RUDI DORNBUSCH (FEBRUARY 2002): ARGENTINA: OVER THE CLIFF AND ON THE ROCKS

Argentina is bankrupt: economically, politically and socially. There is nothing left to work with. Even Argentines who always have an answer of how to play one more round, today are at the end of their wits. The economy, and with it tax revenues and jobs, is crashing. The third President in short time has come into office, not exactly by democratic means but rather on the pressure of the street. Of course, behind the scenes he helped along, having assisted ousting the previous one by supporting riots and looting. Hard money is about to be debased yet again, banks are closed and bankrupt, deposits are frozen but set to be melted to nothing, credit-- domestic and international-- is gone, prosperity has become no more than a fond memory. And all this in less than a year, or less than even a few months, seemingly without warning.

Where to lay the blame and what to do next? The popular explanations are two: On one side, the mistake of a hard currency link to the dollar robbing the country of flexibility and monetary policy. On the other side, an overly neoconservative IMF with ever increasing demands for austerity. Neither explanation captures remotely what is behind the Argentine collapse. The IMF, if anything, has been much too lenient. Argentina had overborrowed and underperformed on the fiscal front. Countries that are overextended on the credit side cannot afford to spend happily -- Europe is finding that out this year, welcoming Maastricht structures on what otherwise might be a year of fiscal largesse-- they must live by tight budgets. Getting ever more IMF credits to make up for the lack of frugality and saving simply cannot be a lasting stricture. The IMF's fault was not to make that point years earlier and more vociferously, not understanding also that more money for Argentina just meant postponing the politically inconvenient decision to start saving. Former President De La Rua was a champion at the game; the very prospect of IMF money got him immediately into election-oriented spending booms rather than viewing the resources as a helpful bridge toward better fiscal performance.

The hard currency link, too, is misread as a source of crisis. Quite on the contrary, it was an element of stability and an anchor for a country that until the early 1990s had gone through 50 years of unrelenting currency debasement. Indeed, the effect of the currency board was powerful enough to shift growth of per capita income from -2.9 percent per year in the 1980s to 3.2 percent in the 1990s. There is other evidence, too. Most strikingly, Argentina's export growth throughout the 1990s averages significantly more than that of Brazil, a fact that contradicts the proposition that Argentina's loss of competitiveness s vis-à-vis the devaluing Brazil is the source of all trouble. The notion of ever again yet another depreciation is behind the 50-year decline of Argentina; the currency board was the first attempt at revival and a very successful one. Regrettably, debasing the currency once more seems to be the central policy proposition of the new President. Let's see what that does to wages and inflation.

If neither currency board nor IMF austerity is behind the trouble, where should we look for the culprits? Two candidates stand out. First and foremost, Argentina is an economy that has been run down for 50 years. The investment rate has been exceptionally low and the saving rate even lower. The consequence is a very obsolete and small capital stock -- even compared to Latin America but far more so relative to high-investment Asia-- and a very large debt, external and internal. Add to that a traded goods sector that has been cannibalized for decades to the point where it is barely 10 percent of GDP. The implication is that Argentina cannot be pulled out of trouble by a strong world economy, that devaluation in this industrial junkyard will do little to turn on growth. It will take a decade or more to create a modern open economy. Most unfortunately all access to credit has been used so that, this time round, it must come entirely from domestic saving. As everywhere in the Americas, saving is not part of the culture and that means a return to prosperity is far off, behind the horizon.

The second culprit is the retreat on reforms in the 1990s and the formidably poor governance of the Argentine political class. On the back of the early stabilization euphoria and a wave of reforms, President Menem (like many of his Latin Presidential colleagues) became enamored with the idea of a second term. And he borrowed and spent a lot of money to get there while deals were made which basically rolled back a lot of the good policies of the early part of his Administration in order to have a constitutional reform. And then, with a second term in hand, came "pizza and champagne" -- a full term of misgovernance. President de la Rua who followed was a disaster: indecisive, loaded with a widely spread coalition that included an anti-reform left, borrowing and spending money was the only way to keep going.

No surprise that one day the house of cards collapses: as growth prospects slipped and budget deficits widened, no creditors willing to put up more money, the IMF increasingly reluctant to fill a widening gap, the game was suddenly over. And that is where we are: without money, Argentina looks as it did at the end of Peron's wasteful administration. No doubt, policy now is no longer driven by the pursuit of free market reforms, Evita's decamisados are back and vocal but there is no money nor an easy plan to fill their justified demand. Their money in the banks is gone, their real wages will collapse, and their jobs are disappearing.

Economists are at a loss for the easy trick. There is the circular problem that without stabilization there can be no stable government, without a stable government there can be no stabilization, without a stabilization plan and government there can be no foreign credit. And, to make things worse, Argentina is no Mexico or Brazil -- it is simply not a burning issue for the prosperity of the US or Europe. And that is even more the case now in that the Argentine military is so discredited to have a come back and that emerging market finance has decoupled from Argentina altogether.

Elements of an answer must be this: a technocratic young government, not the sleaze bags of the past decades. A small committee in the Congress with the right to reject or accept legislation within 24 hours (just as in the 1920s democracies under hyperinflation pressure); a Chilean-style public works program that helps employ 10 percent of the labor force; a foreign credit, a 20 percent cut in wages and prices and an unchanged peso. No question, a reduction of debt to 30% of its face value with a discussion about debt service to follow once stabilization is well underway and growth has returned. Is that what is about to happen? No chance, the immediate future is much worse including depression and hyperinflation, more Presidents and much more violence.