The Costs of Orthodoxy
Argentina was the poster child for austerity
and obedience to the IMF formula.
by Mark Alan Healey and Ernesto Seman
The American Prospect magazine, Winter 2002
What a time Argentines had in the nineties, that age of economic
marvels. Longstanding corruption and mismanagement seemed to be
swept away by a barrage of freemarket reforms and a massive influx
of foreign capital. Years of hyperinflation and stagnation gave
way to a stable peso pegged to the dollar and a solid economy
growing at 8 percent annually, apparently untouched by financial
crises in Mexico and Asia. Overnight, the perennial underperformer
had become the model case of free-market reforms. Everything seemed
on track, at last. Ordinary Argentines could trust in and plan
for the future. During the last years of President Carlos Saul
Menem's second administration, many spoke admiringly of how he
had placed economic policy "on autopilot."
Argentina was a poster child for neoliberal economics- privatizing
everything in sight, restraining wages, limiting social spending,
defending the currency, and opening the door wide to foreign capital.
So how did everything slide so easily into the four years of deepening
recession, rising unemployment, and inexorably increasing debt
that have finally led to the largest default in history?
Argentina, like much of Latin America, industrialized in fits
and starts. Argentine industrialization was shaped by shifting
and unstable alliances among an interventionist state, a rent-seeking
elite, and a powerful labor movement. The result was a half-century
of wildly oscillating economic growth and political instability.
The military brought this cycle to a close with a coup z5 years
ago. While the military were torturing, murdering, and "disappearing"
students, workers, and activists by the tens of thousands, a group
of monetarist economists implemented freemarket policies that
devastated domestic industry but rewarded financial speculation.
Fueled by ballooning external indebtedness, this house of cards
came crashing down in 198Z, leaving the state holding the bag.
Monetarist policies in Argentina were undone by monetarist policies
in the United States, as Federal Reserve Board Chairman Paul Volcker's
abrupt hike of interest rates made an unwise external debt suddenly
Even after the military regime collapsed, this debt would
frustrate future attempts to set the economy on a sound footing.
All the political courage, democratic convictions, and heterodox
economic-growth strategies of the new civilian president, Raul
Alfonsin (who served from 1983 to 1989), ultimately foundered
in the face of the debt. He managed to hand over power to a democratically
elected successor-for the first time in 60 years-but he was forced
to do so six months early by inflation running at 4,9z3 percent
Carlos Menem came to power in 1989 with a mandate for dramatic
change. Repudiating the historic policies of his Peronist Party,
he embraced the neoliberal recipe and initiated an aggressive
set of spending cuts, market openings, and privatizations. Yet
these reforms did not bring immediate relief and inflation spiked
up to 1,l00 percent.
In April 1991, Domingo Cavallo, Menem's third minister of
the economy, launched the policy that would become the centerpiece
of the reforms. He pegged the Argentine peso to the U.S. dollar,
one to one. This literally meant that the government could print
only as many pesos as it had dollars in its vaults. After decades
of inflation and recent bouts of hyperinflation, this stable currency
offered a new common basis for Argentine life. For many, this
stability restored the possibility of planning for the future,
of dreaming of social mobility, of working and living without
the terror of imminent catastrophe. One could hardly overstate
how deeply this all-or-nothing wager came to structure Argentine
politics. For Menem and Cavallo, this was not just a package of
measures, but "The Model" for future economic development.
But after years of being awash in worthless currency, few Argentines
stopped to ask: What might happen if the currency becomes too
THE DOLLAR COLLAR
At first, the strong currency, pent-up demand, and suddenly
lowered trade barriers served to spark a consumer boom. Dozens
of huge shopping malls opened up across the country, while thousands
of factories and small shops closed down, unable to compete with
shiny imported goods. These social costs were evident from the
beginning but were explained away as a passing phenomenon.
The large amounts of incoming foreign investment initially
lent credibility to this argument, providing Argentina with enough
dollars to fuel 8 percent annual growth. But the government was
actually financing this investment boom by selling off its patrimony.
Within a few years, the administration sold off telephone, water,
oil, gas, electricity, railroads, subways, airlines, airports,
and eventually even the postal service to private-and mostly foreign-investors.
At the same time, this dramatically expanding consumer market
also tempted many foreign companies to enter local markets, generally
by purchasing and modernizing existing local producers. From flour
mills to car manufacturers, foreign capital seized the commanding
heights of the Argentine economy. As late as 1995, six of the
10 largest banks in Argentina were locally owned; today, only
Meanwhile, the neoliberal playbook proclaimed the need to
make labor more flexible-so the administration set out to gut
labor rights. The more dynamic sectors became more concentrated,
more capital intensive, more foreign-owned, and much more profitable.
Output per worker soared, but wages stagnated and the number of
Across the rest of the economy, wages and employment simply
collapsed. Even in the boom years, businesses did not create any
net jobs in the officially measured sector. All the expansion
has come in the "informal" sector-the gray economy:
Four million of the nine million Argentines who make up the economically
active population now work off the books. And even workers with
formal contracts have seen their rights systematically eroded,
with management able to impose (or get corrupt and discredited
union leaders to agree to) lower wages, more hours, arbitrary
schedules, vacations out of season, and long "trial"
periods. Historically, Argentina was a labor-poor country with
low unemployment. Since 199l unemployment has never dropped below
1Z percent. Currently, it is over 18 percent, a record high.
Even as the buying power of the middle class was driving the
boom, this austerity program was tearing that very middle class
apart, creating a group that sociologists dubbed the "new
poc the first generation firmly convinced that they will be poor
than their parents. The industrial workforce shrank by nearly
a third, poverty rates rose steadily, and old poor and new poor
alike watched the life drain out of the rickety-although once
impressive, by Latin-American standards-Argentine social safety
net. Welcomed in hope, the model endured out of fear.
For all the hope invested in convertibility, the peso-dollar
peg was a key part of the problem. As the government could print
more currency only if it was backed by dollars, the economy could
expand only if it brought in more foreign exchange through direct
investment, sales of public enterprises, export earnings, or loans.
After the initial rush of privatization, new foreign investment
slowed and then dwindled away after the abrupt Mexican devaluation
of December 1994 sparked crisis across Latin America. Meanwhile,
the rising value of the dollar made exports prohibitively expensive.
The only way to expand the currency supply and the economy was
by taking on debt.
After revising the constitution, Menem easily won reelection
in 1995. Over the four years of his second term, the external
debt doubled. This was partly because of the structural need for
liquidity, partly because of the political need after 1997 to
build provincial support for a possible third term, and partly
because of a wide range of honest or deliberate miscalculations
in early reforms. For example, a futile 1995 attempt by Cavallo
to increase employment by having the state cover part of employers'
wage taxes failed to generate any jobs but succeeded in increasing
state debt by more than $10 billion a year.
Ironically, the worst deficits came under Cavallo's hyperorthodox
successor, who never ceased to condemn the state and extol fiscal
discipline even as he emptied state coffers and distributed favors
to friends and allies. The International Monetary Fund was fully
aware of the trend and-to judge by the waivers that it gave the
administration every year after it failed to meet its targets-did
not care. Along with the U.S. government, they continued to present
the country as a model for the developing world to emulate.
In the orthodox critique, public enterprise is suspect because
it invites corruption. But so does privatization. Widespread corruption
was central to this process, not incidental, and the state usually
ended up footing the bill. A vast web of bribes, subsidies, deals,
and swindles surrounded the selling off of state assets, involving
many top government officials and major international corporations
like IBM, Citibank, and Telefonica. This was common knowledge
at the time, but international financial institutions, the United
States, and the European Union made only token protests.
The case of Aerolineas Argentinas is extreme but illustrative.
When it was sold, the airline was profitable, but the state swallowed
almost $1 billion in debt to sweeten the deal. To keep it running
a few years later, the state absorbed almost $1 billion more.
In the meantime, Iberia, the Spanish national airline that bought
Aerolineas, had sold off all its assets and gutted the company
with dubious accounting tricks. When Iberia faced trouble, it
threatened to shut down Aerolineas. Once more, the Argentine state
came to the rescue, assuming another $93: million in debt so that
the company could be resold again. Needless to say, a large part
of state investments and airline earnings vanished into a tangle
of private accounts and offshore banks. The state took on debts
worth three times as much as the company and was left with an
empty shell it does not even own.
There are many more stories like this, and they help to explain
how the Argentine government could sell off everything it had
and end up more than twice as indebted as before. Meanwhile, dollar
convertibility not only failed to draw runaway capital back into
the country but greased the wheels for even more to flow out.
In 1990, Argentines held an estimated s48 billion abroad-an amount
roughly equal to the national debt at the time. Today, the most
conservative estimates of offshore assets run to $100 billion.
Bank deposits inside the country total only $65 billion-and are
In the end, little separated the age of marvels from the years
of tragedy. They are not even two sides of the same coin; rather,
they are the same continuous side of a Mobius strip: The appearance
of the marvel also marked the onset of the tragedy.
As the boom went bust, orthodox commentators insisted that
the problem was not the reforms done but those left undone. If
only the state were trimmed further, if only labor markets were
liberalized a bit more, they promised, growth and foreign investment
would return. Not only did this undying orthodoxy fail to confront
problems, it made them worse. These commentators portrayed the
crisis as primarily economic, and even financial, in nature. But
the cause of Argentina's collapse is political, not economic.
What's missing is political power, leadership, and imagination
in the face of the shortsighted reasoning promoted by the international
financial community and embraced by local elites. What the country
lacks is not orthodox solutions but the political will to escape
from an exhausted model whose only remaining basis of support
is fear of the unknown.
When the current president, Fernando de la Rua, took office
in December 1999, the country had been in recession for 19 months.
As the reform candidate of the Alliance for Work, Justice, and
Education, de la Rua had campaigned for a clean version of "The
Model": convertibility without corruption, growth without
inequality. Fear of a traumatic break with dollar parity, memories
of the social experience of hyperinflation, and pressure from
big business with investments (and debts) in dollars drove de
la Rua to swear undying fealty to convertibility. Campaign promises
are often momentary concessions that can be changed once a leader
is in power. But the new administration's promises quickly became
a trap with no way out.
Eager to prove himself to investors, de la Rua raised taxes,
slashed spending, and made a priority of passing the labor flexibility
law long demanded by the IMF. The bill went to Congress in January
2000 and was passed in April. By August, rumors that the law had
passed thanks to government bribes of opposition legislators led
to spectacular accusations in the press and judicial system. These
accusations set off a political crisis, and de la Rua's refusal
to take them seriously drove his vice president to resign, breaking
the governing coalition in two.
When modernization becomes a goal to be achieved at all costs,
as happened with privatization, corruption ceases to be incidental
and comes to offer a substitute for political legitimacy, undermining
the institutions and, ultimately, the possibility of democratic
life. By placing modernization before citizenship, de la Rua destroyed
both. In record time, de la Rua had sacrificed his most valuable
ally, betrayed his mandate, and squandered his political capital.
With his political base narrowed to his faithful lieutenants,
he proved incapable of even imagining any risky moves. This year,
his administration could not even manage to implement daylight
In the name of stability, de la Rua honored his short-term
commitments and abandoned his long-term goals. Since he took office,
all that the IMF has proposed and all that the government has
done is cut spending, again and again. Each time the cuts deepen
the recession, bringing down revenues and forcing a new round
of cuts. The country is like a donkey being taught to stop eating:
When it doesn't do what it's told, it gets spanked; and when it
finally does, it starves to death.
This downward spiral has cost the heads of two economics ministers
and, improbably enough, brought Cavallo back to his old post.
Since the beginning of this year, the government has launched
two orthodox debt-refinancing plans. Both failed. Shortly after
returning to office this year, a chastened Cavallo announced another
round of cuts, brushing aside those who said that this would only
deepen the crisis. Within months, the worst predictions had come
true, and the country has been forced effectively to default on
$13Z billion in debt.
After adamantly denying any need to renegotiate for the past
two years, the government now must bring its creditors to the
table. A third debt swap has succeeded in considerably reducing
the government's obligations to domestic bond-holders, but the
more difficult negotiations with foreign bond-holders still lie
ahead; even the most optimistic estimates see the reduction in
payments alone as too little, too late. Some IMF staff have called
for devaluation, and others for an international bankruptcy mechanism
that would enable countries to renegotiate their debt in an orderly
way-a proposal clearly inspired by Argentine chaos that comes
too late to be of benefit. In general, the IMF seems to recognize
that past recipes have failed, but keeps recommending them anyway.
While the government stumbles, trying against all odds to avoid
a full-fledged default, the solid block in favor of convertibility
is beginning to crack. Foreign-owned privatized companies and
the financial sector are pushing to maintain dollar parity as
a way of keeping the value of their investments, while exporters
want to cut the peso loose from the dollar and devalue. Unable
to meet any domestic commitments, the national and provincial
governments have begun to pay wages, months overdue, in scrip-a
desperate road to hidden devaluation.
On the last day of November, a run against the banks drove
Cavallo to impose currency controls, allowing those with bank
accounts to take out only s:50 per account per week. In the name
of convertibility, he has locked up the money in the banks. This
threatens to devastate the informal economy-which operates on
a cash basis-and further deepen the depression. Cavallo also decreed
that bank deposits in pesos were now officially denominated in
dollars, but this means nothing since no one can access the money
and, if they could, the government does not have enough dollars
to give them anyway. At this writing, the latest IMF demand is
a 1o percent budget cut, which will only shred the remaining safety
net and worsen the depression.
So the vicious cycle begins again: the weaker the state appears,
the greater the power of financial markets, further weakening
the state, further strengthening the markets. De la Rua's popularity
is now measured in the single digits; Cavallo's magic has evaporated
into thin air; polls say that most Argentines who have jobs expect
to lose them. The result is a complete collapse of the political
system, with leaders ignoring the will of the people and squabbling
over scraps while the world around them is falling to pieces.
This lack of political leadership benefits the few and excludes
the many from any remotely sustainable long-term or even short-term
During his election campaign, President Bush promised to make
Latin America the first priority of his foreign policy. Now the
most faithful adherent to the Washington Consensus has gone belly-up,
and the Bush administration's response is muted, distant, and
confused. Its only concrete measure since September 1l has been
to push for fast-track authority in order to deepen precisely
the policies that led to this impasse. The studied indifference
of the Bretton Woods institutions to the fall of their former
model pupil is not surprising. But what is striking is the silence
of antiglobalization groups, who had few concrete things to say
about Argentina's ongoing crisis during the heady days of last
summer and have had even less to offer in the disarray that has
followed the terrorist attacks in this country.
As Argentina is melting down, the Bush administration is crafting
a strategy for Afghanistan after the war. On November 18, Secretary
of the Treasury Paul O'Neill said that the right path forward
for that devastated country and its pulverized economy is to put
in place a market economy and open it up to international capital.
The extraordinary similarity of his formula for Argentina or Afghanistan
or any other part of the world only reveals once more Washington's
inability to grasp the radically different realities of this world.
Are the Bretton Woods institutions-the IMF and World Bank-up to
the political challenge of development? Everything would suggest
that they are not. With the encouragement of the U.S. government,
those institutions continue to spread the gospel of the market
with little regard to the failed history of earlier missions or
the diversity of the places they would convert. And the Bush administration
pushes for a free-trade agreement that would only deepen the worst
aspects of the current crisis across Latin America.
Within Argentina, debate continues to be dominated by the
unhappy convergence of the desperate shortsightedness of the local
political class, the imperial disdain of Washington policy makers,
and the orthodox proclamations of financiers. What keeps everyday
Argentines in check is as much the terror of the unknown as the
fear of the return of an all-too-familiar past.
The solutions now being proposed follow familiar orthodox
lines: tax hikes, wage and budget cuts, a new IMF loan to pay
off short-term obligations, and a devaluation of the peso followed
by a new dollar peg, all aimed at a recovery that will never come.
Still missing is the political courage to describe things as they
are and to imagine a different way forward.
MARK ALAN HEALEY, a professor of history at the University
of Mississippi, is currently a Woodrow Wilson Fellow at New York
University. ERNESTO SEMAN is a national-political reporter with
Clarin, the largest newspaper in Argentina, and author of Educando
a Fernando, on Argentina's 1999 presidential campaign.