On Argentina’s (and other Latin American countries’) Discount Factor

The following appeared on RGE-Monitor, on February 2, 2009.

As is widely known, Keynes posed that “in the long-run we are all dead”, as well a role for counter-cyclical fiscal policy.

In Argentina, the statement that in the long-run we are all dead is a way of living for many people. Uncertainty reigns. Thus, when a negative shock hits the median citizen the more likely response is to increase expenditures instead of saving. Why? Well, since this median citizen is not sure if he/she will be able to spend in the future—due to the effects of the shock—then he/she will choose to consume today while he/she can. That is one way of thinking that in the long-run we are all dead. Any standard model in economics that you use to rationalize your “optimal” behavior, on the contrary, will generally make you choose to “save for a rainy day: in response to temporary positive shocks. In other words, you need to smooth your consumption intertemporally so as to maximize your utility.

Basic political economy models teach us that, under normal circumstances, the median voter preferences are reflected in the elected government. Following this reasoning, then, an elected government is likely to also live by the rule of in-the-long-run-we-are-all-dead. Examples of this could be increasing expenditures (many times irresponsibly from an intertemporal sustainability perspective) to win elections and increase power, discretional redistribution, inflation-prone expansionary policies, disrespect for the rule of law (i.e. weak property rights), price controls, (recent) debt swaps at high interest rates (the next government, hopefully, will deal with it…), etc. The list can be long, but there is a word that summarizes this behavior: populism.

Of course, populism hides behind Keynes since he was the one that advocated increasing government expenditures to smooth out a recession to offset the effective demand problem. However, Keynes prescription also includes reducing public expenditures in “good times.” This is the part that populists seem to have missed. Alternatively, we can describe populists as Keynesians that misunderstood Keynes—or, I shall say, that interpret it in a biased way so as to falsely (and purposely) believe that they were supported by some degree of intellectuality. Thus, since in the long run we are all dead, let’s spend now; the next one will pay… (if lucky).

I believe this a good simplification of Argentina (and some other Latin American countries) in the 2000’s. The uninterrupted populist governments since 2001 (and the private sector as well) spent irresponsible, without any care for the repayment time. Instead of taking advantage of the external boom to improve the long-term growth and sustainability of the economy, expenditures ballooned—in good times! Now, that the world economy is in a cleansing mode, the government wants to recall that they praised to be Keynesians. Too late. Good times should have been used to accumulate for bad ones—this goes back to biblical times. (Another way to put it is that the government should have built a anti-cyclical fiscal fund instead of increasing expenditures and then appropriating private sector’s savings—AFJP’s fund—instead.)

So, what happened? A rational model of intertemporal optimization might suggest that the median Argentinean has a discount factor that is way too small (a high discount of the future, in the limit converging to zero).[1] The more so for the government, since they will not be in office when the time to pay for the excesses finally comes. The median voter will be there, though. Hopefully, he/she will be more forward-looking next time and decide based on what has been learnt. Otherwise, unless extreme luck hits the country, it will be difficult. Some extreme luck impacted Argentina between 2002 and H1 of 2008, but it was not internalized. Let’s hope that eventually the median voter will increase his/her discount factor and vote accordingly—and rationally, not only according to economic and political economy models, but also in an intertemporally social way.


[1] As in any basic intertemporal optimization model, the ratio of the marginal utility of present consumption to the marginal utility of future consumption equals the gross interest rate times the discount factor. If the latter is less than one, with a concave utility function, consumption decreases over time. The smaller the dis