July 26, 2002
I am reading Michael Mussa's brand-new very short book on the latest Argentinian financial crisis [Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X)]. In The Importance of Being Earnest, Oscar Wilde gets a laugh out of the idea that a chapter on a rupee crisis is too exciting for young ladies--out of the idea that a technical discussion of anything having to do with international finance can be anything but deadly boring. But reading this is different.
First, I'm weird: I'm an economist, which means (these days at least) that I don't even have the sparkle and flash, the willingness to take risks and go out on limbs, that accountants have. Second, the Argentine crisis is an important setback for human happiness--a much more important tragedy even than the closing of a Zambian copper mine. Plus the crisis has important lessons for international economic policy in the future.
Third, Michael Mussa--former chief economist at the IMF for a decade--is a fearless and witty guy: he (reportedly) spoke of his boss at the IMF, Michel Camdessus, as a man who was 'so optimistic he always sees the glass as half full, even when there's no glass at all'; in this book, he writes of the IMF following its standard approach when a government fails to meet the policy targets it has committed to--the standard 'three-monkeys approach: see no evil, hear no evil, speak no evil'; he writes of the proposals of the Meltzer Commission for IMF reform as '...unnecessary, unworkable... fundamentally misguided...'; and he writes of the Fund staff's spring 2001 analysis of the dynamics of Argentina's debt, '...if, if, if... if my grandmother had wheels, she would be a bus...'
Thus I had no trouble staying awake through the book.
Toward its end, Mussa calls for a thorough evaluation of the Fund's role in Argentina, an evaluation to take the broadest possible scope. He writes (p. 71) that:
... it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question...
And so I have begun thinking: What if I wanted to make the argument that the neoliberal policy mix adopted by President Carlos Menem and Finance Minister Domingo Cavallo was a big mistake, that it was all doomed to failure from the beginning and should not have been undertaken, that from the moment he proposed his Convertibility Plan to stop Argentina's hyperinflation the Sunday Horse was pulling the Argentine cart down a track that led nowhere? What would that argument look like?
As I see it, such an argument would have five steps:
- First, the neoliberal program pushed by Domingo Cavallo demanded free markets--the end to protectionism, the end to quantitative restrictions of all kinds, the end of limits on freedom of contract, and most importantly the end to controls on the ability of not just goods but money to flow into and out of Argentina, and the end of the government's ability to force Argentines to denominate their wealth in a unit of account--the peso--whose value it controlled.
- Second, the neoliberal program pushed by Domingo Cavallo required a hard peg of the value of the peso to the dollar: nothing else would convince Argentines that the days of hyperinflation had passed, and that they no longer had to dissipate resources and waste time insuring themselves against inflation, but could trust the unit of account.
- Third, Argentina is a country in which the government constantly promises the people more than it can deliver. It promises rich oligarchs that it will not collect too much in taxes. It promises workers and consumers a generous social insurance state. It promises rapid economic development, large expenditures on infrastructure, jobs for politically well-connected boys, and so forth. An unequal distribution of income and wealth, a lack of social comity between the working and the middle classes, a viciousness in politics going back to General Galtieri, the Dirty War, Juan Peron and his enemies, and even before means that claims on national product and demands that the government enforce those claims are inevitably going to mount up to more than 100% of what is available. The basic political fight over how national product is to be distributed among social classes is unresolved, and any political movement that makes only promises it can keep is doomed to rapid defeat.
- Hence, fourth, in Argentina government deficits--large government deficits--are a law of nature, a fact of life. Moreover, everyone knows that large government deficits are a fact of life and a law of nature. Hence interest rates on Argentine debt will be low and reasonable only rarely and for short periods.
- Fifth, points one through four mean that the neoliberal reform program in Argentina in the 1990s had exactly the same chance of avoiding disaster as one would expect if one gave a modern gene-splicing biochemistry lab to Doctor Frankenstein. The fundamental unresolved conflicts of Argentine politics mean that debt is going to mount. The fact that everyone knows that Argentine politics generates chronic deficits means that the interest payments due on that debt are likely to explode. Exploding interest payments mean that the dynamics of Argentine debt are unstable, and thus that the hard-currency exchange-rate peg cannot last. And free access to international capital markets, to dollar-denominated bank accounts, and so on, and so forth, means that when the crisis caused by the contradiction between the hard currency peg and the fundamentals of Argentine politics comes, it will be five times as bad: at least with tight controls on foreign exchange and a primitive, underdeveloped banking system, the amount of damage a government default can do to normal economic life is limited.
From this perspective, pushing neoliberal, market-opening reforms on Argentina looks as wise as giving a supply of gasoline to a bunch of pyromaniacs, on the grounds that gasoline is a very useful and powerful fuel.
My intellectual problem right now is that this argument I have just constructed--which was supposed to be a strawman that I, a card-carrying neoliberal, could easily demolish--feels too convincing.
Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X).
Bergsten, p. viii: "[Mussa's] conclusion that the Fund's last pre-crisis loan to Argentina in August 2001 was 'the greatest mistake the Fund made in my ten years there' is thus of considerable importance in the ongoing debate over this crucial and tragic case."
p. 3: "...in other cases... Mexico in 1995; Indonesia, South Korea, and Thailand in the Asian crisis... Brazil... a Fund-supported program was started only after the crisis was already under way. Thus, any failures of the Fund in the pre-crisis period were those of its relatively low-intensity surveillance activities. For Argentina, the failures of the Fund are clearly associated with the core of the Fund's [activities]... when it is providing financial assistance and when the policy and performance of the member are subject to the intense scrutiny of Fund conditionality..."
p.3: "The end result in Argentina has clearly been a disaster... not intended or, until recently, broadly anticipated--by the Argentine authorities, the Fund, or anyone."
p. 4: "...the Fund did make at least two important mistakes... failing to press the Argentine authorities much harder to have a more responsible fiscal policy, especially during the high growth years... extending financial support to Argentina during the summer of 2001, after it had become... clear that... efforts to avoid default and maintain the exchange rate peg had no reasonable chance of success."
pp. 5-6: "...if the Argentines had decided to move to an alternative, more flexible exchange rate and monetary policy regime that maintained reasonable monetary policy discipline, this would also have been acceptable to the Fund. Indeed, at least some in the Fund... would have welcomed serious consideration of such a move..."
p. 6: "As the crisis deepened... and the deficit targets set in the Fund-supported program were missed, the Argentine authorities sought to undertake further austerity measures. The Fund supported these efforts.... However, had the Argentine authorities decided at some time during 2000-2001 ... to pursue an alternative... debt restructuring and a possible change in the exchange rate regime, the Fund would have supported responsible efforts in this direction..."
pp. 9-10: "In sum, if things had broken more in Argentina's favor, this surely would have helped to preserve the success.... Enumerating the many things that contributed to Argentina's tragedy, however, should not obscure the critical, avoidable failure of Argentine economic policy that was the fundamental cause of the disaster--namely, the chronic inability of the Argentine authorities to maintain a responsible fiscal policy..."
pp. 15-16: "In sum, during the period 1993-1998 when the Argentine economy was performing very well [average annual real GDP growth rate of 4.1%] and the Argentina government was receiving substantial nonrecurring revenues from privatization and enjoyed other temporary fiscal benefits [that amounted to 2 percent of a year's GDP], the public-sector debt-to-GDP ratio nevertheless rose by 12 percentage points [from 29 to 41 percent of GDP]. This clearly was not an adequately disciplined or sustainable fiscal policy..."
p. 16: "Because most industrial countries have government debt-to-GDP ratios above 50 percent and some above 100 percent, it might be asked why a debt-to-GDP ratio of just above 40 percent was worrying for Argentina. There are at least five important reasons. First... Argentina has had little success in raising tax revenues (including social security contributions) of more than 20 percent of GDP.... Second... government debt denominated in foreign currency... held externally, Argentina faced the dual challenge of persuading creditors that it was capable both of raising sufficient fiscal revenues to service its debt and of being able to convert these revenues into foreign exchange with an exchange rate that was rigidly pegged to the U.S. dollar.... the ratio of external debt to exports... more than 400 percent.... Third, it is not just the level of the government debt... it is also how the debt has been behaving.... Fourth... Argentina... was potentially vulnerable to external economic shocks.... the collapse of Brazil's crawling-peg exchange rate in early 1999 had important negative spillovers... the debt-to-GDP ratio jumped from 41 percent in 1998 to 50 percent in 2000.... Fifth... Argentina was clearly vulnerable to changes in financial market sentiment... [that might become] self-fulfilling..."
p. 18: "When the actual fiscal deficit began to exceed the program targets during 1995 because of an economy that was weaker than expected, the Fund... showed unusual flexibility (by past Fund standards) in allowing an upward revision of the deficit target. In my view, this was the right approach.... Unfortunately, the Fund's flexibility... was not applied symmetrically. Starting in late 1995, the Argentine economy began three years of very rapid recovery... one would have expected that the Argentine government's fiscal deficit would have come in well below the permitted target... [but] it was just below or even slightly above.... During 1995, when the recession turned out to be steeper... there was plausible reason to grant waivers.... At other times... it is difficult to understand why the Fund did not make active use of its conditionality to press the Argentine government to maintain a more responsible fiscal policy.... And the fiscal targets were significantly less demanding than they appeared to be (even allowing for stronger-than-expected economic growth) because they conveniently ignored... government borrowing that were viewed by the Argentines as off-budget..."
p. 24: "...the fundamental choice of Argentina's monetary policy framework and exchange rate regime was a choice for the duly constituted government of Argentina. The Fund could advise.... However, the basic choice of regime is a decision of the [Fund] member--at least up to the point where the chosen regime has no reasonable chance of success.... Thus, though an independent observer might conclude that the rigidities of the [exchange rate] Convertibility Plan deserve relatively more weight, and the failures of Argentine fiscal policy relatively less weight, in the blame for the tragedy that ultimately befell Argentina, this is not the relevant perspective from which to view the role of the Fund. For the Fund, the relevant question was--given the choice of Argentina to adopt and maintain the Convertibility Plan--what other policies were necessary to make the stabilization and reform effort a success. Given the plan, failure to maintain a sufficiently prudent fiscal policy would likely prove a fatal error. The Fund, having accepted the Convertibility Plan, had the responsibility to press very hard to avoid this fatal error."
pp. 27-30: "For the Fund, the deteriorating situation in Argentina in the autumn of 2000 presented a critical challenge.... A star pupil that the Fund had praised and supported as a model of economic liberalization and reform was in danger of turning into a basket case.... One approach would have been to continue with an essentially standard Fund-supported program... [of] up to 100% of its Fund quota.... The main difficulty... was that... it was clearly inadequate. A second approach would have been to conclude that because of the continuing recession... further official [Fund] support would be available only on the condition that Argentina reach agreement with its private creditors that would substantially reduce its financing requirements in the coming years.... Necessarily, this rescheduling of private credits could not be entirely voluntary.... [A] decision by the Fund in late 2000 to press Argentina into a debt restructuring that would have amounted to a de facto sovereign default would have been a very weighty matter. The Argentine government was dead set against such action.... At the Fund... there was little enthusiasm for such an approach... the Argentine situation was not seen as without realistic hope.... The third approach... actually adopted... [was] levels of support substantially greater than in standard Fund-supported programs... the deficit target would be set so as to carefully balance the need to keep borrowing within responsible limits... against the very real economic and political difficulties of fiscal consolidation in a deepening recession. Official financing would... meet virtually all of Argentina's projected external financing requirements for 2001, assuming the program's fiscal objectives were met..."
pp. 45-8: "By August 2001... prospects for a favorable outcome were pure fantasy.... [I]nterest rate spreads... were... in the range of 1300 to 1600 basis points. This implied nominal interest rates for the Argentine sovereign... of 18 to 22 percent, with real interest rates even higher due to deflation. Economic recovery was impossible in this situation.... The Argentine government's fiscal policy... could not meet its targeted objectives.... The political consensus to raise the huge primary surplus... required to demonstrate sustainable debt dynamics... was, quite understandably, nowhere apparent.... An emergency injection of another $6 billion in cash from the Fund was urgently needed just to stave off immediate default and keep the farce going for another few months.... [A] wide range of analysts... often with differing views on many issues concluded that the game was over for Argentina. Only a fool would conclude otherwise. Why, then, did the Fund... acquiesce in this folly?... Here there was a failure of intellectual courage... and a failure of moral courage.... Argentina was not helped... assistance that was potentially far more valuable in helping to contain the damage once a de facto sovereign default had occurred was instead squandered in a futile effort to avoid the inevitable..."
pp. 60-64: "What should be the elements of the policy program...? Six elements can be delineated.
- First, the program should be based on realistically optimistic economic assumptions... real GDP will likely fall 10 to 15 percent in 2002... the value of the peso at the end of 2002... 20 or 25 U.S. cents... domestic inflation... headed over 200 percent [in 2002]...
- Second.. the government budget needs... the deficit... within the bounds of what can be financed without... hyperinflation.... Tax revenues are likely to be very low because of the economic collapse and very poor tax compliance... substantial costs to the government from dealing with the mess it has created in the Argentine banking system... the absolutely essential task of reining in the deficits of the provinces and terminating their discretionary authority to borrow...
- Third... a reasonable framework for monetary policy... contain the initial inflationary surge from the collapse of the peso and then bring the inflation rate down to more moderate levels during the course of the next two years...
- Fourth... [a] unified floating exchange rate... the peso inevitably will depreciate very substantially (from its old parity) in real terms--and even more so in nominal terms...
- Fifth, something needs to be done to clean up the horrendous mess in the Argentine banking system.... Four actions of the Argentina government have made the banking system... insolvent.... (1) The government defaulted on its... own dollar-denominated debt... held by Argentine banks. (2) The government reneged on... the Convertibility Plan.... (3) The government mandated that dollar-denominated loans of Argentine banks were payable in pesos. (4) The government mandated that dollar-denominated deposits at Argentina banks be converted into pesos at a [higher] exchange rate...
The first three actions together effectively forced a massive write-down in the dollar value of [bank] assets... a write-down that was unavoidable.... The Argentine government.. lacked the political courage to tell the Argentine people... that the U.S. dollar value of their deposits... was being sharply reduced as a result of government actions. Instead, through the fourth action, the Argentina government sought to purvey the fiction that most of the dollar value of deposits could be preserved... and shift the blame for the losses of depositors from the government to Argentine banks. Now the Argentine public has, with good reason, lost confidence in the banking system and... the government.... Moreover, the owners of Argentine banks... robbed of all their invested capital... have little reason to believe any promises of the Argentine government... no incentive for [anyone]... to put in new capital to refloat the banking system...
- Sixth... signal their intention to pursue good-faith efforts to deal responsibly with their external sovereign debt.... [F]oreign creditors... need to recognize that... they will not be made whole, but... need to share in the enormous economic losses.... Argentine authorities must ensure that foreign investors are... not forced to accept disproportionately large losses...
p. 67: "The Fund is expected to... act both as a sympathetic social worker and as a tough cop."
"the 'three-monkeys approach' to dealing with government failures to meet policy targets that it has promised the Fund: see no evil, hear no evil, speak no evil..."
p. 71: "... it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question..."
p. 74: proposals of the Meltzer Commission as "...unnecessary, unworkable... fundamentally misguided..."
p. 78: of the Fund staff's spring 2001 analysis of Argentina's debt dynamics, '...if, if, if... If my grandmother had wheels, she would be a bus...'
Posted by DeLong at July 26, 2002 06:09 PM
Well, Brad, isn't this the fundamental tragedy that afflicts any "realist" who looks at the 3rd world, particularly Africa? You can make up all the optimistic stories you want about how this month's favorite country (Ghana, Mali, whatever) has seen the light, but (IMHO) stories about how it will all fall apart, even in South Africa, are a lot more plausible.
What can be done? I'm not sure anything. It took Europe the slaughter of the Thirty Years war to get their act together. Perhaps, until Africa goes through something quite as gruesome, there will not be a consensus that the brief thrill of seeing your opponents hurt is not worth the hurt you will in turn experience.
It breaks my heart to find those 5 point absolutely convincing. I'm mortified because it sounds as though nothing can be done about this.
I've been worried for a while that the reality of Argentine politics is that no-one understands that budget restictions are a fact of life, not a construct of liberal (economic, not political) opression.
Those are the days when I ask myself why on Earth I decided to study economics, seeing as how no sound economic policy will ever have the chance of being implemented. The next day I reconsider, and hope that someday my countrymen will stop banging their heads against the wall and make the third step in your argument untrue.
I don't think the conclusion is that 'nothing can be done' but rather a recognition that the "second best" applies here,as everywhere. In particular, if any part of the neoliberal reforms fails to happen, then the rest can be a disaster. More specifically - it should be obvious that at least in the short-medium runs, certain countries are very unlikely to undertake reform X due to socio-political constraints/realities, even if reforms A, B, C, D, and E sail through happily. The thing is, that without X, A-E spell misery, not success.
Brad, I think I remember your defending the Fund against those anti-globalization folks by arguing that the Fund's request for fiscal discipline could be either through tax hikes or through spending cuts. The problem is, as just about anyone from South America can tell you, paying taxes is the exception, not the rule. So, increasing government revenue to meet a deadline ie nigh impossible, while going through the motions of cutting spending is simple, at least until the "IMF Riot" occurs.
As a lawyer it's always been easier for me to read significance into institutional arrangements than to deal with equilibrium analysis stuff. (Coase and North are my guys.)
If Argentina's provinces chronically, institutionally -- and literally constitutionally -- spend far more than the central government can raise in tax revenue (40% goes uncollected), then in the long run what alternative is there to either growing inflation or a fixed rate system that periodically goes "bang", with all the attendant costs of each?
Your analysis is very different from that of some prominent economists who have argued that if only the exchange rate hadn't been allowed to get out of line with the currencies of neighboring countries, everything could still be happy. "It was the currency board's fault."
It implies that the need for a currency board in the first place was a symptom of a more fundamental problem, that never was resolved.
It also may explain why most people in Argentina wanted to keep the currency board in spite of all the pain that the exchange rate was causing them. Perhaps they understood something fundamental about their situation.
Until Argentina can be convinced to govern itself properly, I think it's a truism that any neoliberal plan there is just asking for it.
I seem to remember a lot of stuff implying that the neoliberal plan *would* convince Argentina to stop being a basketcase. Maybe that's the problem; everyone should be focused on getting the government to work first instead of hoping economic changes will fix the government.
It's a vicous circle. Perhaps everyone should just bail, and wait until the soul-crushing natural effects of Argentina's governmental problems, in a vacuum from outside economist influence, make apparent to them where the real problem is coming from?
This strikes me as far too mean to be correct; there's got to be a better way. Until someone can find a way to stop the deficits, though, it seems to be the best solution. It's just revolting.
If the IMF wants to resolve the argentine problem it has to write down how things are. This has to be done in a language and in a way that gives every argentinian a chance to understand his personal situation, the situation of his neighbours, his boss's, the landowner's, bureaucrat's ecc.
Then government/parliament make the real and actuaL situation legal (only collectible taxes are due ecc.)and then finally political parties may try to change these laws by consent.
Or do you believe only nazis have to be re-educated ?
nice to stumble via Salon's Joe Conason onto your website. Keep going!
There is very little - and even less encouragement - to add to the analysis of Argentina's woes. What worsened the temptation of the Cavallo solution to Argentina's economic difficulties was the quick buck the Menem government made in selling the public companies and financing the overall deficit - apart from Menem's cronies raking in some doe for themselves. With the "family silver" gone, the bonanza ended. What is the public's view of the FMI and globalization now: First they robbed our national assets and then they drove us into bankrupcy. Try to sell even a "compassionate" globalisation now!
It literally breaks my heart, the Argentiniaans deserve better.
What wasStiglitz' commenton privatixation?
(from memory) 'One might have expected these bureaucrats to strenuously resist selling off assets in their charge. But once they realized t he bribes they could collect, selling off multibillion dollar assets for a dime on the dollar, they were strongly in favor.'
Privatization can be a form of taxation - first the money was moved into the government,then into the pockets of those with connections.
(please excuse the spacing problem - this keyboard is strange)
US Banks lend billions of dollars to a bunch of nightmare generals, then to a government funded by selling off national assets to cronies and when Argentina has debt problems it's due to the irresponsibility of the Argentines!. How about the IMF lets the bankers deal with the results of their fiscally and morally irresponsible lending practices instead of enforcing debt peonage on the victims of those governments?
The problem is that the "second best" is horrible. It's what has merited my country the term of "growth disaster" (for an example of this, check out the introduction to David Romer's Advanced Macroeconomics). It's what made "$100 worth of deposits in an Argentine bank in 1944 worth 1 cent in 1990" (from Calomiris and Powell (2000). NBER WP 7715). When deficits are not financed by "proper" taxes, they're financed with inflation. This "second best" may be fine from the point of view of bankers who'd rather have that than lose their money lending it to a country with no intention of giving it back. But from the standpoint of a concerned citize, it sucks.
And the responsibility of enacting a Constitutional reform lies in the hands of those who have more to lose from it (namely, politicians). That's why I say that sometimes I feel as though nothing can be done. Most of the time, though, I hope someday we'll come to our senses.
I find your straw argument merely that. I find the straw argument and selected comments to you to be sadly condescending. Argentina could have used a devaluation as the economy began to slow to readjust the peg. The peg could better have been set against the Spanish Peso and Euro to better match trade patterns. the peg could have been set to Brazil's currency which had stabilized. Argentina was urged to keep the peg as its economy slowest and slowest. Wall Street Week was filmed in Argentina to crow about the benefits of currency stability. The Argentine government was urged by foreign investors to do precisely the wrong thing in defending the peg and allowing the economy to decline. Of course, unemployment may mean little to a Spanish or Wall Street banker, but it meant a lot to the unemployed. Argentina is not Hong Kong. The peg had to be more flexible at least. Lose the smug critiques.
>>Argentina could have used a devaluation as the economy began to slow to readjust the peg. The peg could better have been set against the Spanish Peso and Euro to better match trade patterns. the peg could have been set to Brazil's currency which had stabilized. Argentina was urged to keep the peg as its economy slowest and slowest. Wall Street Week was filmed in Argentina to crow about the benefits of currency stability. The Argentine government was urged by foreign investors to do precisely the wrong thing in defending the peg and allowing the economy to decline.<<
So in your view it's Domingo Cavallo's fault? If he had designed the currency board to peg the peso to a weighted average of U.S., Europe, England, and Brazil, you think everything would have turned out well?
But I don't think that your strawman argument says that neo-liberal economics is incorrect; it just says that it won't work if the political situation is too far gone. Just as antibiotics won't keep you alive if you've got a drunk surgeon tending to your sucking chest wound. It seems to me (and of course I haven't studied the matter too closely) that nothing would work in Argentina; the perverse incentives of the political system will overcome even the best-designed reforms. The saddest part is that all the Argentinians I know agree with this assessment.
JD: Are you suggesting that Argentina should have switched pegs midstream? Or that it should have accepted the currency risk inherent in the uncertainty about the Euro when it created the peg?
You underestimate the extent to which past inflation experiences have undermined credibility in the government's ability to have a sober monetary policy. Devaluation was avoided for two main reasons: the balance sheet effect it would have throughout the economy (the solution to which was assymetric pesification of debts and deposits, which now through legal channels has become pesification of debts 1-to-1 while dollar deposits are being withdrawn at the current exchange rate), and a run on the dollar, based on the fact that people do not value national currency. We elect governments with deficits to spend for us, but we have elected the Fed as the monetary authority long ago. Not Spain, not Brazil, the US. That's why the initial peg was to the dollar, despite the fact it wasn't optimal from the trade standpoint.
Brad's argument is not condescending, it acknowledges the reality of Argentine politics.
Jane: I completely agree with you (and I'm Argentine).
I surely think the unwillingness of Cavallo to adjust the peg was key to the eventual collaspe. It was long clear the currency was becoming ever more overvalued as the dollar rose in value with the coming to treasury of Rubin. What was good for America was not good for Argentina. Krugman noted it. How could Argentina have kept the peg when the currencies of its trade partners steadily lost value? How much unemployment was tolerable for the sake of the peg? Economic policy should have been adjusted. To force domestic deflation for the sake of a dollar peg was too hurtful. Krugman does not think the problem was a profligate Argentine government. Frankly, I do not understand the unwillingness of Cavallo to alter policies. Argentina was not nearly as strong as Hong Kong and Hong Kong might easily have given over the peg if the Asian crisis of 1998 had not been fairly quickly contained.
Argentina has been America's friend for a decade in many ways and I feel empathy is deserved.
I suggest a look to the unofficial Krugman web page to read back on Argentina.
Please read Paul Krugman 7/99 "Don't laugh At Me, Argentina." There is no question is my mind that Argentina needed to devalue rather than go to an austerity program. The export market was drying up because of the ever stronger dollar. Brazil's currency was growing ever cheaper. Argentina's economy was slowing. An austerity program turned a slowdown to recession to depression. This was not an example of government spending proligacy.
Q: When did Argentine debt spiral?
A: Under the military regime.
Q: What was the reaction of banks and IMF to the imposition of a military regime on Argentina?
A: Lend them a lot of money that they spent on totally unproductive crap and on torturing people, stealing their children, gold braids, etc.
Q: When the military regime collapsed what did the IMF and banks "recommend"?
A: That Argentina have a fire sale of public assets to fund current obligations and that they follow policies that devastated local industry.
So please explain to me who is the irresponsible party here? The IMF functions much like current US bankruptcy law: lenders who assist in masking the fundamental problems of a company or country by making profitable but risky loans, get first rights at the funeral. That is: the government and intra-government rules rig the marketplace to encourage huge investments in stupidity or even sheer evil and then help the lenders drain the blood of anyone left to get their vigorish.
>>Krugman does not think the problem was a profligate Argentine government. Frankly, I do not understand the unwillingness of Cavallo to alter policies.<<
I've read Krugman's articles on Argentina, and though he's brilliant, he shows he does not understand at all how Argentina works.
Argentina is a country with a very recent hyperinflation, which was preceded by 30 years of persistently high inflation. This, due to the fact that governments chose not to endebt themselves (a wise move, after all there was no market for internal debt and external debt was denominated in dollars), but rather to print money to cover deficits. In this context, a prerequisite for growth is to create confidence. The peg was instrumental for this, since attempts to end hyperinflation by other means failed miserably during 1989 and 1990. The peg was adopted in 1991 and it worked fine, for a while.
Two issues arise: government spending and external imbalances.
From 1999 onwards, there is a wide consensus that the peso was overvalued, with estimates of an equilibrium rate ranging from 1.20 to 1.40 pesos to the dollar. Just for comparison purposes, today's exchange rate is about 3.60 pesos to the dollar, and that's just because exporters are required by law to liquidate their dollar holdings.
The question is how to adjust. One option was through labor market institutions, which are far more flexible in the States, and even in Europe, than in Argentina. That was what was attempted by the IMF throughout the decade. They gave loans, conditional on the sanctioning of laws providing more labor market flexibility. Every year they would ask for the same condition, which was never met.
The option of a nominal devaluation was dreaded because of the consequences that can be seen today (not the deposit freeze, but the run on the dollar). Ever since 1989, and even before then, the dollar has been the real store of value and unit of account in this country. And there's no point in devaluing against the unit of account. The only reason why we are still not in a full hyperinflation has been by widespread violation of laws and contracts throughout the economy. Deposits were frozen (although more and more manage to get out of banks, and go directly to demand dollars); contracts with privatised utilities were pesified (the rates were supposed to be in dollars). These restrictions are hardly a way to make the economy grow.
With no prior knowledge of Argentina, Krugman had no reason to believe that demand for national currency is practically zero. He just reasoned the effects that a depreciation of the dollar would have in the States, and supposed they would hold for Argentina, too.
To this you should add the extent of the currency mismatch in Argentine balance sheets. While most of the income came from non-tradeable sectors, most of the liabilities were in dollars. This was a problem in any case, but it could be solved gradually by banks liquidating their loans by not renewing them, or by other means. A nominal devaluation only made matters worse in this respect, by making it impossible for any debtor to repay their debts - producer and consumer credit, bank deposits, government debt became impossible to repay. Sovereign default had already been declared. But the assymetric pesification of debts and deposits [which has destroyed Argentina's financial system and thus prevented the real economy from taking advantage of our newly found "competitiveness"] was the politically unavoidable result of devaluation.
I hope this explains "the unwillingness of Cavallo to alter policies".
As for government deficit, the key problem is not whether you have it or not. It's how you pay for it. When rates are around 10% annual, capital markets are not an option. Printing money means more money goes to the dollar. If you can't finance your deficit, it is by definition too large. Again, Krugman appears to be thinking of developed countries. If the States want to issue debt, they have no problem to do so - the US Treasury rate is considered the riskless rate! So you can run any deficit you consider reasonable. Plus, deficits here were not a product of the recession, they were sustained throughout a decade were the economy grew at annual rates of 7%. There is no argument for running a deficit while the economy booms.
It is true that Argentine debt soared under military regimes. However, deficits from the 1970's onward had a large component of losses in public owned enterprises.
In 1983, according to data from the ministry of the economy, public debt was about 45000 billion dollars. In 1989, it stood at 65300 billion. In 1993, after extensive privatising, and a debt renegotiation which substantially lowered both principal and interest payments, it was 72200 billion. In 1999, total debt (with - keep in mind - no public enterprises to speak of) total debt was 146000 billion.
I know military dictatorships started our indebtedness - but a full blown democracy with no public enterprises doubled outstanding debt in 10 years.
A reason for the deficit lies in social security privatization, which is why I don't understand how Krugman can defend our deficits, while at the same time arguing against social security privatization in the States.
What you say is undoubtely correct although I have to point out that at 5% compounded interest it takes only 25 years to turn 45 into 145.
I"d be interested in knowing how much of the additional debt was for debt service -- a multibillion dollar yearly dollar drain is a heavy load for a weak economy with little hard currency coming in.
If we are going to complain about the irresponsible management of the Argentine economy, it is absurd to ignore the effects of IMF and private lender willingness to allow the generals to build up a huge debt in the first place. Why don't we ever see a bank that lent tens of billions to a prolifigate and illegal government ever go under so as to encourage the others to improve due diligence?
While it is true that most of the debt from the 70s was with banks, most of the debt in the 90s was in the form of bonds. And when social security was privatised around the middle of the decade, retirement funds were forced to keep a lot of the savings in public debt. In this sense, today's default has jeopardized the welfare of pretty much every worker who complied with the law and made the contributions to social security.
As I understand it (and I may very well be wrong) the bank consortia who lent to Argentina and other countries lost somewhat with the Brady plan, and with the debt renegotiation that took place around 1991.
Still, I don't see exactly what you mean. Is your point that the default was OK because banks need to bear costs for their bad decisions? I tend to agree with this - but then I see the effects it has had in Argentina. Economic activity is paralysed. Even with the low peso, exports aren't booming because of the lack of finance. Investment doesn't cover depreciation. But I really don't understand what you suggest should be done about those banks and individual stockholders (including Argentine workers), so I don't know if I agree :-)
Peasanty, I can't exactly see your point. You seem to think that banks should lose money when they make bad loans. Well, Argentina defaulted on its debt, in case you didn't notice, so they ARE losing a lot of money on their bad loans, aren't they?
So your view is what? That the banks shouldn't have lent money to Argentina in the 1980s? Banks probably think that too, in 20/20 hindsight.
I suppose this would have spared the banks a lot of grief... of course, if the Argentine government had less confidence in its debt, it would have to pay higher risk premiums, resulting in more debt service, draining their economy of hard currency and all, or perhaps leading to higher taxes, or lower services, or sooner privatization of state enterprises...
So, banks would be better off if they hadn't lent to Argentina as willing, but since they are already dealing with the consequences of a debt default, why is it that you seem to think they should be penalized more? It seems punitive to poor countries and, to a lesser extent, banks, to penalize banks for making bad loans more than their losses from debt defaults, since it would distort incentives away from risky loans more than the costs of the risk itself, driving up interest rates in poor countries. I can't see why you want that.
Argentina had a debt of about $9B when the generals took over. When the generals left office, the public debt was more than $40B - and not as the result of investments that actually increased the size of the productive economy. The Argentine economy since that date has been dominated by unsustainable service costs for the debt. When Brad Delong says that the unresolved political situation in Argentina made it impossible for neoliberal policies to work, he is ignoring the international politics that were much more important. The IMF acting as the general manager of lenders took the position that Argentina was required to make good on the debts of the Generals. That position put Argentina into a hopeless situation from the start. I don't see any plausible scenario in which Argentina could have met debt payments and at the same time provided minimal public services and invested in the local productive economy. See Jonathon Swift's modest proposal for an earlier economic crisis.
If the IMF had taken the position that Citi and Morgan were free to try to recover their loans from whatever Swiss accounts the borrowers had squirreled away, Argentina could have put money into productive investment instead of debt service.
Did the banks lose money on this? I doubt it. Much of the IMF financing and public asset liquidation in the last twenty years has gone directly into debt service on the compounded debt and Morgan and Citi have made large fees on transactions shifting debt into the artificial bond market.
The primary cause of the Argentine crisis is the morally and economically indefensible international system in which those who suffered from the imposition of a dictatorship are compelled to repay the debts of the dictators.
yes, my comments on the "second best" were not meant to diminish the problem, but merely to say that policy advisors do need to confront the very real issue of what happens when their is a hard constraint on one (or more) of their policy recommendations such that it is likely destined to fail -- and then consider the consequences.
Economist Richard Layard infamously wrote a book entitled "The Coming Russian Boom" - rather ironically published the week of the crash a few years back. Undaunted, he made the media circuit anyway much to the delight of those interviewing him. His basic response was "well, if they'd only done what we told them to do..." Perhaps true, but one has to incorporate the likelihood that they won't, or can't.
Mussa's claim that Argentina had "spectacular success" in part of the nineties is strongly undermined when one faces the reality that despite huge capital inflows and relatively low interest rates during the nineties, Argentina's exports still are the same temperate climate agricultural product mix that brought them so little growth since World War II, i.e., products whose prices are depressed in the world market because of subsidies and protection to agriculture in the rich countries.
In Mussa's "spectacular success", Argentina did little better than establish themselves as the supplier of dairy products and wheat to Brazil. Of course, industrial policy is a forbidden word for IMF officials and Argentineans...
Everyone is assuming fiscal profligacy by Argentina. What evidence is there that Argentinian deficits were as high a percentage of GDP as those the US ran recently (1982-1995)? My understanding = none.
>What evidence is there that Argentinian deficits were as high a percentage of GDP as those the US ran recently?<
Why would anyone think that Argentina, with its history of one fiscal debacle after another, ought to have the same borrrowing capacity as the U.S., which sets the standard for zero-risk debt with a perfect debt record for 200+ years -- in fact, since before it existed?
It's like saying someone starting a business in his garage after coming off two bankruptcies ought to have the same proportionate borrowing capacity as Microsoft or IBM.
Anyhow, the US in its recent best of times ran a surplus while Argentina in its booming best of times doubled its debt. And as someone noted above, if you can't finance your deficit then it's too large, no matter what.
It strikes me that the lesson from Argentina is that the IMF should stop playing at microeconomics. The key is Mussa's sentence:
"... it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach"
These two policies (macreconomic stabilisation and "market-oriented reforms") are being treated as if they were on the same footing, when they're not. Throughout the 1990s, the IMF seemed to be operating on the basis of the equation:
Massively irresponsible macro policy + Lots of privatisations = Reasonable overall policy, we can continue to lend.
I think that they are very much on the hook for this, and that it is the weakest part of the whole neoliberal program; the idea that you can trade off macroeconomic policies for whatever happens to be flavour of the month in micro policy. The IMF doesn't have any real evidence to suggest that its privatisation policies are going to have massive effects on economy-wide productivity, and in any case those productivity changes would be long-term rather than short term.
Argentina wasn't a "good pupil" of the IMF in the macro sense; it had bewilderingly heterodox policies, which Mussa correctly points out. However, it was always treated as a "good pupil" and held up as an example to the rest of the emerging markets, because it privatised everything it was told to.
couple more points:
>>Why would anyone think that Argentina, with its history of one fiscal debacle after another, ought to have the same borrrowing capacity as the U.S., which sets the standard for zero-risk debt with a perfect debt record for 200+ years -- in fact, since before it existed?<<
While this is true of US Federal Government obligations, it is not at all true of state government debt; various states of the Union (Mississippi was a particular offender) defaulted spectacularly on debts in the 19th century, and a material proportion of the development of the USA was financed in this matter.
2) It strikes me that the real problem in Argentina is *inequality*; the political system is how it is, because this is a society in which the policy-making elites and the electorate have a massive gulf between their interests. Are the neoliberals planning on making wealth redistribution part of their development strategy any time soon (and if not, why not?)
Daniel Davis is struck with inequality as the real problem in Argentina. Yet, Argentina is hardly more unequal than its incredibly-unequal neighbor Chile.
Moreover, Argentina's inequality was exacerbated by the policies adopted during the nineties.
Good point. Although, I was assuming that it would be clear that the political pathology in Argentina was a result of the combination of inequality plus democracy; I was aiming to bait the inevitable Chicagoites who might come along to extoll the Chilean solution to Bard's development conundrum.
stiglitz too was quite critical of the imf trade off between macro and micro policy reforms in argentina - argentina had turned from the military to civilian goverment - the macro economy was stable for several years - debt was becoming less a burden with a growing gpd - employment rose - there was much opportunity for a better income distribution - then the dollar began to strengthen other trading currencies weakened and argentina sadly chose to sacrifice the domestic economy for the sake of the peg
dear brad - i sadly do believe cavallo egged on by spanish bankers and wall street made a fierce mistake in not allowing a devaluation
"argentina had turned from the military to civilian goverment - the macro economy was stable for several years - debt was becoming less a burden with a growing gpd - employment rose - there was much opportunity for a better income distribution"
But better income distribution is NOT an issue for Argentina. Argentina is a relatively low inequality country. If compared to most countries with similar income, they need income redistribution as much as, say, Atlanta needs a blizzard rescue planning team.
Income inequality has long been and is a most important issue in Argentina. Suggest a turn to united nations statistics. A profound hope of democracy in Argentina was increased economic opportunity for a working class that was floundering for decades. As in Brazil or Chile poverty was and is severe and broad-spread.
Please show me the numbers.
I could not find any reference to income inequality statistics in Argentina at the UN website.
From my own experiences traveling in Argentina and living in Brazil, it is clear that Brazil is in a whole different league as Argentina in terms of income inequality.
Believe me, there has been a huge increase in poverty in Argentina, starting in the mid-nineties. Before that, Argentinean levels of poverty and inequality were the unattainable dream of every progressive in Latin America.
One of the symptoms/consequences of Argentinean relatively compact society and low inequality were the old ladies wearing gold and pearls I could see walking at night in downtown Buenos Aires in the mid eighties, back home from the movies and theaters - something that would never happen in Sao Paulo, Mexico, and perhaps even New York in the eighties.
Borden - Look at Marcela Valente, "Low Inflation has No Effect on Poverty," for a discussion of United Nations stats on poverty in 1980's and 1990's in Argentina. Google....
Income inequality was and is a significant problem though I do not in any way doubt your account.
In the hyperinflation era of the 1980s, when the price index rose 5,000 percent in one year, poverty reached an all-time high but a price stabilisation plan enabled an improvement in the gross domestic product (GDP) at the start of this decade.
New problems emerged in the mid-1990s however - high unemployment rates and unequal income distribution. In 1994, according to the World Bank, 9.2 million people in Argentina lived below the poverty - a figure representing 27.4 percent of the population. Last year, the number of poor people had increased to 13.4 million - 36 percent of the population. During this period, which coincided with the second term of President Carlos Menem, the number of indigent people - those suffering extreme poverty - rose from 1.6 to 3.2 million, or about eight percent of the population.
The definition of families living below the poverty line are those who cannot afford the basic goods and services necessary to sustain life, estimated in Argentina to be 140 dollars per adult. The indigence level, on the other hand, is 70 dollars per adult.
Argentina was singled out in the 1998 Social Outlook of the Economic Commission on Latin America and the Caribbean (ECLAC) for bucking the general trend of economic growth and poverty reduction in the region. From 1990 to 1997, per capita income in Argentina grew by 37 percent but the number of poor households fell by only three percent. Meanwhile in Brazil, which showed only moderate income growth of 12.5 percent, poverty fell by 12 percent.
''Very low inflation does not always provoke a decrease in poverty (as in Argentina between 1990 and 1997), nor does moderate inflation always impede its reduction (as in Uruguay between 1990 and 1994),'' the report concluded.
Income inequality is an issue in Argentina.
However, until the '94 tequila crisis, inequality was lower than during the '89 hyperinflation, and every index of social welfare (atkinson with various aversions to inequality, pareto, sen) showed a steady improvement. Inequality was on the rise, but so was income for every decile. So even though iequality rose (explained mainly by education differentials) it was not the main problem.
At least until last year, Brazil and Argentina are not comparable in terms of inequality. Brazil is one of the most unequal countries of the world, and Argentina had traditionally been one of the least unequal in Latin America.
There is a deep redistributional conflict in Argentina, but it is not between politicians and "the people". In my view, it is between the middle classes and the lower classes. Argentine public spending is progressive, but there tend to be some deeply regressive expenditures (for instance, public universities which are free and with no entry restriction, but are attended mainly by students in the top three deciles of the income distribution). The middle class pays almost no income tax, and those who should evade it. Politicians have traditionally depended on middle class voters, and it is (IMHO) because of that fact that they refuse to prosecute evaders more actively, having large deficits as a result of that. Which end up being paid disproportionately by lower income families, since the inflationary tax is quite regressive.
So even if inequality rose, I don't see how keeping the deficit financed by inflation (since no investor in their right senses would lend any more money) would help solve this issue.
''Very low inflation does not always provoke a decrease in poverty (as in Argentina between 1990 and 1997), nor does moderate inflation always impede its reduction (as in Uruguay between 1990 and 1994),'' the report concluded.
Sociologist Susana Torrado explained that if ''extremes'' were taken into account, it was true that poverty levels today were lower today than in 1989 because in times of hyperinflation, many middle-class homes fell into the ''poor'' category. However, she warned that this decrease was not permanent but rather a technicality. The government uses a methodology of comparing the basic cost of living of one family with its income. In times of decontrolled prices and fixed salaries, the number of families that are counted as poor rises, although they might be middle class professionals, who own their own homes and cars. ''When inflation rises the number of poor people always goes up and, with stability, the number goes down. What has been unprecedented these last few years is that poverty is rising with zero inflation,'' Torrado said.
In the same way, sociologist and pollster Graciela Romer explained that the economic programme put in place by the government in 1991 managed to reduce poverty levels until 1994. ''(But) at the start of this year, poverty indicators started rising again,'' she lamented.
This phenomenon is associated in Argentina with a rising growth rate, which seems not only to not contribute to lowering poverty but also is accompanied by high unemployment, low wages, inequitable distribution and a fall in investment in public education. In periods of peak economic growth, like 1994, joblessness grew in Argentina to 18.4 percent of the economically active population.
-- The dollar peg stopped inflation and spurred gdp growth but did not address poverty. Poverty appeared to grow grew as the economy stabilized and grew. When the strengthening dollar caused gdp growth to slow and the administration chose to defend the peg with an austerity program, the result was depression. -- Were Menem and Cavallo at fault for failing to alter the peg?
Thanks for the posts confirming my views!
The nineties saw a large increase in inequality and poverty in Argentina, even before the currency crisis (unless one argues that the currency crisis started in 1995, which is a reasonable argument after all).
Of course, Argentina still does not seem to be up to the same levels that Chile and Brazil have reached in terms of inequality. But of course, what is Washington policy advice good for? If they follow the right guidelines, they can definitively make it!
'In Mussa's "spectacular success", Argentina did little better than establish themselves as the supplier of dairy products and wheat to Brazil. Of course, industrial policy is a forbidden word for IMF officials and Argentineans..'
Last time I checked, wheat still trades for hard currency.
The questions are - a. given democratic political reform, a stable price environment, several years of rapid gdp growth, could there have been more emphasis on reducing unemployment and poverty? b. when dollar strength began to slow growth, could the peg have been adjusted to spur gdp growth rather than further raise unemployment and increase poverty for what had become an abstract stability?
True, and wheat and other agricultural products are considered to be important enough to bot the US and the EU for them to be heavily subsidized.
If beef and wheat are not that important for the wealth of a nation, why not let countries like Argentina export all they are able to? It shuldn't be too much of a deal, right?
Last time I checked, wheat was a over-supply commodity, and producers from US and Europe could only continue in business due to heavy subsidies.
It is at least stupid if a country's strategy is based on exporting a product subsidized by other much larger country.
It is as if every wealthy college student wanted to be, say, a neurosurgeon. With millions of neurosurgeons in the market, and with wealthy young neurosurgeons accepting to work for minimum wage, would it be a good idea for a poor young man to try to be a neurosurgeon too?
That is Argentina's tragedy. All the fiscal/monetary problems are consequence of their poor growth. And their poor growth is due to their comparative advantage in goods whose prices are contracted in world markets reflecting an array of subsidies and protectionist policies by the North.
That the economics profession is mostly mute about this only shows how ill-equipped they (we) are to give economic advice :)
Jason and Maria - Why do the poorer nations have so hard a time using natural resource and agricultural wealth as a driver to development? Is there a genral answer? Is it because developed nations protect their own markets especially against agricultural imports?
Maria Eugenia wrote:
"If beef and wheat are not that important for the wealth of a nation, why not let countries like Argentina export all they are able to? It shuldn't be too much of a deal, right?"
Too bad that they just do not care for Argentina. US and EU policymakers care about their voters and more so to their lobbyists. In every country of the North, pork is distributed to farmers unrestrictedly.
Tough luck. That is all.
All of you agree that the Argentine peso was deflated ("too strong") but refuse to recognize the importance of the first signal. Argentina was doing pretty good before 1997, big deficits, military history, turgid populace and all. It was Greenspan's fault for deflating the dollar in 1997, as measured against gold and later commodities. Too bad, because the US isn't doing so good in the deflation either. Argentina could have been a signal of what Greenspan's monetary policy was doing to the little countries of the world, and would do later to the US economy. Many column inches were wasted on how slothful those South Americans are, or why Argentina's government had to implement deficit-reduction policies that got them thrown out of office. Showing basic mistrust of the electorate to determine their own fate, essentially a mistrust of humanity. It's a misread brought on by the 1994 punishment of deficit-reducer Clinton. Too bad, too bad.
Neither Europe nor America were willing to assist Argentina from 2000 on. That were was a private capital flow to Argentina after the peg began was fine, but it may have misled Menem and Cavallo to maintain the peg wehn alteration was sorely needed. The peg experiment was not coupled with policies to foster better income equality or poverty reduction and in the sad end the country is the poorer.
China may be a significant enough force to command a market for its most strategic exports. India may also command such a market. Argentina has less of an influence. India has a booming export market for information services. Ghana would love to compete in the same field, but Ghana may run up against more trade resistance because it lacks the geo-political significance of India. We must look to these problems. Argentina's development as Ghana's must be better fostered by the developed nations.
Finished Mussa. Merely an imf apology. Menem and Cavallo appear to have set a proper macro course for Argentina early on but they showed no significant concern for the working class or poor. When it became clear that an adjustment was needed in the currency peg to protect the working class, Menem and Cavallo chose austerity and produced a depression. Had there been real concern for workers, the peg would have been adjusted or dropped. Neo-liberal? I do not think so. Argentina is a tragedy of good but incomplete policy and harsh refusal to adjust the policy when it began to fail. America and Europe might have helped. Imf might have helped. No one helped. Your straw critique seems quite wrong.
Hopefully Brazil is not headed for a serious economic downturn....