Argentina Feeling Growing Pains and Gains

In the annals of Latin American policy reform, Argentina clearly stands out. After suffering price increases of nearly 5,000% in 1989, last year’s inflation rate was zero, a target still not hit by the United States. Annual growth averaged 8% between 1991 and ’94. Although the economy did skid into a sharp recession in the wake of the December 1994 Mexican peso devaluation, the growth rate rebounded to more than 4% in 1996, with exports and investment leading the way.

So why has the popularity of President Carlos Menem plunged as low as 10%? Why did May alone witness 40 major protests over economic policy? And why has the killing of a magazine photographer in Buenos Aires erupted into a continuing major scandal, fueled in part by intense class resentment of a wealthy investor suspected of ordering the killing?

Both the gains and pains of reform have been sharply etched in Argentina, a country whose economy is Latin America’s third-biggest and whose external debt ratios (as a share of either gross domestic product or export base) are the highest of the region’s six major countries.

The centerpiece of Argentina’s economic strategy remains the 1991 Convertibility Law, a measure adopted at the insistence of former Economy Minister Domingo Cavallo. Acting like a modern-day equivalent of the gold standard, the law fixes the value of the Argentine peso at a 1-to-1 rate against the U.S. dollar and ties domestic monetary creation to the stock of foreign reserves--that is, dollars.

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As a result, the government is unable to address budget imbalances via the usual Latin method of printing currency and is equally unable to address trade imbalances with an inflation-inducing devaluation. With the state’s hands tied, the market has ruled, with positive consequences for inflation and growth.

Moreover, the Convertibility Law has survived two shocks that would have derailed most Latin reform efforts. The first, the so-called tequila effect, occurred when investor worries after the Mexican currency crisis spilled southward and induced a withdrawal of 20% of Argentina’s banking deposits. The second shock was the July 1996 sacking of Cavallo for political reasons. Despite the removal of the messenger, the message remained: Argentina was committed to a fixed peso and market economics.

But is all that glitters really the gold standard? In Argentina, the years of rapid economic recovery (1991-94) were accompanied by a rise in unemployment from 5% to 10%--an uptick that was attributed to the privatization of state firms, increasing international competition and other efficiencies. In the wake of the tequila effect, Argentine unemployment climbed to 20% and has hovered right below that ever since. Growth without jobs has become the norm.

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To address the problem, the government has sought the sort of labor market “flexibilization” that might help employment but would surely drive down wages. Labor unions have reacted by organizing general strikes. It is little wonder they are concerned: Over the course of the program, income distribution has become steadily more inequitable and business ownership has become far more concentrated.

Indeed, the separation between growth and jobs has been mirrored by a separation between the wealthiest and the rest of the economy: Even as GDP slipped by 5% in 1995 and small businesses went belly up, Argentina’s top 200 companies increased their profits by 30%.

What should the government do?

First, it will have to root out the corruption that is causing distrust and dissolution in Buenos Aires. In the most recent scandal, officers from the Buenos Aires provincial police have been arrested and accused of slaying a prominent journalist. The country’s justice minister resigned recently after telephone records contradicted his earlier denials and revealed that he had been in regular contact with the wealthy magnate suspected of masterminding the attack. That same investor stands accused of bribing legislators to draft privatization legislation that favored his company, casting a cloud of suspicion over the effort at “streamlining the state.” The administration must clean up its act, recognizing that good governance is necessary to gain the confidence of citizens and foreign investors.

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Second, the government will need to evaluate the exchange rate rules. Cavallo once referred to Argentina as “Mexico two years later.” Although he changed his tune soon after the Mexican crash, the Argentine peso, like Mexico’s before it, has risen to the level it enjoyed on the eve of the 1982 debt crisis. The challenge here is that much of Argentina’s credibility has been hung on convertibility; investors must be made to realize that more responsible macroeconomic policy has been institutionalized beyond a monetary gimmick.

Third, the government will need to address the widening gap between the haves and have-nots. Even the head of the International Monetary Fund, Michel Camdessus, has said that “Argentina’s bright prospects could turn to failure unless more concerted efforts are made, at this new stage of the reform process, to reduce the inequity in income distribution, and more important, to create more opportunities for the most disadvantaged.”

This last message applies to much of Latin America. In many countries, private enrichment, shrinking social services and rising inequality have been tolerated, mostly because there are clear recollections of the costs of high inflation and social disorganization. However, as time passes, the memory of budget deficits has receded and the awareness of the “social deficit” has risen.

A new round of policy measures will need to elevate addressing the needs of the poor and unemployed. Such efforts at more honest and socially conscious government could widen the circle of “winners” from reform and help markets deliver truly sustainable growth for Argentina and the rest of Latin America.