A Strategy for Argentine Economic Recovery
Copyright © 2005 by Thomas Gangale
In late 2001 and early 2002, the Argentine economy suffered perhaps the most spectacular meltdown anywhere in the world since the US stock market "Crash of 1929." The roots of the Argentine "Crash of 2001" can be examined in light of decisions made over the course of more than half a century by a succession of governments that steered the nation in one direction and then another. Also of interest are decisions in the year or so leading up to the crash, during which time the peso came under increasing pressure, as well as actions taken in three years since the crash. Finally, from the position that Argentina now finds itself in, and the constraints this places on its options, this paper recommends a strategy for recovery.
History Fast Forward
For Argentina, the beginning of the 20th century was bright with promise. The large, fertile plain of the Pampas gave the agricultural sector good conditions and were the basis for strong, export-oriented growth in primary produce (mainly wool, wheat, corn, and beef). As the country was also short of both people and capital, the high yields on these resources brought massive immigration and high investment rates. In 1913, Argentina ranked among the top 15 nations in the world in terms of wealth, on a par with Italy. However, in 1999, it ranked 56th, at the level of Hungary and the Czech Republic (Sørensen 2001). What happened to Argentina in the 20 century?
The open Argentine economy of the early 20th century was badly mauled by the effects of the First World War, when international trade contracted, and agricultural exports were especially hit. It became apparent that the economy, being based on the export of only half a dozen agricultural products, was highly vulnerable to fluctuations in world-market prices of these products. Also, Argentina was dependent on foreign capital investments, as domestic savings were limited; however, in the 1920s, international capital was more attracted to the booming US stock market. The Crash of 1929 dried up investment capital even more, and the dramatic decline in international trade devastated the export-oriented Argentine economy. Argentina’s openness backfired when world trade contracted. As exports and foreign investment became less important to the Argentine economy, economic policy shifted from laissez faire to government intervention, from an open economy to a closed one. These changes made import substitution industrialization an attractive strategy in the 1940s for diversifying the economy and making it less vulnerable to external shocks. In retrospect, it was precisely the wrong decision at the wrong time. The Bretton Woods conference turned the post-war international economy back in the direction of open markets, but the now-closed Argentine economy was unable to reap the benefits. Furthermore, import substitution required the importation of capital equipment to build infrastructure and industry. This was financed by rising foreign debt. As inflation rates rose in the late 1970s, the military government declared import substitution a failed experiment, and began to open the economy. However, the peso was overvalued. Cheap imports flooded Argentina, resulting in the decline of local industry, and many of Argentina’s exports were priced out of the international market. A series of failed currency stabilization plans in the 1970s and 1980s resulted in hyperinflation. Capital flight was massive (OECD 2001; Sørensen 2001).
Table 1: Currency Reforms, 1881-1992
Source: Central Bank of Argentina
Between 1970 and 1992, four currency reform acts resulted in the elimination of 13 zeroes from the Argentine currency. In other words, neglecting returns on investment, ten billion pesos in 1970 became one peso in 1992.
In 1991, a currency stabilization regime established a currency board, which pegged the Argentine peso to the dollar on a 1-to-1 basis. Inflation was virtually eliminated. Foreign investment returned. GDP growth was strong in the early 1990s, but unemployment increased as a result of extensive structural reforms. Argentina finally seemed to have a handle on its chronic economic problems. It was the International Monetary Fund’s star pupil. However, external events in the late 1990s buffeted the Argentine economy:
Because of its long history of economic instability, every economic crisis in the Third World, particularly in Latin America, caused investors to pull out of Argentina, creating a self-fulfilling prophesy. It was investors’ hair-trigger reaction to crises elsewhere that caused Argentina’s instability, thus the adverse effects of these crises were greater in Argentina than in most other new-growth economies. Another reason for this enhanced vulnerability is that Argentina stood alone with its fixed-exchange-rate policy, whereas the floating currencies of its neighbors depreciated (Sørensen 2001). By 2001, the peso was significantly overvalued, in no small part due to the dollar itself having become overvalued (Weisbrot 2002). The devaluation of the Brazilian real had a particularly large effect. It reduced demand from Argentina’s largest trading partner, and businesses began to move from Argentina to Brazil in search of lower production costs. The lengthy Argentine recession in the wake of the Russian crisis strained public finances. Tax revenues declined, resulting in an increasing budget deficit and government debt. At the same time, the credibility of the peso at its pegged value declined, and the government had to expend huge sums to support the currency, which in turn necessitated more borrowing. Under these conditions, interest rates that were already high rose even higher, and as both debt and interest rates rose, the ability of the government to service its debt became increasingly in doubt. The IMF loaned the government $22 billion in 2001. In part, this enabled Argentina to keep the peso pegged to the dollar, even though this was now an unrealistic strategy. On the part of Argentine decision-makers, clinging to this failing strategy reflected a deep-rooted domestic fear of a return to hyperinflation. In the aftermath, however, there has been much finger-pointing at the IMF that it should have given Argentina better advice (Weisbrot 2001; Stiglitz 2002).
The buzzards came home to roost in December 2001, when the Argentine government announced that it would suspend payments on a debt that was estimated to be in the range of $132 billion, the largest default in history. The nation rapidly descended into chaos. As economic activity shuddered to a virtual halt, governments resigned and were hastily replaced amid sporadic rioting. The following month, when Eduardo Duhalde (the fifth person to hold the presidency in two weeks) unpegged the peso in January 2002, the peso crashed hard, losing more than 70% of its value.
As bad as was the fallout of the devaluation, the default on the debt, the run on the banks, and the rioting, it probably was not nearly as bad as had been feared, and as of today, the effects (except for what may be a long-term effect on the middle class) seem to have been brief. The fear of hyperinflation turned out to be exaggerated. Although the immediate effect of the devaluation was an inflation rate of 41% in 2002, this was a far cry from the nearly 5000% in 1989. Nor does this seem to have been the harbinger of a return to the chronic inflation levels above 100% of the 1970s and 1980s. In 2003, inflation dropped to 3.2%. Although GDP declined by 10.9% in 2002, the economy grew by 8.4% in 2003.
However, numerous problems remain in the Argentine economy. Unemployment remained high in 2003 at 16.3%, having dropped only 1.5% from the previous year (US Commercial Service 2004). At the same time, income inequality is high, which is usually a barrier to sustained growth. This is not a new problem, in that Juan Peron ruled with the active support of the descamisados (militant blue-collar unionists) and the acquiescence of the upper class, presumably to the detriment of the middle class. The privatization binge of the early 1990s greatly benefited the wealthy and the upper middle class, which bought up government industries at fire sale prices. Goods and services that were formerly subsidized by the government now had to be paid for at market prices, further contributing to the widening of the gap between the rich and poor (Azul 2003). The middle class was squeezed yet again in the Crash of 2001, when the devaluation instantly wiped out 70% of savings on deposit. Meanwhile, as IMF loans enabled a prolonged propping up of the peso, much of the investment capital that could move out of the country did so before the axe fell. It is an astounding statistic that in a nation with a 97.1% literacy rate, where agricultural manufactures, industrial manufactures, and fuels accounts for 79.1% of economic activity, 51.7% of the population now lives in poverty (Fundacion Invertir Argentina 2002; CIA 2004).
Enter Nestor Kirchner, who assumed the presidency from Duhalde’s caretaker government after winning election in the spring of 2003. In his inaugural address, President Kirchner called for a large public works and housing program, in part to provide jobs quickly. In another part of this speech, he stated that the government should not spend more than it collects in revenue, that it should not run up additional debt or print more money (Weintraub 2003). This seems like a mixed message, but the government could take in more revenue by increasing compliance with existing tax laws. It may be that over the long run, a more progressive tax structure favoring the working and middle classes may be needed to correct massive income inequality. Also, the growth spurt that the Argentine economy has experienced in 2003-2004 makes credible moderately expanded government spending without running huge deficits. But even were the Argentine economy still in recession, the government should not be compelled to balance its budget, much less to run a surplus. There needs to be a return to Keynesian economic principles at the IMF. The Fund must return to its original mandate of providing funds to restore aggregate demand in countries facing economic recession. Anti-Keynesian "structural adjustment" conditionalities have wreaked havoc time and again.
Inefficiency and corruption exists throughout the public sector, from tax administration to the delivery of public services. Another problem that Kirchner needs to tackle is the judicial system, which is seen as inefficient, taking years to reach final judgments, and is occasionally corrupted by political or financial interests (Word IQ 2003). This discourages foreign investment.
Some economists point to "inflexible" labor regulations--the legacy of justicialismo (Peronism)--that contribute to chronically high unemployment (Zaragoza and Kiser 2002; Azul 2003). Although labor protection has been diminished and layoffs have become easier, some say that labor market deregulation has not gone far enough and that further output growth plus deregulation will bring employment. The argument is that more of what has not yet worked eventually will work well. Even if this turns out to be true, the obvious question is what happens to displaced workers in the meantime? A deepening trade relationship with Brazil has been credited with some job growth, but the trend in employment evolution overall has been negative since the mid-1990s (Soifer 1999).
Systemic impediments to Argentine prosperity also need to be addressed. High priority must be given to reforming the global trade system in which the developed economies preach free trade while maintaining high tariffs on agricultural and textile products, where Argentina enjoys comparative advantages. Here Argentina may find common cause with its neighbors in developing, if not identical, at least mutually supportive negotiating positions at the World Trade Organization. Additionally, Argentina can explore the possibilities of strengthening and broadening relationships within Mercosur:
Since his election, Kirchner has emphasized regional alliances, with repeated visits to Brazilian president Luiz Inacio Lula da Silva and Ricardo Lagos, the president of Chile. Both Kirchner and Lula support the formation of a close regional economic block as an alternative to a Free Trade Area of the Americas controlled by Washington (Azul 2003).
If the problem with import substitution industrialization (ISI) schemes of the mid-20th century was that the individual markets of Latin American countries were too small to permit economies of scale and competition, a regional trading bloc would solve this. Although a Latin American Free Trade Association was tried in the past (Richards 1997), it was used as an attempt to further entrench ISI within a larger market, whereas an expanded and more robust Mercosur could provide the larger, regional market, and at the same time provide a regime of steadily diminishing trade barriers to the rest of the hemisphere, in the hope of facilitating a smoother transition from ISI economies to a hemispheric free market. These formerly import substituting economies would develop their competitive edge together on a much more level playing field than if the US were in on the deal. Then, after a couple of decades of development, a South American trading bloc might be ready to merge with NAFTA on a more equal basis. Possibly this could be a phased merger, with some nations joining in a more integrated FTAA earlier than others, and at different levels of participation and commitment, similar to the multi-tiered process in the European Union. However, Soifer warns against excessive dependence on regional markets, in that the improvements in competitiveness needed to reach wider markets might be neglected. In particular, the emphasis on regional trading relationships may disincentivize innovation in larger companies, although technologically sophisticated medium-sized firms may step in to fill the breach (Soifer 1999).
A Fate Worse Than Debt?
Without a doubt, however, the key to sustained recovery is to equitably address the staggering public debt. As a result of government borrowing in the futile attempt to defend the overvalued peso and its subsequent devaluation, foreign debt as a percentage of GDP shot up from an already high 52% in 2001 to an astronomical 134% in 2002. The IMF has kept money cycling through the Argentine government in the three years since the crash with rescheduled loan arrangements. It has done so in the face of tough bargaining on the part of President Kirchner. While the IMF would like the Argentine government to run a primary surplus (before loan payments) of 3.5% to 4% on its budget in order to put the government in a better position to service its debt, Kirchner insists that the Argentine people can only bear a 3% primary surplus (Smith 2003). More than that would choke off the economic recovery. Furthermore, in September 2003, Kirchner demanded that creditors accept a 75% reduction of the principal owed them (The Economist 2003). His position is that Argentina simply cannot pay the full amount of the debt.
Table 2: Exposure of Multilateral Lending Institutions to Argentine Debt
Source: Weisbrot 2003
At first glance, the head of a government that owes $132 billion or more would hardly appear to be in a strong negotiation position, but as the old adage goes, "If you owe the bank $50,000 and can’t pay it, you have a problem; but if you owe the bank $50 million, then the bank has a problem." The money that Argentina owes to the IMF, the World Bank, the Inter-American Development Bank amounts to about 14, 8, and 20 percent of these institutions’ portfolios, respectively. If Argentina defaults on them, they have a problem (Weisbrot 2003).
Another saying that comes to mind is "too big to fail." These multilateral lenders are so heavily invested in Argentina that they dare not let it fail. An all-out default of this magnitude would damage the credit ratings of these institutions, which would in turn make borrowing for other developing nations more expensive (Smith 2003).
But there is more than simply the credit ratings of the multilateral lenders that is at stake. There is also the IMF’s reputation as an economic advisor, a reputation already badly tarnished by its handling of the East Asian and Russian financial crises. In the 1990s, Argentina was the IMF’s "poster child." But did the star pupil go wrong, or did the mentor? In this sense, the IMF has a lot riding on Argentina’s recovery.
First of all, the correlation between the privatization binge (as prescribed by the Washington Consensus) of the early 1990s and the performance of Argentina’s economy is problematic. With large state-owned enterprises being practically given away, it is unsurprising that capital rushed to take advantage and the economy boomed, but once the vultures had made their short-term killings, they naturally sought fresh opportunities elsewhere. The argument can be made that this was a bubble, not a sustainable trend. For the Washington Consensus to take credit for pulling Latin America out of the "lost decade" of the 1980s may be like the rooster taking credit for the sunrise (Zaragoza and Kiser 2002).
Secondly, if pegging the peso to the dollar was a good idea in the early 1990s, it was a manifestly bad idea by the end of the decade. Eight months before the devaluation, economist Mark Weisbrot pointed out that the fear of hyperinflation was overblown, and that the IMF should have known better:
Another potential ramification of a complete Argentine default is that it might encourage other heavily-indebted governments to follow suit. Opening the floodgates would severely damage the entire Bretton Woods system:
The IMF board has responded to Kirchner’s intransigence by breaking its own lending rules to accommodate his demands, mainly because it doesn’t want to be confronted with the institutional and political consequences of an Argentine default to its multilateral creditors. If Argentina walks away from its private and multilateral debts successfully -- meaning that it doesn’t collapse economically when it is shut out of international financial markets completely after repudiating its debt -- then other countries might soon take the same path (Jubilee Research 2004).
The IMF’s credibility as a lender of last resort might be damaged if it was seen to enforce too harsh conditions on Argentina to protect the private sector to the detriment of the country’s economic recovery (BBC News 2004b). Extending this idea further, there is a possible consequence of a total economic meltdown in Argentina that perhaps many are afraid to mention. The neoliberals are fond of taking credit for the tide of democratization in Latin America as markets have opened and trade has increased over the past quarter-century, so that today the sole remaining dictator in the hemisphere is Fidel Castro. But the tide can turn, particularly in Argentina. Adam Przeworski and Fernando Limongi (1997) observe:
There is a reason why Przeworski and Limongi use the oddly specific benchmark of higher than $6,055. It happens that the one democracy at $6,055 per capita that did collapse was Argentina in 1976. In other words, Argentina holds the world record as the most prosperous democracy ever to be overthrown. In the Przeworski and Limongi paper, the per capita income of $6,055 is figured in 1985 US dollars purchasing power parity (PPP). Using two online consumer price index calculators (Friedman 2000; NASA-JSC 2004) and averaging the results, $6,055 in 1985 dollars equates to $10,291 in 2003 US dollars. The per capita GDP PPP of Argentina in 2003 US dollars was $11,200 (CIA Factbook 2004), only 8.8% higher. In relative terms, Argentina is not much more prosperous today than it was when a military coup toppled Isabel Peron’s government in 1976, and another sharp economic downturn could drop Argentina below where it was in 1976.
Furthermore, it must be considered that the figures cited above are the average per capita GDP, and do not take into account the great disparity in income distribution that has arisen since 1975. A year before the 1976 coup, the Gini coefficient for urban Argentina was about 0.363, and since the Gini coefficient for rural Argentina was only 0.017 points higher than the urban figure in 1970, probably the overall national figure for 1975 was about 0.38 (World Bank 2002). Another World Bank source (2002a) states:
In greater Buenos Aires, the Gini coefficient, or the measure of the income inequality in which zero equals perfect equality and one equals perfect inequality (one person has all the income), has risen from around 0.38 in 1980 to nearly 0.53 in 2002. As the country’s income distribution has worsened, the rates of poverty have risen as well, especially since the high rates of economic growth in the early 1990s.
A devastated middle class does not augur well for continued democratic government in Argentina. With 51.7% of the population now living below the poverty line, the threshold for revolution could be considerably higher than it was in 1976, especially if the newly-impoverished as well as the traditional underclass remember too fondly the military governments of the past. Howard Wiardia points to the continued preference for "strong government" throughout the population of Latin America (Wiardia 1997, 16), and correspondingly:
Argentina oscillated between elected governments and military juntas throughout the 20th century (coups occurred in 1930, 1943, 1955, and 1976), and in the long historical view, were it to revert to a military government after several years of severe economic stress, this would hardly be unprecedented. Rather, it would be remarkable if this did not occur! How would the IMF look if its tight-fisted policies could be blamed for driving Argentina back to a dictatorship? The riots at the end of 2001 ought to give pause to anyone who would try to drive too hard a bargain with Kirchner’s government.
So, paradoxically, Kirchner is actually in a very strong negotiating position.
Kirchner is dealing with an IMF that has been weakened not only by its role in the Argentine crisis, but also its handling of the East Asian crisis of 1997 and the Russian crisis of 1998. A growing chorus of voices is calling for a change in the IMF’s basic assumptions and in the way it does business, most prominent of these being Nobel laureate Joseph Stiglitz (2002a). By September 2002, nearly a year after the Argentine default, the IMF began to give some thought to developing a sovereign debt restructuring mechanism (SDRM) for nations that could not pay their debts in full. The idea is sometimes referred to as a "sovereign Chapter 11 (Walker 2002)." However, the horses are already out of the barn, and the IMF still does not have a procedure in place, principally due to US opposition (Beattie 2003). Meanwhile, Kirchner has now forced an issue whose time has come.
One condition of the rescheduling of the IMF loans was that Argentina negotiate in good faith with its private creditors, but as of February 2004, Argentina still had not appointed a bank to advise it on how to restructure the outstanding debts. Furthermore, regarding the 75% "haircut" that Kirchner proposed, "bondholders did their own arithmetic and concluded that it was more like 90 cents on the dollar they were being asked to sacrifice. The creditors say that since that opening offer, Argentina has not budged. And that, they argue, is not negotiating in good faith (BBC News 2004; BBC News 2004a)." But the Argentine government "has made it clear that it would rather default than pay too much and force its economy into recession. International bondholders might receive nothing (BBC News 2004b)." As of November 2004, the Argentine government’s position remains unchanged with regard to the 75% haircut (Helft 2004a).
Kirchner’s strategy is not without danger, of course. Regarding the IMF and the other multilateral institutions, Weisbrot acknowledges:
At the same time, Weisbrot points out that if Kirchner calls the IMF’s bluff, it is not clear that Argentina could suffer more than it already has at the IMF’s hands.
As for the private bankers and investors, who would be forced to take the haircut, they would be reluctant to invest in Argentina in the future (BBC News 2004b). This would hold not only for foreign sources, but domestic sources worrying that their country had become economically isolated. Again, the effect would be to force the country to conduct all international trade in hard currency rather than commercial credit, just like Cuba (Jubilee Research 2004). This concern is probably overblown for two reasons. First of all, Argentina is South America’s second largest economy. It is not Somalia. For the same reason that it is "too big to fail," it would be too big to shun. Secondly, if it were shunned by global finance, the resulting economic collapse would likely drive Argentina into authoritarian rule, and the nation would stand out as both capitalism’s and democracy’s greatest failure. No one wants this to happen.
Amid all of these conflicting concerns, it is interesting to note that while Argentina wrangles with the largely US-controlled IMF, the country has received support from an unexpected quarter: the Bush administration. Assistant Secretary of State Roger Noriega, the top U.S. diplomat for Latin American affairs, said in September 2003, "It’s time for the IMF to be more flexible and reasonable with Argentina. The U.S. believes the IMF must show more flexibility to help Argentina put its house in order (Jeter 2003)." It seems that the US is opposed to an institutionalized SDRM, but at the same time is an advocate for leniency in the specific case of Argentina. What is the US’s interest in this matter? The calculation may be that Argentina needs to get up and running before any political momentum--either in the US or in South America--can be built for a full-blown effort to implement the FTAA. Here again, Argentina has leverage it can use to its advantage.
Another potential source of strength is to coordinate strategy with Brazil, which is not only Argentina’s largest trading partner, but whose government also has a sizable debt with the IMF and private foreign creditors. Kirchner’s tough stand with the IMF--which has been rewarded with concessions--has made life awkward for Brazil’s left-wing president, Luiz Inácio "Lula" da Silva, who has a history of verbally bashing the IMF. As Brazil’s $30 billion IMF agreement came due in December 2003, Lula had to consider whether to live up to his rhetoric and follow Argentina’s bold example by holding up the IMF for more flexible terms, or pay up on time. However, as much as Lula might have derived personal satisfaction from the former course of action, his political position and Brazil’s economic position differ from Kirchner’s and Argentina’s, and unsurprisingly, so do Lula’s priorities:
The problem with the vision of a Southern Cone united front against the multilateral economic institutions has always been that each nation has different economic and political problems, and different relationships with the multilateral lenders. Brazil is not in the desperate straits that Argentina finds itself in, nor can it place as much blame on past bad advice from the IMF, so the extent to which da Silva will find it convenient to coordinate strategy with Kirchner is limited.
But if Lula "looks uncool" while implementing a strategy that seems to be working, Kirchner "looks way cool" in his tough stance with the IMF... and that strategy also seems to be working. Kirchner asked for a more relaxed schedule for repaying the IMF, and the IMF agreed. He asked to lower the primary fiscal surplus from 4% to 3%, and the IMF agreed. He refused to budge on the 75% haircut, and the IMF gave him the next installment of its loan even though it previously insisted that he negotiate in good faith.
Shave and a Haircut... Two Bits
There is a strong case to be made for the IMF taking a haircut in recognition of its support for the currency board long after this policy ceased to be sustainable. However, as a matter of national strategy, it might be wiser for Argentina to try to get back on the IMF’s good side as much as possible, and to eventually repay the IMF in full over an extended schedule that both sides agree as being realistic. As for other multilateral lenders, little has been said in the literature about their role--if any--in the Argentine debacle, so here again, the country would be best served by coming to an accommodation.
With regard to private creditors and the proposed 75% reduction on the principal owed, Argentina might take particular pleasure in throwing Margaret Thatcher’s famous pronouncement on neoliberalism back in the face of international finance: "There is no alternative." However, a 75% haircut across the board (returning only two bits on the dollar) may not be just. This money was borrowed from different sources at different times under very different conditions, thus some creditors (presumably earlier ones were mostly traditional sources that charged less interest) had much less expectation of risk than others who sailed into the gathering storm with eyes wide open. Most egregious of the latter are the "vulture funds" that buy up debts owed by companies or countries in financial difficulty for a deep discount, and then try to get full payment. In one case in the 1990s, a New York fund paid $11 million for Peruvian debt with a face value of nearly $21 million, and was eventually awarded more than $55 million by a US court, the figure including overdue interest payments (Walker 2002). Obviously, such vulture funds are in a high-risk business--they can turn a handsome profit, or get left holding the bag--and a realistic outlook is that they can expect some of each. As a matter of economic justice, the vulture funds should get not just a haircut but a close shave as well, while the more traditional funds should receive better treatment. Such an approach would also be in Argentina’s long-term interest, as the more mainstream investors are the people it will want to do business with again in the future.
However, it may not be legal for Argentina to offer better terms to some creditors and not others (Helft 2004). This uncertainty points up the lack of a formal process for sovereign bankruptcy. Argentina and its creditors are having to make it up ad hoc. Perhaps as Argentina goes through this process, the star pupil will have the opportunity to be the teacher, setting precedents that may inform the future construction of a more institutionalized procedure. This would be Argentina’s contribution to the stability and credibility of the global financial system.
At the same time, Argentina also must look to its own economic stability, and to the domestic credibility of its government. The current debt load constrains Kirchner’s choices to near zero. Creditors would be well advised look at Argentina’s current economic problems in light of its history of political instability, and to give its democratic government sufficient maneuvering room in which to turn the nation onto the course of long-term prosperity, to give the Argentine people the opportunity to work out the balance between public works, education and health care expenditures, and trade protection on the one hand, and debt repayment on the other. The last thing anyone wants is for a politically re-engaged military to sing, "Don’t cry for me, Argentina. The truth is I never left you."
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