Argentina’s Fall: The Myth of the Good Powerless Policymaker
Sebastian Etchemendy, Political Science

The Argentina of the 1990s was a model of economic reform for orthodox economists and international financial institutions alike, said Manuel Pastor, a professor of economics and Latin American and Latino Studies at UC Santa Cruz, at the Center for Latin American Studies in September. The country tamed inflation, pursued radical tariff liberalization, and adopted a currency board that fixed the peso to the dollar, thereby stopping domestic monetary expansion and forcing the government to curb fiscal deficits. The government’s tightening of monetary matters through the currency board was seen as a source of Argentina’s stability.

Massive privatization and vast amounts of capital flooded into this historically crises-ridden economy, helping to control deficits. The experiment seemed to be working: Argentina reached outstanding growth rates from 1991 to 1995. The exchange rate overvaluation triggered a huge increase in imports and a consumption boom that fueled the political ambitions of former President Carlos Menem and his Minister of the Economy, Domingo Cavallo. The team faced no major hurdles and was reelected in 1995.

Argentina’s capacity to resume growth in 1996 and 1997 after the Mexican peso crisis seemed to confirm the robustness of its fixed exchange rate, Pastor said. Argentina could keep investor’s confidence and weather the storm in spite of—and, for many, because of—a virtually powerless government in monetary matters. Argentina’s highly liberalized and privatized economy had become the “poster-child,” the paradigm of neo-liberal reform for the international financial establishment, Pastor explained in his presentation titled “From Poster Child to Basket Case: Argentina on the Edge.”

Then the unexpected happened in 2001: Five presidents in two weeks—one of whom lasted only 40 minutes, a default on public debt of about $140 billion, a currency that lost 75 percent of its value after December 2001, a freezing on citizens’ bank deposits and a 13 percent decrease in GDP. Nearly 50 percent of the population quickly fell below the poverty line in a country that was once proud of its buoyant middle class, Pastor said.

What is the link between the success story and the recent tragedy? There are two generally contrasted analyses of Argentina’s economic disaster. The first focuses on the exchange rate policy and the second, which is mostly touted by orthodox economists, is based on state spending. Pastor clearly falls among the first group of economists. In his view, the seeds of the future collapse were already present in the exchange rate policy pursued in the 1990s. Pastor explained that radical tariff liberalization, coupled with the increasing overvaluation of the exchange rate, began to undermine local productivity. Brazil’s devaluation, the Euro’s depreciation to the dollar—and, therefore to the peso—and the economic crises in Asia and Russia only made things worse. Eventually, currency appreciation destroyed the competitiveness of the “real economy” and sparked a predictable shrink in investment and growth. Unemployment increased, reaching 25 percent by 2001, while the rate of gross fixed investment plummeted. In this context, former President Fernando de la Rua had little room to maneuver within the constraints of the inherited exchange rate system. His attempts to adjust and further push deflation—the “deficit zero policy,” combined with an IMF approved emergency packet, proved useless.

Pastor argued that exchange rate fixation can have disastrous consequences in a world of capital mobility. But he acknowledged that some of the explanations given by more orthodox economists—such as the continuous rise of government spending in the second half of the 1990s, especially in the provinces, and the lack of labor reform to help the private sector face the decline in competitiveness—are also valid. Pastor’s argument would suggest, however, that the structural problems caused by the convertibility scheme were in place long before fiscal problems arose. Fiscal problems stemmed from the lack of competitiveness and the internal recession, and not the reverse.

Dr. Pastor used the comic strip above to illustrate his argument, with the worker believing that the only economic opportunities now available in Argentina involve becoming a politician.

Pastor concluded that Argentina’s sudden conversion to a “basket case” after years of being hailed by the Washington financial establishment should prompt officials to rethink the whole financial architecture of globalization. Pastor’s compelling argument challenges policy makers to examine the feasibility of continuous deflation policies in democratic societies with relatively mobilized civil societies. His case also shows that it is important to consider whether nation-states and state officials with little power in changing policy can really bring “certainty” and “predictability” to emergent economies. Two examples show how governments can maintain a substantive capacity of policy intervention even in the context of liberalization. The first is Chile, which kept a fundamental source of foreign exchange through its control of the copper production, and the second is Mexico, which developed a strong policy of export promotion while maintaining control of its main exporter, oil giant PEMEX. Even in a global economy, these and other examples demonstrate that liberalization with a domestic state strategy is possible and even helpful in avoiding the disastrous consequences of powerless policy makers.