How Argentina Got into This Mess

Reprinted from The Wall Street Journal � 2002 Dow Jones & Company, Inc. All rights reserved.
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Argentina's miseries now cry out in the headlines: riots and violence, afarcical procession of presidents-for-a-day, and the gathering doom ofdefault and devaluation. But behind the headlines lurk deeper ills that gnawaway at the foundations of the country's political and economic life. Thoseills helped to bring about the current crisis, and they will persist longafter the media spotlight now on Argentina fades away.

Argentina's woes are many, but underlying them all is the dilapidated stateof its political and legal institutions. According to an annual index ofcorruption levels published by Transparency International and based onsurveys of business people, academics and risk analysts around the world, in2001 Argentina ranked a dismal 57th out of 91 countries. Worse, in otherwords, than Botswana, Namibia, Peru, Brazil, Bulgaria, and Colombia, and onpar with notoriously corrupt China.

Uncompetitive

The same results came through in the 2000 Global Competitiveness Report,coproduced by Harvard University and the World Economic Forum, whichsurveyed business leaders from 4,022 firms in 59 countries on theirperceptions of business conditions. Again, Argentina languished near thebottom: 40th for the frequency of irregular payments to governmentofficials; 54th in the independence of the judiciary; 55th in litigationcosts; 45th for corruption in the legal system; and 54th in the reliabilityof police protection.

It wasn't always this way. The disrepair of Argentina's institutionalinfrastructure is a legacy of its Perónist past. Look, for example, at thecrucial question of judicial independence. Prior to the descent intostatism, justices of Argentina's Supreme Court enjoyed long tenuresundisturbed by political interference. At the beginning of Juan Perón'sfirst administration in 1946, Supreme Court justices averaged 12 years onthe bench.

It's been downhill since then. Since 1960, the average tenure has droppedbelow four years. After Perón (he left the presidency for the second time in1974), five of 17 presidents named every member of the court during theirterm, a distinction that had previously been limited to Bartolomé Mitre, thecountry's first constitutional president (1862-1868). And so, while beforePerón, it was typical for a majority of the court to have been appointed bypresidents from the political opposition, that was no longer the case. TheSupreme Court, the supposed bulwark of the rule of law, was reduced to apuppet of executive power.

The pro-market reforms of the early 1990s brought little improvement.President Carlos Menem, who deserves credit for stabilizing the currency andprivatizing industries, nonetheless persisted in traducing the integrity ofthe country's institutions. Faced with a politically hostile Supreme Court,Mr. Menem responded with a court-packing scheme -- he expanded the courtfrom five to nine members and filled the new slots with politicalsupporters.

His transgressions did not stop there: Allegations of corruption swirledthroughout his two terms in office. Those charges finally caught up with himin June of last year, when the former president was arrested for his allegedrole in an illegal arms-shipments deal. But after five months of housearrest, Mr. Menem was set free by his hand-picked Supreme Court.

Corruption in Argentina extends far beyond Buenos Aires. To get a first-handlook at the problem, I visited the northwestern province of Tucumán earlierthis year. During the "dirty war" of the 1970s, Tucumán served as a refugefor pro-Castro guerillas and was roiled by bloody fighting. Today it isbetter known as home to the world's largest producer of lemons, as well as anow-declining sugar industry, and its problems are more prosaic: bloated andcorrupt bureaucracy, and a backward and unreliable legal system.

The public sector in Tucumán, for example, serves primarily to enrichpoliticians and fund patronage jobs. Out of a formal work force of some400,000, there are nearly 80,000 provincial and municipal governmentemployees and another 10,000 federal government workers. Elected officialssiphon off small fortunes for themselves: The annual salary for provinciallegislators is roughly $300,000.

Tucumán is by no means noteworthy for such abuses. In the impoverishedprovince of Formosa on the country's northern border, about half of allformally employed workers are on the government payroll, and many show uponly once a month -- to collect their paychecks.

Such profligacy lies at the root of Argentina's present financial crisis.Government spending as a percentage of gross domestic product climbed to 21%in 2000 from 9.4% in 1989 despite the fact that sweeping privatizations werealleviating significant fiscal burdens.

And while the country's mess may begin in the capital, free-spendingprovincial officials bear much of the blame as well. Operating expenses atthe provincial level rose 25% from 1995 to 2000 even though inflation wasnonexistent. The spending binge was financed by an unsustainable runup ofexternal debt -- the reckoning for which has now arrived.

Meanwhile, as the public sector ballooned uncontrollably, vital governmentresponsibilities went unfulfilled, among them the provision of a legalsystem that promptly and reliably vindicates the rights of the citizenry. Asa result, the acute financial traumas that now beset Argentina arecompounded by a business environment that is profoundly hostile toinvestment, dynamism, and growth.

In San Miguel de Tucumán, the capital of Tucumán province, I spoke withIgnacio Colombres Garmendia, the head of a major law firm in town. "Thelegal system is absolutely vital for our region's economic development," henoted, "but the politicians are blind to it. It's hard to see what doesn'thappen because of a bad legal climate, and so nobody knows about it. Butevery day I see deals collapse -- I see potential investors who decide notto come to Tucumán -- because of the legal risks. They call and ask me aboutthis or that legal issue, and I have to tell them, and they say 'Thank youvery much' and that's the end of it. 'The world is a big place,' a clienttold me once, 'and we don't need Tucumán.'"

It takes an average of five years to foreclose on a commercial mortgage inTucumán. And given the punishingly high interest rates that prevail now inArgentina, delays like that can render even excellent collateralinsufficient to cover the amount ultimately due. In a vicious circle, therisks caused by delay and uncertainty serve to drive interest rates up evenhigher. And, lo and behold, the net effect of a system that leaves investorsand creditors so badly exposed is simple: less investment, less financing,and less growth and opportunity.

Market Economy

It is fashionable now to blame Argentina's problems on the free market. Thecountry's latest president, old-school Perónist and unabashed protectionistEduardo Duhalde, has joined the anti-market chorus by vowing to break withthe "failed economic model" of the past decade. But Argentina's tragiccrack-up occurred not because pro-market reforms went too far, but becausethey did not go nearly far enough.

A healthy market economy requires not just the absence of statist controls;it requires the presence of sound institutions. And although the reforms ofthe Menem era made strides toward meeting the former requirement, theyignored the latter altogether. Today Argentina is suffering grievously fromthat oversight. Until it is corrected and the country's ramshackle politicaland legal systems are overhauled, there is little hope that a stable andprosperous Argentina can emerge from the wreckage.