Research Department Working Papers
Argentina’s “Missing Capital” Puzzle and Limited Commitment Constraints
Abstract: Capital accumulation in Argentina was slow in the 1990s, despite high total factor productivity (TFP) growth and low international interest rates. A possible explanation for the “missing capital” is that foreign investors were reluctant to take advantage of the high returns to investment seemingly offered by that small open economy under such favorable conditions, on the grounds that previous historical developments had led them to perceive Argentina as a country prone to external debt “opportunistic defaults.” The paper examines this conjecture from the perspective of an optimal contract between foreign lenders and a small open economy subject to limited commitment constraints. Numerical experiments for a deterministic version of that analytical framework show that limited commitment constraints introduce an asymmetry to the capital accumulation process of small open economies: the responses of investment to positive TFP shocks are muted and shortlived, while those to negative TFP shocks are large and persistent. Furthermore, under some circumstances, a lower international interest rate environment can magnify the asymmetry. A quantitative implementation of the model economy to data from Argentina accounts, in line with asymmetry just described, for the rapid decline that that country’s capital stock experienced, along with a falling TFP during the 1980s, as well as for the lack of any visible recovery of that stock during the significant surges of TFP observed between 1992-1998 and 2002-2008. In the absence of the limited commitment constraint, Argentina’s capital stock in 2008 would have been 50% higher than it actually was.