Lessons from Argentina's
Straits Times, January 10, 2002
(Stiglitz was Chief Economist at the World Bank
during the East Asian financial crisis and the beginnings of Argentina's
ARGENTINA'S collapse incited the largest default in
Pundits agree this is merely the latest in a string
of bail-outs, led by the International Monetary Fund (IMF), that
squandered billions of dollars and failed to save the economies they were
meant to help.
Some claim the IMF was too lenient while others say
it was too tough. And some see the problem was self-inflicted through
profligate and corrupt spending by Argentina.
Such attempts at blame-shifting are misguided: The
default can be seen as the result of economic mistakes made over a decade.
Understanding what went wrong provides important lessons.
The problems began with the hyper-inflation of the
1980s. To slash inflation, expectations needed hanging; 'anchoring' the
currency to the dollar was meant to do this.
If inflation continued, the country's real exchange
rate would appreciate, demand for its exports fall and unemployment
increase, dampening wage and price pressures.
Market participants, knowing this, would realise
inflation would not be sustained. While the commitment to the
exchange-rate system remained credible, so did the commitment to halt
If inflationary expectations were changed, then
disinflation could occur without costly unemployment. This prescription
worked for a time in a few countries, but was risky, as Argentina was to
The IMF encouraged this exchange-rate system. Now it
is less enthusiastic, though Argentina is the one paying the price. The
peg lowered inflation but did not promote sustained growth.
Argentina should have been encouraged to fix a more
flexible exchange rate, or at least a rate more reflective of its trading
There were other mistakes in Argentina's 'reform'
programme. It was praised for allowing large foreign ownership of banks.
This led to a seemingly more stable banking system,
but one which failed to lend to small- and medium-sized firms. After the
burst of growth which came with hyper-inflation's end, growth slowed,
partly because firms could not get adequate finance.
The government recognised the problem, but was hit by
numerous shocks beyond its control before it could act. East Asia's crisis
of 1997 provided the first shock. Partly because of IMF mismanagement,
this became a global financial crisis, raising interest rates for all
emerging markets, including Argentina.
Argentina's exchange-rate system survived, but at a
heavy price - double-digit unemployment.
Soon, high interest rates strained the country's
budget. Yet its debt to gross domestic product (GDP) ratio remained
moderate, at around 45 per cent, lower than Japan's.
But with 20 per cent interest rates, 9 per cent of
the country's GDP would be spent annually on financing its debt. The
government pursued fiscal austerity, but not enough to make up for the
vagaries of the market.
The global financial crisis that followed East Asia's
crisis set off a series of big exchange-rate adjustments.
The US dollar, to which Argentina's peso was tied,
increased sharply in value. Meanwhile, Argentina's neighbour and Mercosur
trading partner, Brazil, saw its currency depreciate.
Wages and prices fell, but not enough to allow
Argentina to compete effectively, especially as many agricultural goods,
which constitute Argentina's natural advantages, face high hurdles in
entering rich countries' markets.
The world had hardly recovered from the 1997-1998
financial crisis when the 2000-2001 global slowdown started, worsening
Here the IMF made its fatal mistake: It encouraged a
contractionary fiscal policy, the same mistake it had made in East Asia.
Fiscal austerity was supposed to restore confidence. But the numbers in
the IMF programme were fiction; any economist would have predicted that
contractionary policies would incite slow-down, and that budget targets
would not be met.
Needless to say, the IMF programme did not fulfil its
Confidence is seldom restored as an economy goes into
a deep recession and double-digit unemployment.
Perhaps a military dictator could have suppressed the
social and political unrest that arises in such conditions. But in
Argentina's democracy, this was impossible. I was more surprised unrest
took so long to manifest itself, than that street turmoil unseated Argentina's president.
Seven lessons must now be drawn:
. In a
world of volatile exchange rates, pegging a currency to one like the US
dollar is highly risky.
exposes a country to enormous shocks. Adjustments in exchange rates are
part of the coping mechanism.
ignore social and political contexts at your peril. Any government
following policies which leave large parts of the population unemployed or
underemployed is failing in its primary mission.
single-minded focus on inflation - without a concern for unemployment or
growth - is risky.
requires financial institutions that lend to domestic firms. Selling banks
to foreign owners, without appropriate safeguards, may impede growth and
seldom restores economic strength – or confidence - with policies that
force an economy into a deep recession.
ways are needed to deal with situations like Argentina's.
I argued for this during East Asia's crisis; the IMF
preferred its big bail-out strategy. Now it belatedly recognizes that it
should explore alternatives.
The IMF will work hard to shift blame - there will be
allegations of corruption, and claims Argentina did not pursue needed
Of course, it needed to undertake other reforms - but
following the IMF's advice made matters worse.
Argentina's crisis should remind us of the pressing
need to reform the global financial system - and thorough reform of the
IMF is where we must begin.
The writer, a professor of economics at Columbia
University, won the Nobel Prize for Economics last year. He was formerly
chairman of the Council of Economic Advisers to then US President Bill
Clinton, and chief economist and senior vice-president of theWorld Bank.