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Backgrounder #1537 on Latin America

April 17, 2002

Argentina: No Aid Without Reform

By

Argentina, submerged in its worst political, economic, and institutional crisis in recent history, is seeking $25 billion in financial assistance from the United States and the International Monetary Fund (IMF) to address the crisis.1 Argentina's situation has deteriorated rapidly; people are rioting and attacking politicians in the streets, looting supermarkets and stores, and withdrawing money from banks to buy U.S. dollars. They clearly have lost confidence in their institutions and leaders.

Additional international assistance, however, will not change this fact. Only profound reforms of Argentina's economy, political system, and judiciary can begin to restore the people's trust and set the country on the path to recovery.

Although the need for such comprehensive reform in Argentina is not new, instituting drastic reforms is politically costly. Consequently, successive governments--including the current administration of President Eduardo Duhalde--have avoided reform and have sought instead to gain more foreign assistance to assuage their economic problems. But the $30 billion the IMF has provided to Argentina since 1983 has done little to prevent this crisis and, even worse, has enabled Argentina's leaders to delay reform.

For this reason, the Bush Administration is reluctant to support more aid to Argentina until its leaders begin advancing vital reforms on their own. U.S. Secretary of the Treasury Paul O'Neill is among those who have made it clear that Argentina must do more to end the crisis.

According to the local media, the Duhalde administration has adopted a new strategy to obtain U.S. and international assistance. Its goal is to take the question of international assistance out of the purview of the Treasury Secretary's office and to place it on the agenda of the U.S. Department of State. Argentine officials call the strategy the desfondomonetarizacion (or "de-monetary funding") of Argentina.2 In other words, the government of Argentina wants to become a U.S. ally in the fight against terrorism and seeks financial assistance to contain the riots and skyrocketing crime in its own country to prevent Argentina from becoming a lawless society--a situation that eventually could encourage the presence of terrorist cells. Argentina's leaders believe that the U.S. State Department would support financial aid to Argentina on these security grounds.

This new strategy is politically smart but economically unwise. It reveals, however, how far Argentine authorities will go to avoid reform. If Argentina obtains foreign assistance before designing a credible plan for recovery and without advancing some reforms on its own, such assistance will get lost in the corrupt Argentine political system, doing nothing for ordinary Argentines. The Bush Administration should make it clear that it will send no money and support no new IMF loans for Argentina until the government of Argentina advances reforms and proposes a credible recovery plan.

Equally important, the Bush Administration should take this opportunity to advance immediate reform of the lending practices of international financial institutions (IFI) to prevent other Argentine-like crises in the developing world. Such practices allow international investors to avoid the risks of poor investment choices, governments to mismanage economies, and corrupt officials to stay in power. If Argentina's crisis proves anything, it is that without economic, political, and judicial reform, international assistance merely prolongs the pains of the people in crisis.

Security Depends on Economic Stability

Argentina's economic and institutional problems are rooted in ineffective policies. These policies include high trade barriers, heavy regulation of labor markets, convoluted tax systems, numerous bureaucratic steps to start a business, financial restrictions on individuals' and businesses' funds, price controls, an electoral system that leaves government officials unaccountable for their actions, and a weak rule of law.

The riots, protests by the middle class, long lines to buy U.S. dollars, and high crime levels are the symptoms of the country's problems. These symptoms can be alleviated only by strengthening the economy and increasing the judiciary's independence and transparency, which is the only way to guarantee that the reforms will be carried out and that corrupt political leaders will go to jail. In addition, the government should end the "co-participation pact," a mechanism through which the federal government funds provincial government spending, and eliminate rigid labor laws.

Doing all this requires a political commitment to reform, not more money from the IMF. Argentina's leaders have chosen, instead, to politicize the crisis, making its symptoms--the riots and looting, for example--appear to be the problem, which they contend can be contained only with international assistance.

To be sure, Argentina's crisis can still get worse, and many predict that it will.3 The country has experienced a prolonged recession, during which the GDP growth rate declined, while amassing $150 billion in foreign debt. But international assistance cannot resolve the underlying economic problems. The $20 billion IMF loan package that was approved in January 2001 obviously has had little effect, and there are at least two persuasive reasons to believe that sending more international financing to Argentina before the Duhalde government advances the necessary economic and political reforms will not change the status quo:

  • IMF money has never helped Argentina. Since 1983, successive Argentine governments have failed to meet the conditions attached to each IMF loan.4 In addition, the $30 billion in loans that the IMF has given to Argentina over the past 18 years has failed to foster economic growth or stability. To the contrary, the loan packages have had the perverse effects of encouraging faulty investment decisions by reducing the risk investors face from their choices, leaving the Argentine people with greater debt, a lower standard of living, and higher unemployment.

    For example, as depicted in the chart, foreign debt as a percentage of GDP grew from 44 percent in 1997 to 55 percent in 2001. During that same period, the GDP growth rate declined continuously from 8 percent in 1997 to -4 percent in 2001, poverty increased from 13 percent to 40 percent, and unemployment rose from 13 percent in 1998 to 18 percent in 2001.5 Additional funds will be equally ineffective because what Argentina needs to revive its economy is comprehensive structural reform.
  • Change in Argentina remains crisis-driven. Over 10 years ago, with Argentina facing hyperinflation, President Carlos Menem pushed forward many free-market reforms to curtail inflation and modernize the Argentine economy. The Argentine people were rewarded with better and less expensive goods and services, increased productivity, a stable currency, and economic growth. However, neither the Menem government nor its successor under Fernando de la Rúa took steps to deregulate labor markets, streamline regulations, improve the independence of the judicial system, or lower trade barriers. Without such vital reforms, investment stayed away, unemployment rose, and, eventually, the latest crisis hit.

    For the past three months, since Argentines lost access to their money in the banking system, families of all economic classes have been out on the streets expressing loudly their desire for change. This kind of pressure, coming from the people and not from the IMF, is the single thing Argentine leaders fear the most and, therefore, the only true incentive they have to reform. Fresh funds from the United States before any reform occurs will remove those incentives and, consequently, the prospects for recovery.

How the United States can Encourage Reform in Argentina

The Bush Administration is right to insist that, before any additional financing is offered, the Argentine government must work with the national Congress and provincial governors to implement the policies that are necessary to attract foreign investment and foster job creation. More employment will restore some of the confidence Argentines have lost in their leadership, encourage people to spend more, and promote economic growth while reducing the frustration and despair that prompts many Argentines to riot and break into stores to steal food, clothing, household appliances, and many other goods. Foreign money is not needed to pass any of these reforms: What is needed is political will.

Although the solution to the Argentine crisis ultimately depends on domestic actions, the United States can create incentives that encourage the Duhalde government to adopt the necessary reforms to recover from the current crisis. To that end, the Bush Administration should:

  • Stop all lending to Argentina until Argentine authorities propose a credible reform plan. Argentina needs a plan to rebuild its economy. Such a reform plan must include steps to:
  • Reform the co-participation pact with the provinces into a system of decentralized government in which each province collects its taxes to support its own public expenditures;
  • Reduce the size of the public sector;
  • Simplify the convoluted tax system;
  • Reduce bureaucracy;
  • Lower trade barriers;
  • Lift price controls and financial restrictions on individual and business funds;
  • Institute political reforms to hold elected officials accountable for public funds management; and
  • Strengthen the judiciary to enforce the law and punish corrupt officials.
  • Only when Argentina sets forth a credible strategy to achieve these goals should the U.S. government support financial help for Argentina in whatever area is necessary to carry out the plan.
  • Advance reform of the lending practices of international financial institutions. Financial crises have increased over the past decade in countries around the world even as the IMF and the World Bank have committed ever greater resources to those countries. The basis for reforming the lending practices of the IFIs to improve their track records can be found in the report of the International Financial Institutions Advisory Commission, chaired by Allan H. Meltzer of Carnegie Mellon University.6
  • With regard to the IMF, the report advocates establishing a system of lending that is based on preconditions that countries must meet before obtaining a loan.
  • For the World Bank, the report advocates a system of performance-based grants paid directly to private-sector contractors based on the job they performed, circumventing the government and thereby avoiding potential corruption sources.

  • Overall, in Latin America, dependence on foreign loans and economic crises will decline if an environment develops that promotes the efficiencies and benefits of an open market.

Conclusion

The Argentine government wants fresh international assistance to avoid having to make politically costly reforms. To achieve that goal, it has devised a strategy to obtain financial aid from the United States and the IMF on security grounds. But sending financial aid or supporting IMF loans to Argentina without requiring a credible plan and a commitment to institute the necessary political and economic reforms will merely prolong the crisis.

To help Argentina recover, the Bush Administration should hold back aid to Argentina and refrain from giving its support for additional IMF funding until the Argentine government presents a credible pro-growth plan. In addition, the Bush Administration should advance reform of the international financial institutions to minimize the likelihood of recurrent crises. Such an approach would foster an environment in Argentina and elsewhere that promotes long-term economic stability, market efficiency, and prosperity.

Ana I. Eiras is Latin America Policy Analyst in the Center for International Trade and Economics at The Heritage Foundation.


1. "Que pide el FMI al gobierno de Duhalde," La Nación, April 8, 2002.

2. Walter Curia, "El gobierno busca sacar rédito de su alineamiento con EE.UU.," Clarín, March 11, 2002. See also Luis Tonelli, Escenarios y Tendencias, on-line newsletter, March 2002, available by request at luis_tonelli@hotmail.com.

3. "Daer: Puede haber un estallido social si no se pagan los salarios a los estatales," La Nación, February 2, 2002; "Hay alerta en el gobierno por el cacerolazo de hoy," La Nación, January 25, 2002.

4. Ana I. Eiras and Brett D. Schaefer, "Argentina's Economic Crisis: An `Absence of Capitalism,'" Heritage Foundation Backgrounder No. 1432, April 19, 2001.

5. Economist Intelligence Unit, 2001Country Profile and 2002 Country Report. See also Eiras and Schaefer, "Argentina's Economic Crisis: An `Absence of Capitalism,'" and Silvia Stang, "Hubo 3,7 milliones mas de pobres en solo un año," La Nación, March 27, 2002.

6. The report of the International Financial Institutions Advisory Commission is available in English at http://www.house.gov/jec/imf/meltzer.htm, and in Spanish from the Heritage Foundation.

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