The International Monetary Fund played Santa Claus over the holidays and organized a rescue package for Argentina worth $40 billion, which was officially approved on Jan. 12. The deal allows Argentina to avoid defaulting on its $124 billion in foreign debt. That’s as good as the news gets, however. A close look at the agreement shows that it has little chance of solving Argentina’s problems in the long term or putting its economy on a robust growth path in the near future.
Argentina’s problems do not stem from the 1991 Convertibility Law that linked the peso at a fixed one-to-one rate with the dollar and made the peso convertible on demand, as critics of that reform claim. To the contrary, the problems stem from the government’s seemingly insatiable thirst for money. The currency board, which prevents the central bank of Argentina from printing more pesos than the dollar-denominated reserves that it holds, has made that thirst more apparent.
Government spending at state and federal levels has increased from 38.9 percent of gross domestic product to 49.4 percent since 1997, an increase of 10.5 percentage points. In that same period, public-sector external debt as a percentage of GDP has risen from 26 percent to 32.1 percent, an increase of 6.1 percentage points. With tax revenues failing to keep up with spending and privatization proceeds drying up, the government is looking to outside sources for financing. Unfortunately, the IMF is all too happy to oblige, acting like a bartender who keeps pouring drinks for an alcoholic.
Argentina joined the IMF in 1956. It has borrowed money from that organization in 34 of the last 45 years. In March of last year, the IMF loaned $7.4 billion to help Argentina launch a fiscal responsibility plan, a combination of tax increases and spending cuts aimed at bringing the public-sector deficit into balance by 2003. By September 2000, it was apparent that the target date would be missed. Rather than suspend the loan, the IMF wants to provide a new loan, and push the target deficit date to 2005. Yet tax-and-spend policies are not a good recipe for growth.
The Argentine economy has performed poorly since 1995, growing at an annual rate of 1 percent per capita on average. There are two reasons for that poor performance. First, Argentina has one of the most regulated labor markets in the world. Those rules make it difficult and costly for employers to dismiss workers, so companies don’t hire workers in the first place. Not surprisingly, the rate of unemployment in Argentina has hovered around 15 percent since 1995. The rate of underemployment (the percentage of the labor force working less than 35 hours per week but wishing to work more) is also around 15 percent.
In addition, tight regulation of the labor market makes it nearly impossible for Argentine companies to react rapidly to changing conditions and new opportunities in the world economy.
Second, taxes are prohibitively high. This kills investment and job creation and encourages tax evasion, which in turn worsens the government’s financing woes. In 1999 the Argentine congress passed, at the urging of the IMF, a fiscal responsibility law. This law called for increases in personal income and wealth taxes, a broadening of the base of the value-added tax, and renewed efforts to increase tax compliance. Not surprisingly, the response of the productive sectors of the economy has been to avoid paying taxes even more than in the past and, when possible, to leave Argentina.
Argentina’s problems—and the solutions to those problems—are homegrown. The IMF is responsible for giving money and bad advice to the Argentines. Unfortunately, that is unlikely to stop. For years the fund has touted Argentina as its model client. To leave her now would deal a severe blow to the fund’s already tarnished reputation. Buenos Aires knows that and behaves accordingly, failing to make the necessary reforms to get the economy on the path to sustained growth.
Knowing that the IMF will come to its rescue time and again, the Argentine government has little incentive to reform. And thus the charade continues.