.

Relocations to zones under stress (i.e. trafficking routes with a presence of violent groups, hostile or isolated communities) expose soldiers to extra dangers and burdens. Sources note these relocations often necessitate living in makeshift facilities that further alienate new recruits, who are often employed to do manual labor such as destroying drug crops and patrolling strategic points in remote territories, such as woodlands and deserts.

This type of rotation* has always been a common practice for troops assigned to particular missions such as destroying crops of marijuana or poppy seed. However, as the war against cartels has taken a greater dimension, so has the number of troops which are being deployed and rotated. Although these military deployments are often relaxed by retraining, vacations, and less stressful or administrative activities, the deployments of troops nowadays are more frequent, more exhausting, and not necessarily followed by any of the relaxing activities mentioned above.

[* Not to be confused with the "policy of rotation,” which only applies to higher posts of the army. This policy was designed to prevent the higher ranks from being corrupted by the cartels, local politicians, or powerful landlords, and/or from acquiring extraordinary powers in the zones where they operate. The principle is the same, however rotation of higher ranks usually happens every three to six years, depending on the nature of the appointment.]

Now with increased frequency, deployments to conflict zones expose the military (mostly lower- and middle-ranks) to threats against their lives or their families, a previously unknown phenomenon.

Finally, soldiers in the war against cartels are increasingly used for short-term, highly dangerous missions (i.e. capturing drug lords or large confiscations) where the probability of clashing with heavily armed groups is imminent, a risk for which there is little reward.

Other related factors of desertion and low morale

There have also been some legal issues about the transfers from the army to reinforce the federal police, which have divested soldiers from some of the benefits they had in the army. The latter was a key factor in soldiers deserting the army during the Fox administration, but the problem still persists (“Desertan del Ejército uno de cada cinco militares,” El Financiero, March 12, 2009).

Desertion, Deployment Rotations: Implications on the Mexican Army’s Capability

Despite the high rates of desertion, both military and academic sources indicate the army does not have a shortage of human resources that could jeopardize its performance in case of an emergency, nor does the frequency of rotations constitute a serious threat to military responsiveness or mobility. These sources confirm the army has given a high priority to preparing for multiple complex scenarios involving natural disasters such as hurricanes and floods. For this purpose, the army maintains a specific number of soldiers stationed in each one of the country’s 12 military zones, which vary according to probability of disaster. This plan is known as DN3 (Defensa National 3) and it involves constant planning and re-training of soldiers. These soldiers are independent from those troops involved in anti-narcotic operations. Thus, according to sources, a challenge posed by natural disasters can easily be managed by the army.

However, two different sources believe that the size of the Mexican army (which consists of 200,000 ground troops ready for deployment, but no reserves) is small when geographic and demographic factors are considered. One source states that if the lawlessness and high levels of violence in certain regions or cities—such as Ciudad Juarez in Chihuahua State—are considered as a potential source of instability, then the number of soldiers currently being deployed to these hotspots is extremely small. This source notes that, according to a number of military doctrines, there should be one soldier per every 50 inhabitants in a conflict zone. However, in Ciudad Juarez, which has two million people, the army has only deployed 7,000 soldiers (plus 3,000 police) to reinforce security—the latter being the largest contingent in a Mexican city. Yet, according to that previous assessment, there should be at least 40,000 soldiers in this area.

Of course, even doubling the number of troops currently deployed to the most serious hotspots would entail a great deal of problems. It would effectively overstretch the army, but more importantly this would be politically impossible for a number of reasons that relate to the army’s performance and unethical conduct.

Nevertheless, increasing the size of the army does not seem to be a priority. Despite the high levels of desertion, it was not until this year that the Mexican army increased its recruiting posts from 380 to 450—still a small number (“Refuerza el Ejército plan de reclutamiento,” El Mañana, February 7, 2009). The army has not undertaken a more aggressive recruiting campaign (i.e. using mass media) simply because it has no shortage of elements.

Joining the Enemy’s Ranks

According to experts, a more acute problem faced by the army today is not overstretching or desertion per se, but the scores of soldiers that leave their ranks to join the cartels—a trend that has been on the rise since the early 1990s, when Mexico’s largest cartels began experiencing an unprecedented expansion. Even with a low-level of training, deserting soldiers bring with them a great deal of knowledge from the army, including secret codes.

At the very least, military recruits have shooting and tactical skills, and they possess more discipline and technique than the average  civilian working within a given cartel.

The biggest risk comes from a small percentage of deserters who are experts in a particular field. Although there is no accurate estimate of how many deserters have joined with the enemy, recent detentions of members from the Zetas indicate a presence of former military specialists of which many have come from an elite group known as the GAFEs (Grupo Aeromovil de Fuerzas Especiales). The GAFEs unit was created to address the insurgency in Chiapas back in the mid-1990s. These elite soldiers also have training in skills which are often used to corrupt soldiers in the service.

One source recalls a large number of pilots who have deserted from the Mexican navy, in which case the navy has no information on their whereabouts. Because of the shortage of resources in the army and particularly in the navy, chasing after deserters to bring them into martial court is rare.

Despite mounting evidence of corrupt army elements, this has not prompted any structural changes or incremental reforms to reverse this trend. As one source notes with irony: “Mexico is perhaps the only country in the world where the state knowingly recruits and trains personnel for its own enemy.”

Training, Ethics, and Human Rights Violations

Deploying the army against the cartels has also exposed a series of problems that relate to the historical low-level of education and poor training of recruits. National and international journalists as well as the media and several human rights watchdogs have documented a large number of cases involving rapes, arbitrary detentions, extortion, torture, kidnappings, and murders of civilians by the army.

One of the sources states the Mexican Army is increasingly acting unlawfully: for example, executing cartel members that could and should have instead been arrested. In such incidents, the army is acting methodically like the cartels—“picking up” cartel members to torture them and tossing their bodies to have a scene appear like the work of a rival cartel. The source argues that these unethical methods explain particular attacks against soldiers, notably the discovery of the decapitated bodies of 12 soldiers in December 2008 in the state of Guerrero, as a vendetta by those cartels whose members have been executed.

Deficient Recruiting System

Most of the security experts interviewed for this report concur this problem of desertion and low morale is rooted in a deficient recruiting system that, because of its budgetary constraints, only becomes attractive to young people who want to escape unemployment but do not necessarily have a real interest in a military career. These recruits soon become overwhelmed by the burdens and sacrifices that the service demands. Other recruits only join the army until they save enough money to migrate to the United States. These sources agree it is urgent for the military to increase the benefits of being a soldier via better salaries and improved opportunities for young entrants.

Yet, at this time, the requirements for entering the army are extremely low. A soldier in Mexico is only required to have finished secondary education (a sixth grade equivalent). Because most recruits come from rural areas with poor education systems, this does not guarantee a minimal level of education. A large percentage of troops lack the most basic math skills, not to mention they rarely know how to spell.

Implications on the War Against the Cartels

The shortcomings in the army described above, which are de facto structural problems, are seen by security experts as a danger that will delay progress in the war against the cartels. These sources stress that despite some celebrated arrests and confiscations, the army has rarely met its own established timetables and broader objectives in this conflict, such as the eradication of criminal groups and the pacification of key zones.

The case of Ciudad Juarez, Chihuahua is particularly important given the heavy presence of the army and the federal police in the state compared to other regions. After experiencing a mild decline in violence between March and May this year, drug-related executions in the state have subsequently increased into unprecedented levels.

Drug-related Executions in the state of Chihuahua*

Source: EMPRA, based on statistics from Milenio.

* The bulk of executions have taken place in Ciudad Juarez, where the army is most heavily deployed.

Corruption also at the Higher Levels

Corruption in the middle- and higher-ranks of the army is another problem with long-term implications. In 2008 there were several cases of high-ranking generals suddenly arrested or forced to retire, given their role in protecting or passing sensitive information to a given cartel. These cases were not given the same coverage by the media as in the past due to a series of political reasons, but mainly because it was detected internally as opposed to the U.S. intelligence pointing it out.

Interestingly, during the mission which resulted in the arrest of 29 public officials (including 12 mayors) allegedly protecting the operations of the Michoacan based cartel, La Familia, the army did not notify the local battalion in the state and instead used an external contingent to carry out the operation—no less because it feared corruption within the local battalion could foil the mission.

Journalists also mention administrative anomalies wherever the army is deployed (i.e. manipulative spending, funneling of resources, etc.), which have become commonplace during the war against the cartels.

Lack of Transparency and Accountability

Although the army is still a highly respected institution, perceived as less corrupt and more professional than federal security agencies, the increased number of human rights violations have already begun to have a negative effect on the image of the military, particularly in the cities and communities where the army has a strong interaction with the people. At the same time, there is little accountability in front of the federal government regarding the army’s operational and legal procedures.

Because President Calderon has made the war against the cartels his political flagship, the federal government has avoided any bickering with the army. In fact, maintaining a cordial relationship with the army has been a priority for the Executive. Nevertheless, the above concerns have been noticed in the U.S. government; hence a series of conditions to increase monitoring of the Mexican army imposed by the U.S. Congress to grant the resources for the Merida initiative.

Finally, the Mexican army is being increasingly criticized by experts for exhibiting the same flaws as any other governmental institution (excessive bureaucracy, wasteful and discretionary spending, poor training), yet with even less transparency.

The Army’s View

From the army’s point of view, for decades the troops have suffered due to low levels of investment, which is to blame for many of its current problems. Historically, the army has been reluctant to participate in the war against drug cartels simply because it is not considered to be their duty, but also because it believes that its increasing involvement (1) responds to the high levels of corruption and inefficiency in both the Attorney General’s Office and the Ministry of Public Security; and (2) it believes the more involved it becomes in this conflict, the harder it will be to extract itself down the road.

Similarly, there is a growing perception that while the army has done its share in the war against the cartels (i.e. dismantling operations, large confiscations, dangerous arrests), the federal government has done little to reach the higher echelons of corruption, no less because the government is protecting certain untouchables which includes bankers, entrepreneurs, football team owners, and politicians. The latter are allegedly assisting the cartels with money laundering. The federal government is afraid that pursing money laundering will turn into a cascade of political scandals with potential destabilizing effects for the country’s political and business environment.

Outlook: Increased Discontent and Political Pressure

The current dynamics in the army described in this report (i.e. low salaries, deficient recruiting, desertion, and corruption of troops, middle- and higher-ranks) are unlikely to change any time soon. On the contrary, some academic and journalistic sources expect the army increasing involvement in war against the cartels will exacerbate the problems outlined above (i.e. increased exhaustion, low morale, desertion, corruption, and human rights violations). Consequently, a number of sources believe this offensive could strain relations between the army and the Executive, if the government is unable to deliver as the military demands more resources to modernize its forces and a stronger commitment from the federal government to seize the cartels’ financial assets.

Pipe Dreams

For these experts, it is also urgent to undertake reforms that reduce the bureaucratic departments of the army and reduce sub-employment; improve training; and improve flexibility and transparency. According to military experts, these kinds of reforms would allow the army to be better prepared for internal as well as external threats.

In the past, several countries—notably Spain—have undertaken important reforms to restructure their armies while improving its effectiveness and responsiveness to threats. Yet, like any other reform that threatens to alter the status quo in Mexico, this will be met with a daunting opposition.

At least two sources mentioned that a meaningful reform that results in the restructuring of the Mexican army could only be motivated by increased pressure from the U.S. government in view of the lack of progress in the war against the cartels

Bruno Saraiva and Otaviano Canuto [1]

Picture a Latin American country sitting on US$350 billion of international reserves, while running current account deficit, fiscal deficit and paying an interest bill on public debt that hovers above 5% of GDP every year. Given the enormous opportunity costs of hoarding such chest of gold, how could that money ever be used outside a crisis situation, without unleashing the very currency appreciation that it disguisedly tried to curtail? Brazil could well be in that position by the end of 2010 if the same rate of reserve accumulation observed in 2007 prevails in the next 18 months (and, in fact, the current pace is not too far from it).

Since 2002, strong capital inflows have sustained a process of exchange rate appreciation in Brazil, briefly interrupted in the last quarter of 2008 by the financial crisis. To be fair, several other emerging market currencies behaved likewise. For most of this period the sum of the current account and direct investment has posted positive figures, accumulating US$ 90 billion since 2003. Net portfolio inflows amounted to US$ 80 billion in total from 1Q03 through 3Q08 (having spiked to US$ 48 billion in 2007) and net loan flows totaled a positive US$75 billion in the same period (excluding IMF flows). In this environment of abundant liquidity, Brazil prepaid the IMF in November 2005. Since then, the CB and the Treasury interventions in the market have escalated amassing net purchases of US$ 169 billion by September 2008, with international reserves (IR) piling up to above US$ 200 billion.

Reserve accumulation, even within a floating exchange rate regime, has been widely seen as a self-insurance device against volatility and sudden stops, given that this insurance could not be properly provided multilaterally by the existing channels. The use of high levels of international reserves as an insurance mechanism has eloquently proven its effectiveness in the recent episode (2008-9). As the crisis erupted, while the floating exchange rate absorbed the shock, the reserves arsenal provided the needed liquidity in foreign currency; at the same time the Brazilian net negative external debt reversed the impact exchange rate devaluation typically had on fiscal accounts in previous crises. Given the excess of reserves over government foreign currency liabilities, as well as the dollar-long position of the public sector in domestic derivatives markets, the devaluation led to a reduction of the public sector net debt (PSND), contributing with 330 bps to the 6 percentage points plunge of the PSND/GDP ratio to 36% in 2008. The ensuing perception of a sound fiscal stance permitted the adoption of a countercyclical stance, which has been critical to avoid a deeper recession in the country. This year through July, the Central Bank reduced the basic interest rate in 500bps to a record low of 8.75%, in contrast to previous crisis, when interest rates were bumped up to avoid the free fall of the currency and its effects on consumer prices. Likewise a relaxation of fiscal targets met with mild reaction from the market (at least, so far), given the perceived solvency of the public sector under possible stress scenarios in the medium run.

Notwithstanding the evident effectiveness of the floating exchange rate cum IR accumulation strategy in helping to absorb the external shock and sustain the confidence at levels necessary for a (relatively) quick economic recovery, some questions remain open for debate. In particular, while the benefits from the strategy seem to have been accomplished in the crisis, the costs are not negligible and the question of what should be done looking forward looks quite unresolved. The IR carrying costs have two main components: interest rate differentials and valuation effects. The first are above the line deficits resulting from the excess interest paid on domestic debt vis-à-vis the interest earned by the IR (in Brazil’s case, proxyed by the difference between the monthly Selic rate and the benchmark US rate for the relevant average maturity[2]). The second cost, which reflects the reduced R$-value of the foreign exchange assets, is mostly marked to market (below the line) and highly volatile, and would only be realized in case reserves are effectively sold.[3]

While in Asia (the leading region in IR accumulation), interest rate differentials have played a decreasing role from 2004-05, becoming more relevant after mid-07 again (see the chart from JPMorgan GDW, below), in Brazil interest differentials have been substantial all along the road.[4]

Considering that the pre-payment to the IMF signaled an assessment that IR had reached a comfortable level[5], a rough estimate of the costs incurred by the interest rate differential on the “excess” reserve accumulation since then yields a non-negligible sum of 2% of the GDP through July/09 (of this cost, more than 1% of GDP was incurred in the last 15 months).[6] At the margin, the sterilization costs stemming from the interest rate differential hovers around US$800 million per month, in 2009. One could assume that this is the premium paid for the self-insurance policy - however the idea that this cost is being inflicted to the country for the lack of an effective multilateral emergency lender providing this service as a global public good has been weakened by the strengthening of the IMF weaponry after the crisis, in particular the creation of the Flexible Credit Line (FCL).

Unfortunately, the benefits are somewhat more difficult to be assessed and quantified, and they are mostly in the form of avoided losses. We are not proceeding with this exercise here, but it should account for the precluded economic losses related to a deeper and longer crisis, which prominently include: larger direct fiscal expenditures, as interest rates on the public debt would behave procyclically in the absence of the dampening effect of the negative external PSND and the stock of debt cycle would likely present an asymmetric behavior (i.e., increasing abruptly and decreasing gradually, leaving a trail of higher debt service expenses); and the costs related to forgone growth. Previous crises have shown eloquently how these costs may be extremely significant.

Nonetheless, the fact that reserve accumulation continues to take place at a very fast pace, even after the level previous to the crisis has been restored, suggests that self-insurance might not be the driving force behind the phenomenon. Concerns about the persistent exchange rate appreciation, which have been cautiously voiced by some authorities recently, would be propelling the current push for IR accumulation, as pursuing an even higher level of insurance does not seem required at this point. The precautionary purpose was probably sufficient to explain the reserve accumulation through 2008; however, further increasing IR from that level may require other explanations.

To be fair, one cannot overlook the push factor behind the strong resumption of capital inflows in 2Q09, as the humongous liquidity injection in mature economies facing uninspiring prospects for economic recovery has apparently not found attractive outlets at home. In fact, sluggish growth for a significant period in mature economies might not be an unlikely scenario, which might signal a renewed season of excess liquidity in search or higher yields in emerging markets (see here)

In the first phase (2006-08), precautionary reserve accumulation could be questioned on the grounds of efficiency, i.e., whether the costs incurred by the strategy would be more than compensated by its harder-to-quantify benefits. Or alternatively, whether there would be a cheaper way of obtaining the same results (maybe, by keeping a lower level of reserves). In the second phase, after resuming the pre-crisis level in mid-2009, any additional accumulation of IR, considering that it remains a very costly strategy, could now be challenged on its objective (viz., avoid further appreciation of the real) and on its effectiveness (i.e., whether it can effectively withhold the pressure toward appreciation).

It is almost tautological that emerging market currencies present a longer term trend toward appreciation, as the status of emergence implies convergence towards a higher level of productivity. The issue here concerns the ability of capital flows, driven by very high coupon in the short term, to set at each moment an exchange rate that is consistent with the process of climbing up the productivity ladder in the longer term. So far, the response from the Brazilian industry seems to have been largely positive, with industrial production increasing at a consistently higher pace.

That virtuous reaction could have been fed by capital goods imports, as well as cheaper and longer term credit, facilitating technology absorption and lumpy productivity-boosting investments. In addition, financial hedges and the use of ACCs and ACEs (advances of exchange receipts for exporters) to obtain financial gains in the domestic market might have dampened some of the effects of the appreciation for the exporters[7].

Analysts like Alexandre Schwartsman, from Santander, have resorted to recent manufacturing export performance data as a signal that concerns about the impact of exchange rate appreciation might be overstated (see following chart).

Notwithstanding that, further investigation is warranted as the fact that Brazil has lost share in the world’s industrial exports suggests a counterfactual scenario with plausibly an even higher rate of industrial expansion. Moreover, the doubts about the market being able to set the right pace for the currency appreciation have been magnified by the very factors leading to the current financial crisis in developed economies. A thorough investigation should therefore assess whether such heightened cyclical appreciation (and its ensuing correction) have hysteresis effects that are negative for the country’s competitiveness over the longer term. In other words, it is critical to know whether the cyclical fluctuations can be mainly absorbed by the financial sector, with no significant trauma and not much ado with the real sector in a longer horizon.

Assuming, for a moment, that something must be done to avoid excessive exchange rate appreciation, our attention should then shift towards assessing which instruments could be used effectively for that purpose. We are left with a three-pronged set of options: (i) putting sand in the gears to lessen the inflows of capital, either by lowering the foreign exchange coupon – reducing domestic interest rates or, for example, reinstating the IOF tax that was relaxed in 2008 – or by adopting capital controls (which in the less strict form may resemble a tax); [8] (ii) doing exactly the opposite, i.e., greasing the gears to facilitate outflows of capital or fostering Brazilian direct investment abroad; and (iii) intervening in the domestic market to dry excess foreign exchange liquidity.

Keeping draining foreign exchange into the Central Bank coffers seems to be the strategy currently, albeit not openly, adopted by the Brazilian authorities. As explained by the BCB Deputy Governor for Monetary Policy (link in Portuguese), pumping out foreign liquidity from the market tends to further encourage inflows, as expectations tilt toward appreciation (or to a reduced likelihood of depreciation) and pushes the coupon up. Capital inflows becomes endogenously determined by CB interventions, as any intervention above the level of inflow would bring inflows to the new level in t+1, without affecting the exchange rate. Would the same reasoning apply symmetrically, with less intervention lowering inflows? Apparently not, as the current strategy implicitly assumes that drying up excess liquidity would help balance the market and avoid undue volatility.

The bottom line is two-fold:

1. There is ground to doubt whether measures to withhold currency appreciation will ultimately remain effective, particularly if the current scenario of abundant international liquidity searching for yield in emerging markets assets is to remain for longer than next year.

2. If there is fear about the productive restructuring that would ensue from that exchange-rate appreciation, the best thing to do is address straightforwardly the negative factors that affect directly the competitiveness in technologically more dynamic sectors of the Brazilian economy. IR accumulation will likely cease to be a cost-effective means to postpone facing those challenges.  

In response to Eugenio Diaz-Bonilla's previous post:

Since I’m not sure anyone but the two of us is still reading, I’ll keep my remarks as brief as I can. But first of all (and most importantly): I agree entirely that the importance of this analysis is in informing the debate about what Argentina should be doing now and in the future to arrest its relative decline. Yet most of what we have been arguing about belongs to a different era, one of an agrarian society with a dominant landowner class. That world has long gone – although, as I previously noted, Cristina Fernandez still demonises the landowners when it is politically useful.

Whether or not you think the 19th century Argentine elite made bad choices – and in fact it is the 1930s and 1940s when I think the truly bad decisions started – the country is not bound by those events now. Argentina’s main problems over the past couple of decades include fiscal delinquency, political corruption and choking regulation (it ranks 118th on the World Bank’s Doing Business measure, below Nicaragua, Swaziland and Uganda). Those are fixable if the electorate votes for the right people and they then have the courage to implement the right policies. Mistakes that were or were not made a century ago do not have to bind their hands. If Argentina really is trying to find its way to a diversified economy, its agrarian past isn’t stopping it. After a while, path dependence and hysteresis become excuses, not reasons.

Anyway, on the specific points:

-       I didn’t say Argentina and the US were identical; I said they were similar. While admittedly less endowed with natural resources, the big surpluses generated by Argentine agriculture towards the end of the nineteenth century should have helped it relax the resource constraint by importing them. Instead, it imported too many consumer goods. I fail to see how Argentina’s agrarian structure prevented it industrialising, particularly since its low labour utilisation meant it wasn’t competing significantly for workers. The fact that the Argentine industrial economy was hedged around with restrictions, monopolies and regulations had a lot more to do with it. And as I said before, the resource argument doesn’t explain the success of Japan, which had coal early on in its industrialisation but soon used it up and largely had to rely on imported inputs.

-       On the comparison with the UK: “The structure of incentives is different if you produce food for the internal market as the UK landowners did, and were forced to reconvert because of the pressure of other internal forces”. Nice try, but no. The British nobility started investing significantly in proto-industrial enterprises as early as the 16th century (mining of coal, lead and salt), well before industrialisation had put pressure on their agricultural interests, and continued doing so throughout the Industrial Revolution – despite having no model to follow.

-       “The narrative in the article and his two answers, with anthropomorphic constructions such as “Argentina did this” or the “US did that,” evoke the image of all-powerful planners”. Maybe to some readers, but I think it is fairly clear from the context that I am talking about decisions taken collectively through the political process – though in Argentina during the late 19th and early 20th centuries that generally meant a fairly small elite.

-       The long section on population I think is making far too much out of quite a simple argument: I was merely rebutting the earlier point that Argentina was physically too small to be a superpower.

-       I've explained before why Australia is a misleading comparator.

In conclusion, we will indeed have to agree to disagree. Eugenio regards my book as not serious analysis: I regard his critique as the latest in a long, long line of apologias for Argentina which ascribes to bad luck, natural resources or the whims of a capricious world that which should substantially be attributed to its misgovernance.

Countries can effect remarkable transformations in their economic management: in Argentina's own neighbourhood, Brazil has done so over the past decade and Chile, via a more circuitous route with some missteps, has done so over a longer period. There is no intrinsic reason that Argentina cannot do the same. As I have reported in the FT, several very senior policymakers have told me or my colleagues that they regret inviting Argentina into the Group of 20 because its contributions to the debate do not suggest it is a serious participant in global economic governance. (Less than a decade ago it also defaulted to the World Bank, an action that puts it in the company of Sudan and Zimbabwe.) For a country that used to be one of the ten or so biggest economies on earth, that is an indictment that cannot be explained away by natural endowments or misfortune.

ends

The business cycle of four of the largest Latin American countries is synchronized. The output gaps of Brazil, Chile, Colombia and Peru all peak before the crisis at the end of the century, go into a trough during the rise in risk aversion and the crisis of accounting practices crisis in 2002 and peak again before the Great Recession. The business cycle in Mexico is different. The output gap plummeted during the Tequila crisis and peaked in 2000. It went into a trough in 2003 and peaked again in 2007.

The synchronicity of the business cycle in these Latin American countries is due to common external factors that affect GDP. These factors are capital flows, the real price of exports and foreign output. It is possible to add these factors together–provided they are all defined in units of GDP (I explain this in the methodological note to the article “The external factors of monetary policy in Latin America” which is in this same blog). In Brazil, Chile, Colombia and Peru, business fluctuations closely follow the first two external factors that were mentioned: capital flows and the real price of exports. In Mexico after the Tequila crisis, the business cycle is explained mostly by foreign output.

The key to understanding where activity is heading in Latin America, and in emerging economies in general, is the evolution of these external factors. Take capital flows first. The flow of capital to emerging economies depends on the mood of Mr. Market, which may be measured many ways; the one shown in the graph below is the return on Bb bonds over and above that of Aaa bonds. Mr. Market’s changing mood is also evident in the financial account of the US, which is clearly related to that of Latin America (see graph below). Now, take the real price of exports. The graph shows that it is related to world economic activity.

What does all of this mean for the outlook for Latin America? In the central scenario, commodity prices have rebounded perhaps a little ahead of world economic activity. This will certainly help the recovery. An upside risk is that capital flows are typically correlated with export prices so the rebound in export prices could make emerging-market economies look attractive to investors. If this risk materializes, it would be two, not one external factor helping the recovery. A downside risk for all three external factors and hence for activity in Latin America is that of a double dip recession in advanced countries.

All the above helps explain fluctuations around potential. Potential output in emerging economies may not go through a downward level effect as it is expected in advanced economies. Among the factors that explain the downward shift in potential output in the advanced world are a drop in net investment and hence in the stock of capital and a permanent shift in consumption habits. These are not developments that should be expected to take place in the emerging world.

In response to Alan Beattie's previous post:

1. I do not think it suffices to argue that it is “surreal” to discuss the article because it had to be truncated for journalistic reasons: the story line and the quality of the reasoning and the accuracy of the facts to support (or not) the story line, are what they are.  Therefore, I believe the article (which is what most people in this time-constrained world will read anyway) is a legitimate area of discussion.  Also next year Argentina will celebrate 200 years of the first national government, and there are already several debates as to what happened since 1810, and about possible future scenarios for my country.  Therefore, Alan Beattie’s interpretation appears at the right time for that debate.  But, in my view, it does not help to understand Argentina’s history – nor that of the US, for that matter.  I do not want to bore the readers (if there are still some out there following this somewhat arcane topic).  So I will summarize agreements and differences with Alan Beattie, as I see them, and leave it at that.

2. It is clear that we both agree that Argentina has underperformed her potential, which I find extremely disappointing, and Beattie seems to consider that too.  Also, I believe, as Alan Beattie does, that policies matter, and that in the history of Argentina there is much to criticize (I have my share of academic, journalistic, and official pieces with my criticisms of Argentina’s policies at different times, and, of course, I have also written in support of actions I thought appropriate).

3. Moving to disagreements, we have clearly different opinions about the benchmark against which to measure underperformance in a realistic way.  And, second, there are also differences about the importance of policies compared to other structural factors, global economic conditions, and the like.  But more perplexing to me is the tendency of the article and two blogs to invoke “deus ex machina” type of arguments to stick to a predetermined story line.  I will cover both groups of issues next.

BENCHMARKS

4. Alan Beattie uses the US as the point of reference.  I do not think this is an adequate comparison for Argentina; unrealistic expectations are not good to understand the past or to define policies for the future.  It is far more illuminating to base the analysis on comparisons with Australia or with other Latin American countries.  The inadequate benchmark is, in my opinion, the original sin of Alan Beattie’s story, from which erroneous inferences and contrived arguments follow.

For instance, he says in his FT article “The countries were dealt quite similar hands… The similarities between the two in the second half of the 19th century, and in fact up to 1939, were neither fictional nor superficial.”  This is incorrect.

*Rainfall in the Eastern coast of the United States is about 40/60% more abundant than in the Argentina’s pampas, and therefore the northern regions had the forests and rivers the southern lands lack.  As noted by Diaz Alejandro in his “Essays on the Economic History of the ArgentineRepublic”, the lack of forests and rocks to build settlements was a serious problem in the Pampas.  At the same time, because both the Eastern US and the Pampas were not good for tropical products nor had precious metals, they did not have plantation or enclave structures which would have fostered inequality (see, for instance, Engerman and Sokoloff, NBER. Historical Paper 66, 1994).  But while the Eastern side of the US, nicely covered with forest and rivers, had strong immigration from UK during colonial times (which was larger than Spanish immigration to all Latin America), Argentina was an underdeveloped and unpopulated flat area with not much more than grass during colonial times (most of Spanish migration went to regions with minerals or tropical crops).  The low-value land (given the existent technology and structure of global markets) in Argentina was given in large tracts to the people that ventured there, mostly as a way for Spain to maintain political claims against native tribes and the eventual British or Portuguese explorer that passed by.

*Landes (“The Wealth and Poverty of Nations”) also points out (p.295) “These frontier lands abounded in natural wealth, but this wealth proved differentially useful in the context of new technologies. Here the United States came out best.” And then Landes goes on to enumerate all the variety of advantages, in climate and natural resources (not the least coal and iron, for metal production; cotton, for textiles; and rivers, for hydropower) the US enjoyed.  This was crucial for an early industrial development.

Which leads me to another quote by Alan Beattie.

* “On the face of it the economies of the two countries also looked similar: agrarian nations pushing settlement westwards into a wilderness of temperate grasslands.” (The qualification “on the face” is because Alan Beattie then argues about differences in the agrarian structures between both countries).  The problem, though, is with the wrong idea of similarly agrarian countries (even though the internal structure of the sector may differ). Alan Beattie was referring to a period broadly between 1850/1880, but the US was already a country with a relatively strong and diversified industrial base by the time of his independence (see again Landes, which points out that by the late 1770s the US already produced 30,000 tons of iron, with just Britain, France, Sweden and Russia producing more; p 298).  In contrast, only since the creation of the Vice Royalty of the River Plate in 1776 (notice the year), the port of Buenos Aires, but not yet the hinterland, started slowly to develop because Spain, still in control of the region and fearing political encroachment from Portugal and the UK, rerouted the silver trade from Bolivia, towards the south instead of using the previous northern route towards Perú.  Therefore, at about the same time the US colonies, already economically advanced and military strong, declared independence from the main Imperial power of the time, in the Pampas there was no important agricultural, or, even far less, industrial activity. Since then, the US has had a long period of endogenous growth, based on a large domestic market, with a strong industrial component, linked to a more decentralized and egalitarian agrarian structure, which also supported a more participatory political system.  On the other hand, since the early 1800s, Argentina embarked on an export-led approach (obviously dependent on external markets), based on livestock production during the first part of that century, and, only by the late 19^th century, on agricultural products.  The productive development of Argentina reflected the comparative advantage of the, until then, very backward and unpopulated Pampas, based on climate, geography and available technology.  Those comparative advantages, within a specific structure and evolution of trade and demand in world markets, defined a long period of export-led development based on livestock products, and an agrarian structure of large units with low utilization of labor.   Different from the US, when Argentina started a stronger and more diversified industrialization process, it had to contend with a specific agrarian structure that was not conducive to the development of a more diversified economy and a better integrated society.  Since then Argentina has been trying find the path to such economy and society. 

STRUCTURAL FACTORS, GLOBAL CONDITIONS, AND POLICIES

5.  I think that besides policies there are very powerful determinants of a country’s development trajectory, such as structural factors linked to geography and climate, the cumulative forces of demography and institutional history, and the global external conditions (on the latter, see, for instance, several papers by John Williamson and coauthors in the NBER series on external terms of trade and volatility; see also Engerman and Sokoloff, 1994, who discuss the importance of factor endowments for long-run paths of institutional and economic development).  In fact, even policies in most cases are not exogenous events, but are greatly influenced by political economy forces within a specific setting of structural determinants.

6. Alan Beattie says that I am dangerously close to economic determinism.  Rather, in my opinion, is Beattie’s analysis that suffers from unhistorical voluntarism, suggesting unlikely courses of action, not only for government but also for economic agents, without considering the existing incentives within specific geographic, climate, technological, state of the world economy, and political conditions.  All these circumstances provide the setting for the cost benefit analysis that governments and economic agents consider in their decision making process.  In my view, when facts do not fit his narrative, some ‘deus ex machina’ is utilized to maintain the story line without considering the incentives and restrictions for the policy makers or the economic agents.  I already mentioned some of his phrases such as that the landed elite did not distribute the land to the peasants in Argentina. Of course not.  There are other examples. For instance, according to Alan Beattie “Given their cultural Anglophilia, the Argentine landowners had an obvious model to follow (AB talks about the UK landowners that invested in industry), but they ignored it.”  The problem is that, as many analysts of Argentina’s history have noticed, the structure of incentives is different if you produce food for the internal market as the UK landowners did, and were forced to reconvert because of the pressure of other internal forces, than if you are earning good profits selling food to external markets and for many years there were no strong economic or political pressures to change.  The latter only started when middle and lower income groups associated with Yrigoyen early in the XX century and, then, Perón in the 1940s and 1950s, challenged that status quo and pushed for industrialization.

7. All in all, the narrative in the article and his two answers, with anthropomorphic constructions such as “Argentina did this” or the “US did that,” evoke the image of all-powerful planners, operating outside the society, and making the right decisions with an appropriate social objective function, unconstrained by structural restrictions and political-economy considerations. It may be an interesting intellectual exercise but, in my opinion, is not real-world economic or political analysis.

8. Another example of unhistorical voluntarism is the issue of population. In his latest blog Alan Beattie says

“The Argentine population is indeed a lot smaller than that of the US, and hence it would have difficulty being a superpower with the population it has. But part of the reason it is so small is that it didn't attract enough permanent immigration. Since its current farmland is about a third the size of that of the US, let us (crudely) say it could have three times its current population if its economic growth had been sufficient to attract migration…. Could you be a superpower with 120m people? Probably.”

First, if Argentina has a third of US land, it is a mistake to multiply Argentina’s current population (about 40 million) by 3.  The proper comparison is to divide US population (about 300 million) by 3. The reference number should be 100 (300 divided by 3) and not 120 (40 times 3).

Second, any of those numbers is, again, highly unlikely. The issue is not only immigration but also the level of population at the beginning of the US and Argentina’s histories as independent nations.  I have already mentioned the far better climate and geological conditions in the Eastern of the US compared to the Pampas, which led to larger and earlier settlements in the former but not the later.  According to Angus Maddison, in 1820 the US had already a population of some 10 million people, when Argentina had about 500.000 (a ratio of 20:1).  Since then, and until 2008, the US population grew 30 times (to 300 millions), while Argentina’s population increased by a multiple of about 80 (to 40 millions).  As a reference, the number for Australia is 62 and for Canada, 41, over the same period.  In order to get to Alan Beattie’s miscalculated 120 millions, Argentina’s population would have to have grown about 240 times (or about 200 times, properly applying Alan Beattie’s own rule of thumb of 1/3 of land and people).  This may be a challenge even for an all-powerful Soviet planner, given the constraints on the supply side of population and the absorption capacity of the recipient country.  For instance, Diaz Alejandro, in his “Essays on the Economic History of the Argentine Republic” argues that between 1857 and 1929, 60% of the population growth can be attributed to immigration, and that around 1914 about 30% of the total population and almost 50% of the labor force were foreigners, proportions far higher than in the US or other immigration countries.  The large immigration caused serious adjustment problems in political, social and economic terms, and to get to the implausible figures suggested by Alan Beattie, the problems would have been even worse (another methodological issue that is perplexing in his analysis is the lack of general equilibrium considerations).

9. There are other issues he also raises in the last blog that for the sake of brevity I will skip here (such as whether in his article he implies or not that in economic terms the US did better than Argentina, which I think he does; or some misinterpretations about the “trends” that I drew, but not calculated, just to illustrate the cointegration, which I did calculate, between Argentina’s and Australia’s ratios of GDP per capita to the same US variable; the cointegration clearly breaks down in the mid 1970s but not before).  I doubt anyone is interested, but I may expand on the comparison with Australia at another time using something more precise than the simple chart with my own eyeball drawings I presented in the previous blog.

10. In summary, I believe that Alan Beattie story line comparing US and Argentina is flawed.  It can be considered a piece of journalism in which you get a provocative story line and stick to it marshalling selective evidence.  Or it can read more like a satisfying Victorian morality tale (the sort of stories that, by the way, I enjoy very much).  But, in my opinion, it is not serious economic or political analysis.  Of course I acknowledge that he believes that the explanations are all there in his “excellent book.” Based on the FT article and his two answers in this blog, I do not agree.  So, using a formula from diplomacy that Beattie must recognize, let’s agree to disagree.