An Evaluation of the Argentina Crisis

Argentina’s Financial Crisis

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23 April, 2021

Argentina’s Financial Crisis

The 1990s brought with it a sudden and deep change in economic organization in Argentina. The cornerstone was the 1991 implementation of the Convertibility Law, a currency board system that pegged pesos to the dollar at a 1-1 rate (Petrocolla and Losteau 36). Convertibility was accompanied by other fundamental transformations including trade liberalization, broad deregulation, and fiscal reform comprising of social security reform, debt restructuring, tax reforms, and privatizations (Petrocolla and Losteau 36). The convertibility regime led to significant productivity improvements and made Argentina one of the main destinations for FDI inflows in the developing word in the early 1990s. For several years during this decade, annual FDI inflows accounted for over 10 percent of gross fixed capital formation and over 2 percent of GDP (Chudnovsky and Lopez 8). Under the convertibility regime, capital movements had a direct impact on the fluctuations of economic activity through their effect on aggregate expenditure, internal liquidity, and interest rates (Chudnovsky and Lopez 8). As a result, the Argentine economy was heavily destabilized at times of high volatility in international capital flows such as the Russian and Brazilian crises of 1998 and 1999. (Chudnovsky and Lopez 8). The unexpected stop in capital inflows to emerging countries occasioned by the Russian default was followed by huge capital outflows that in 2001 triggered the worst economic and political crisis in Argentine history.

This paper attempts to clarify the reasons for the 2001 crisis that ended the market-oriented reform that had shaped Argentina’s economic evolution since the 1990s. It is organized into three sections. The first section discusses the relationship between Argentina and the International Monetary Fund (IMF) and its role in fueling the crisis. The second section discusses the sufficiency of Argentina’s democracy, while the third section discusses the support offered to multinationals by the Argentinian government.

Section One: Argentina’s Relationship with the IMF

This section argues that contrary to IMF reports, the Fund acted inappropriately in the case of Argentina and played a significant role in the 2001 economic crisis. The IMF was too lenient, allowing Argentina to continually implement the Washington Consensus even when the same placed the country’s economy in danger of collapse.

In 1991, Argentina began to follow the IMF formula for economic development and stabilization, which was very similar to the Washington Consensus (Paddock 158). The formula involved reducing trade barriers and regulation of capital inflows, privatization of state assets, reducing inflation, raising interest rates, and reducing balance of payment and deficits. The IMF backed these programs, which sources contend, significantly helped to combat fiscal profligacy and bring inflation under control (Paddock 158). Following years of high inflation and huge budget deficits of up to 23 percent of GDP, the decision to privatize state industries, reduce inflation, and cut state spending seemed to be the most appropriate action (Paddock 158). IMF’s decisions, however, began to have a substantial influence on the Argentine economy in 1995, when the nation was experiencing a recession due to the Mexican crisis that forced it to obtain $11 billion in financing, including $2.4 billion from the IMF due to capital flight and budget deficits (Paddock 158).

The Argentine government was forced to renegotiate its loan conditions with the IMF despite initial reports indicating that it had no intention to do so (Paddock 158). Worryingly, despite noticing that Argentina was entering a period of recession, the IMF retained is fiscally-oriented dogmatic advice to Argentina (Paddock 159). Despite a growing recession, the IMF continued to insist on austerity measures and a fiscal surplus, resulting in the worsening of the economic slowdown that made it impossible for the nation to reach the fiscal targets of the IMF (Paddock 159). The IMF continued its support to Argentina a long as the nation continued to liberalize its economy through deregulation, privatization, and attempts at fiscal targets (Paddock 158).

The Argentine economy quickly resumed is expansionary trend after the 1995 recession – an occurrence that some sources attribute to the IMF’s continued support (Rozenwurcel 3). However, sources contend that the recession had increased the fragility of both the public and private sectors and that there was a need for fiscal changes (Rozenwurcel 3). According to Paddock (160), the IMF’s decision to retain its fiscal austerity program in Argentina was problematic as it made Argentina heavily dependent on the IMF to the extent that failure to adhere to the IMF policies threatened to create a backlash from investors.

Sources argue that the IMF’s decision to retain its fiscal austerity program in Argentina despite the recession was driven by the fact that the program had worked effectively during the 1994 Mexican crisis, which was identified as a financial crisis (Paddock 159). This may have compelled the IMF to adopt a similar approach and similar conditions during Argentina’s 1995 recession and the 1998 Asian crisis (Paddock 159). In Paddock’s (159) view, these were different types of crises, requiring different responses – whereas the Mexican case was a financial crisis, Asia’s was a banking and regulatory crisis and the fundamental problem in Argentina in 1995 was the recession, not fiscal profligacy. The IMF’s one-size-fits-all approach of fiscal austerity may have worked effectively in the Mexican crisis because of Mexico’s huge public debt and loose monetary policies, which was not the case in Argentina (Paddock 159). Throughout 1996, Argentina continued to follow IMF’s advice, but was unable to meet most of the conditional tax and fiscal targets set by the IMF due to recession (Paddock 159).

Despite emerging resistance from interest groups, which held that the IMF’s economic policy risked plunging the Argentine economy into further recession, President Carlos Menem continued to introduce tax increases and spending reductions (Paddock 159). Rather than using the higher resultant tax revenues to stimulate the economy and pay off foreign debt, Menem continued to accumulate foreign debt, while raising taxes and interest rates (Paddock 159). The IMF maintained that although the austerity measures would increase unemployment and slow down growth, it would help Argentina survive the coming amortization and interest payments (Paddock 159). For this reason, the IMF kept providing loans to Argentina to service the foreign debt, which, by 1997, stood at $101 billion (Paddock 159). The IMF loans continued to come through 1998 despite Argentina being unable to meet IMF conditions (Paddock 159).

The country’s trade deficit kept growing largely due to an overvalued peso, but the pegged currency model placed the peso at the mercy of the dollar and limited the government’s ability to exercise expansionary monetary policy as a means to stimulate the economy (Paddock 159). According to renowned economist Paul Krugman, the most plausible option for Argentina at this time would have been to devalue its currency so as to make exports less expensive and hence, more competitive in the international market (Paddock 159). However, the IMF advised against devaluing, in the same way it did Russia during the 1998 crisis (Paddock 159). This meant that the nation would have to rely on the IMF credit to support the currency board (Paddock 159). On its part, the IMF kept its support, maintaining that the currency board had served the country well and was an adequate framework for stale growth (Paddock 159).

Krugler, however, holds that the IMF’s advice in regard to the currency board would not have worked in Argentina because the real problem in Argentina was not fiscal, but economic (Paddock 164). The budget deficit was only 1 to 3 percent of GDP, which was better than many European countries (Paddock 164). The peg precludes any action that a country could take to fight deflation such as letting the currency depreciate or lower interest rates (Paddock 164). By supporting the peg, the IMF was urging Argentina to instead default on its debt. Advanced countries often devalue their currency and never default on debt, yet the IMF seemed to prefer that Argentina, whose debt at the time was only half of GDP (not excessive by modern standards) to default (Paddock 164). Default, however, would not have any impact on the crisis as it would not lower interest rates or make the country’s exports more competitive (Paddock 164).

If Argentina was to end its peg and allow the exchange rate to flow freely, there would have been no need for loans and the balance of payments would freely attain equilibrium (Paddock 159). The IMF program would essentially be unnecessary if Argentina adopted a floating exchange rate. Thus, the IMF’s actions contributed to the worsening of the 1995 recession, which in turn, increased the fragility of both the private and the public sector in Argentina, making the Argentine economy unable to withstand the 1997 crises in Southeast Asia and Russia respectively. As Paddock (162) puts it, “the fate of the economy was inexorably linked to its relationship with the IMF”.

Section Two: The Strength of Democracy in Argentina

Broz (861) emphasizes the importance of political systems transparency in influencing effective fiscal policies. The author defines transparency as “the ease with which the public can monitor the government with respect to its commitments” (Broz 861). He concludes that nations with transparent political decision-making (democracies) are more likely to produce low inflation and hence, better economic conditions. The transparency (openness) of the political system allows the political opposition or the attentive public to observe government pressures on fundamental agencies such as the central bank and make it difficult for the government to misrepresent or conceal its actions (Broz 861). Thus, transparency in a nation’s political system (democracy) is a crucial influencer of fiscal and monetary policy, both of which inform the willingness of foreign investors to invest in the nation.

This section demonstrates that Argentina’s political systems lacks transparency and may limit the public’s ability to exercise oversight over government decision-making. The 1853 Argentine Constitution provides the foundation for the country’s political system (Alston 6). In many respects, the political system resembles the US model, in which the democratically elected government officials and the separation of powers are the foundation of the political system (Alston 6). Like is the case in the US, the Argentine political system is Presidential, with the Senate (seats by province), two legislative chambers, the Deputies (seats according to population), and an independent judiciary to keep the power of the other two branches in check (Alston 6). The provinces are headed by governors, who essentially control provincial politics.

Sources contend that the country has reported some notable improvements in democracy since 1914 (Alston 6). Prior to 1914, conservative governments controlled both houses of Congress as well as the Presidency (Alston 6). They secured their power through fraud and intimidation, particularly in the Pampas, which was the Conservative Party’s dominant force (Alston 7). The Conservative elites, however, yielded to pressure in 1914 and passed the Saenz Pena Law, which established the secret ballot and more stringent control of the electoral roll (Alston 7). With this, the Radical Party won the Presidency in the 1916 elections and a majority of seats in the House of Deputies, while the Conservative Party won the control of the Senate (Alston 7). With the divided governance, Alston (7) points out that “the political system became more transparent.”

The number of roll call votes in the National Congress increased significantly after 1916, indicating that Congress was not a mere rubberstamp of the president’s will (Alston 7). Roll call votes are votes in which each member votes ‘yea’ or ‘nay’ as their name is called by the clerk. The roll call voting system provides a means for constituents to monitor the voting behavior of their representatives, and hence, knowing where they stand in regard to issues of governance and national concern (Alston 7). The improvement in democracy was also evident from the number of citizens who came out to vote after 1916 – sources indicate that the voting population grew by over 133 percent between 1918 and 1931 (Alston 7). This is termed the Camelot period for Argentina, where the President was tasked with agenda-setting power but was constrained by judicial review and veto power by the Senate (Alston 7). The new institutional setting allowed the Supreme Court to exercise independence from the legislative and executive branches. In several instances, the court ruled against the preferences of the legislative chambers and the president – in Horta vs Harguindeguy (1922), for instance, the court struck down a law seeking to control urban rents (Alston 7).

However, sources contend that judicial independence in Argentina has been far from remarkable, particularly in regard to corruption cases involving elites in the political class (Alston 7; Pereyra 357). The use of roll call voting declined dramatically with the onset of fraud investigations in the mid-1930s (Alston 7). Following the massive corruption scandals that marred the Menem administration, the country moved to strengthen its institutional ability to fight fraud through the establishment of the Anticorruption Office (OA) in 2000 (Pereyra 356). The OA was an improvement of its predecessor, the Public Ethics Office, and had enhanced executive powers, bringing together two agencies: The Department of Investigation and the Transparency Policy Planning Department (Pereyra 356). By the end of 2000, the OA had received a total of 1,076 cases, most of them involving officials who had worked under the Menem administration (Pereyra 357). However, the OA met huge resistance from the executive and legislature when it attempted to move forward with cases involving prominent political figures (Pereyra 357). Data from the OA indicates that by 2003, the bureau had filed 667 cases with the courts, of which only 71 officials were indicted, and only 1 case had reached trial and ended up with an acquittal (Pereyra 357). This happens as Argentina ranks as the third most corrupt country in South America after Venezuela and Ecuador (Transparency International). Internationally, Argentina was ranked 107th out of 175 when it comes to lack of corruption (Transparency International).

The lack of transparency is also evident at the provincial level. Studies investigating the way politics is played out at the provincial level in the 23 Argentine provinces have shown that provinces are characterized by limited political competition and executive dominance, all of which limit transparency (Martin et al. 15). Martin and colleagues investigated the dynamics of the provincial political systems based on four measures of democracy: a) structural features and political practices; b) citizen-party linkages and the prevalence of vote-buying and patronage, c) executive-legislative relationships, and d) who the governors are and the extent of turnover at the gubernatorial level (Martin et al. 15).

The study found that Argentine federalism is characterized by huge regional disparities, with strong inequalities in health and basic education outcomes (Martin et al. 16). The country’s four largest provinces – Buenos Aires, City of Buenos Aires, Cordoba, and Santa Fe – account for over 70 percent of the country’s GDP (Martin et al. 15). Economic development may not directly predict democratic governance, but the study established that in provinces characterized by lack of education and poverty, the political game is controlled by a single family or clan, with outgoing governors in some instances passing their office to close friends and family members (Martin et al. 17). These leaders control business opportunities, the media, and the state in a monopolistic fashion. The control over fiscal resources gives authorities at the provincial level the opportunities to finance their political machineries using public resources and to operate as large-scale political machines (Martin et al. 17). This is evidenced from the low turnover rates in the gubernatorial level – between 1983 and 2010, for instance, only 6 of the 40 governors who ran for reelection lost (Martin et al. 19). A study of governors of the 23 provinces between 1980 and 2011 showed a high degree of name repetition, an indication that single families or individuals control many provinces over extensive periods of time (Martin et al. 17). The study further showed that in over 80 percent of the legislatures at the provincial level, 50 percent or more of the legislative seats are filled by members of the governor’s party, indicating the risk that the legislature is a mere rubberstamp of the governor’s preferences (Martin et al. 22).

This discussion shows that there are fundamental issues threatening the transparency of political systems in Argentina both at the federal and provincial levels. The lack of transparency among political institutions and lack of judicial independence hinder the attentive public or opposition’s ability to maintain effective oversight. This could partly explain why the Menem administration was able to institute unhealthy fiscal policies after the 1995 recession with minimal resistance from the citizenry.

Section 3: Support Offered to Multinationals in Argentina

Markusen (170) emphasizes the importance of an enabling business environment as a driver of foreign investment by multinational companies. In his view, a multinational company’s decision on whether to operate as a joint venture or to make a direct investment depends on factors such as licensing that influence the ease of doing business (Markusen 170). A multinational enterprise is a firm that engages in direct foreign investment, by either setting up a subsidiary in a foreign country or acquiring a controlling interest in a foreign firm (Markusen 170). How well licensing arrangements are structured by a nation’s laws determines whether or not multinational enterprises choose to invest therein. This section argues that whereas Argentina has made some significant strides in creating an enabling environment for multinationals, the country’s laws are insufficient in terms of protecting multinationals. This hinders the growth of multinational enterprises and makes the Argentinian economy unattractive for potential multinationals.

A 2020 report by Bloomberg points out that Argentina faces a mounting exodus of multinationals that have concluded that doing business in the Argentine economy is unprofitable and complicated even disregarding the Covid19 pandemic (Gillespie n.pag). In general foreign investments in Argentina are regulated by a framework of Argentine laws and international treaties that establish the norms for monetary policy, foreign exchange, as well as the legal treatment of foreign investors (Marval et al. 3). Argentina has over 60 bilateral treaties with other countries (Marval et al. 3). Generally, multinationals who wish to invest in Argentina either by acquiring existing businesses or starting up new businesses do not require prior government approval, except for general rules such an antitrust regulations or investment in regulated industries (Marval 3). However, if the investment of that foreign company is in holding equity in an Argentine company, the foreign company is required to register with the Public Registry of Commerce and comply with certain reporting requirements in the jurisdiction where the local company is incorporated (Marval 3).

Any company duly existing under the laws of its home country can set up a branch in Argentina. However, this is subject to certain conditions. First, the Argentine branch must keep separate accounting records in Argentina and file financial statements annually with the IGJ (Inpseccion General de Justicia) (Marval 6). Over the past decade, the Argentine government has taken steps to establish alliances between the state and the private sector to address enterprise development and youth unemployment. Beginning 2005, for instance, the government set up platforms or channels for dialogue with the chambers of commerce of the US, UK, Sweden, Spain, Norway, Germany, Denmark, and Canada – the countries that represent the bulk of multinational enterprises operating in Argentina. The network emphasized the crucial role of the home countries in promoting socially responsible labor practices among their enterprises as per the Multinational Enterprises and Social Policy (MNE Declaration). The chambers played an active role in promoting decent work practices in multinational enterprises operating in Argentina.

Sources identify several challenges that limit Argentina’s attractiveness to multinational enterprises. The first problematic area is that of construction permits. The TMF Group identifies this as the most complicated and time consuming part of doing business in Argentina (TMF Group n.pag). According to a report by the TMF, it takes not less than 150 days to obtain an environmental impact assessment and construction project permit in Argentina, which is way above the OECD average though at par with other Latin American countries (TMF Group n.pag). The process of obtaining approval for electricity plans is equally cumbersome, with the TMF report indicating that the process of getting the service application approved by an Argentine distributor of electricity takes up to 45 days, and one has to wait an additional 47 days for inspections and connection work to be completed (TMF Group n.pag). The registration of property is another problematic area that interferes with the ease of establishing multinational enterprises – according to the TMF report, property registration requires seven procedures and an average of 51.5 days, about 10 days less than other countries in Latin America (TMF Group n.pag). However, before the process of registration begins, one needs to obtain a large number of certificates including a certificate of good standing, certificate of ownership, certificate with fiscal valuation, and a certificate showing compliance with all relevant local taxes, all of which add to the time and costs (TMF Group n.pag). Another area of concern for multinationals is in regard to taxes – the Argentine government does not offer any tax benefits to multinationals. In fact, the TMF report identifies paying taxes as one of the most complicated procedures for businesses, with around nine payments per year and an average of 311 hours of work (TMF Group n.pag).