On Thursday, June 20, 2013, the roundtable discussion “Inflation or Competitiveness: Is It Necessarily a Dilemma?”—organized by the National Academy of Economics—was held in the auditorium of the Faculty of Administration and Social Sciences at Universidad ORT Uruguay. The panel for the debate, which discussed anti-inflation measures and their impact on Uruguay’s competitiveness, consisted of economists Aldo Lema, Juan Carlos Protasi, and Juan Manuel Rodríguez.
According to Aldo Lema, managing partner at Vixion Consultores, competitiveness is linked to the nominal exchange rate, which determines whether tradable or export sectors are competitive or not. In Uruguay, Lema noted, the debate on competitiveness “is colored” by the discussion of whether or not there is an exchange rate lag. In Uruguay, exchange rate lag is interpreted as dollar-denominated inflation. But what matters, he noted, should be the misalignment and/or imbalance of the real exchange rate. Misalignment occurs when there is a fiscal adjustment in spending but the exchange rate, instead of appreciating (improving competitiveness), does not, resulting in low inflation but high unemployment. Imbalance occurs, for example, when there is a large fiscal deficit and debt, and growth is based on demand that is unsustainable in the medium term, causing the exchange rate to appreciate, but only in the medium term.
According to Lema, there is no exchange rate misalignment in Uruguay because unemployment remains low alongside inflation. However, there is an imbalance because the fiscal deficit is expected to rise, and demand for commodities (Uruguay’s main export) will not be sustainable in the long term. According to Lema, a “wealth effect” occurred in Uruguay, whereby increased revenues from high commodity prices led to higher spending. However, the ability to finance this larger fiscal deficit will be reduced because the flow of capital into the region will decline, and the cycle of rising commodity prices will come to an end .
According to the economist, to boost competitiveness, it is essential that the Central Bank “stop losing credibility and reputation by defending exchange rate targets that have not made us more competitive.” “Monetary policy must keep inflation low, which promotes competitiveness and helps correct exchange rate misalignments in the short term, but only if there is credibility in the goals and targets,” he said.
Economist Juan Carlos Protasi, former director of the Central Bank of Uruguay (BCU), agreed with Lema that the decline in capital flows to Latin America and the increase in government spending driven by the “wealth effect” of commodities are pushing the real exchange rate downward. According to Protasi, Uruguay is experiencing the symptoms of “Dutch disease,” where everything is centered on the exploitation of natural resources, and there is a decline in the manufacturing industry, just as happened in the Netherlands when the entire economy focused on oil production in the late 1960s. Protasi said that in Uruguay there is an excessive concentration on agricultural production, driven by the profitability of commodities.
The Dutch disease can be solved through credibility, argued Protasi, echoing Lema’s view. “There is a serious credibility problem, and a persistent disconnect between target ranges and inflation. Inflation is linked to a loss of credibility in the currency, which is reflected in uncertainty regarding price-setting and wage increases that are out of step with productivity. Wages rose faster than productivity because the government and labor unions went against the BCU’s targets and market rules that indicate the opposite,” Protasi argued.
He also argued that the recent measures adopted by the Central Bank—imposing restrictions on capital inflows—are ill-timed, belated, and dangerous given the uncertain external environment. “The only effective response to counteract the Dutch disease is to curb public spending and dismantle the perverse system of wage adjustments. All crises are the result of recurring fiscal indiscipline on the part of every government. Welfare and poverty reduction policies based on a low real exchange rate—depressed by unsustainable public spending—fail in the long run,” Protasi concluded.
Economist Juan Manuel Rodríguez, director of the National Institute of Employment and Vocational Training (INEFOP), disagreed with Protasi and pointed out that the government plays only a minor role in collective bargaining. Before 2009, the government would approve or reject agreements between workers and private employers based on guidelines from the Ministry of Economy, but now wages set above inflation targets depend more on companies than on the government. Rodríguez sees signs that the government will be cautious regarding spending expansion. “The government wants to moderate wage growth but will have little success,” he predicted.
For Rodríguez, the most concerning issue is the “vulnerability” of the Uruguayan economy to external shocks, given that its entire productive structure is geared toward commodity production. “When there is a negative external shock and there are no defense mechanisms in place, investment, employment, wages, and social progress all decline. And that is a real possibility,” he said. According to Rodríguez, we must “reorient the structure and try to produce for markets that are less volatile than commodities.” He also proposed “altering the relative profitability” of the sectors that have seen the most growth so far in order to redirect investments and change the productive structure. “To that end, some propose implementing deductions on agricultural exports, but with an upcoming government led by Tabaré Vázquez, I don’t think that will happen,” he concluded.