Lessons From Argentina's Debacle
By Joseph Stiglitz
January 10, 2002
Argentinas collapse incited the largest default in history.
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 neighbour 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 contractionary 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 contractionary policies would incite slow-down, and that budget targets would not be met.
Needless to say, the IMF programme did not fulfil 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.
The writer, a professor of economics at Columbia University, won the Nobel Prize for Economics last year. He was formerly chairman of the Council of Economic Advisers to then US President Bill Clinton, and chief economist and senior vice-president of the World Bank.
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