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 unpayable.

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 annually.

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 valuable?


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 one is.

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 workers shrunk.

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 dropping.


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 saving time.

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 solution.

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.

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