Argentina's 'Missing Capital' Puzzle and Limited Commitment Constraints

Argentina’s capital stock has consistently fallen in periods of total factor productivity (TFP) declines, while remaining largely unresponsive in periods of TFP surges. The net result of this asymmetry is that capital appears to have been “missing” from the Argentine economy when conditions were particularly favorable to an investment boom. Models that assume that a country cannot commit to honor its external debt obligations are a natural candidate to capture this “missing capital problem,” because they predict that investment will fall in response to a declining TFP, but not rise much in response to a soaring TFP. This theoretical consideration finds empirical support in the fact that traumatic developments in Argentina’s economic history may have led investors to perceive it as a country prone to external debt “opportunistic defaults.” Accordingly, the paper explores the extent to which Argentina's missing capital can be quantitatively accounted for by a model featuring an optimal contract between foreign lenders and a small open economy subject to a limited commitment constraint. The paper finds that a deterministic version of this analytical framework, calibrated with data from Argentina, accounts surprisingly well for that country’s missing capital. More precisely, the model economy accurately mimics the rapid decline that that country's capital stock experienced, along with a falling TFP, during the 1980's, and the lack of any visible recovery of that stock during the significant surges of TFP observed from 1992 to 1998 and from 2002 to 2008. Numerical experiments show however, and somewhat paradoxically, that by making the limited commitment constraint more binding, low international interest rates played an important role in the disappointing performance of investment in those two periods and, furthermore, that in absence of that constraint, Argentina's capital stock in 2008 would have been 50% higher than it actually was.