Adios, Argentina

Companies are leaving for Brazil

"Love thy neighbor" is not an easy commandment to live by for Argentina. Brazil's abrupt devaluation a year ago rendered Argentine products comparatively more expensive both at home and abroad. Worse, the cost of doing business became far cheaper in Brazil than in Argentina, spurring some two dozen companies to jump the border. The effect was to drag Argentina into a deep recession that it still hasn't shaken. Meanwhile, the Brazilian economy is set to rebound nicely in 2000. Thank you, Brasilia.

This double whammy of a cheaper Brazilian currency and a local recession is presenting Argentina's newly elected president, Fernando de la Rua, with one of his first big policy challenges. The 35% slide of the Brazilian real against the Argentine peso is luring one manufacturer after another north to Brazil. If de la Rua cannot stop it, the corporate exodus could cut short any nascent economic recovery, boost 14% unemployment to even higher levels, and spark social unrest in Argentina's poorest provinces. Corporate flight will deal another blow to Mercosur, the trade group anchored by Brazil and an increasingly disgruntled Argentina.

SHUTTING DOWN. The latest to pull up stakes is Delphi Automotive Systems Corp. The world's largest auto-parts maker announced on Dec. 27 that it would shut down a wiring plant in Argentina's Cordoba province. Delphi is in good company: Lured by Brazil's lower costs and larger market, at least 15 auto-parts companies have moved north, taking with them 7,000 jobs, equal to one-fifth of the industry's total workforce. Meanwhile, General Motors Corp., Ford Motor Co., and Italy's Fiat are all shifting some of their production to Brazil.

The stampede isn't limited to the auto industry. It includes food processor Compania Industrial de Conservas Alimenticias (CICA), a unit of Anglo-Dutch giant Unilever, and plastic-container manufacturer Tupperware Corp. CICA will close a plant in Mendoza province at midyear and ramp up exports from facilities in Brazil and Chile to supply Argentina. The company had considered the possibility of shuttering the Mendoza factory before Brazil's devaluation, but the real's slide "accelerated our decision," says Miguel Angel Gonzalez Abella, CICA's head of institutional relations.

De la Rua said just before New Year's that he will do everything in his power to stop the exodus. So far, the President has offered to ease the burden on business through cuts in payroll taxes and a reduction in import tariffs on key industrial goods. That could help slow the rush of companies out of Argentina, but it will compromise de la Rua's efforts to curb a gaping $6.5 billion budget deficit.

The fastest way out would be a devaluation, but there is virtually no support for such a move in Argentina. Scrapping the peso's 1-to-1 peg to the U.S. greenback would devastate scores of Argentine companies with dollar debts and end the country's nine-year streak of single-digit inflation. "This is a problem that has no quick solution," says Abel Viglione, an economist with the Latin American Economic Research Foundation (FIEL), a Buenos Aires think tank.

Argentina can't blame all of its troubles on a weaker real. Many local businesses have been slow to revamp since protectionist barriers were lifted in the early 1990s. "For years, Argentina concentrated on the domestic market and didn't do much to help its own exports," says Daniel Mateu, chief financial officer of Argentine shoemaker Grimoldi. "That makes it difficult for our industry to compete." Indeed, his company bought two Brazilian footwear companies in 1999 to take advantage of their lower production costs.

Argentina is also learning the hard way that when times are tough, companies will focus on the big markets. Brazil's population of 165 million is nearly five times that of its neighbor. That's one reason why auto makers, even while scaling back in Argentina, are plowing more money into Brazil. Fiat plans to invest $1.5 billion over the next three years to step up sales of small trucks in the country--its largest market outside Italy. DaimlerChrysler is spending $500 million to modernize its truck plant near Sao Paulo. Although its economy barely grew in 1999, Brazil received a healthy $29 billion in foreign direct investment last year, compared with an estimated $6 billion for Argentina.

Some Argentine provinces are trying to curry favor with foreign investors with offers of tax breaks and other perks. Cordoba has promised Volkswagen, which is considering installing a gear-box factory in the province, exemptions on provincial and municipal taxes and its own power line. However, Brazilian states have been even more generous, giving free land and big financing packages to carmakers including France's Renault and Ford. Still, the days of subsidies may be numbered, as Argentina and Brazil, both of which are trying to contain large fiscal deficits, can ill afford such largess.

COMMON COIN. To become more competitive over the long term, Argentina will have to find ways to reduce the cost of doing business in the country. Above all, that means an overhaul of the country's antiquated labor laws, which make it difficult--and expensive--for companies to dismiss workers. Such reforms face stiff opposition from Argentina's influential unions, and de la Rua probably does not want to lock horns with labor leaders so early in his four-year term. Still, some analysts believe that if the economy continues to perform poorly, workers will have to swallow wage cuts if they want to hang on to their jobs. "The market by itself will take care of high labor costs, but it will be tough on a lot of people," says FIEL's Viglione.

One long-term way out of Argentina's quandary is a Mercosur single currency. The introduction of a common coin would eliminate the risk of a devaluation like Brazil's wreaking havoc on the other members of the bloc, which includes Uruguay and Paraguay. It would also reduce the incentive for companies to hop from one country to another.

All of Mercosur's members have endorsed the concept of a common currency. But it is clear that the merco, as it could be called, cannot emerge overnight. It took Europe more than a decade to lay the groundwork for the debut of the euro last year. "A single currency can be achieved, but it will probably take at least six years," says Michel Alaby, a Sao Paulo economist who is an expert on Mercosur.

In the meantime, expect lots of disagreement within Mercosur. Two-way trade between Brazil and Argentina fell by over 25%, to an estimated $10.6 billion in 1999, the first annual decrease since the bloc was launched in 1991. Argentina has hiked tariffs and imposed quotas on an array of Brazilian goods, from steel to shoes to household appliances, and introduced rules making it more difficult for importers of Brazilian goods to receive credit guarantees. Brazil has retaliated with its own assortment of protectionist measures. Beggar thy neighbor, not love thy neighbor, are the words that Mercosur's two leading partners live by nowadays.

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