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    Cambridge Review of International Affairs,Volume 15, Number 3, 2002

    Argentina: The Case for a Permanent End to FiscalTransfers

    Jerome BoothThe Ashmore Group, London

    Abstract This article argues that (1) Argentinas current economic crisis is areection of a long-running chronic political situation;1 (2) that sustainable economic

    recovery will not be possible without addressing these political problems; (3) that theIMF is not the villain in the case and, given its understandable support for convertibilityin 1991, did not err signicantly in subsequent support; and, (4) that Argentinasexperience is another nail in the cofn of the Washington Consensus as rigid dogma, butthis is neither a great surprise nor should be seen as a negative development as far aspolicy prescription is concerned. The article rst elaborates structural rigidities inArgentina. It then discusses convertibility, arguing it was not a panacea but provideda missed opportunity to implement long-term structural reforms. The central issue ofscal irresponsibility is then discussed and constitutional reform to stop transfers to the

    provinces permanently is proposed. The role of the bond market is then discussed,including a discussion of the nature of nancial contagion. The IMFs role is then brieycovered and largely defended, and nally the nature of the Washington Consensus andArgentinas impact on it is briey examined.

    Argentina, until the recent devaluation, could be characterised as having aclosed economy with a xed overvalued exchange rate, an inability to export,and structural rigidities, particularly in the labour market. The debt-to-GDP ratio

    has grown signicantlya growth that was unsustainablebut has been lessworrying, being a closed economy, than the debt-to-export ratio. Argentinaseconomic history has been one of relative economic decline over the better partof a century, arguably accelerated by Peronism and its impact on reducinginward investment and competitiveness. The country has been plagued not onlyby the scourges of Latin American politicsauthoritarianism and populismbut also by poor economic management and periodic bouts of high ination andhyperination. The much maligned convertibility policy is the result, not thecause, of economic distress. In 1989, owing to economic chaos, President

    Alfons

    n left the presidency early to make way for then President-elect CarlosMenem. After trying two other Economy Ministers, the new Menem administra-tion experienced an even more virulent ination and Menem fell back on a more

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    dollar and the Argentine peso. This led to stability, an investment-led boom andstrong economic growth. Concurrently there were many market-led reformsincluding a major privatisation programme, though one driven primarily by thedesire for revenue than to establish greater competitiveness.

    However, the historical pattern remained: Argentina had been and continued

    to be unable to live within its means. Debt service on the existing stock of debtcalled for larger primary surpluses to stabilise it. Signicant scal surpluseswere the requirement to turn the situation round. After initial recovery at thestart of the convertibility period, the country managed successfully (if narrowly)to weather the subsequent Mexican Tequila Crisis of 199495. The relief, whenit came in 1995, was fortuitous. After the tightening in 1994, US interest rates fell,exports to Brazil increased, and the country managed to access capital marketsmuch sooner than previously anticipated. The banks survived intact, though inretrospect it is clear that they were only weeks away from crisis. Rather than

    heed the near escape as a warning, however, the next few critical years weresquandered as an opportunity to generate long-needed scal surpluses. Indeed,the debt burden rose and the government took advantage of every opportunityto issue yet more debt in order to nance itself. Consequently, it barely met IMFscal targets, and never tried to exceed them.2 The IMF in turn concentratedperhaps less on scal targets than (with the benet of hindsight) it should havedone.

    Though having survived the Russian devaluation, recession then set in as thedollar strengthened, reducing Argentine competitiveness and, in January 1999,

    Brazil, a large importer of Argentine goods, devalued. Yet despite all this,Argentinas problems could still be characterised as primarily political in nature,not economic. The economic problems were for a long time chronic rather thancritical, with recovery possible until the last few months. The precariousness ofthe situation was visible for many observers for not months but years before thehouse of cards collapsed, and many shrewd emerging market bond investorswere avoiding core positions in Argentina for two years prior to default.

    Convertibility as a Missed Opportunity not a Panacea

    Although convertibility stabilised markets for 10 years, the reforms that ac-companied it did not sufciently address structural problems to avoid futurecrisis. Though economists have spent vast amounts of time in academic discus-sions regarding exchange rates, the policy decision of which exchange ratesystem to use is one that has to be taken in the practical wider context at thetime, not in the abstract. An exchange rate is a means to achieve economicobjectives rather than a goal in itself. That said, an encompassing policy objectiveof any exchange rate system is arguably to reduce uncertainty about what the

    rate will be in the future, where the future need not mean just the immediatefuture and where different time preferences may possibly lead to differentprescriptions With reduced uncertainty other prices can adjust (though necess-

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    would typically require a low probability assigned to a maxi-devaluation andalso a signicant uniformity of beliefs by economic actors as to the time vectorof future exchange rates.3 This objective can be met by completely differentsystems in different contexts. A xed exchange rate may on the face of it appearto achieve this best, but not if there is sufcient speculation as to the peg

    holding. The introduction of the peso/dollar peg and of convertibility wasarguably the best way of reducing uncertainty in 1991, but part of the reason forthis was that convertibility tied Argentinas policy-makers hands. In the contextof previous policy excesses it ensured that monetary and scal policy wereemasculated. This was perceived as the means to force greater scal prudencewithout requiring prior wider political appetite for it.

    In short, exchange rate systems do not solve scal imbalances, instead theycan put off the day of reckoning. They can help give political impetus to enactreforms. But they are not a substitute for structural reform and the transient

    opportunity given by the window of stability may be used productively orwasted. The convertibility system could never be a substitute for structuralreform. Further, convertibility was not ideal for Argentina as a permanentfeature (and neither is dollarisation). It suited small and powerful interestgroups, and was an initially highly successful response to the crisis in 199091,but made the country vulnerable to both exchange and trade shocks. Thebroader context was that dollar parity did not reect a trade-weighted basket ofthe currencies of Argentinas main trading partners (Brazil and the EuropeanUnion), and Argentina was not and is not on a convergence path with the

    United States.In the last four years the discipline of the currency board, which pro-

    cyclically shrinks the money supply as reserves dwindle, constrained domesticdemand at exactly the time stimulus was needed. Consequent low growth led tolow tax revenues, hence more difculty in meeting scal targets and the need forgreater scal austerity, which, in turn, again hampered growth. With a largeexternal debt, low growth also worsened the debt ratios and their projections,damaging international condence. The way out of such a trap is not easy. Therewas no simple magic to enable Argentina to escape quickly: hence the denition

    of the problem as chronic. Abandoning the currency board or defaulting on theexternal debt was recognised as catastrophic.

    The Fiscal Problem

    In that the opportunity for reform given by convertibility was wasted, especiallyin the boom years following the Mexican devaluation, what reforms weremissing? The perennial and current problems are largely linked to scal irre-sponsibility and in particular to the relationship between the federal government

    and the provinces, which have been signicant both for contributing to scalimbalance and sustaining collective political irresponsibility. Other reforms werelacking or awed and four inter alia come to mind Firstly the judicial system

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    has been a major impediment to cleaning up corruption, which in turn hasimpeded other reforms. Secondly, Congressional reform for a Chamber ofDeputies that only meets once a week and often fails to reach quorum, and thushampers and fails to balance the Executive, has been lacking. Thirdly, labourmarket reform has been woefully insufcient to address the chronic unemploy-

    ment and underemployment of labour. Fourthly, the privatisation process wasdriven by the one-off scal motive, rather than to create a more competitivemarket. Inefcient natural monopolies were transferred to the private sectorpurely to raise revenue without increasing competition or efciency and further-more did so in a way that led to greater corruption of public ofcials. Nonethe-less, it is in the area of scal transfers that the most substantial long-term benetcan be achieved from the current crisis.

    The federal constitution of the mid-19th century established that provincialtax revenues would be collected on their behalf by the federal government. The

    federal government is obliged to collect and transfer this revenue and may betaken to court by the provinces if transfers fall short, even should this be areection of weak federal tax collection.4 In theory, then, the provinces can forcethe federal government to raise taxes whilst they themselves need not raise any.

    The political consequences of such a mismatch between where tax is raisedand where it is spent have been predictable: collective scal irresponsibility. Atleast in normal and good times, provinces need not collect their own revenuesand can leave the politically damaging task of tax collection to the federalgovernment. Those politicians in a position to spend money, solve local prob-

    lems through expenditure, create local jobs (including many in the public sector)and represent provincial interests in lobbying for more federal resources inBuenos Aires have historically and unsurprisingly attracted more voter popular-ity than federal government politicians more associated in the public mind withtax collection. Indeed, whether voters have or have not thought through theconsequences of associating expenditure pledges at election time to the conse-quent need for higher taxes, it has nevertheless been in their interest to vote forcandidates offering more expenditure given the wider national tax base thanlocal expenditure base. At least in this sense voters have been complicit. The

    clear policy solution is to have tax and expenditure at the same level: local taxespaying for services provided locally and federal taxes paying for those providedby the federal governmenti.e. to stop net transfers to the provinces.

    However, provincial politicians clearly benet from the current arrangementand have, over time, come to dominate national politics.5 Presidential candidatesare often from the provinces. Likewise, those in federal government whosupport provincial interests may also benet politically as a result.

    In the case of a strong state with universalistic values and a clear nationalidentity of joint interests, such political dominance of the centre by the peripherymay be balanced by strong central leadership. For much of Argentinas history

    4 The Argentine Constitutions mandate for the federal government to take care of

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    The Case for a Permanent End to Fiscal Transfers 487

    this has to some extent been provided by Buenos Aires province, with a maindynamic of political tension being between Buenos Aires and the otherprovinces. As in Brazil, where centralised government is associated withauthoritarianism, the decentralised government structure has been seen by someas a bulwark against tyranny.6 The military experience in Argentina was

    particularly unpleasant, and few, including the military themselves, want to seeany return.

    However, Argentinas sense of national unity has perhaps been wanting.Similarly to other large federal structures, including the United States andMexico, there have been signicant and persistent differences in political valuesand cultural identications across states and provinces. Though perhaps asomewhat nebulous concept, the sense of unity and national identity is import-ant for reaching consensus. It can be gauged by the degree to which nationalinterest can be united and sustained with regard to issues with political facets.

    In the case of Argentina, this was achieved by the war in the South Atlantic, butthen quickly evaporated. Tax collection is another test. For many years payingtaxes has been a somewhat voluntary activity in Argentina, and though thesituation improved over the last 10 years, scal revenues remain weak andevasion high.7 Another test for large countries is the extent to which presidentialcandidates are identied as national or regional gures. This certainly used to bea major feature of elections in Brazil, but presidential candidates in the last twoelections have enjoyed widespread national, as opposed to marked regional,support.8 In contrast, Argentine presidential candidates are still associated

    largely with particular provinces.9

    Moreover, the perception that the political class is corrupt, and thus thatmuch expenditure is wasted, only increases the desire to maximise the localpay-off from the system, and further reduces a possible unifying force creatingnational, as opposed to provincial, identity. Corruption feeds on itself. It erodesnational identity and increases anomie and disillusion. It reduces tax revenue,the ability to gain a consensus for radical structural change and it reduces trustin authority. Hence, the other reforms mentioned above: of the judiciary,Congress, labour market and privatisation, though important, are linked to the

    scal problem through the public culture of excess and corruption.The tendency towards economic determinism, which is so prominent inter-nationally, belittles this realityeconomic determinism is now interpreted as aright-wing rather than a solely left-wing phenomenon. However, insofar asone can dene underdevelopment as the absence of, and imperfection of,institutions, from the structure of the nance ministry down to cultural normsdominant in everyday individual economic transactions, so non-economic

    6 After the long transition from military rule in Brazil, the 1988 Constitution reacted to

    the previous over-concentration of power by decentralising it to the extent that consolidatedscal responsibility became problematic there also.7 Estimates of tax evasion have typically been around 50% of the federal budget. See,

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    factors are arguably signicantly more important in successful economic policymaking in developing than industrialised countriesand economic determinismconsequently less relevant.

    Specically, the tendency to see reforms piecemeal and to marginalise theprovincial scal problem (in line with the size of public scal decits) is

    misleading as an identier of where policy change should be prioritised. Theproblem inltrates the whole public culture and is not separate from otherissues. One might of course criticise the focus that several analysts have on thescal issue, and to the extent that many of the problems of mismanagement ofthe economy are linked, such a criticism would have some validity. One couldargue for a whole package of reforms, as the IMF continues to do, at least inpublic at the time of writing,10 but this has been the case in the past and it isunsurprising that the hardest and most long-term of problems then becomesleast prioritised. Then again, it could be argued that other policy areas are more

    comprehensive. For instance, it could be argued that the one policy area thatshould be prioritised is the creation of a strong independent judiciary to stampout public excess and corruption directly, following which many of the otherproblems may fall into place and be resolved. This view also has some validity;however, the justication of the choice of the provincial transfers as the focus forthis article is that it both forces benecial structural political change and can beformulated as a tangible objective. Some might (incorrectly) argue with indignitythat Argentinas judiciary is already strong and independent. It is not thepurpose here to ght that argument except to say that it is easy to visualise

    a potential judicial reform that lacks effectiveness in the absence of strongpolitical support for it. The point is that to stop permanently all net transfersfrom the federal government to the provinces is in contrast a clear target,independently veriable, one that will force a change in the natural power baseof national politicians and policy makers, and can be used to cut excessdramatically. The fact that it is a clear target means political consensus can bebuilt to support it.

    The Bond Markets Perspective11

    The bond market is an efcient processor of information on sovereign risk. Itlearns fast, adjusts quickly to new realities and is in many ways a much bettermeasure of policy than either academic economists or G7 policy makers. How-ever, it is also ckle and myopic, the latter in part due to accounting methodolo-gies and how Anglo-Saxon capitalism is nanced, and this may lead to largeswings in market perceptions, which are not entirely undesirable. This has been

    10 On 1 April 2002 IMF First Deputy Managing Director Anne Krueger said any economic

    programme would have to include sustainable monetary and scal policies, a workableexchange rate regime, changes to bankruptcy laws, the reversal of the nations economicsubversion law, a scal policy that includes some kind of hard budget restraint on the

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    The Case for a Permanent End to Fiscal Transfers 489

    the case for Argentina. In the mid-1990s the country could do no wrong.Its economic teams were impressive, responsive and understood well theissues investors cared about most. This was in contrast to the unofcial bodyof opinion in Washington that viewed convertibility as an unorthodox andtemporary stop-gap measure, and who helped catalyse, through ofcial

    lending, more external nancing in part from fear of what might happen if theydid not.12 The market simply ignored the chronic scal problem. With 8%growth the debt ratios were not expanding signicantly even if its service costswere.13

    Put simply, the market at the time assessed countries ability to service debtin a static way, counting income and expenditure on the balance of payments,and rather like Charles Dickenss Mr Micawber, when projected expenditurecame within revenues the result was happiness, but if the reverse happened,misery ensued. This binary lack of sophistication of the market led to arbitrage

    opportunities for some, but one should not draw the conclusion from this thatindividual market participants were being irrational, or that the ofcial sectorwas a better judge of the situation. Gauging the perception of the market inadvance is most of the time more important to an investor than being right aboutfundamental risks.

    In the specic case of Argentina, the discipline imposed by convertibility wasseen as a knife-edge equilibrium. If one is walking along a mountain ridge witha 1,000 ft drop on either side ones situation is clearly in one sense precarious,but there is also a strong incentive not to stray from the path. The benet of

    convertibility is similar. By tying its monetary hand and, in effect, its scal handbehind its back Argentina was forced to adjust. Moreover, at the timeArgentinas problems were seen as resolvable through the application of greaterpolitical will. Compared with economic crises, political crises are more likely tobe able to generate their own solutions before an extreme event occurs. Thesense of crisis creates political consensus, even if only driven by the fear of beingsingled out and blamed for catastrophe. In Argentinas case this pattern wasrepeated many times under the Menem presidency, often taking the form oftension between Menem and Economy Minister Cavallo.14

    The condence that politicians would deliver reforms when pushed keptconcerns about chronic economic problems at bay, and short-term balance ofpayments and political concerns dominated market perceptions. This started tochange in late 2000 when after a perceived weak start to Fernando de la Ruaspresidency, Vice-President Carlos Alvarez resigned, weakening the ruling co-alition between the formers Radical Party and the latters FrePaSo Alliance.Market concerns over devaluation and default started to come to the fore. As abroad characterisation, it was roughly at this time that the market shifted fromperceiving Argentinas scal problems as minor irritants, which could be re-solved with time, to perceiving them as intractable problems. However, though

    12 This reects private opinion expressed to the author whilst he was a member of staff

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    arguably still a chronic rather than critical situation the myopic nature of thebond market meant that chronic problems become critical once noticed, bothbecause that is how they are perceived and because that is how marketparticipants believe others in the market will perceive them.15

    The scal problem became critical because the market focused on it, but until

    this point the Argentine government did not focus on it as important. In otherwords, the government had previously been too responsive to investors con-cerns at the expense of other issues. This reactionary policy dynamic can betraced back through Argentine economic policy making. President Menemconsistently appeared to concentrate on xing economic problems only whenthey became serious, after which complacency again set in. This combined witha natural tension between him and his Economy Minister Cavallo, who was nota Peronist Party member and was in part responsible for accusations of corrup-tion against his own cabinet colleagues.16 Another contributory factor was a

    widespread ideological tendency to view free markets as a sufcient indicator ofwhich policy areas to focus on.17 Unfortunately for the Argentine policy makersthis myopic focus of the market ignores chronic structural problems until theyresult in crisis.

    The response at this stage was still considered to stick broadly with currentpolicies. Failure led to the appointment of Ricardo Lopez-Murphy as EconomyMinister who attempted to impose a sharp scal adjustment that was politicallyunacceptable, and then Cavallo was again appointed in March 2001. Havingreceived the message that medium-term issues were important, Cavallo tried to

    address medium- as well as short-term issues. First, he adjusted the exchangemechanism to reduce vulnerability to terms-of-trade and dollar shocks.18 Moreimportantly, having successfully completed a US$29.4 billion debt swap toreduce dependence on external capital markets for the next year, Cavallo pickeda ght with provincial Governors over their scal proigacy, trying to cut backscal transfers. This was the right ght and, arguably, the right time to pick itas his bargaining power was heightened by the sense of crisis.

    The market reacted badly to many of Cavallos policies, however, particu-larly his changing of the exchange regime,19 and the sense of crisis deepened, but

    this in turn enabled a more profound policy response. The federal government15 Such sudden changes in market focus are common due to the myopic herding instincts

    of nancial market participants. Whereas anticipating a change in market perceptions canbe highly protable, holding a view which in the longer term may be fundamentally correctbut is not taken up by the market can be costly. Hence market participants tend to act inthe short term as if they share the same view, and a particular fundamental problem canquickly change status from irrelevant to critical as a paradigm shift of the collective marketview takes place.

    16 Cavallo was allegedly the source of accusations against business tycoon AlfredoYabran that led to the resignation of two cabinet colleagues in 1997.

    17

    With Reagans and Thatchers legacy this was a global and not merely an Argentinephenomenon, underpinning much policy prescription to the developing world.18 Argentine trade with the United States is signicantly less than with either the

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    The Case for a Permanent End to Fiscal Transfers 491

    announced the zero-decit programme whereby it would not spend more thanit received in revenue, to a large extent month by month, and invited (i.e.pressured) the provinces to do the same. They agreed initiallya major politicalachievement.20 The programme was simple and, as a result, binary, in the sensethat either it would or would not work. Either way, policy drift was avoided.

    The programme also had the benet of addressing both of the countrysmedium-term problems: not just scal imbalance but also overvaluation. Thereare two policy responses to an overvalued exchange rate: change the price of onethingthe rate of exchangeor change the price of everything else. The impactof the programme was expected to lead to a 25% drop in money wages, withgoods prices to follow.21 This was politically too much, however, and theprogramme failed, banks were closed, Cavallo and de la Rua resigned; EduardoDuhalde emerged eventually and formalised the devaluation and default. Theknife-edge failed, and this was seen as a failure of the Argentine political system.

    Politicians who in the past had been pushed into line in crisis, at the end seemedeager to jump into the abyss instead. Collective self-destruction resulted fromthe lack of any effective leadership as much as their own lack of vision. Thecracked facade of national common purpose shattered, and also unleashed agroundswell of opposition to the entire political class.

    The Demise of Financial Contagion and the Consequences for Argentina

    The lack of nancial contagion from Argentina to other countries (bar Uruguay)

    poses minimal systemic risk to the international monetary system, in contrastto the Asian, Russian or LTCM crises. Hence the argument for bailing outArgentina is reduced.

    The context was that the mid-1990s was also a time of nancial contagion inbond markets, very different from the more institutional investor base and lessvolatile market that has developed since the Russian devaluation in 1998.22 Fordeveloping countries most trade and investment links are with industrialisedcountries, not with each other: NorthSouth not SouthSouth. Developingcountries are also highly heterogeneous. As mentioned, one denition of under-

    development is poor institutional development, and institutions develop onlyslowly over time, their gaps and inefciencies remaining highly country specic.Hence, developing countries are often much more diverse economically thanindustrialised countries. So, a broadly diversied portfolio of developingcountry sovereign debt should pool and reduce non-correlated risks.

    Hence the claim that nancial contagion was collectively irrationaland isarguably the most irrational feature of any nancial market. It may be collec-tively stupid, but knowing that the behaviour exists, the intelligent act of anindividual is to act likewise (and rst), in turn strengthening the pattern. The

    20 At this time provincial Governors did not want to be singled out as responsible forfailure.

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    additional germ of contagion in emerging markets had been excessive leverageby non-discriminating speculative investors. Although Brazil and Russia do nottrade with each other, when Russia devalued and defaulted in 1998 the problemspread to Brazil and other countries. This contagion was largely driven bymargin calls on leveraged investments: as the value of Russian debt fell, so other

    assets elsewhere were sold to generate cash to meet margin calls on theleverage.23 The same pattern had previously been observed when Mexicodevalued in late 1994, also generating widespread bond market contagion,though the impact on sovereign bond spreads was more limited in 1997 with theAsian crisis.24

    The depth of losses in 1998 from the Russian crisis was sufcient to scare offthese leveraged speculators. Many found more fashionable investments else-where, especially the Nasdaq, and emerging debt at last fell out of fashion.Hedge funds reduced activity in the market and many disappeared altogether.

    Institutional investors became a more signicant proportion of the investor base.Volatility decreased substantially, just as it was rising in many other assetclasses, and over the last three years has been substantially less than for anymajor equity market.25

    The remaining investors were, and still are, largely unleveraged and morediscriminating of country risks. Contagion risks reduced as a result. The rstmajor test was the Brazilian devaluation in January 1999. It was well anticipatedby the market and, with the sole exception of Argentina (which suffered a majorterms-of-trade shock to which it could not adjust given its xed exchange rate),

    the major emerging markets rallied after no more than two days of uncertainty.26

    The Argentine crisis has also been well agged, but has been more severe.But even though the crisis in Argentina is dramatic, involving default anddevaluation, recession and political crisis, there has been no nancial marketcontagion beyond its blameless neighbour, Uruguay.27

    The silver lining of the collectively irrational nature of nancial contagion isthat when it does not exist and is perceived not to exist it is unlikely tore-emerge. Those who try to push the market around by short selling will bemore likely to get their ngers burnt. The market has matured. The general

    move to oating exchange rates has also helped, as it was typically throughcurrency markets, speculating against xed rates, that macro hedge funds madetheir returns. However, the lack of contagion has also reduced the systemic riskthat Argentina poses for the international nancial system, and hence reducedthe chance of being bailed out.

    23 Many investors in emerging debt in the mid-1990s bought bonds and borrowed to payfor the purchase from the selling bank, which kept the bonds as security on the loan. As theprice fell, the deposit or margin call on the loan needed to be increased.

    24

    The main reason why the Asian crisis had less direct impact on the emerging bondmarket (though not on other asset classes) was that the stock of bonds was much lower inAsia than in Eastern Europe or Latin America. This reected higher historical savings rates

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    The Case for a Permanent End to Fiscal Transfers 493

    In Defence of the IMF (but not the G7)

    What was the role of the IMF throughout? It is easy to criticise the IMF withhindsighta seemingly tireless activity. The IMF has many enemies, but it isunreasonable to expect perfect vision from the IMF or anyone else. What one can

    expectthat the IMF learns and adapts quickly from experienceis broadlydelivered, certainly compared with any other international agency. Moreover,insofar as the IMFs reputation has been tarnished in recent years, this is almostentirely due to visible, excessive and politically motivated intervention by G7shareholders, rather than staff deciencies or the desirable function of the Fund.

    With regard to Argentina there are three broad categories of criticism thatdeserve attention. First is that insufcient attention was paid to structuralreforms to improve long-term scal balanceincluding the transfers toprovinces. Second, the last two support packages should not have been ex-

    tendedin January and September 2001. Third, the IMFs greater perceivedpoliticisation reduced its credibility in markets and hence its ability to inuencemarket opinion in support of Argentine reform efforts; it undermined its ownobjectives.

    With regard to scal focus, it has to be taken into account that the IMF is nota development bank but a balance-of-payments reman. There is also a defencethat there was limited opportunity to push scal reforms harder. Throughout thelast 10 years the IMF-supported Argentine economic programmes have beenlargely designed in Argentina. Convertibility was certainly not an IMF design;

    indeed, it was considered to be rather unorthodox from the start, even if aninitially effective one given its impressive results in stabilising ination andboosting market condence sufcient for an investment-led growth boom. Onceconvertibility had been supported initially, though, it was difcult to stopsupporting Argentina until its collapse. Arguably, deeper scal reform shouldhave been emphasised more strongly in the boom years after 1995 but with agovernment uninterested at the time it was difcult to exert pressure.

    One might also argue that structural reforms to improve long-term scalbalance were not as important 10 years ago as they are now. There are parallel

    arguments elsewhere that as the world changes so do policy priorities withthem. To some extent this explains the phenomenon that after a crisis wheneconomists list their lessons learned many of the lessons look familiar; butarguably, the principal value in these papers is what is included, and the orderin which they appear, as well as what is not included. For example, prior to theAsian crisis, it was believed that opening the capital account and regulatingones nancial sector were both desirable. The former was considered moreimportant, though. After the Asian crisis we know that the latter has to occurbefore the former to avoid subsequent unpleasantness, and the reason why thisordering was different after the crisis is in large part because the world changed:

    not that economists were previously wrong, rather that they were previouslyanalysing a different world. Over the last 10 years scal issues have clearly

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    constitution that made consolidated scal management similarly difcult toArgentinas, has spent years addressing its scal problems through consti-tutional reform with considerable success, and now has a stronger tax base as aresult.28 It was also understood as a priority in Argentina, and measures weretaken to increase tax revenues29 and eventhough only signicantly effective

    temporarily and in times of crisisto reduce provincial expenditure.Concerning the IMFs two packages in 2001 there has already been much

    criticism. To support Argentina in the rst case (January) with a larger package,even though scal targets had been missed, was understandable and predictable.Argentina was in an existing programme and could still pull through, and toabandon the country at that point would have been irresponsible. With hind-sight, it was only a mistake given what happened subsequently. At the time,there was a strong probability that the programme would enable Argentina tosurvive. The market clearly believed this and Argentina managed to issue a new

    bond. However, this was followed by very poor scal results in the rst threemonths, and de la Rua replaced Jose-Luis Machinea as Economy Minister withRicardo Lopez-Murphy. As mentioned above, he proposed a more radical scaladjustment, which in the face of widespread opposition de la Rua refused toback, replacing him with Cavallo. The second package (approved in September)was less defendable by its likelihood of success, but still success was possibleand the same defence of the IMFs actions apply. Cavallo had managed to regainsome market condence and extended external debt maturities through a $29.5billion swap, and he had started to pick a ght with Governors over transfers

    arguably the right ght.The third criticism is not really directed at the IMF at all, but an observation

    of the consequences of actions taken by its major shareholders.30 Any institutionowned wholly by governments is inevitably political, but in recent years themarket perception of the impartiality and technically driven nature of Fund staffrecommendations has been eroded. The rst major incident occurred when therewas last-minute intervention in the design of the Russian IMF programmeitwas toughened in a way that made the conditionality non-credible, weakeningmarket condence in the programme.31 The second was the perceived involve-

    ment of Washington ofcials (albeit denied, but not credibly) in Ecuadors Bradybond default, at a time when the money to pay the coupon sat in the CentralBank waiting to be paid. Since their Cologne summit, the G7 and bond marketappeared to be on a collision course. The positive-sum game of cooperation hadgiven way in ofcial circles to an excessive concern with moral hazard and theneed for burden sharing, souring relations with the bond market and reducingtrust in the impartiality of the IMF. This, in turn, contributed to the reduced

    28 Brazils tax revenue in 2001 was at a record high, 8% above target (source: Agency EFE

    News Service), and the country is expected to meet its primary surplus target of 3.5% of GDPin 2002.29 These included several efforts to improve tax administration and tax amnesties in the

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    market credibility of IMF statements and actions and hence, to reduced IMFeffectiveness.

    W(h)ither the Washington Consensus?

    The Washington Consensus, developed from a set of 10 policy reform areaswhere there appeared to be some consensus in Latin America, was articulated ina conference held in Washington in 1989 and then emerged as a book.32 Itbecame a set of prescriptions, then became a dogma that was extremely effective.It focused policy makers across much of the globe and gave an ideologicalimpetus to the spread of market economy. However, this was not without costs.The benet of dogma is that it helps to focus policy on key areas and reducestime-wasting conict over design, and is most appropriate for a focused insti-tution like the IMF with a narrow mandate to help prevent, but above allmanage, balance-of-payments crises. For development banks, dogma is more ofa mixed blessing. Its aws are, rst, that developing countries problems areheterogeneous and so should be the prescriptions to address them, and second,that ownership of policy is increasingly more signicant to its effectiveness thanits technical design. In short, as a sales technique, dogma is effective, but as ameans to design policy it is often a hindrance.

    The Washington Consensus may now be dead, but how far as a result ofrecent events in Argentina? Arguably very little: it was dead already. Converti-bility was certainly never part of the consensus. If anything killed it, it was the

    G7s own reaction to the Asian crisis, during which G7 countries started openlycriticising the IMFs prescriptions to an extent that started impairing the Fundseffectiveness.33

    To what extent are Argentinas problems specic to Argentina and of limitedgeneral prescriptive use elsewhere? Insofar as Argentinas problems are long ingestation and home grown, they may argue for special case status and not bereective on the case against the Washington Consensus. Then again, the caseagainst is precisely that all countries are special cases, and that the ideology ofhomogeneity propounded by the Washington Consensus was always both a

    simplifying ction and, as it contributed to perceptions that fed nancialcontagion, a decidedly unhelpful one.

    The Washington Consensus does have different meanings. As a body ofacquired policy experience from which useful lessons can be drawn, it has someuse. As dogma, its demise (i.e. that a policy maker does not use it as a blueprint)is to be welcomed. With its demise also goes the trap of circular logic denyingthe existence of aws in its logic. Specically, the circular logic oft employed bythe Washington Consensus as dogma is that if a country does not get the resultsdesired after completion of an economic programme, there can be only two

    32 J. Williamson, ed., Latin American Adjustment: How Much has Happened?, Washington,DC, Institute for International Economics, 1990. See also F. Stewart, John Williamson and

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    possible reasons. Either the country did not carry through the conditionsmandated or, alternatively, more medicine is required. Notice that incorrectprescription is not in the dogmas policy vocabulary. The case with Argentina(the dead patient in this example) is that large doses of medicine have beengiven over a considerable period: hence, one may conclude instead that loan

    conditions cannot have been adhered to. Thus, in turn, the ofcial communityhas been supporting the country either in ignorance of its non-compliance or byway of throwing good money after bad. Therefore, there has to be a witch-huntand the IMF criticised as a result. The alternative truth is that Argentinasproblems were home grown and specic to Argentina, and Washington canneither take a great deal of credit for earlier success nor current failure.Conversely, Argentinas policy makers have to take the lions share of the blamefor what has happened, and the electorate much of the blame for voting forthem. Argentinas experience is another nail in the cofn of the Washington

    Consensus as rigid dogma, but this is neither a great surprise nor should be seenas a negative development as far as policy prescription is concerned.

    Conclusion

    The bond market has belatedly focused on the political nature of Argentinasproblems. The observation that the political elite did not deliver scally whenpressed means that the promise of deep-seated structural reform to createlong-term scal balances will be required before capital markets can be accessed.

    The market is often accused of having a short memory, but no rational investorwill lend without trusting there will be full repayment. The timescale ofArgentinas problems is very different from that in, for example, Russia. Themarket cannot trust Argentina not to have identical problems in another ve toten years unless scal sustainability is in place and permanent. Just over 10 yearsago, convertibility was implemented as a means to convince markets of futurescal discipline by making the cost of failure high: by creating a knife-edgeequilibrium. Fiscal and monetary policy discretion was largely taken out of thehands of Argentine policy makers and left to the automatic rule of convertibility

    and the mercy and trust of the international capital markets. Likewise, Bradybonds were made deliberately difcult to restructure, as the only means tore-establish credibility and enable new issuance again. All these measures weretaken in recognition of Argentinas history of irresponsibility. None haveworked, and the inevitable price is now being paid. There is no quick x. It isnow time for Argentina to re-examine profoundly its scal proigacy and thelegitimacy of its leaders, and this will require not only new elections but alsoconstitutional amendment to halt transfers to the provinces permanently.

    There is also no clear case for a change in international nancial architecturefrom Argentinas recent experience. Such a change would be to alter incentives

    for the whole bond market not because new information has become available:the costs of default were understood by Argentina and bond holders many years

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    manage to access markets quickly againand will be rewarded for making theeffort to pay until the end. Lack of willingness to pay, as in Ecuador, will alwaysbe penalised more by the bond market than lack of ability to pay, as inArgentina. A less than genuine bond restructuring too soon could jeopardisethis.

    In summary, Argentinas current economic crisis is a reection of a long-running chronic political situation; specically, the lack of political will tocontrol scal expenditure. The scal irresponsibility is structural in thatprovinces are not obliged to raise their own revenue to nance their expenditure,but rely on transfers from the federal government. Political power is largely inthe hands of provincial politicians or national politicians with dominant provin-cial loyalties, and this political dominance is in part caused by the ability tospend at the provincial level without the political cost of imposing taxes.Sustainable economic recovery will not be possible without addressing the scal

    and political facets of this arrangement. Delaying deep reform to address theissue is no longer possible as there is no longer any source of nance availableto the government until scal responsibility is clearly established. Net transfersfrom the federal government must stop, and must stop permanently.

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