The Costs of Orthodoxy

"En este país está todo mal hecho, pero
está tan bien hecho que es indestructible."

(Everything in this country is made badly, but it is so craftily done as to be

--Argentine President Arturo Frondizi (1960)

What a time Argentines had in the nineties, that age of economic marvels.
Long-standing corruption and mismanagement seemed to be swept away by a barrage
of free-market reforms and a massive influx of foreign capital. Years of
hyperinflation and stagnation gave way to a stable peso pegged to the dollar and a
solid economy growing at 8 percent annually, apparently untouched by financial
crises in Mexico and Asia. Overnight, the perennial underperformer had become the
model case of free-market reforms. Everything seemed on track, at last. Ordinary
Argentines could trust in and plan for the future. During the last years of
President Carlos Saúl Menem's second administration, many spoke admiringly
of how he had placed economic policy "on autopilot."

Argentina was a poster child for neoliberal economics--privatizing
everything in sight, restraining wages, limiting social spending, defending the
currency, and opening the door wide to foreign capital. So how did everything
slide so easily into the four years of deepening recession, rising unemployment,
and inexorably increasing debt that have finally led to the largest default in

Argentina, like much of Latin America, industrialized in fits and starts.
Argentine industrialization was shaped by shifting and unstable alliances among
an interventionist state, a rent-seeking elite, and a powerful labor movement.
The result was a half-century of wildly oscillating economic growth and political
instability. The military brought this cycle to a close with a coup 25 years ago.
While the military were torturing, murdering, and "disappearing" students,
workers, and activists by the tens of thousands, a group of monetarist economists
implemented free-market policies that devastated domestic industry but rewarded
financial speculation. Fueled by ballooning external indebtedness, this house of
cards came crashing down in 1982, leaving the state holding the bag. Monetarist
policies in Argentina were undone by monetarist policies in the United States, as
Federal Reserve Board Chairman Paul Volcker's abrupt hike of interest rates made
an unwise external debt suddenly unpayable.

Even after the military regime collapsed, this debt would frustrate future
attempts to set the economy on a sound footing. All the political courage,
democratic convictions, and heterodox economic-growth strategies of the new
civilian president, Raúl Alfonsín (who served from 1983 to 1989),
ultimately foundered in the face of the debt. He managed to hand over power to a
democratically elected successor--for the first time in 60 years--but he was
forced to do so six months early by inflation running at 4,923 percent annually.

Carlos Menem came to power in 1989 with a mandate for dramatic change.
Repudiating the historic policies of his Peronist Party, he embraced the
neoliberal recipe and initiated an aggressive set of spending cuts, market
openings, and privatizations. Yet these reforms did not bring immediate relief
and inflation spiked up to 1,100 percent.

In April 1991, Domingo Cavallo, Menem's third minister of the economy,
launched the policy that would become the centerpiece of the reforms. He pegged
the Argentine peso to the U.S. dollar, one to one. This literally meant that the
government could print only as many pesos as it had dollars in its vaults. After
decades of inflation and recent bouts of hyperinflation, this stable currency
offered a new common basis for Argentine life. For many, this stability restored
the possibility of planning for the future, of dreaming of social mobility, of
working and living without the terror of imminent catastrophe. One could hardly
overstate how deeply this all-or-nothing wager came to structure Argentine
politics. For Menem and Cavallo, this was not just a package of measures, but
"The Model" for future economic development. But after years of being awash in
worthless currency, few Argentines stopped to ask: What might happen if the
currency becomes too valuable?

The Dollar Collar

At first, the strong currency, pent-up demand, and suddenly
lowered trade barriers served to spark a consumer boom. Dozens of huge shopping
malls opened up across the country, while thousands of factories and small shops
closed down, unable to compete with shiny imported goods. These social costs were
evident from the beginning but were explained away as a passing phenomenon.

The large amounts of incoming foreign investment initially lent credibility
to this argument, providing Argentina with enough dollars to fuel 8 percent
annual growth. But the government was actually financing this investment boom by
selling off its patrimony. Within a few years, the administration sold off
telephone, water, oil, gas, electricity, railroads, subways, airlines, airports,
and eventually even the postal service to private--and mostly foreign--investors.
At the same time, this dramatically expanding consumer market also tempted many
foreign companies to enter local markets, generally by purchasing and modernizing
existing local producers. From flour mills to car manufacturers, foreign capital
seized the commanding heights of the Argentine economy. As late as 1995, six of
the 10 largest banks in Argentina were locally owned; today, only one is.

Meanwhile, the neoliberal playbook proclaimed the need to make labor more
flexible--so the administration set out to gut labor rights. The more dynamic
sectors became more concentrated, more capital-intensive, more foreign-owned, and
much more profitable. Output per worker soared, but wages stagnated and the number
of workers shrunk.

Across the rest of the economy, wages and employment simply collapsed. Even in
the boom years, businesses did not create any net jobs in the officially measured
sector. All the expansion has come in the "informal" sector--the gray economy:
Four million of the nine million Argentines who make up the economically active
population now work off the books. And even workers with formal contracts have
seen their rights systematically eroded, with management able to impose (or get
corrupt and discredited union leaders to agree to) lower wages, more hours,
arbitrary schedules, vacations out of season, and long "trial" periods.
Historically, Argentina was a labor-poor country with low unemployment. Since
1991 unemployment has never dropped below 12 percent. Currently, it is over 18
percent, a record high.

Even as the buying power of the middle class was driving the boom, this
austerity program was tearing that very middle class apart, creating a group that
sociologists dubbed the "new poor": the first generation firmly convinced that they
will be poorer than their parents. The industrial workforce shrank by nearly a
third, poverty rates rose steadily, and old poor and new poor alike watched the
life drain out of the rickety--although once impressive, by Latin-American
standards--Argentine social safety net. Welcomed in hope, the model endured out
of fear.

For all the hope invested in convertibility, the peso-dollar peg
was a key part of the problem. As the government could print more currency only
if it was backed by dollars, the economy could expand only if it brought in more
foreign exchange through direct investment, sales of public enterprises, export
earnings, or loans. After the initial rush of privatization, new foreign
investment slowed and then dwindled away after the abrupt Mexican devaluation of
December 1994 sparked crisis across Latin America. Meanwhile, the rising value of
the dollar made exports prohibitively expensive. The only way to expand the
currency supply and the economy was by taking on debt.

After revising the constitution, Menem easily won reelection in 1995. Over
the four years of his second term, the external debt doubled. This was partly
because of the structural need for liquidity, partly because of the political
need after 1997 to build provincial support for a possible third term, and partly
because of a wide range of honest or deliberate miscalculations in early reforms.
For example, a futile 1995 attempt by Cavallo to increase employment by having
the state cover part of employers' wage taxes failed to generate any jobs but
succeeded in increasing state debt by more than $10 billion a year.

Ironically, the worst deficits came under Cavallo's hyperorthodox successor,
who never ceased to condemn the state and extol fiscal discipline even as he
emptied state coffers and distributed favors to friends and allies. The
International Monetary Fund was fully aware of the trend and--to judge by the
waivers that it gave the administration every year after it failed to meet its
targets--did not care. Along with the U.S. government, they continued to present
the country as a model for the developing world to emulate.

In the orthodox critique, public enterprise is suspect because
it invites corruption. But so does privatization. Widespread corruption was
central to this process, not incidental, and the state usually ended up footing
the bill. A vast web of bribes, subsidies, deals, and swindles surrounded the
selling off of state assets, involving many top government officials and major
international corporations like IBM, Citibank, and Telefónica. This was
common knowledge at the time, but international financial institutions, the United
States, and the European Union made only token protests.

The case of Aerolíneas Argentinas is extreme but illustrative. When
it was sold, the airline was profitable, but the state swallowed almost $1 billion
in debt to sweeten the deal. To keep it running a few years later, the state
absorbed almost $1 billion more. In the meantime, Iberia, the Spanish national
airline that bought Aerolíneas, had sold off all its assets and gutted the
company with dubious accounting tricks. When Iberia faced trouble, it threatened
to shut down Aerolíneas. Once more, the Argentine state came to the
rescue, assuming another $932 million in debt so that the company could be resold
again. Needless to say, a large part of state investments and airline earnings
vanished into a tangle of private accounts and offshore banks. The state took on
debts worth three times as much as the company and was left with an empty shell
it does not even own.

There are many more stories like this, and they help to explain how the
Argentine government could sell off everything it had and end up more than twice
as indebted as before. Meanwhile, dollar convertibility not only failed to draw
runaway capital back into the country but greased the wheels for even more to flow
out. In 1990, Argentines held an estimated $48 billion abroad--an amount roughly
equal to the national debt at the time. Today, the most conservative estimates of
offshore assets run to $100 billion. Bank deposits inside the country total only
$65 billion--and are dropping.

Orthodoxy Impeached

In the end, little separated the age of marvels from the
years of tragedy. They are not even two sides of the same coin; rather, they are
the same continuous side of a Möbius strip: The appearance of the marvel
also marked the onset of the tragedy.

As the boom went bust, orthodox commentators insisted that the problem was
not the reforms done but those left undone. If only the state were trimmed
further, if only labor markets were liberalized a bit more, they promised, growth
and foreign investment would return. Not only did this undying orthodoxy fail to
confront problems, it made them worse. These commentators portrayed the crisis as
primarily economic, and even financial, in nature. But the cause of Argentina's
collapse is political, not economic. What's missing is political power,
leadership, and imagination in the face of the shortsighted reasoning promoted by
the international financial community and embraced by local elites. What the
country lacks is not orthodox solutions but the political will to escape from an
exhausted model whose only remaining basis of support is fear of the unknown.

When the current president, Fernando de la Rúa, took office in December
1999, the country had been in recession for 19 months. As the reform candidate of
the Alliance for Work, Justice, and Education, de la Rúa had campaigned
for a clean version of "The Model": convertibility without corruption, growth
without inequality. Fear of a traumatic break with dollar parity, memories of the
social experience of hyperinflation, and pressure from big business with
investments (and debts) in dollars drove de la Rúa to swear undying fealty
to convertibility. Campaign promises are often momentary concessions that can be
changed once a leader is in power. But the new administration's promises quickly
became a trap with no way out.

Eager to prove himself to investors, de la Rúa raised taxes, slashed
spending, and made a priority of passing the labor-flexibility law long demanded by
the IMF. The bill went to Congress in January 2000 and was passed in April. By
August, rumors that the law had passed thanks to government bribes of opposition
legislators led to spectacular accusations in the press and judicial system.
These accusations set off a political crisis, and de la Rúa's refusal to
take them seriously drove his vice president to resign, breaking the governing
coalition in two.

When modernization becomes a goal to be achieved at all costs, as happened
with privatization, corruption ceases to be incidental and comes to offer a
substitute for political legitimacy, undermining the institutions and,
ultimately, the possibility of democratic life. By placing modernization before
citizenship, de la Rúa destroyed both. In record time, de la Rúa
had sacrificed his most valuable ally, betrayed his mandate, and squandered his
political capital. With his political base narrowed to his faithful lieutenants,
he proved incapable of even imagining any risky moves. This year, his
administration could not even manage to implement daylight saving time.

In the name of stability, de la Rúa honored his short-term commitments
and abandoned his long-term goals. Since he took office, all that the IMF has
proposed and all that the government has done is cut spending, again and again.
Each time the cuts deepen the recession, bringing down revenues and forcing a new
round of cuts. The country is like a donkey being taught to stop eating: When it
doesn't do what it's told, it gets spanked; and when it finally does, it starves
to death.

This downward spiral has cost the heads of two economics ministers and,
improbably enough, brought Cavallo back to his old post. Since the beginning of
this year, the government has launched two orthodox debt-refinancing plans. Both
failed. Shortly after returning to office this year, a chastened Cavallo announced
another round of cuts, brushing aside those who said that this would only deepen
the crisis. Within months, the worst predictions had come true, and the country
has been forced effectively to default on $132 billion in debt.

After adamantly denying any need to renegotiate for the past two years, the
government now must bring its creditors to the table. A third debt swap has
succeeded in considerably reducing the government's obligations to domestic
bond-holders, but the more difficult negotiations with foreign bond-holders still
lie ahead; even the most optimistic estimates see the reduction in payments alone
as too little, too late. Some IMF staff have called for devaluation, and others
for an international bankruptcy mechanism that would enable countries to
renegotiate their debt in an orderly way--a proposal clearly inspired by
Argentine chaos that comes too late to be of benefit. In general, the IMF seems to
recognize that past recipes have failed, but keeps recommending them anyway.
While the government stumbles, trying against all odds to avoid a full-fledged
default, the solid block in favor of convertibility is beginning to crack.
Foreign-owned privatized companies and the financial sector are pushing to
maintain dollar parity as a way of keeping the value of their investments, while
exporters want to cut the peso loose from the dollar and devalue. Unable to meet
any domestic commitments, the national and provincial governments have begun to
pay wages, months overdue, in scrip--a desperate road to hidden devaluation.

On the last day of November, a run against the banks drove Cavallo to impose
currency controls, allowing those with bank accounts to take out only $250 per
account per week. In the name of convertibility, he has locked up the money in
the banks. This threatens to devastate the informal economy--which operates on a
cash basis--and further deepen the depression. Cavallo also decreed that bank
deposits in pesos were now officially denominated in dollars, but this means
nothing since no one can access the money and, if they could, the government does
not have enough dollars to give them anyway. At this writing, the latest IMF
demand is a 10 percent budget cut, which will only shred the remaining safety net
and worsen the depression.

So the vicious cycle begins again: the weaker the state appears,
the greater the power of financial markets, further weakening the state, further
strengthening the markets. De la Rúa's popularity is now measured in the
single digits; Cavallo's magic has evaporated into thin air; polls say that most
Argentines who have jobs expect to lose them. The result is a complete collapse
of the political system, with leaders ignoring the will of the people and
squabbling over scraps while the world around them is falling to pieces. This
lack of political leadership benefits the few and excludes the many from any
remotely sustainable long-term or even short-term solution.

During his election campaign, President Bush promised to make Latin America
the first priority of his foreign policy. Now the most faithful adherent to the
Washington Consensus has gone belly-up, and the Bush administration's response is
muted, distant, and confused. Its only concrete measure since September 11 has
been to push for fast-track authority in order to deepen precisely the policies
that led to this impasse. The studied indifference of the Bretton Woods
institutions to the fall of their former model pupil is not surprising. But what
is striking is the silence of antiglobalization groups, who had few concrete
things to say about Argentina's ongoing crisis during the heady days of last
summer and have had even less to offer in the disarray that has followed the
terrorist attacks in this country.

As Argentina is melting down, the Bush administration is crafting a strategy
for Afghanistan after the war. On November 18, Secretary of the Treasury Paul
O'Neill said that the right path forward for that devastated country and its
pulverized economy is to put in place a market economy and open it up to
international capital. The extraordinary similarity of his formula for Argentina
or Afghanistan or any other part of the world only reveals once more Washington's
inability to grasp the radically different realities of this world. Are the
Bretton Woods institutions--the IMF and World Bank--up to the political challenge
of development? Everything would suggest that they are not. With the
encouragement of the U.S. government, those institutions continue to spread the
gospel of the market with little regard to the failed history of earlier missions
or the diversity of the places they would convert. And the Bush administration
pushes for a free-trade agreement that would only deepen the worst aspects of the
current crisis across Latin America.

Within Argentina, debate continues to be dominated by the unhappy convergence
of the desperate shortsightedness of the local political class, the imperial
disdain of Washington policy makers, and the orthodox proclamations of financiers.
What keeps everyday Argentines in check is as much the terror of the unknown as
the fear of the return of an all-too-familiar past.

The solutions now being proposed follow familiar orthodox lines: tax hikes,
wage and budget cuts, a new IMF loan to pay off short-term obligations, and a
devaluation of the peso followed by a new dollar peg, all aimed at a recovery
that will never come. Still missing is the political courage to describe things
as they are and to imagine a different way forward.