Capital Accumulation, Sectoral Productivity and Real Exchange Rate: The Case of Argentina1

Jos e Anchorena2

ABSTRACT Kydland and Zarazaga (2002b) documented that in the 90s in Argentina huge increases in total factor productivity (TFP) were accompanied by low investment. I try to solve this anomaly by disaggregating into two sectors, tradable and nontradable sector, an otherwise standard dynamic general equilibrium model. I nd that the model can not account for the path of aggregate capital. This is mainly due to underinvestment in the tradable sector. Moreover, I nd a second and quite robust anomaly: the simulated real exchange rate (the price of the nontradable good in terms of the tradable good) moves strongly opposite to the data. Consequently, I measure the misalignment of the real exchange rate and I incorporate it as an exogenous state variable. In a new run, I nd that I still can not account for the path of aggregate capital. This time, it is due to underinvestment in the nontradable sector, given the high exogenous price of the nontradable good. As a result, a general equilibrium analysis is not supportive of the (partial equilibrium) real exchange rate story of low investment. JEL Classication Codes: E32, O40, N46. Key Words: Argentina; Capital Accumulation; Nontradable Good; Real Exchange Rate.
I thank Michele Berardi, Daniele Coen Pirani, Finn Kydland, Pedro Silos, Carlos Zarazaga and participants in a seminar in the Federal Reserve Bank of Atlanta for valuable comments. I gratefully thank the William Larimer Mellon Fund for nancial support. 2 Tepper School of Business, Schenley Park, Pittsburgh, PA 15213. E-mail: jfd@andrew.cmu.edu.
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The Question

Kydland and Zarazaga (KZ[2002b]) found that a neoclassical dynamic general equilibrium model overestimates the capital stock for Argentina in the 90s, given the productivity levels, measured as Solow residuals (see gure 1). The capital stock grew in the 90s, but it grew too little, given the huge increases in measured total factor productivity (TFP). Why? One plausible explanation for underinvestment is the lack of credit: rms observe the increases in productivity and want to invest in capital to maximize their prots, but they can not do it because of lack of funds. This line of research would emphasize the inexistence of markets (e.g., Banerjee and Duo [2005]), the lack of collateral (e.g., Caballero and Krishnamurthy [2001]), the possibility of default (e.g., Alvarez and Jermann [2000] or Kehoe and Perri [2002]) or the crowding out of credit by the government. The objective of this paper is to assess the validity of an alternative explanation: low investment is the consequence of the behaviour of the real exchange rate. The real exchange rate story of low investment is well described by Calvo et al (2002): Another popular view stresses the impact of a xed exchange rate regime coupled with a devaluation by Argentinas major trading partners as an important cause of real exchange rate (RER) misalignment, which reduced protability in the tradable sector. This, in turn, slowed down investment and led the economy into a protracted recession as it deated away the RER disequilibrium.3 This story is suggestive but it needs to address two issues. First, why was there RER disequilibrium and how fast did the real exchange rate adjust? Second, given the overvaluation of the RER (or a too high price
By 2002 many academicians and policy makers put the alleged overvaluation of the real exchange rate at the center of the explanation for Argentinas recession (1998-2001) and crisis (2002), though not all of them tie it explicitly with low investment. Feldstein (2002) writes: An overvalued exchange rate (locked at one peso per dollar since 1991) and an excessive amount of foreign debt were the two proximate causes of Argentine crisis. Krueger (2002) states: With hindsight, two factors came together in a destructive cocktail: weak scal policy and mounting overvaluation. Hausmann and Velasco (2002) argue: There is an unmistakeable sense then that Argentina did have an exchange rate problem [...] It was the combination of relative price misalignment with increasingly scarce nancing that made the situation vulnerable. It must be noticed that Calvo et al (2002) account of the crisis includes the RER story of low investment only as a minor component of a more complex picture.
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of nontradables in terms of tradables), proponents of this explanation argue that the production of tradables will be low. But they do not say what would happen with the production of nontradables. In fact, by the same logic, it might be higher than in equilibrium. Similarly, there is no mention of what would be the reaction of consumers to the disequilibrium RER. Presumably, they will react to the misalignment in opposite direction as the producers do. These two issues imply that this story is asking for a model and for a quantitative general equilibrium inspection. Misalignment stories are pervasive in geography and history (see, for example, Hinkle and Montiel (1999)). The detailed study of the extreme case of Argentina might shed light on the theoretical understanding of the misalignment process as well as on the practical consequences of it. Argentina xed its currency to the dollar for a long period, from 1991 to 2001, while the dollar appreciated against most currencies, and at a time when most of Argentinas trading partners (Brazil and Western Europe) and competitors (East Asia and East Europe) were devaluating their own. If we do not nd signs of misalignment or relevant consequences of misalignment in Argentina in the 90s, or if the results do not accord with the data, we will be conclude that, in general, misalignment explanations of the performance of economies are not appropriate. The practical conclusion for the case of Argentina will then be that the change in the RER is not enough to enter into a sustainable growth path. The strategy in this paper is to build on KZ (2002b) closed economy, exible price, general equilibrium model. Ideally I would like to do two things: open the economy in goods and assets and introduce a nontradable sector. To keep things simple I decided to do just the second innovation. Of course, in a closed economy model all goods are nontradable internationally. Yet, this does not disqualify the exercise: I will divide the economy into two sectors which can have dierent proles of capital accumulation given changes in sectoral productivities. I believe that opening the model economy will ultimatey be necessary to explain Argentinas economy in the 90s (and, for the case, in the present decade); in particular, to understand the relevance of both physical and nancial international capital ows, and the movements in the real exchange and the real interest rates, but I think that I can go a long way in interpreting facts with a two-sector closed economy model. I address two questions. First, can I account for the paths of capital and other variables paths by the mere innovation of disaggregating the economy into two sectors? If not, then, can I better account for those paths under some rigidity of the real exchange rate? By disaggregating into two sectors I will be able to dierentiate produc3

tivity shocks in each sector, as well as calculate a price of the nontradable in terms of the tradable good, that I will call the real exchange rate.4 I will address then the rst question. Subsequently I will be able to dene the real exchange rate overvaluation or undervaluation as the dierence between the observed real exchange rate and the one obtained with the model. Finally, I will consider a model where the real exchange rate is exogenously xed to assess if the articial paths of capital thus generated better replicate the data or not. In section 2 I refer briey to related literature. In section 3 I introduce the data used and highlight the facts to be explained. In section 4 I present the model with two sectors and dene the equilibrium. In section 5 I calibrate the model. In section 6 I present the main results and discussion. In section 7 I conclude.

Related Literature

This paper is embedded, by methodology, in the recent literature on depressions, pioneered by Cole and Ohanian (1999), and collectively put forward in the Great Depressions issue of the Review of Economic Dynamics (January 2002). In this paper I am not considering a depression but a boom and bust, but, of course, the methodology is equally appropriate. More specically, I am trying to solve a puzzle unearthed by KZ(200b), which was a follow-up to Kydland and Zarazaga (2002a), in the aforementioned issue. Kehoe (2003) has done a case study for Argentina for the period between 1970 and 2002. He emphasizes two points, among others, that I will pick up in this paper: i) the importance of TFP changes to explain the behaviour of the economy (most of the changes in output in Argentina over the period 1970-2002 were due to changes in TFP); ii) the relevance of the relative price of nontradable goods for real exchange rate explanation (a promising direction for modeling real exchange rate uctuations in Argentina is given by Fernandez de Cordoba and Kehoe (2002), who relate real exchange rate uctuations to changes in in the relative price of nontraded goods and to changes in foreign investment). More generally, I see this strand of literature as a middle land between business cycle and growth literature. Usually it focuses in explaining periods longer than one business cycle but not longer than 10 or 15 years. Moreover,
By denition, then, I will use the relative price of nontradable to tradable goods and the real exchange rate interchangeably (see equation (4) below).
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in this literature the long-term trends are taken as given, and specic drastic booms or busts are to be explained relative to those trends. Another way of putting it is: growth literature seeks to explain some constant long-time trend; real business cycle literature seeks to explain some deviations from a moving trend, and this literature seeks to explain the moving trend. The explanation of the changes in the real exchange rate by the changes in the relative price of nontradable good, which are, in turn, explained by the changes in relative productivity of tradable and nontradable sectors, go back to Balassa (1964) and Samuelson (1964). Deloach (1997) and Kakkar (2003) have lent some support to the second relationship. Betts and Kehoe (2001) and Burstein et al (2005) have lent some support to the rst relationship. Stockman and Tesar (1995) and Mendoza (1995) did thorough analyses of international business cycles with nontradable goods. They were able to replicate with technology shocks many of the data correlations and volatilities.

The Data

I used data on aggregate output, capital and employment elaborated by Maia and Nicholson (2001), which spans from 1960 to 2001. This data diers slightly from the one used by KZ(2002b). I have worked with both data sets and no essential nding in this paper depends on the use of either one. The main data innovation is to separate output, employment and capital in tradable and nontradable sectors. I considered agriculture, mining and manufacturing as tradables and the rest (construction, transportation and public utilities, wholesale trade, retail trade, nance, insurance and real estate, and service and government) as nontradables during the whole period.5 I used data by sector to separate aggregate output and employment into tradable and nontradable. To separate capital used in each sector I proceed in the following way. I got electrical energy data disaggregated into two main sectors, industry and commerce. I identied energy used in industry with capital utilization in
Of course, this is a rough division between tradable and nontradable goods, and some subcategories in each sector could be more reasonably included in the other sector; e.g. international air transportation might be included in the tradable sector while cheap heavy minerals might be included in the nontradable sector. But I think it is a fairly good approximation. De Gregorio et al (1994) and Herrendorf et al (2005) explicitly disaggregate the economy in very similar ways.
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the tradable sector and energy used in commerce with capital utilization in the nontradable sector. I calculated the share of energy used in each sector and multiply that share by the total capital to obtain the capital utilization in each sector.6 I used the real exchange rate between Argentina and the U.S. computed with consumer price index (CPI) series. Alternatively, I could have used directly the relative price of nontradable to tradable. In fact, the correlation between the two series is 0.85 for the period 1981-2001 and 0.95 for the 90s (see gure 2), which gives some support to the approach followed here, that is, the real approach, with nominal exchange rate playing no role, and the closed economy approach. We can understand the relationship between the real exchange rate and the relative price of nontradable good with the following formulas. Lets dene RER as: EP P

RER =

(1)

where E is the nominal exchange rate, P is the home price level and P is the foreign price level. Then, consider that the price level in each country has a tradable (P T ) and a nontradable (P N ) component: P = PT PN
1

(2)

P = PT

PN

(3)

with and determining the weights of each component in the domestic and foreign price indexes respectively. Substituting (2) and (3) in (1), multiplying and dividing by applying the law of one price for tradables,
6

EP T T P

PT 1 , PT

and

= 1, I can obtain:

Two checks reassured me on the reasonableness of this method. First, the correlation between total electrical energy used and aggregate capital is high (0.95). Furthermore, some studies (Burnside et al [1995] and Brandt et al [2004]) prefer to use energy rather than capital stock as a proxy for capital services, a path I do not follow here. Second, Baxter and Farr [2001] obtain for the US a high correlation between energy use and capital stock for the manufacturing sector, the main tradable sector. It seems natural to assume that the correlation will be high for the nontradable sector too.

RER =

(P N /P T )

(P N /P T )1

(4)

I will denote the ratios of nontradable to tradable prices as p and p . In this paper I will attribute all change in RER to the change in p and abstract of the inuence of the foreign relative price. Figure 2 and gure 5 below support somewhat this assumption. In appendix A I describe in more detail the data sources and the series constructed. Table I presents a growth accounting exercise for aggregate, tradable and nontradable output per capita, assuming a Cobb-Douglas production function,
Yt = At Kt Lt (1)

(5)

where Yt is aggregate output, At is productivity level, Kt is the capital stock and Lt is employment.7 I follow Hayashi and Prescott (2002), divide by the population, Nt , and decompose the output per capita, Y /N , into three components: a TFP component, a capital intensity component and an employment intensity component:
1 Yt Kt 1 Lt = At1 ( ) . Nt Yt Nt

(6)

In Table I we can observe many curious growth episodes. First, observe that, in 1991-1996 for the aggregate economy, an annual increase in 6.33% in the TFP component was accompanied by an annual decline of 1.69% in the capital intensity component. This was the seed for the puzzle in KZ(2002b), which they called capital shallowing. Second, a similar anomaly is the labor shallowing in the same period: despite the increase in productivity, the employment intensity diminished.8 Third, moving to the dissaggregated cases, we observe the huge decrease in tradable TFP in the period 19761981 with an important increase in capital intensity. Fourth, and more
I considered = 0.4 for both sectors and for the aggregate. In the calibration of the explicit model I will nd that this is not an egregious approximation. 8 This reminds me of the present discussion in the US with high productivity gains but few employment gains. In the case of Argentina, the reader might be reminded that between 1991 and 1996 the unemployment rate increased from 6.0% to 17.3%.
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important for the present paper, there is the huge increase in nontradable TFP in the period 1991-1996 with a decrease in capital and employment intensity. The most important piece of information that I obtain with this table is that the productivity gains in the rst half of the 90s were mainly in the nontradable sector. Under the Balassa-Samuelson hypothesis, this should have an important depreciating eect on the real exchange rate. In the following sections I will present two models, one with perfectly exible RER and the other with some type of intervention in the goods markets. The stylized facts of the 90s by which I will judge the appropriateness of these models are the following:9 1. A decrease in aggregate capital in the 90s (KZ[2002b] anomaly), reecting an increase of capital in the nontradable sector and a decrease of capital in the tradable sector (gure 3). 2. An increase in output, reecting an increase in the nontradable output and a decrease in the tradable output (gure 4). 3. The real exchange rate appreciates drastically in the rst years of the 90s and slowly depreciates afterwards (gure 2). I would like to emphasize two more points related to the information that is obtained when I disaggregate between tradable and nontradable sector. First, observe gure 5. In the upper panel I show TFP in Argentina and in the lower panel I show TFP in the US, both constructed in the same way. I observe that TFP in both sectors in Argentina were much more volatile than in the US. Furthermore, while productivities in both sectors moved generally in the same direction for the US (correlation 0.96), they moved more often in opposite directions for Argentina (0.43). In this paper I take productivities as exogenous or given, but these graphs and numbers show that there is a lot to be explained with respect to them, as stressed by Kehoe (2003). Second, observe gure 6. It shows the relative TFP (the ratio of TFP in the tradable to TFP in the nontradable sector) and the real exchange rate. The mirror image is striking both because of its symmetry and because the relationship goes in the opposite direction to the one emphasized by BalassaSamuelson (see also Obstfeld and Rogo [1996], p.210-214, or De Gregorio and Wolf [1994]). Indeed, higher growth of productivity in the nontradable sector than in the tradable sector (as in the episodes 1976-1980 and 19909 Most variables in the model are detrended by both constant population growth rate and per capita income growth rate, so the following quantity variables have been detrended accordingly.

1993) is accompanied by an appreciation of the real exchange rate. I will get back to this fact when I present the model and simulate the economy.

The Model

The model economy is populated by many identical consumers, who own two types of rms: those that produce tradable goods and those that produce nontradable goods. All agents take prices as given. Following KZ(2002b), I consider an economy with linear deterministic trends in population growth and income per capita growth. Therefore all variables are in per-capita, per-eciency unit terms, except for employment and leisure, which are in per-capita terms. These transformations allow me to obtain a stationary solution to the recursive problem. In what follows T and N indicate tradable and nontradable sector respectively. Households The representative consumer chooses tradable consumption, cT , nontradable consumption, cN , leisure, l, labor, h, and investment, x, to maximize his expected innite lifetime utility:

max E [
t=0

t U (cT , cN , lt )]. t t

(7)

I assume the following momentary utility form: [(acT + (1 a)cN ) l1 ]1 U (c , c , l) = . 1

T N

(8)

is equal to (1 + )1 (1 + )(1) , where is the population Here growth rate, is the deterministic income per capita growth rate and is the consumer discount factor. The consumer faces a number of constraints. First, he is entitled to one unit of time each period so that labor in each sector, hT and hN , must satisfy
N hT t + ht + lt = 1.

(9)

Second, he accumulates capital in each sector separately according to the laws of motion
T T T T (1 + )(1 + )kt +1 = (1 )kt + xt

(10)

and
N N N N (1 + )(1 + )kt +1 = (1 )kt + xt

(11)

where k T and k N are capital in each sector, and T and N are depreciation in each sector. In some warm-up exercises I found that a key decision for obtaining dierent paths for capital is the classication of investment as tradable or nontradable. If I classify investment as a tradable (think about machinery), I can replicate quite well the declining aggregate capital. If I classify it as a nontradable (think about construction), then I missed the aggregate capital, as the simulated capital grows during the period. These results are not surprising. The meager performance of productivity in the tradable sector constrains the increase in investment as a tradable; the strong performance of productivity in the nontradable sector enhances the increase in investment as a nontradable. These considerations led me to dene a more realistic investment sector10 . I postulate now that investment in each sector has both tradable and nontradable components, with the following functional forms:
T TT NT TT xT t = G (xt , xt ) = xt 1 N T 11 xt

(12)

N NN N NN xN , xT t = G (xt t ) = xt

2 T N 12 xt

(13)

where xij represents investment produced in sector i and used in sector j . Third, the consumer satises his budget constraint,

TT TN N NT NN T T N N T T N N cT ) wt ht + wt ht + rt kt + rt kt (14) t + xt + xt + pt (ct + xt + xt

In a recent paper, Burstein, Neves and Rebelo (2003) suggest that modeling open economies with a nontradable component of investment may be a better approach to generate plausible investment dynamics. My dataset indicates that near 50% of investment is nonresidential construction, which I classied as a nontradable.

10

10

where p, w and r are the price of the nontradable good, the wage and the price of capital, all in terms of the tradable good. While wages in both sectors will be equal in equilibrium as labor can be reallocated immediately between sectors, prices of capital can dier as both capitals are not the same good. Firms Each rm chooses capital and labor to maximize period-by-period profits:
T T T T T T T zt F (kt , nT t ) wt nt rt kt

(15)

N N N N N N N p t zt F (kt , nN t ) wt nt rt kt

(16)

where F i (k i , ni ) = y i = k i ni with i = T, N . The technology process is driven by:

i 1 i

(17)

zt+1 = b + Azt +

(18)

where z is a two element vector, A is a matrix of 2 by 2, b is a vector of 2 by 1, the same as , the productivity shocks, which are normal iid with mean zero and variance . Equilibrium A competitive equilibrium is (for every t)
T , r N , w T , w N ), i) a set of prices (pt , rt t t t T d , nT , y T ) for the typical rm T, ii) an allocation (kt t t N d , nN , y N ) for the typical rm N, iii) an allocation (kt t t TT TN N N N , xN T , k T s , k N s , hT , hN ) for iv) and an allocation (cT t , xt , xt , c t , xt t t t t t the typical household, such that:

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T d , nT , y T ) solves (15) at the stated prices; a. (kt t t N d , nN , y N ) solves (16) at the stated prices; b. (kt t t TT TN N N N , xN T , k T s , k N s , hT , hN ) solves the household c. (cT t , xt , xt , c t , xt t t t t t maximization subject to (9)-(14) at the stated prices; T d = k T s , k N d = k N s , n T = hT , n N = hN , cT + d. all markets clear: kt t t t t t t t t T N T N N N T = yN . + xt = yt , ct + xt + xN t t

T xT t

To solve for the policy functions I am interested in a recursive equilibrium. I write down then the problem of the household in the following way (I denote with capital letters aggregate per capita variables and with small letters individual agents variables):

V (z T , z N , K T , K N , k T , k N ) = max U (cT , cN , 1 hT hN )+ +E [V (z T , z N , K T , K N , k T , k N ) | z T , z N , K T , K N , k T , k N ]

(19)

I can replace wT , wN , rT and rN in equation (14) with the rst order conditions of the problems of the rms, and I can replace p with the rst order condition of the problem of the household (all these conditions are evaluated in aggregate per capita variables):

TT TN cT t +xt +xt +

U2 N N T U2 N N N U2 N N N N T T T T (ct +xt +xN ) z T F2 ht + z F2 h t + z T F1 kt + z F1 kt t U1 U1 U1 (20) U2 (1 a) C N 1 = ( T) . U1 a C

using p= (21)

To reduce the quantity of variables (looking forward to the computation) I do the following simplications. First, I solve for lt in (9) and replace it in (7). Then I replace (12) and (13) in (10) and (11) respectively. Then I solve for xN T and xT N and replace them in (14). Finally, I equate aggregate supply and demand for K T , K N , N T , N N and C T , and solve the constraint (with equality) for cT and replace it in the utility function in (19). After these simplications I count two exogenous state variables (z T , z N ), two endogenous aggregate state variables (K T , K N ), two endogenous individual state variables (k T , k N ) and seven endogenous control variables (xT T , xN N , hT , hN , k T , k N , cN ). 12

Now I can dene a recursive competitive equilibrium. A recursive competitive equilibrium is: i. a value function V : R6 + R+ ,
7 ii. a policy function h : R6 + R+ for the representative household,

iii. rules determining the aggregate per capita values of these variables, 7 H : R4 + R+ , iv. and price functions rT , rN , wT , wN and p (R4 + R+ ) such that: a. V satises the household recursive problem (with all constraints replaced in utility function); b. h is optimal policy function for this problem; c. h(z T , z N , K T , K N , K T , K N ) = H (z T , z N , K T , K N ); d. rT ,rN ,wT ,wN satisfy rst order conditions of (15) and (16); e. p satises (21).

Calibration and Computation

I have 13 parameters to calibrate (, , , , , 1 , 2 , T , N , T , N , and a) and 6 more to estimate with a VAR for the technology process. Table II presents the parameters calibrated and estimated. I set to the actual growth rate of population in the period 1960-2000 (1.38%) and to the actual growth rate of output per capita in the same period (0.9%). I set , and to be the same as in a one sector model, i.e., 0.889, 0.38 and 2 respectively. I used series on machinery and transport equipment (tradable investment) and nonresidential construction (nontradable investment) to calibrate 1 , 2 , T and N . I obtained the share of construction in each sector by using data on construction permits (in square meters). I found that, on average, 75% of construction was assigned to the nontradable sector and 25% to the tradable sector. I obtained the share of tradable investment in each sector by using data on sectoral destination of imports of machinery and

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transport equipment. I found that, on average, 60% of imported machinery was destined to the nontradable sector and 40% to the tradable sector. I calculated 1 and 2 using these data and the following equations: 0.4xT 0.4xT + 0.25xN 0.75xN 0.6xT + 0.75xN

1 =

(22)

2 =

(23)

where xT and xN are average values of machinery and construction respectively. I obtained values of 0.62 and 0.55 for 1 and 2 , which indicates that the tradable sector is relatively intensive in tradable investment and the nontradable sector is relatively intensive in nontradable investment, though both sectors use a fair amount of each type of investment. I used laws of motion (10) and (11) in steady state and the ratios (0.079) and
xN kN xT kT

(0.068) to obtain T (0.056) and N (0.045).

I used the following rst order conditions in steady state to calculate k T k N xT T xN N simultaneously the ratios n T , nN , xN T , xT N (the subscript indicates partial derivative):
T T (z T F1 G1 + (1 T )) = (1 + )(1 + )

(24)

T T (z T F1 G2 + p(1 T )) = p(1 + )(1 + )

(25)

N N G1 + (1 N )) = (1 + )(1 + ) (z N F1

(26)

N N (pz N F1 G2 + (1 N )) = (1 + )(1 + )

(27)

p=

T z T F2 N z N F2

(28)

I proceed in the following way to calibrate T andN . I imposed the income share of aggregate capital to be equal to 0.4, the value used in a one T sector model. The average shares of output of each sector are yy = 0.35 and

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= 0.65. I used then the rst order condition (considering that in steady state capital in each sector have the same return), (1 T )/T k N /nN = , (1 N )/N k T /nT

yN y

(29)

plugging in the capital-employment ratios obtained above, to attain T and thetaN equal to 0.433 and 0.382 respectively. These values are reasonable. I can not calculate these parameters directly calculating the share of capital income in each sector because there are no income accounts in Argentina, but I calculate them directly for the US and found that the share in each sector is around 0.3, similar to the aggregate capital income share. Gonz alez Rosada and Neumeyer (2003) found econometrically a value of -1.5 for , which implies an elasticity of substitution in consumption between tradables and nontradables of 0.4. I used that value for , a consumption ratio rst order condition:
cN cT

of 2.07, and the following

T 1 a cN 1 z T F2 = ( T) N a c z N F2

(30)

to obtain a value of a of 0.121. Table II also presents the estimated parameters of the stochastic process. The spillover coecients, those that determine the eect of productivity in one sector on the productivity in the other sector the following period, are very small and statistically insignicant, so I decided to set them to zero. The computation procedure is the following: i) given the parameters calibrated and estimated, I compute decision rules for the centralized problem using the linear quadratic method as presented in, for example, Hansen and Prescott (1995); ii) I simulate paths for aggregate and sectoral capital, investment, labor, output and consumption. This is done by assuming that the economy was in steady state in 1986 (that is setting capital and productivity levels in 1986 to their steady state values) and inputing the observed changes in productivity in the decision rules;

15

iii) I calculate the simulated real exchange rate using the shadow price, that is, the ratio between marginal utility of nontradable consumption to marginal utility of tradable consumption (equation (21)).

Findings

Endogenous RER Figure 7 shows the simulated aggregate capital for the two sector model. I include also the simulated path for the one sector model (equivalent to KZ(2002b) of gure 1). It shows that the new model still overestimates the capital stock in 2001 by near 15%. It certainly improves on the one sector model in the period between 1991 and 1994, when there were huge increases in productivity in the nontradable sector but almost none in the tradable sector, but overestimates capital in the latter half of the decade. Figure 8 shows the sectoral capital paths. I observe that all of the overestimation of aggregate capital is due to overestimation of capital in the tradable sector (8a), by 100% in 2001. In fact, capital in the nontradable sector is underestimated (8b). Figure 9 shows the simulated investment series. First, observe that the model series follow the direction of change of the data series quite well, though not the magnitudes: during the 90s both types of investment grew less than in the model. Second, observe that most of the underinvestment is in the construction type, the nontradable investment. The RER puzzle Figure 10 presents the simulated behaviour of the real exchange rate, calculated with equation (21): it moves in opposite direction to the data. The simulated behaviour is determined mainly by the relative change in sectoral productivities. Some may argue that I should consider the changes in sectoral productivities of the rest of the world, and, in particular, as I am using the RER with respect to the US, the change in sectoral productivities of the US. That is correct, but I suspect that the results will not change as the US relative productivity did not change much, and was much less volatile than Argentinas, as shown in gure 5. As long as the RER is explained by relative sectoral productivities, it is mainly an internal process (consider gure 2 too). In the model, why does an increase in nontradable productivity with respect to tradable productivity depreciate the real exchange rate? We can

16

gain some intuition about this relationship by working an impulse-response exercise: a 5% increase in the level of nontradable productivity. The results are shown in gure 11. Supply of nontradables will increase due to the increase of its productivity. This will induce the increase of the demand of the four types of investment. With no change in price, there will be an excess supply of nontradables and an excess demand of tradables. Therefore, the price of nontradable to tradable will have to diminish to clear markets. In Argentina in the 90s, the opposite to the impulse-response exercise happened (compare gure 11 to gure 6). In the period 1990-1994 the relative productivity of nontradable increased drastically but the price of nontradables increased drastically too! In the period 1996-2001, on the contrary, the relative productivity of nontradable sector lost gradually some terrain, and the price of nontradables diminished. In a general exercise in business cycles analysis, Stockman and Tesar N (1995) found that the correlation between relative consumption c and relcT ative prices p was -1 in their model and between 0.39 (Japan) and -0.86 pT (US) in the data, which they consider an anomaly. In the present exercise the striking result is that the correlation in the model is -1 while the correlation in the data is 0.91! Now we have not one but two anomalies! Of course, both can be related. That seems, in essence, the story suggested by the initial quote of Calvo et al (2002), where low investment is caused by the misalignment of the RER. But before considering the case of an exogenous exchange rate I would like to explore an alternative exible RER possibility. The income eect story The appreciation of the RER in the early years of the decade came along with an increase in income. It has been noticed that tradable and nontradable desired consumption change dierently with income growth. An increase in income will increase the share of nontradable consumption in total consumption. In other words, cN is a superior good. This fact, other things equal, will increase the price of nontradables as a response to an increase in income, which have led to the argument that the appreciation of the RER was due to the increase in income, despite the increase in the relative productivity of nontradables. To test this hypothesis I postulate a new momentary utility function with non-homothetic preferences: U (cT , cN , l) = [(acT + (1 a)cN 17
+ / 1 1
N

/(1 )

(31)

I calibrate in the following way. I calculated dierent output per capita annual growth rates in each sector, T and N (1.4% and 5.5% respectively for the 90s). For the utility to be stationary given these rates, I have to detrend tradable and nontradable consumption by their respective growth rates, and must be such that: (1 + T ) = (1 + N )+ which implies a value of equal to 0.89. I adjust accordingly the value of a to 0.16. 11 Now I get the the path for the equilibrium price by using equation (21) modied 1 a ( + ) cN p= a cT 1 and plugging in actual data on consumption. I show the result in Figure 12: the RER should still have depreciated, though less than with homotheticity. Thus, we can not attribute the appreciation of the real exchange rate to the combination of growing income and the superior character of nontradable goods. This exercise also claries the puzzle: even if I can precisely replicate the consumption proles I will badly miss the price. In other words I need a model where equation (21), or (34), is broken down, and the price of the nontradable good increases despite the increase in its relative productivity and consumption. Exogenous RER I would like to summarize the results I obtained up to here. First, I found that the large increases in productivity in the early years of the 90s were mainly due to increases in the nontradable sector productivity (table I). Second, I conrm in a two sector model the overestimation of aggregate capital found by KZ(2002b) in a one sector model (gure 7). This means that the mere desaggregation into two sectors with dierent productivity proles is not enough to account for the pattern of capital accumulation. Third, the overestimation of aggregate capital by the model is due mainly to overestimation of capital in the tradable sector (gure 8a). Fourth, I obtained mainly overestimation of construction investment
Gonz ales Rosada and Neumeyer (2003) obtained a value near 1.4 for this parameter. The results are similar using this alternative value.
11

+1

(32)

18

(gure 9b). Fifth, according to the model, the real exchange rate should have depreciated in the early years of the 90s, when it appreciated strongly (gure 10). Sixth, the misalignment between actual RER and modeled RER appeared in the rst years of the 90s, and it decreased later in the decade. This is clear in gure 13, where the misalignment, , is dened as: po 1, ps

(32)

where po is the observed price and ps is the simulated price. I assumed that in 1990, a year where the currency oat freely and there were no capital controls in the Central Bank, the observed exchange rate was the equilibrium exchange rate. That is, I set 1990 = 0. According to this picture, overvaluation was very high, up to 150%, in the years following the launch of the convertibility plan in 1991 and declined steadily from 1993 onwards.12
13

It must be noticed that all of these results are, qualitatively, consistent with the real exchange rate story of low investment. If the real exchange rate is determined exogenously (say by government intervention, say by exogenous moves of international capital, say by some rigidity in the real exchange rate) and it is xed too high, then it is expected that a exible endogenous price model will overestimate the capital in the tradable sector (and underestimate it in the nontradable sector), and that it will overestimate the construction investment (that is, the nontradable investment). The question now is if the story is consistent quantitatively with the data. Under this hypothesis, to be able to construct a new model I have to address two questions: i) why was there no adjustment of the RER? ii) how can I incorporate parsimoniously this new feature in the framework that I set above? i) Why was there not adjustment of RER? The answer to this question is dicult. One possible answer is that the RER is sticky (specially, with a xed nominal exchange rate) because of
Not much of this picture will be changed if the data used were a multilateral real exchange rate, including Brazil, instead of the bilateral rate with the US. The appreciation of the Brazilian currency during the mid-ninities and its depreciation by the end of the decade are minor movements compared with the earlier movement in the Argentinian currency. 13 I would like to mention that as a predictive model of the level of RER that would have been attained after liberalizing the exchange market, the model does quite well. Indeed, the simulated equilibrium real exchange rate for 2001 (0.87 with year 1990=1) is very similar to the actual datum for the moment in which the exchange market was liberalized after the crisis (0.67 for 2002 and 0.78 for 2003).
12

19

stickiness of the nominal price of nontradables. If I had found that the misalignment occurred in a couple of years of my sample, or if it were relatively small, then I would have followed this possibility. But I found that it occurred for more than 10 years and that the RER was overvalued on average by 100%. Given recent evidence on the high frequency of price changes (for example, Bils and Klenow (2002), I consider this possibility implausible.14 A second, more plausible, answer is that during the whole period the government was intervening to maintain a high real exchange rate. This possibility raises two questions: why do it? and how? I will not answer the rst question thoroughly, because I do not have such an answer. I will suggest though that the reason for keeping a high RER might have been fear of deation, diculty to lower public wages and/or political inuence of the newly privatized public services, being the government and public services important components of the nontradable sector. The instrument to maintain a high RER might have been the following. During almost the whole period the government was borrowing funds abroad to close the scal decit. During almost the whole period there was decit in the current account. These are the so-called twin decits. So I hypothesize that the government was maintaining a high exchange rate by using the loans to buy the excess supply of nontradables, while the net ow of imports was closing the excess demand of tradables. Figure 14 illustrates this idea. In this sense, the collapse of the real exchange rate was just the follow-up of the dryness of the international capital market. In 2001, with no more external loans, the government could no longer maintain the high real exchange rate; it had to change the nominal exchange rate (and observe the increase in the price of the tradable goods) or let the nontradable sector deate. They chose the rst. In this paper I do not provide complete evidence to judge this hypothesis but the following exercise might indicate which type of evidence we need as well as the quantitative magnitude of it. It might also suggest that the hypothesis is implausible if results are less in accordance with the data than the benchmark model. ii) A model with xed RER and xed labor I want to compute a model with relative price of nontradable good xed exogenously. One problem is that with a xed price the previous model is
Indeed, Rogo (1996), reconsidering the purchasing power parity doctrine, states: Consensus estimates for the rate at which PPP deviations damp, however, suggest a half-life of three to ve years, seemingly far too long to be explained by nominal rigidities.
14

20

overdetermined. To see this, observe that the ve equations (24) to (28) are k T k N xT T xN N dened on ve unknowns, the ratios n T , nN , xN T , xT N , and p. If I make p exogenous, I will have ve equations in four unknowns. I decided then to simplify the model and eliminate the labor decisions, both the labor-leisure decision and the division of labor between sectors (which will let me loose equation (28)). For the purpose of our exercise this is an innocuous decision: after solving this simplied model with xed labor and exible endogenous RER, both the aggregate capital and the RER anomalies are still there (see gure 15). Consequently I x the labor inputs to their steady state values, nN = 0.21 in the nontradable sector and nT = 0.09 in the tradable sector. Computationally, the only essential dierence with the previous exercise is that I estimate a stochastic process for the RER and include this price as a third exogenous state variable in the decentralized version of the benchmark model. The coecient of the rst order autoregressive process for the price is 0.79. The results are presented in gure 16. As expected, now there is a decrease of the capital in the tradable sector (g. 16b), at least for the period of strong appreciation of the RER, and a strong increase of the capital in the nontradable sector (g. 16c). 15 The aggregate capital is still overestimated (g. 16a). In fact, more than ever. This is due, of course, to the overestimation of capital in the nontradable sector. And this, in turn, is due to the high protability of the nontradable sector when its price is xed too high. As I suspected when I started to think about the real exchange rate story of low investment, there is no reason for the capital gap to vanish if we consider the eects of the alleged misalignment in both sectors. For this story to work we must assume some asymmetry between the goods markets. For example, we might assume that there is demand rationing in the nontradable sector. Of course, in this case, we must be able to put forward the reasons for such market behaviour. But I will leave this for further research.
The decrease of the simulated capital in the tradable sector would have been bigger if not for the zero constraint on investment. In fact, I obtained that for the period between 1990 and 1994 there was no investment in the tradable sector. Firms in this sector just let their capital to depreciate.
15

21

Concluding comments

In this paper I put the extremely dierent performance of the tradable and nontradable sectors in Argentina in the last 25 years at the center of the case study. And I ask two questions. First, does an exogenous productivity process in a two sector (tradable and nontradable) general equilibrium model explain the KZ(2002b) anomaly? The answer is no. And there is a new anomaly: the simulated relative price of nontradable good moves in opposite direction to the data. Second, does an exogenous real exchange rate process better explain the data? The answer is again no. In the rst part, both, the found misalignment of the RER and the overestimation of capital in the tradable sector and its underestimation in the nontradable sector, gave some credibility to the real exchange rate story of low investment. But, in the second part, the too strong eects of the exogenous price and the much larger overestimation of the aggregate capital undermined it. Overall, I conclude that an endogenous RER model overestimates the aggregate capital and is not able to explain the RER movements. On the other hand, a simple exogenous process for the RER does not eliminate the anomalies. It remains to be seen if a more complex model, as an open economy model, a rationing model or a sticky price model can be rationalized and do any better at replicating the time series. I would like to conclude with a suggestion for policy makers and a conjecture for researchers. The suggestion is that policy makers should look at the relative productivity of tradable and nontradable goods when analyzing real exchange rate behaviour. For example, there is plenty of debate nowadays about the alleged undervaluation of the Chinese Yuan without any reference to sectoral productivities. In the case of Argentina, some warnings that the real exchange rate was overvalued were dismissed during the rst years of the 90s alleging that productivity was increasing. Yes, productivity was increasing, but in the nontradable sector! If policy makers had considered this disaggregation they would have not dismissed the warnings. The conjecture is the possibility that the sectoral productivities, that were taken as exogenous in this paper, depend causally on the real exchange rate. While sectoral productivities in the long run might be determined on more structural conditions, I hypothesize that sectoral productivities in the short and medium run might depend on the behaviour of the real exchange rate. The high protability on either sector due to the real exchange rate

22

might provide the incentives to increase the TFP in the favored sector. In the case analyzed here, the productivity of the nontradable sector would have been enhanced and the productivity in the tradable sector would have been ignored because of the high real exchange rate. Table III provides simple regressions of TFPs on the real exchange rate, the seed of the conjecture. A 10% increase in the relative price of nontradable good is associated with a 2% increase in the nontradable productivity and a 2% decrease in the tradable productivity, no minor changes. In this context, the explosive nature of the process must be noticed. Lets say that the government xes a high real exchange rate with respect to the equilibrium real exchange rate. Then, under this conjecture, the nontradable productivity will increase with respect to the tradable productivity, which, by Balassa-Samuelson hypothesis, will diminish the equilibrium exchange rate and increase the misalignment. Moreover, increasing quantities of funds will be necessary to maintain the original xed real exchange rate.

References

Alvarez, Fernando and Jermann, Urban (2000). Eciency, Equilibrium, and Asset Pricing with Risk of Default, Econometrica 68, 775-797. Balassa, Bela (1964). The Purchasing-Power Parity Doctrine: A Reappraisal, The Journal of Political Economy 72, 584-596. Banerjee, Abhijit, Duo, Esther (2005). Growth Theory Through the Lens of Development Economics, in Handbook of Economic Growth Vol. 1A, Amsterdam: Elsevier, 473-552. Baxter, Marianne and Farr, Dorsey (2001). The Eects of Variable Capital Utilization on the Measurement and Properties of Sectoral Productivity: Some International Evidence, NBER Working Paper W8475. Betts, Caroline and Kehoe, Timothy (2001). Real Exchange Rate Movements and the Relative Price of Nontraded Goods, Federal Reserve Bank of Minneapolis, Sta Report. Bils, Mark and Klenow, Peter (2004). Some Evidence on the Importance of Sticky Prices, Journal of Political Economy 112, 947-985. Brandt, E., Dressler, S. and Quintin, E. (2004). The Real Impact of Financial Crises, Federal Reserve Bank of Dallas Economic and Financial Policy Review 3. Burnside, C., Eichenbaum, M. and Rebelo, S. (1996). Sectoral Solow Resid23

uals, European Economic Review 40, 861-869. Burnstein, A., Eichenbaum, M. and Rebelo, S. (forthcoming). The Importance of Nontradable Goods Prices in Cyclical Real Exchange Rate Fluctuations,Japan and the World Economy. Burnstein, A., Neves, J. and Rebelo, S. (2003). Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilizations, Journal of Monetary Economics 50, 1189-1214. Caballero, Ricardo and Krishnamurthy, Arvind (2001). International and Domestic Collateral Constraints in a Model of Emerging Market Crises, Journal of Monetary Economics 48, 513-548. Calvo, G., Izquierdo, A. and Talvi, E. (2002).Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentinas Lessons, Inter-American Development Bank Working Paper. Cole, Harold and Ohanian, Lee (1999). The Great Depression in the U.S. from a Neoclassical Perspective, Federal Reserve Bank of Minneapolis Quarterly Review 23, 2-24. De Gregorio, Jos e and Holger Wolf (1994). International Evidence on Tradables and Nontradables Ination, European Economic Review 38, 12251244. Deloach, Stephen (1997). Do Relative Prices of Non-Traded Goods Determine Long-Run Real Exchange Rates?, The Canadian Journal of Economics 30, 891-909. Feldstein, Martin (2002). Argentinas Fall. Lessons from the Latest Financial Crises, Foreign Aairs 81(2), 8-14. Fernandez de Cordoba, Gonzalo and Kehoe, Timothy (2000). Capital Flows and Real Exchange Rate Fluctuations Following Spains Entry into the European Community, Journal of International Economics 51, 49-78. Gonz alez-Rozada, Mart and Neumeyer, Pablo A. (2003). The Elasticity of Substitution in Demand for Nontradable Goods in Latin America. Case Study: Argentina, Working Paper. Hansen, Gary and Prescott, Edward (1995). Recursive Methods for Computing Equilibria of Business Cycle Models, in Frontiers of Business Cycle Research (Thomas Cooley, Ed.), Princeton, NJ: Princeton Univ. Press. Hausmann, Ricardo and Velasco, Andr es (2003). Hard Moneys Soft Underbelly: Understanding the Argentine Crisis, in Brookings Trade Forum: 24

2002 (S. Collins and D. Rodrik, Eds.), Brookings Inst. Press. Hayashi, Fumio and Prescott, Edward (2002). The 1990s in Japan: A Lost Decade, Review of Economic Dynamics 5, 206-235. Herrendorf, Berthold and Valentinyi, Akos (2005). Which Sectors Make the Poor Countries So Unproductive?, Working Paper. Hinkle, Lawrence and Montiel, Peter (1999). Exchange Rate Misalignment. Concepts and Measurement for Developing Countries, Oxford Univ. Press. Kakkar, Vikas (2003). The Relative Price of Nontraded Goods and Sectoral Total Factor Productivity: An Empirical Investigation, The Review of Economics and Statistics 85, 444-452. Kehoe, Timothy (2003). What Can We Learn from the Current Crisis in Argentina, Scottish Journal of Political Economy 50, 609-33. Kehoe, Patrick and Perri, Fabrizio (2002). International Business Cycles with Endogenous Incomplete Markets, Econometrica 70, 907-928. Krueger, Anne (2002). Crisis Prevention and Resolution: Lessons from Argentina, NBER Conference, July 17th. 2002. Kydland, Finn and Zarazaga, Carlos (2002a). Argentinas Lost Decade, Review of Economic Dynamics 5, 152-165. Kydland, Finn and Zarazaga, Carlos (2002b). Argentinas Recovery and Excess Capital Shallowing of the 1990s, Estudios de Economia 29, 35-45. Maia, Jos e Luis and Nicholson, Pablo (2001). El Stock de Capital y la Productividad Total de los Factores en la Argentina, Working Paper. Mendoza, Enrique (1995). The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations, International Economic Review 36, 101-137. Obstfeld, Maurice and Rogo, Kenneth (1996). Foundations of International Macroeconomics, Cambridge, MA: MIT Press. Rogo, Kenneth (1996). The Purchasing Power Parity Puzzle, Journal of Economic Literature 34, 647-668. Samuelson, Paul (1964). Theoretical Notes on Trade Problems, The Review of Economics and Statistics 46, 145-154. Stockman, Alan and Tesar, Linda (1995). Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Co-

25

movements, The American Economic Review 85, 168-185.

Appendix A: Data Sources and Procedures

All the data can be retrieved from (my webpage). I thank Carlos Zarazaga for generously providing KZ(2002b) dataset, to Oscar Meloni for referencing me to the MN(2001) dataset, and Beatriz Anchorena and Ezequiel Caviglia for helping in the collection of additional data. The main dataset is the one constructed by Maia and Nicholson (MN(2001)). It can be retrieved from http://www.mecon.gov.ar/peconomica/basehome/ evolucion productividad.html. The MN dataset contains aggregate data on output, labor, investment and capital from 1960 to 2001. It also contains the investment disaggregated into machinery and construction. The series of machinery that I used includes national and imported machinery. The series of construction that I used excludes residential construction, consistent with the capital series, that does not include residential capital, and with KZ(2001) series. I used series of shares of tradable and nontradable to disaggregate GDP, labor and capital. For GDP, between 1965 and 2001, I used the shares informed in Worldbank Development Indicators: I sum the shares of agriculture and manufacturing for tradable share and consider the rest nontradable. For labor, between 1960 and 1991, I used data in the Censuses of Argentina for 1960, 1970 and 1991. Again, I calculate the share of tradable employment by summing the employment in agriculture, mining and manufacturing and dividing by total employment. I interpolate the values of these shares between censuses to obtain annual shares. Between 1994 and 2001, I used data of employment by sector informed by the AFIP through the Ministry of Economy (http://www.mecon.gov.ar/peconomica/basehome/infoeco.html). Again, I interpolated for years 1992 and 1993. For capital, I used data on electrical energy between 1976 and 2001 obtained by private email from the Secretary of Energy (http://energia.mecon.gov.ar). The total energy data is disaggregated into energy for commerce and energy for industry. I used that data to calculate shares identifying industry with tradable sector and commerce with nontradable. I thank Ana Maria Duco of the Secretary of Energy for providing this information. I calculate the data on consumption (used in the income eect story section) by substracting investment from output in each sector. 26

I obtained the data on real exchange rate and price of nontradables goods in terms of tradables between 1981 and 2002 from ECLAC, Buenos Aires (http://www.eclac.cl/argentina/noticias/paginas/9/9839/Cuadro13.xls). I obtained data on construction permits by sector at INDEC (http://www.indec.mecon.ar), section Industry and Construction. I obtained data on imported machinery by sector from Ministry of Economy (http://www.mecon.gov.ar). I obtained data for US from the following sources. Total and sectoral GDP and labor from the Bureau of Economic Analysis as well as total capital. Electricity shares were obtained from the Energy Information Administration (http://www.eia.doe.gov/fuelelectric.html).

27

1.1 model data 1.05

0.95

0.9

0.85

0.8 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 1. Aggregate Capital (1986=1). One sector model. The series is detrended by constant income per capita and population growth rates for the period 1960-2001. This figure is a replication of figure 2 in KZ(2002b). There are some differences though between this figure and theirs. In particular, I obtain less overestimation by 2001 (20% against 25%), and the overestimation appears mainly after 1994, while in theirs it appears since 1990. The differences are due to the use of a different dataset and the calculation of TFP in a slightly different way. However, the main feature is present in both figures: capital did not grow as much as the model predicts.

1.2

0.8

0.6 rer p

0.4

0.2

0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Figure 2. Real Exchange Rate (RER) and Relative Price of Nontradable (p) (1993=1). RER measured using the nominal exchange rate and the CPI ratio between Argentina and US. p measured using CPI for services (nontradable goods) and Wholesale Price Index for industrial goods (tradable goods). Source: http://www.eclac.cl/argentina/noticias/paginas/9/9839/Cuadro13.xls

14

12

10

total tradable nontradable

0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 3. Capital per capita (thousands of pesos of 1993). Total and Sectoral. The series have been detrended by average growth in total income for period 1960-2001.

total tradable nontradable

0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 4. Output per capita (thousands of 1993 pesos). Total and Sectoral. The series have been detrended by average growth in total income for period 1960-2001.

7.5

7 tradable 6.5 nontradable

5.5

4.5

3.5

3 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

9.5

8.5

7.5

6.5 tradable nontradable 6

5.5

5 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 5. Sectoral TFP. a) Argentina. b) US. For both countries I used equivalent data (constant price GDP and capital, employment measured by employed persons, shares of capital used in tradable and nontradable sector using electricity data) and production function (setting the capital share of income to 0.4). Using the more realistic capital share of 0.3 for US gives the same graph but scaled up.

1.8 relative tfp rer 1.6

1.4

1.2

0.8

0.6

0.4

0.2 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 6. Relative TFP (ratio of TFP of tradable sector to TFP of nontradable sector) and RER.

1.1

1.05 2 sector model 1 sector (kz) model data 1

0.95

0.9

0.85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 7. Capital (1986=1). One sector and two sector model.

1.2

1.1

0.9 data 2 sector model 0.8

0.7

0.6

0.5

0.4 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 8a. Capital in tradable sector (1986=1).

1.2

1.1

0.9

0.8 data 2 sector model 0.7

0.6 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 8b. Capital in nontradable sector (1986=1).

4.8

4.3

3.8

3.3

2.8

2.3

1.8

1.3 2 sector model data 0.8

0.3 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 9a. Machinery Investment (1990=1).

5.3 4.8 4.3

3.8 3.3 2.8 2.3

1.8 1.3 data 0.8 2 sector modelt

0.3 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 9b. Construction Investment (1990=1).

1.8

1.6

1.4

1.2

2 sector model data

0.8

0.6

0.4 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Figure 10. Real Exchange Rate (1990=1).

1.020

1.000

0.980

0.960

0.940

p tfpT/tfpN

0.920

0.900

0.880 0 1 2 3 4 5 6 7 8 9 10 11 12 13

Figure 11. Impulse-Response simulation.

1.2

non-homothetic pref homothetic pref

0.8

0.6

0.4

0.2

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 12. The income effect story: Relative price of nontradable with homothetic and non-homothetic preferences, calculated using consumption data and equations (21) and (34) respectively.
2.000

1.500

1.000

0.500

0.000

-0.500

-1.000
19 76 19 77 19 78 19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00

Figure 13. Misalignment of the Real Exchange Rate ( t ) (1990=0).

pN

Excess supply of nontradables covered by the government with external funds

qNs

qNd

pT

qTs

Excess demand of tradables covered by imports

qTd

Figure 14. Excess supply of nontradables and excess demand of tradables due to the setting of a high relative price of nontradables.

1.05

0.95

0.9

0.85 data without labor adjustment with labor adjustment 0.8 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 15a. Capital (1986=1). The capital gap anomaly persists even with no adjustment of labor.

1.8

1.6

1.4

1.2

data without labor adjustment with labor adjustment

0.8

0.6

0.4 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 15b. RER (1990=1). The RER anomaly persists even with no adjustment of labor.

1.5

1.4

1.3

1.2 data p endogenous p exogenous 1.1

0.9

0.8 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 16a. Aggregate Capital (1986=1). No labor adjustment. The capital gap is bigger with exogenous price.

1.4

1.2

0.8

0.6 data p endogenous p exogenous 0.4

0.2 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 16b. Capital in tradable sector (1986=1). No labor adjustment.

1.9

1.7 data p endogenous p exogenous 1.5

1.3

1.1

0.9

0.7 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Figure 16c. Capital in nontradable sector (1986=1). The effects of an exogenous price are too strong.

Table I: Argentina - Sectoral Growth Accounting (in percentages) Aggregate Y/N -0.17 -0.61 -0.79 3.55 -0.35 Capital intensity 1.81 -0.37 -0.06 -1.69 0.93 Capital intensity 6.29 0.76 1.22 -2.31 -0.58 Employment intensity 0.82 0.50 0.87 -0.86 1.29 Employment intensity -0.72 -0.57 -0.26 -0.05 -3.25 TFP -2.60 -0.58 -1.38 6.33 -2.45

1976-1981 1981-1986 1986-1991 1991-1996 1996-2001 Tradable

1976-1981 1981-1986 1986-1991 1991-1996 1996-2001 Nontradable

Y/N -5.81 -0.49 -3.08 -1.01 -2.73

TFP -10.67 -0.43 -3.37 1.57 1.40

1976-1981 1981-1986 1986-1991 1991-1996 1996-2001

Y/N 4.06 -0.39 0.73 5.46 0.41

Capital intensity -1.07 -0.83 -0.55 -1.41 1.32

Employment intensity 1.59 0.99 1.35 -1.19 3.03

TFP 3.80 -0.05 0.49 8.40 -3.75

Table II: Parameter values Parameter Value Benchmark 0.009 0.0138 T 0.433 N 0.382 -1.5 a 0.121 0.889 1 0.62 2 0.55 T 0.0564 N 0.0452 0.38 2 a11 0.79 a12 0 a21 0 a22 0.79 b1 0.94 b2 0.91 cN superior 0.89 0.16

RER exogenous b3 0.245 a33 0.79

Table III. OLS regression of TPFs (z N and z T ) on RER (p). Standard errors in parenthesis. ln(z N ) 0.2275 (0.03) 0.70 ln(z T ) -0.2061 (0.091) 0.17

ln(p) R2