Dollarize with Care: Argentina’s Lessons for Canada

Commentary, Workplace, Milton Boyd

The 62-cent Canadian Peso means that Florida vacations have become an impossible luxury for most Canadians. More importantly, high levels of taxes and government spending are constantly compromising the real values of our homes, investments and pensions – policies that drive the loonie even lower. The idea of adopting the U.S. dollar might bring a glimmer of hope to some. But dollarization would require a major policy shift to avoid the same problems that are now shaking Argentina.

To be effective, moving to the U.S. dollar would entail a policy of flexible wages and prices. We would also need to harmonize economic policies between Canada and the U.S, particularly those that govern labour, immigration, trade, taxation, property rights and regulation, the same issues faced by countries in the European Union as they convert to the Euro.

Argentina is learning this lesson the hard way. To sustain its policy of pegging its currency one to one to the dollar, a standard of convertibility assumed in the early 1990’s, that country needed to enact much broader policy changes. It did not, and the riots in the streets that have recently toppled a stream of Argentine Presidents are the consequence. Some doctors in Buenos Aires are selling their vacation homes in nearby Punta del Este to buy food. The Argentine debacle provides lessons for Canada and other countries in the Americas that are considering a common currency.

Lesson 1: Argentina’s lack of wage and price flexibility caused a large part of its failure. Any country that decides to tie its currency to the American dollar must also be prepared to let its costs of goods and labour reflect its economic efficiency relative to the United States. It must allow prices to fall freely to competitive world export levels instead of being overvalued, a serious risk if there is no longer an exchange rate to assist in wage and price adjustment.

Even more rigid than Canada’s, Argentina’s labour policy was built on Peronist principles that favoured inflexible wages, which allowed labour to keep wages relatively high in relation to real output. Higher Argentine wages meant higher costs, which then forced higher prices for Argentine goods, above world levels. Priced too high for world buyers, uncompetitive export goods resulted in lower production and a slowing of the economy. At the same time, relatively cheaper imports further dampened production for the domestic market. Employers were losing money and denied the flexibility to lower prices to world levels. Argentine workers were laid off, with unemployment reaching about 20 percent. Unemployed workers lacked money to buy goods, which further slowed the economy.

Lesson 2: Argentina’s bloated government made dollarization difficult by reducing productivity. Argentina, like Canada, became less productive partly because too large a proportion of its population was employed by the government in pushing paper and make work projects, rather than in the production of things that consumers need, like food, houses and cars. But inflexible Argentine wages meant wages could not drop in step with the declining productivity, leaving the domestic and export goods overpriced. To keep Argentine government employment and salaries up, the government borrowed heavily on both the domestic and world markets, producing an escalating $US140 billion debt. As the interest on the debt became excessive the government defaulted. Adding to the misery was an Argentine government riddled with bribery, nepotism and corruption that made life difficult for the private sector.

Lesson 3: Canada escaped Argentina’s fate by not dollarizing. Canada’s goods could have become over-priced on the world market like Argentina’s and forced massive unemployment, but this didn’t happen. Instead, Canada’s flexible exchange rate system accommodated currency devaluation, and prices were able to drop to levels that world buyers were willing to pay. This allowed workers to keep their jobs.

On the downside, Canadian workers had their effective wages cut by the 40-percent devaluation of the Canadian dollar over the last 30 years. Therefore, Canadians who might otherwise have earned $US 50,000 instead made US $30,000, as high spending and tax policies cut productivity, and forced a devaluation. Unlike Argentina, Canadian employers were saved from the hassle of severe bargaining over inflexible wages. Instead, foreigners simply did the bargaining for them by paying a lower exchange rate. The steady erosion of Canadian exchange rates over the last 30 years indicates that our labour rates have been relatively inflexible like Argentina’s, but we’ve let the judgement of world markets become a substitute for slowing wage growth.

Lesson 4: Argentina erred by suddenly changing economic policies. First, Argentina attempted to cut government spending severely in order secure more loans from the International Monetary Fund. But this shocked the economy, as many government workers could not be paid, and so could not spend. Second, Argentina suddenly restricted the amount of money citizens could withdraw from banks, causing less spending that further shocked the economy. Third, a flawed dual exchange rate policy was suddenly instituted that allowed the Peso to float, but at the same time permitted a higher exchange rate of 1.4 Pesos to the dollar for "selected" industries and firms. This simply fosters more unfairness and corruption, as more Argentinians seek political protection from economic reality.

After the Peso was allowed to float, the restrictions on bank withdrawals kept the Peso above its fair market value, with initial trading around about 1.6-1.8 Pesos. After Argentina removes these restrictions and allows a normal supply of Pesos, some expect the currency to fall below 2.0 Pesos to the dollar. This would represent a wage cut of more than 50 percent, and should make Argentina’s goods more competitive. But if a flexible wage and price policy had been in place, wages and prices would have dropped sufficiently, and the Peso could likely still be pegged to the dollar, with no devaluation and no crisis necessary.

In summary, if Canada and other countries wish to adopt another currency, they must ensure their policies include flexible wages and prices, and harmonize their economic policies across countries. As well, direct from the "there is no free lunch" department comes the judgement that a reduction in the proportionate size of government from 45% of the economy in Canada to U.S. levels of 31% would begin moving us back to parity.

It’s either that or we continue with the Canadian Peso, and vacation in Vancouver instead of Florida.