Pundits agree this
is merely the latest in a string of bail-outs, led by the International
Monetary Fund (IMF), that squandered billions of dollars and failed to
save the economies they were meant to help.
Some claim the IMF was too lenient while others say it was too tough.
And some see the problem as self-inflicted through profligate and corrupt
spending by Argentina .Such attempts at blame-shifting are misguided:
The default can be seen as the result of economic mistakes made over a
decade. Understanding what went wrong provides important lessons.
The problems began with the hyper-inflation of the 1980s. To slash inflation,
expectations needed changing; 'anchoring' the currency to the dollar was
meant to do this. If inflation continued, the country's real exchange
rate would appreciate, demand for its exports fall and unemployment increase,
dampening wage and price pressures. Market participants, knowing this,
would realise inflation would not be sustained. While the commitment to
the exchange-rate system remained credible, so did the commitment to halt
inflation.
If inflationary expectations were changed, then disinflation could occur
without costly unemployment. This prescription worked for a time in a
few countries, but was risky, as Argentina was to show.
The IMF encouraged this exchange-rate system. Now it is less enthusiastic,
though Argentina is the one paying the price. The peg lowered inflation
but did not promote sustained growth. Argentina should have been encouraged
to fix a more flexible exchange rate, or at least a rate more reflective
of its trading patterns.
There were other mistakes in Argentina's 'reform' programme. It was praised
for allowing large foreign ownership of banks. This led to a seemingly
more stable banking system, but one which failed to lend to small- and
medium-sized firms.
After the burst of growth which came with hyper-inflation's end, growth
slowed, partly because firms could not get adequate finance. The government
recognised the problem, but was hit by numerous shocks beyond its control
before it could act. East Asia's crisis of 1997 provided the first shock.
Partly because of IMF mismanagement, this became a global financial crisis,
raising interest rates for all emerging markets, including Argentina.
Argentina's exchange-rate system survived, but at a heavy price - double-digit
unemployment. Soon, high interest rates strained the country's budget.
Yet its debt to gross domestic product (GDP) ratio remained moderate,
at around 45 per cent, lower than Japan's. But with 20 per cent interest
rates, 9 per cent of the country's GDP would be spent annually on financing
its debt.
The government pursued fiscal austerity, but not enough to make up for
the vagaries of the market. The global financial crisis that followed
East Asia's crisis set off a series of big exchange-rate adjustments.
The US dollar, to which Argentina's peso was tied, increased sharply in
value. Meanwhile, Argentina's neighbor and Mercosur trading partner, Brazil,
saw its currency depreciate.
Wages and prices fell, but not enough to allow Argentina to compete effectively,
especially as many agricultural goods, which constitute Argentina's natural
advantages, face high hurdles in entering rich countries' markets.
The world had hardly recovered from the 1997-1998 financial crisis when
the 2000 2001 global slowdown started, worsening Argentina's situation.
Here the IMF made its fatal mistake: It encouraged a concretionary fiscal
policy, the same mistake it had made in East Asia.
Fiscal austerity was supposed to restore confidence. But the numbers in
the IMF programme were fiction; any economist would have predicted that
concretionary policies would incite slow-down, and that budget targets
would not be met.
Needless to say, the IMF programme did not fulfill its commitments. Confidence
is seldom restored as an economy goes into a deep recession and double-digit
unemployment. Perhaps a military dictator could have suppressed the social
and political unrest that arises in such conditions.But in Argentina's
democracy, this was impossible. I was more surprised unrest took so long
to manifest itself, than that street turmoil unseated Argentina's president.
Seven lessons must now be drawn: In a world of volatile exchange rates,
pegging a currency to one like the US dollar is highly risky. Globalisation
exposes a country to enormous shocks. Adjustments in exchange rates are
part of the coping mechanism. You ignore social and political contexts
at your peril. Any government following policies which leave large parts
of the population unemployed or underemployed is failing in its primary
mission.A single-minded focus on inflation without a concern for unemployment
or growth - is risky.
Growth requires financial institutions that lend to
domestic firms. Selling banks to foreign owners, without appropriate safeguards,
may impede growth and stability. One seldom restores economic strength
- or confidence - with policies that force an economy into a deep recession.
Better ways are needed to deal with situations like Argentina's. I argued
for this during East Asia's crisis; the IMF preferred its big bail-out
strategy. Now it belatedly recognises that it should explore alternatives.
The IMF will work hard to shift blame - there will be allegations of corruption,
and claims Argentina did not pursue needed measures. Of course, it needed
to undertake other reforms - but following the IMF's advice made matters
worse.
Argentina's crisis should remind us of the pressing need to reform the
global financial system - and thorough reform of the IMF is where we must
begin.