This is a paper exploring the financial and political causes of the Argentina economic collapse at the turn of the century

1. The Politics of Economic Instability in the 21st Century:
Argentina and the Dissipation of an Economic Miracle
Christopher Rinaldi
POL 95W -- Senior Capstone Seminar
Thesis Paper
Professor Caroline Arnold
This paper was written in 2008 for a capstone seminar course to complete my political
science major at CUNY Brooklyn College.
Introduction
In 1998, following the East Asian Financial Crisis and Russian Fiscal Crisis, the
economies of Latin America were confronted with the possibility of economic crises of
their own. A decade later the result of this confrontation seems to favor the resilient
economies of Latin America. This would be true, except for the case of Argentina, which
overshadows the achievements of their neighbors in avoiding economic disaster.
Not only was Argentina overcome by an economic crisis, but the Argentine
economy was overcome, wholly, leading to a complete economic collapse. The central
question that this paper aims to answer is: Why did Argentina‟s economic crisis devolve
into utter economic collapse?
I argue that, at first, Argentina‟s reaction to the crisis was deficient and
inefficient. The government failed to make change in monetary policies to ease the
shocks of devaluing their severely overvalued dollar. They maintained the currency
board, pegging the value of the Argentine peso to the US dollar, therefore encouraging
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2. capital flight out of the country, since the peso could be easily converted to the safer US
dollar currency of equal value.
The manner of their privatization programs (Structural Adjustment Programs)
was extremely laissez-faire. This included a lack of regulatory boards, tax reforms,
budgetary reforms, and any necessary reform policies that should accompany
liberalization. Adequate policy to address the enormous public debt and the possibility of
bank insolvency was lacking as well. This left Argentina unprepared to maintain any
ground underneath their economy. Problems with fiscal responsibility at the provincial
level were never dealt with in any capacity by either federal or provincial governments.
By this, it is meant that during Argentina's economic boom until their economic collapse,
the government never made any reform that tackled the problem of maintaining spending
limits. This was compounded with a poor tax collection system which, as well, never
received any effective reform initiatives.
All of these deficiencies displayed an economy built on a bubble defenseless to
the prodding international economy and economic shocks. This fragile economy was a
product of unstable politics and the Argentine government's reaction to the crisis they
faced, yet again, was produced by unstable politics. In sum, the faults of Argentina‟s
economy and their economic recovery efforts trace their roots to a political structure in
which political actors find no calculation worth making besides political ones. From the
federal to provincial level all issues, including economic issues, are political issues.
The Argentine collapse is important to understand because it tells us something
about the new international economy and the shifting rules of capital. Capital, today, has
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3. an abundance of investment options compared to the Cold War period before the
dissolution of the Soviet Union. No longer is capital so single-minded to allocate itself
based on economic philosophies. In an environment in which almost every country is
liberalizing to some extent, and joining the international economy, capital‟s options
expand, and even sitting on capital in the short-term may be better than rash investments,
for the simple fact that if profits are missed in one country today, there will be another
country tomorrow.
The consequences of this is that capital demands security in structures, not
philosophy. Therefore, the most liberal economy should be subject to stronger scrutiny.
Structures are the new magnetizing force for capital. In a time when “hot money” and
disruptive capital flows can drive the economy down, capital flees towards gains, but also
safety. A country which can‟t accommodate capital‟s ever growing (and changing)
wants and needs is doomed for failure. But to think that economic structures are not a
product of political structures, or to write this off as unimportant, is consistent with
philosophies which speak of the market as if it is natural and pre-existing. Humanity built
the market and humanity built its structures. Where there is conflict in humanity (politics)
there will be a conflict in the structures (economics). This conflict defines Argentina from
1991-2002, and it explains the country‟s economic collapse.
Other scholars present varying explanations of the Argentine economic crisis
including: the unilateral action of Brazil in fixing their economic woes; IMF-style
development policy and privatization, and the formation of a small economic power bloc
of large domestic and international business interests that controlled capital and insisted
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4. on the maintenance of the currency board at the sake of Argentina‟s economy. These will
be considered against my hypothesis.
I intend to focus on Argentina‟s economic collapse as an illustration of the
necessity to have a political system which allows for dexterity in economic policy and a
separation of that policy from political calculations. It is not an argument about state‟s
and their involvement with the economy, so much as it is an argument about states and
their ability to allow their economies to successfully react to and interact with the
international economy.
Before undertaking my argument and taking on other explanations of the crisis, I
will lay out a brief history of the Argentine economy. This begins with the economic rise
in the first-half of the 1990‟s along with introduction of the fixed currency board. It ends
in 2002, after three years of deep recession leading to economic collapse.
Following this, I will analyze and address alternative explanations of the
Argentine financial crisis. Finally, I will provide empirical support for my argument that
the politics of Argentina created an environment opposed to sustainable and competitive
economic development.
A History of Argentina: 1991-20021
At the beginning of the 1990‟s Argentina faced a dire problem of hyperinflation.
(Gallo et al, 2004, 196). When President Carlos Menem took office in 1991 this would
quickly change. He and his political ally, economic minister Domingo Cavallo, undertook
an IMF style austerity plan to revive the stagnant Argentine economy. At the center of
1
All statistics in this section are taken from Gallo et al, Table 1: Economic Indicators, pg197.
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5. this plan was the creation of a convertible currency board which pegged the Argentine
peso to the US dollar. In other words, 1 peso equaled 1 dollar. The currency board was
paired with privatization efforts, and soon the Argentine economy was well on its way to
development. The economy grew at a meteoric rate of 31.5% from 1991-1994.
In 1995 the Mexican economic crisis caused shocks throughout the world, but
particularly in Latin America. Argentina saw economic recession after its quick boom.
The currency board, now fixed as law due to the iron-fisted President Menem, remained
in place (Gallo et al, 196). This seemed to be no problem though, as the Argentine
economy grew an astounding 13.6% in 1996 and 1997, including a 8.1% rate of growth
in 1997.
1998 and 1999, by contrast, witnessed rates of growth, but below 4% for each
year. Still, more troubling, in 1999 GDP per capita declined at 4.3% in a year which the
GDP grew 3.4%. At this point, pessimism about the economy might have been helpful to
the extent it could have prompted reform. Unfortunately, both a critical eye and critical
action were not present in Argentina.
Argentina saw the national budget deficit continually grow. As the government
tried to reel in its spending, the politics of pandering, particularly at the provincial level,
continued to contribute to a growing government debt. This debt continued to put
downward pressure on an Argentine peso that was already overvalued, and this would be
a precipitant of the crisis.
Growth plummeted after 2000: GDP declined -.7% in 2000 which was followed
over the next two years by a further 15.3% decline in GDP. In 2003 the economy grew
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6. 8.8%, mostly due to the fact it had already reached its floor.
There are many factors to consider when assessing what happened to cause, both
in its creation and extent, the Argentine economic crisis, but only one reason it led to the
ruins of an “economic miracle”. Therefore, many hypotheses serve as attractive answers
to the question, but only one can account for deep-seated problems that cause economic
collapse--- that is political instability.
The Argentine economic collapse was accompanied by social strain and social
unrest. The crisis serves to display what economic prescriptions are needed to avoid
doom, but it also serves as a reminder that economic collapse equates to social collapse.
Macroeconomic troubles are not confined to paper, but instead are a build up of
individual, human troubles.
Just as economic troubles are representative of the individual struggles of people
in society, they are also symbolic of the struggles in the politics of a country. In the end,
an economy is only as stable as its government and political institutions. The economy
will not have more dexterity than the political institutions that regulate it; economic
growth will not outpace the growth of leadership, and although good politics may be able
to fix an irresponsible market, a market, responsible or not, can not fix the irresponsible
politics which created it.
Literature Review
Privatization Hypothesis
The first, and most basic, explanation of the Argentine economic collapse points
to economic factors. This explanation posits that privatization and economic reforms in
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7. peripheral countries, such as Argentina, are bound to fail. In the vein of dependency
theory, it claims that international financial institutions such as the IMF, governments of
the west (core countries), and multi-national companies, push privatization in an attempt
to advance their economic interests at the expense of developing countries.
In this view Argentina is seen as an economic pawn that serves the interests of
more powerful interests. “The Rise and Collapse of Neoliberalism in Argentina: The Role
of Economic Groups”, by Miguel Teubal, criticizes the post-ISI liberalization policies
adopted by Argentina beginning in the mid-1970‟s for these very reasons. Teubal
claims that economic liberalization created societal tension by eroding an old system in
which large business interests co-mingled with small and mid-sized businesses (Teubal,
174). Under the structural adjustment policy (SAP), adopted through the 1990's by
President Carlos Menem, large economic conglomerates, both national and transnational,
came to dominate the adjustment process. Therefore, the process favored large enterprise
and involved a tighter concentration of capital among them.
In the late-1980‟s Argentina was facing hyperinflation in their currency.
Argentina‟s showdown with hyperinflation is seen by Teubal as the perfect environment
to introduce the currency board (181-185). Menem and Cavallo fixed the value of
Argentina‟s peso to the US dollar and the problem of inflation was solved. According
to Teubal, it also provided a solid footing to enhance the privatization processes by
"limiting... the central bank to... an exchange broker" and "eliminating all government
discretionality [over] monetary and foreign exchange policy." (Teubal, 181) Therefore,
as industry privatized, foreign interests would be attracted by a strong currency,
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8. prompting more international mobility for their capital earned in Argentina.
As the process became enhanced, the welfare of the Argentine majority became
neglected. Without proper instruments to guard against capital flight and the
“[exclusion of] the institutionalization of efficient regulatory boards, which in the First
World are an essential part of most privatization programs”, the Argentine economy was
fundamentally flawed (Teubal, 181). Since the Argentinian peso was pegged 1:1 with the
dollar, it was a simple decision to exchange pesos into dollars, put those dollars in a
foreign account, and therefore cash-out at the overvalued rate opposed to the undervalued
rate that lied inevitably ahead. Large enterprise, both foreign and domestic, could do this
easily though their transnational financial service companies, while draining the money
supply of the Argentine nation and their banks. On the other hand, the Argentine people
were vulnerable to be hit the hardest from the crisis. Their only protection was a
government which had spent the last quarter of a century deconstructing itself (Teubal,
186-187).
Teubal‟s analysis touches on many problems, such as how SAP left the people of
Argentina without a hope in the worst of times. He portrays the idea that the classes
which controlled capital used Argentina as a sponge for their debts, while acting as a
vacuum for capital produced within Argentina. The Argentine people were the most
effected and during this privatization process they saw their interests abandoned.
Regional Hypothesis
A developing international economy means more economic integration,
particularly at the regional level. In the Americas, regional economic integration
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9. highlights itself in the organization MERCOSUR and the trade pact NAFTA. The
former, MERCOSUR, is of concern. It is a South American trade association with four
full members, including Argentina and Brazil (Genna and Hiroi, 337).
As mentioned prior, financial hardship faced many countries approaching the new
century, and Brazil‟s economy demanded policy adjustment to be saved. “The Effects of
Unequal Size: The Costs and Benefits of Unilateral Action in the Development of
MERCOSUR”, by Gaspare M. Genna and Taeko Hiroi, explains the role of Brazil as the
largest member of MERCOSUR, and the effect that this has upon smaller member states
of MERCOSUR.
Genna and Hiroi, explaining the crisis through a liberal viewpoint, argue that
Brazil finds itself in a unique role in MERCOSUR as its largest and most wealthy
member. Due to their status, Brazil becomes the country that all of the other
MERCOSUR members will look to in times of crisis or despair. Brazil will be expected
absorb shocks and fix problems (Genna and Hiroi, 338).
The authors contend that a study of Brazilian policy displays that their active
engagement in regional crises is necessary for smaller states to work through their crises.
If they act unilaterally, as they did when they faced a currency crisis in 1999, the smaller
neighboring economies can be directly affected due to their integrated position with
Brazil. As they note, “Much of the existing political economy literature on free trade and
regional integration argues that successful trade liberalization and economic integration
requires a regional preponderant power that acts as a core provider of collective goods for
member states.” (Genna and Hiroi, 338)
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10. Once Brazil was able to devalue their way through their crisis and return to its
feet, the Argentine economy was at its knees. Instead of focusing only on itself, Brazil‟s
policymakers were able to concern themselves with the current situation in Argentina,
which was about to devalue their peso. This time, Brazil actively pursued trade and credit
policies that would ease the burden on the Argentine economy. When President Duhalde
was ready to devalue the Argentine peso in 2002, he sought Brazilian assistance. The
communications between the countries resulted in lower tariffs for Argentine exporters,
while a reciprocal credit accord gave the central banks of Argentina and Brazil the right
and responsibility to exchange exporter‟s currency received for domestic currency. As
well, Brazil became a mouthpiece for Argentina on the international level, lobbying the
IMF, US government, the World Bank, and other important financial institutions to help
Argentina. (Genna and Hiroi, 347-349) In order to support their speech, “the Brazilian
National Bank of Economic and Social Development opened a line of credit for Brazilian
foreign direct investment in Argentina.” (Genna and Hiroi, 351)
Genna and Hiroi study a key aspect of the Argentine Financial Crisis. Over the
last decade of the 20th Century, Argentina had become part of MERCOSUR. As the new
century neared, MERCOSUR remained a young institution in which member states
contracted in policies that attempted to evolve towards integration and coordination, but
were not yet there. The effects that Brazil‟s devaluation would have on Argentina‟s
economy were not considered because for Brazil, “their primary concern may not be on
the effect that their actions will have on regional partners but the effect on their domestic
constituencies.” (Genna and Hiroi, 338)
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11. Capital Relations Hypothesis
David Woodruff„s study, “Boom, Gloom, Doom: Balance Sheets, Monetary
Fragmentation, and the Politics of Financial Crisis in Argentina and Russia”, offers an
alternative explanation to the Argentine financial crisis. Woodruff sees the problem in
Argentina‟s economy lying directly with the fixed currency board and the capital
relations that built around it.
First, Woodruff contends that currency boards have three phases. The first is
boom, or large economic growth. The second is gloom, or slowdown from such large
economic growth. The third, and final phase, is doom, or the collapse of the economic
growth which was heralded in the „boom‟ phase. (Woodruff, 4)
As well, the study views capital from an “institutional-sociological” point of
view. This view allows for an explanation of the impact the currency board had on the
majority of capital interests (Woodruff, 6). This is combined with an analysis of business
interests and actions which define the purpose of business action and interests as relating
solely to the balance sheet of a business (Woodruff, 9-10).
Woodruff maintains that when these two perspectives are used the Argentine
maintenance of the currency board, and therefore their economic collapse, can be
explained. Argentine banks and utility companies, the largest capital interests, mannered
their balance sheets to assume liabilities and assets in dollars. When the peso could no
longer keep up with the dollar, in terms of value, these businesses were so entrenched,
that they were better off “gambling for resurrection”, as opposed to disbanding the
currency board itself, which would have to be done in due time anyway. Woodruff terms
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12. these interests “go-for-brokers” whom will be willing to issue any number of “costly
signals” of their commitment to maintaining the peg, since these signals will in fact add
nothing to their costs in the event the peg fails” (Woodruff, 30)
These “go-for-brokers”, representing a majority of the capital that created the
boom in Argentina, lost their chance to cut their losses (lobby for a repeal of the currency
board) in the gloom, and became willing to fight for their position until all the money
available from all sources had dried up, and the doom turned into an inevitable retraction
of the currency board. The other group that represented Argentine capital interests is the
“good fighters”. This group tried to cut their losses and support the currency board,
although they are not all-in, and become aware that devaluation may be the best option at
a certain point. Eventually, this group will reach the point where they maximize their
cover of dollar denominated asset liability. At this point, peso devaluation will help them
cover remaining liabilities more than maintaining convertibility (Woodruff, 31-32).
Argentine provinces began issuing their own surrogate pesos which “by the end of
the year…had been issued to almost a quarter of the volume of pesos.” (Woodruff, 28) A
monetary surrogate is a form of capital that is not legally recognized. For example, in
Russia, Woodruff points out (24-25) that the electric companies used to accept metal
from metal companies to compensate for missed electric payments by the metal
companies. But surrogates appeared only in 2001 and in much more restricted form (I.e.,
no bartering) in Argentina (Woodruff, 27-28). They only served to speed up the
devaluation process so much as they were looked upon as actual notes that could service
payment in provinces.
12

13. The lack of monetary surrogates, Woodruff argues, also points to the large
international interests in the Argentine economy. Utilities and financial interests derived
mobile capital from Argentina due to the 1:1 fixed ratio of the peso and the dollar. They
could not accept surrogates for a value that was fixed so high on their balance sheets
(Woodruff, 23-24).
Woodruff leaves little to question about the phases of boom, doom, and gloom
involving the implementation and maintenance of currency boards. But, what if the
currency board is enacted and repealed in gloom times, before doom onsets? What if it is
repealed at the beginning of a crisis? Take the Brazilian case, for example.
His analysis gives one possible answer to a puzzling question concerning the
Argentine financial crisis, which is why did the currency board remain intact so long?
He says that powerful capital interests viewed the currency board as essential to
maintaining their balance sheets.
Political Hypothesis
“The Role of Political Institutions in the Resolution of Economic Crises: The
Case of Argentina 2001–05”, by Andres Gallo, Juan Pablo Stegmann, and Jeffery W.
Steagall, frame Argentina‟s economic woes as a result of political instability. The
country, since hyperinflation that struck at the end of the 1980‟s, has been dominated by
corrupt political rule that is inefficient. Corruption and inefficiency can also be credited
to an unresolved federalism, which has led to a lack of coordination on economic issues
between Argentine provinces and the federal government. The study identifies that, “At
the root of Argentina‟s economic problems lies an irresolvable conflict between the
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14. nation‟s federal and provincial political powers.” (Gallo et al, 195)
Beginning with President Menem, and his insistence on the creation of the
currency board and IMF-style development, political instability is indexed. Menem used
tactics such as manipulation of the Supreme Court, which led him to rule through
“executive decrees” and to undermine legitimate legal institutions. Menem‟s policies
advanced development, but a development built on a false foundation of political unity on
economic issues (Gallo et al, 196).
The provincial authorities, at odds with Menem‟s reforms, undermined them with
rogue spending on enhancing budgets, and eventually with the production of monetary
surrogates, as Woodruff noted. But unlike Woodruff‟s hypothesis, which says that this
was due to an exhaustion of the benefits of the currency board, Gallo finds the cause of
this occurrence in the exhaustion of political outlets to form economic policy (Gallo et al,
198-201).
When devaluation was finally on the brink the political in situation in Argentina
was at the height of its fracture. The country faced the difficult task of devaluation, and
had no mechanisms in place that could ensure a fair and efficient devaluation (Gallo et al
201-202). At this point the extent and impact of the poor political structures of Argentina
bared itself to the world and the Argentine nation.
Policies that continued into the economic collapse were ill-fated due to their lost
nature and their inherent failure to actually deal with the problem. Instead, they dealt with
the political power‟s problems. The corralito on deposits harmed the depositor, as their
deposits fell victim to devaluation. A series of measures that attacked bondholders of
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15. Argentine debt, bank depositors, and banks themselves persisted due to the government‟s
drive to fix their own budget at the expense of private property rights (Gallo et al
201,208).
The attempt to close the budget deficit was a political and self-interested
calculation done to remain in power and not to benefit the Argentine economy or
population. The government continues in this vein. Long-term resolutions to solve the
federal-provincial power and revenue sharing and revenue sharing problems, along with
banking reform, remain untouched due to the lack of political coordination. Successful
debt restructuring is also hindered by the retarded political system, and as long as this
continues, the Argentine people can expect to slowly pay off the first great economic
crash of the 21st Century (Gallo et al 208-210).
Empirical Review
Gallo‟s argument, the political hypothesis, explains many of the problems that the
other scholars mentioned have explored. It seems that: a) privatization is not the problem,
but the politics of Argentine privatization is; b) Brazilian unilateral action in the context
of MERCOSUR had an effect on Argentina, but it is nothing that could have not been
avoided by unilateral action of Argentina, and c) a small power bloc controlling exchange
rate policy, whether true or not, does not answer the main question, why is there a
concentrated power bloc controlling these decisions? The answer is an unstable political
system. Below I aim to detail a political system filled with corruption, incomplete
reforms, fragmentation, and incompetence, leaving no room in between for sound
economic policy and development. Also, keep in mind, politics is important because it
15

16. creates economic structures. Today, these structures are more important than ever.
The Politics of Carlos Menem
When Carlos Menem was elected into office he was faced with the political
nightmare of hyperinflation. As talked about before, he solved this problem by
implementing economic adjustment reforms based around the currency board. But, the
currency board and economic liberalization was not universally accepted in Argentina.
While some politicians and citizens supported the liberalization reforms, others were
against them and believed that solving the problem of hyperinflation required something
other than the currency board and liberalizing the economy.
Moreover, Menem faced a Supreme Court that was hostile to his new economic
reforms. Therefore, Menem had to answer two evident questions to reform Argentina‟s
economy: 1) how can enough political support be garnered to pass economic reforms?,
and 2) how can these reforms be maintained through judicial support? In essence,
Menem needed to devise a plan to suppress a majority of political representation and
tarnish Argentina‟s judicial integrity, or reverse a long history of legal precedent which
restricted liberal economic policies.
First, concerning the issue of the judiciary, Menem saw his best option as
compromising judicial integrity. Menem, very early on, “packed” the Supreme Court
with loyal judges by expanding the court itself. Other government auditing and
prosecuting institutions were compromised by Menem‟s attempt to consolidate political
and legal power in support of his economic reforms (Blake, 7-8).
The consequence of the forceful consolidation was that Argentina‟s economy was
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17. built on a legal system backed by a political machine. By 1995, Menem‟s reforms and
political style were falling out of favor and he was lacking credibility with the Argentine
population. 1995 also marked Menem‟s second term, which was only allowed after a
generous legal alteration to the electoral rules (Blake, 8). He won re-election and
continued to erode national confidence in democratic institutions. While he was
internationally praised, he was nationally disdained. His popularity in 1995 was nearly
equal to that of his predecessor, Raul Alfonsin, whom led the country during
hyperinflation (Blake, 17-18). Still, no one considered what would happen to the
economy when the only politician supporting the economic structure ceased being a
politician.
Secondly, there is the issue of passing these reforms through the legislative
process. How did Menem do this? Well, he often did not. When he came into office he
was granted the utilitarian political tool of economic disaster. The country‟s dire
economic situation swayed Congress to grant Menem powers “equivalent to a blank
check, as Congress authorized the president to enact economic reforms through executive
orders.” (Blake, 7) Menem, the Peronist candidate, was also given the benefit of a
friendly Chamber of Deputies (congress) filled with other Peronist politicians, who found
their self in power, like Menem, due to the country‟s dire economic situation. Menem
leveraged his force with a poor economic situation, a competitive political unit in
Congress, and a compromising of the Argentine legal system. Charles H. Blake, in the
paragraph below, details Menem‟s political force in the early years:
As a result, early privatization measures and other key reforms were implemented with minimal
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18. congressional oversight. The legislature established the Comision Bicameral de la Reforma del Estado
(CBRE), a congressional commission to monitor the privatization process. The CBRE could request that
the executive branch justify its plans, but had no power to stop a sale. Interestingly enough, when the
time came to vote for the State Reform Law, the Chamber of Deputies lacked the prescribed quorum. To
bypass the problem, the Peronist leadership apparently brought into the voting session several
congressional employees, who voted in support of the measure. (7)
Soon enough, Argentina‟s economic reform included a currency board. The
pegging of the Argentine peso to the US dollar finally eliminated inflation, but it came
with other consequences. The system propelled a rigid economy that took away the
possibility of nearly all monetary adjustments for the future. It also presents a more
attractive environment for foreign investment, as the currency‟s value becomes backed by
US dollars, and therefore comes with the security of the US dollar. Not to mention, the
peg was a political strength too--- the times of inflation were over. But, were the causes
of inflation really dealt with?
Sub-national Politics in Argentina
The politics of Argentina‟s provinces and nature of Argentine federalism are
important in an analysis of the country in any topic or at any level. In any federal
system the distribution of power and revenue are important, but in Argentina it is even
more important due to the important and dependent, but not harmonious, relationship
which defines the co-existence between the provincial and federal governments.
There are 24 provinces in Argentina, containing 1,100 municipalities (Rezk,
2002). While they each have ample taxing powers, most taxation is done by the federal
government. This money is then distributed to each province based on population. This
tax arrangement is referred to as “co-participation” in Argentina (Edwards, 2002). In
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19. 2001 the provinces drew 52.7% of their revenues from this federal sharing program
(Rezk, 2002). In addition to a bulk of their revenue flowing from the federal to state
level, budget performance numbers flow the opposite way (Remmer and Wibbles, 430).
Therefore, a province, technically, never has a budget surplus or deficit, because this will
be reflected in the Argentine federal government budget.
Also, party politics change at this level. Smaller parties, not involved in federal
politics, are important in politics at the provincial level. A handful of them can either oust
a national party, or in some provinces, the national party or provincial party may come to
solely dominate provincial politics (Remmer and Wibbels, 429).
Sub-national Politics in the Context of National Economic Adjustment
Although Menem first pushed his economic reforms, at some point fiscal and
administrative reform would be needed to ensure economic success. Argentina came into
the 1990‟s with a large budget deficit. Addressing the deficit was put on hold temporarily
by a restructuring of debt resulting in the issuances of Brady bonds to cover the country‟s
debt (Cavallo and Cottani, 18). But, reforming the country‟s fiscal prudence was essential
to economic success. A country which converts to a currency board can not have its
reserves threatened because the reserves are what back the currency (Blake, 8).
Beating back the budget deficit was not something that could be dealt with
through economic adjustment on the national level. It involved policy changes that the
national government had to initiate and carry through. The provincial level is where the
spending takes place, as “the federal government has been collecting more than 80% of
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20. public revenues and retaining 55%”. The other 25%, or 5% of GDP, makes it ways into
provincial coffers (Remmer and Wibbels, 430).
The “co-participation” law unevenly distributes money to provinces. The
distribution, despite being based on population, doesn‟t even out per capita. The result is
this: small provinces (ex. Santa Cruz), in terms of population, are left with a large amount
of revenue, while the larger (ex. Buenos Aires) provinces are given a small amount
revenue in account of its large population (Remmer and Wibbels, 435). As Karen
Remmer and Erik Wibbels point out (432), the situation of a large budget in a small
province facilitates political patronage networks. “Public sector employment figures
reflect the divergence in national and provincial policies. After increasing approximately
25% between 1983 and 1990, the number of civil servants in the national public
administration was cut dramatically from 835,485 in 1990 to 190,414 in 1994. At the
provincial level, the trend was diametrically the opposite. After expanding 40% between
1983 and 1990, provincial public sector employment may be estimated to have increased
by an additional 77% between 1990 and 1995, a period marked by one of the most
intense stabilization efforts in Argentine history.”
From 1984-1985 to 19952 provincial revenues grew, overall, at a rate of 67.6%,
while their expenditures grew at a rate of 71.2%. Revenues from co-participation and
their own taxes grew 130.1% and 82.4% respectively. Still, in this scenario only three
provinces, including Buenos Aires, kept their budgets out of the red by the end of 1995.
2
The statistics following within the paragraph are all taken from Remmer and Wibbels,
Table 2: Revenues of the Argentine Province, 1984/1985-1995 (Constant 1995 US
Dollars), pg 431
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21. Combined, the provincial governments ran a deficit of $3,275,000,0003 pesos in 1995
alone. With “salaries [absorbing] roughly 60% of current revenues” (Remmer and
Wibbels, 436), the Argentine provinces used the co-participation fund as a civil servant
fund. Between 1991 and 1994, the provinces raised their payroll 41%, meanwhile, overall
spending spiked 38.9% between 1991 and 1995 (Remmer and Wibbels, 438-439).
Therefore, some of Miguel Teubal‟s grievances about the government‟s social
expenditures find a stronger link to patronage networks and corruption, opposed to
privatization.
This is, again, important for several reasons. The point is that not only were the
provinces adding to a deficit, but they were doing it at the expense of the currency board.
Menem, with his political career tied to the boards success, did not attack the problems of
the provinces. He either supported the spending or was trying to win political favor, as
displayed when ,“Under the auspices of [the] stabilization program, these
[co-participation] arrangements were renegotiated in 1992 and 1993, when the number
and percentage of taxes subject to co-participation were lowered in exchange for federal
agreement to a minimal contribution of 8.9 million pesos, which represented a 50%
increase over the amount received by the provinces in 1990.” (Remmer and Wibbels,
430)
The problem of the provinces was not solely shown in the budget deficit. The
effect it had upon the budget deficit caused a reaction. The Argentine national
government compensated for overspending with under spending. “The success of
3
Table 3: Provincial Operating Balances, 1991-1995 (millions of pesos), pg 438,
21

22. Argentine adjustment effort of the early 1990s was thus achieved through policies of
over-adjustment at the national level that compensated for public sector expansion and
financial fragilities at the provincial level”(Remmer and Wibbels, 432), meaning the
government continued in its privatization efforts, without funding it with proper
regulation and oversight. On the eve of Menem‟s departure in 1999 Peter Hudson (1999)
wrote “a reduction in local costs will demand that Menem‟s successor pays urgent
attention to tasks left undone: a major restructuring of the tax system to stamp out
evasion, lowering of taxes on employment, a reduction in public-utilities tariffs, and a
reorganization of inefficient government spending.” (180)
Economics as Politics and Vice Versa: Maintaining ‘The Peg’
So far some of the problems with the currency board have been explored. In this
section, I will talk about them more, but first, here‟s a list of the problems the currency
board causes:
1) Low exports due to the relative high price of manufacturing
2) High percentage of import consumption due to monetary strength
3) The currency board can not manage high budget deficits
4) Small domestic manufacturing sector (see (1)), low real wages due to high monetary
value, and high unemployment for the same reason.
The currency board is a reasonable tool, in the sense in can begin to ignite
investor confidence by securing a currency and it can remove a population from the perils
of inflation. But, an environment like the one described above does not facilitate the
Remmer and Wibbels (2000)
22

23. currency board as a permanent feature. Much of the literature on Argentina‟s economic
reforms refers to Menem and Cavallo‟s reforms as „shock therapy‟. This term itself points
to the temporality and care which these reforms necessitate.
The problem is that Menem and Cavallo found themselves and their reputations,
for the former nationally and the latter internationally, on the line with the success of the
currency board. They hailed it as the be-all-end-all of economic reforms. Not even the
IMF encouraged and supported these reforms (Cavallo and Cottani, 19). Matter of fact,
they discouraged these reforms. Cavallo lived up to his reputation as a bellicose public
figure with a brazen attack on the IMF and floating exchange rates in his paper
“Argentina‟s Convertibility Plan and the IMF”, written with Joaquin A. Cottani, and
presented at the Hundred and Fourth Annual Meeting of the American Economic
Association in 1997.
Cavallo‟s conclusions about the currency board are questionable and almost
delusional. He emphasizes the need for consistent, rule-based economic policy. This of
course, is provided by the currency board. On the other hand, discretionary, or floating
currency value, is portrayed as a political tool (Cavallo and Cottani, 19-20).
He goes on to speak of reform by a “democratic government, with no
extraordinary foreign assistance.” This reform, backed by the currency board, is
responsible for “improvements in technology and management” at the microeconomic
level. The former claim is misleading and the latter claim, even if true, does not speak
to the fact that these improvements were all for naught. What Cavallo forgets to mention
is that the “improvements in technology and management” manifest themselves as debt in
23

24. a failing economy. Exports remained dismally below the levels of the region (See (1)
above) and “the supply-side shocks” were not enough to offset import consumption with
domestic consumption.
As Cavallo continues to read from his personal economic history book the words
become more surreal. He speaks of “Argentina‟s outstanding use of IMF credit” which
goes against much of the conclusions in the literature on the issue. Many people tend to
point to the IMF as lending and advising in a manner that caused Argentina‟s downfall.
According to Domingo Cavallo the IMF was certainly in conflict with Argentina, but not
as the consensus believes.
“Nevertheless, differences of opinion have existed in matters of economic policy
between the Argentine authorities and the IMF staff since the beginning of the
Convertibility Plan”, he says, “the IMF never believed in the currency board as a
long-term arrangement.” He also reveals that many of the tax cuts initiated in Argentina
were not supported by the IMF and they were blatantly discouraged (Cavallo and Cottani,
19).
David Woodruff‟s paradigm of “go-for-brokers”, “unwinders“, and “good
fighters” seems correct, but not in his context. The political players in Argentina were
looking at their balance sheets. The political balance sheet is denominated in something
far more intangible than dollars and can not explain how society shapes around economic
policy, but instead how politics shapes around economic policy.
The Election of 1999 and the Revolving Presidency: Inheriting A Political and
Economic Nightmare
24

25. The election of 1999 marked the end of Carlos Menem‟s reign as President. There
was talk of him, that March, attempting to run for a third time. This would be done
through bypassing electoral law through a popular referendum. The previous July, of
1998, saw Menem announce that he would not seek to maneuver his way into a third
term, but something seemed to spark a change of heart. The fickle Menem, in July of
1999, explicitly dropped his bid for a third term, most likely resulting from party pressure
and the possible embarrassment of being beaten by Eduardo Duhalde in the Peronist‟s
run-off elections.
The election of 1999 also marked the beginning of the end for Argentina‟s
“economic miracle”. The ensuing three years would see three presidents, in addition to
one “provisional president for 48 hours”. These three years saw: additional loans from the
international community; an initial run of the banks; the re-introduction of Domingo
Cavallo as Minister of the Economy; the issuance of “provincial bonds…to pay public
salaries”; various debt swaps; a debt moratorium; a final run on the banks leading to
devaluation; rising unemployment, and social unrest (Hornbeck, 2002). As capital fled
the country and provincial bonds were used to service salaries the inevitable devaluation
and its economic and social consequences continued to deteriorate.
As spoken of before, devaluation is a process that should have occurred sometime
near the beginning of Menem‟s second term, before overvaluation of the peso was locked
in and problematic. The campaign of 1999 was not a pretty one as well and added to the
burden on the Argentine economy. Eduardo Duhalde and Fernando De La Rua provided
25

26. populist rhetoric and economic evaluations which hurt investor confidence. Cavallo
railed each of the candidates for their behavior on the campaign trail, in his typically
blunt fashion. Still, despite the two candidate perceived disagreement with the policies of
the 1990‟s, the winner, Fernando De La Rua, maintained these same policies. When they
proved especially difficult to manage, De La Rua turned to Cavallo himself to fix the
economy (Makuc, 73).
The disaster of maintaining a pegged currency in Russia was available as
evidence, while Brazil at this time was going through a devaluation process of there own.
Why then, was there such faith in the currency board in Argentina? Even more, why from
an administration that ran a campaign presenting policies opposed to the currency board?
One reason, as discussed prior, is that the strength of the political benefit of enacting the
currency board in Argentina would have produced the exact opposite political effect with
equal strength when the currency board was retracted. The economic institutions,
political institutions, and legal institutions were all built around the currency board and
loyalty to Carlos Menem. Although the following thought is not supported by empirical
facts, it doesn‟t seem presumptuous to assume Argentina may not have possessed the
human capital to devalue. In the end, the populist rhetoric in the 1999 campaign was
political pandering and served no other purpose than to hurt everyone‟s confidence in the
system.
The patience of the citizens is also in question concerning devaluation. President
de la Rua, or none of his successors, had the political clout to devalue. Adrian Makuc,
national director of foreign trade policy in Argentina beginning in 1998, said in 2002,
26

27. while still in his official position: “Politicians are not credible in Argentina. When
somebody comes to the podium and talks as a politician in Argentina, nobody believes
him.” (Makuc, 73) By the time Duhalde devalued in 2002, there was little chance there
wouldn‟t be social unrest. The social unrest was justified by the plight of the Argentine
population, but, although it could never be measured exactly, the Argentine people‟s
history of protest in the face of fiscal reform made devaluing an unattractive option in
2002 and prior. Still, in no way do I mean to indict the people of Argentina, because
politicians are supposed to be leaders, and therefore devaluation should have been
worked out in the face unpopular sentiment.
The Argentine population‟s short patience for tough reforms is not only justified
by their economic realities, but also by the trust issue introduced by Makuc. Distrust of
Argentine politicians is quite reasonable in reference to history and the present. Carlos
Menem‟s regime became known for corruption which the politician was able to brush off
despite the fact the corruption did exist. Despite the “official” ability to survive, in reality
it tarnished his reputation and planted the seeds of distrust in society (Blake, 8).
Secondly, De La Rua followed by continuing to provide a safe haven for corruption. The
situation was so bad that his Vice President Carlos Alvarez resigned due to De La Rua‟s
inability and inaction in weeding out corruption from the government (Hornbeck,
CRS-3).
Finally, to portray how bad the economic situation was concerning politics, look
at the events of power succession following de la Rua‟s resignation according to a
Congressional Report (Hornbeck 2002):
27

28. December 20: President de la Rua resigns in the wake of continued rioting...
December 21: …Senate President Ramon Puerta is named provisional president for 48 hours
December 23: Congress appoints San Luis Governor Adolfo Rodriguez Saa as interim president until
elections in March 2002.
December 30: President Rodriguez Saa resigns after continued rioting…Senate leader Puerta resigns to
avoid second appointment as interim president… (CRS-4)
Essentially, no politician wanted to get their hands dirty with this devaluation. After less
than a week in presidency Rodriguez Saa, from his house in San Luis province, away
from the capital, gave an unsympathetic resignation to the Argentine people (Makuc,
2002):
“…„Well, I‟m resigning.‟ He said „I am giving here to the armed forces officer that is with me, my
letter of resignation to take to the national capital.‟ That was original.
He went there, secluded himself in his province like a big landlord and just told the thirty-seven
million Argentinians, „You can do whatever you want.‟ ” (74)
Less than a week later Eduardo Duhalde, leader of the new Peronist party
(Menem‟s coalition representing the old Peronist bloc), officially ended the currency
board on January 6, 2002, after being appointed President (Hornbeck, CRS-5). At this
point the economy, society, the banking system, and practically all major areas of
Argentine life were dealt the long overdue, and therefore powerful, blow of devaluation.
This was the economic „shock therapy‟ that Domingo Cavallo could be proud of.
Duhalde‟s devaluation made every US $1 equal to 1.4 pesos concerning loans.
Concerning deposits, there was an even 1:1 swap from what was a US dollar to the now
properly, and extremely low, valued peso. This made matters worse by hurting
confidence in the banking system and hurt depositors as well (Gallo et al 201,208).
Overall, Duhalde‟s policies weren‟t received well in “Menem‟s Court”, so at the expense
of legal integrity, again, the court was unpacked and re-packed to push through
28

29. Duhalde‟s reform. The new Peronist political machine has followed Duhalde‟s
presidency with the chosen successor Nestor Kirchner and in the name of democracy
Kirchner‟s wife, Cristina Elisabet Fernández Wilhem de Kirchner, followed in line and is
currently serving as President.
Banking and Monetary Policy in the 21st Century: Brazil and Argentina Compared
Argentina‟s banking system is the final issue in the analysis of the crisis.
Argentina had no foundation for banking law, including a lack of policy concerning
insolvent banks. As evidenced by a 2003 Economist article, Argentina, one year after
devaluation, had yet to sort out the problems within their banking system. Again,
dealing with banks would open up political vulnerabilities. Despite the generally
optimistic Economist article, it ends on the same note that this paper is based upon: “Mr.
Duhalde will indeed leave Argentina in a much better state than he found it--but he is also
bequeathing many unpopular decisions to his successor.” (Economist, 2003)
Social unrest in Argentina began in 2001 when the first hold on bank deposits
took place. The following corralito of 2002 worsened the social upheaval. This need
for freezing bank withdrawals and the uneven devaluation also highlighted the lack of
rules, regulations, and structure in the banking system and economy as a whole. It also
displayed the lack of regulation and planning to monitor banks and their operating
abilities. Therefore, weather the devaluation ended up favoring depositors or borrowers
was arbitrary without the guidance of law. The government, being a prolific borrower,
constructed a devaluation policy favoring borrowers. In reality each side should have
29

30. sacrificed in a fair devaluation.
In 1999 John W. Head thought that the East Asian Financial Crisis would teach
countries and supranational organizations lessons about banking standards in the
international economy, which would be “the silver lining to the dark cloud of the Asian
financial crisis.” In the case of Argentina, he was wrong. Head‟s other “silver linings”
was the crisis‟s ability to display the need for central bank independence and policies that
would thwart disruptive capital flows (for example, Chile heavily taxes short-term
inflow) (Head, 951-954). Again, this information did not seem to make it to Argentine
policy makers.
Argentina‟s devaluation policy was indiscriminate to banks which may still be
solvent and those which were insolvent. Head advocated the adoption of international
banking standard and encouraged central banks, commercial banks, and governments to
join in to restructure domestic banking law. This included a tough policy for insolvent
banks which in some countries, including Argentina, are allowed to stay open and “bleed
[depositors] dry of all the…money.” (Head, 953)
When trouble started to appear in Argentina the political situation was so bad that
banks had no one to work with on creating a law. Like the previous years, no one was
working on laws or any other sort of policies to maintain the economy. Argentina‟s
“leaders” were to busy riding the political carousel. In most part, the lack of regulation
and structure in banking and capital markets can be attributed to Menem‟s continual
neglect to create policies that complemented the currency board, or liberalization in
general. On the other hand, when economic fortunes were grim in Brazil their
30

31. politicians reacted to the possibility of devaluation.
The Genna and Hiroi article talked about Brazil‟s devaluation of the real, and its
effect upon Argentina. This was not the only thing Brazil did though, and it would be
unwise to think that simple devaluation will be followed by an economic upturn. Brazil,
like Argentina, consists of many provinces (26) and municipalities (5,500). The Brazilian
budget is also at the mercy of the provincial budgets, as they show up as one statistic as
in Argentina (de Albuquerque, 165, Guira, 486).
On top of Brazil‟s devaluation they increased taxes, cut spending, and drastically
reformed the country‟s tax code and civil servant system (de Albuquerque, 2000, Guira,
2001). Pretty much, everything that post-East Asian Financial Crisis literature was
advocating, Brazil was initiating. Brazil, while addressing these issues, also provided “the
political will to educate their citizentry on the need to absorb short-term pain to ensure
long-term gain.” (Guira, 492) Hand-in-hand with the IMF, Brazil went through
devaluation. The IMF‟s cooperation and assistance was buoyed by an already existing
cooperative arrangement to clean up Brazil‟s banking law. Before devaluation Brazil took
part in adopting the Basle Twenty-Five Principles for Effective Banking, along with
preparation to start selling state-owned banks (Guira, 504).
In short, it seems Brazil was preparing to devalue, and their need to devalue
appeared a little earlier than expected, but the reforms were underway already. They
were building the economic structures that the 21st Century international economy
demanded. That means political in-roads had been developed, and therefore Brazil held
the country in harmony through some very tough reforms. Brazil‟s system favored action
31

32. to bail out the economy, while Argentina‟s lack of a banking system favored action to bail
out the government. For example, the nearly 12 billion dollars in loans and commercial
bank debt attributed to the Argentine government looks a lot better divided by 1.4.
Banking reform also tackles the “moral hazard” question (Head, 962-963). If a
bank is aware of the conditions that it becomes liquidated, restructured, or propped under,
it no doubt effects their actions. Argentina is a tricky situation because it seems the lack
of banking law led “moral hazard” to favor the government (insolvent banks benefited as
well), but usually it is the other way around. In the end, the lack of banking law is bad for
its effects in deteriorating investors‟ confidence, and immoral characters (abound in both
developed and developing countries) can maneuver their way to the beneficial side of
“moral hazard” if the rules are not defined. Governments must define the terms and
therefore eliminate uncertainty and “moral hazard” altogether.
The fates of Brazil and Argentina seem to diverge somewhere in the mid-1990‟s.
Brazil‟s attitude was something along the lines of: If we have to devalue, we have to
devalue. To mediate the costs adjustments must take place. Therefore, devaluation will
still be able to retain capital inflows due to the fact the system is sound and fair.
Argentina simply took the attitude: If we have to devalue, something went
horribly wrong, so we won‟t have to devalue. Adjustments were never in mind. Domingo
Cavallo and the Argentine political elite thought the currency board, unregulated markets,
the promise of capital mobility, and making statements to keep investor confidence was
the key to maintaining capital inflows. In their context, devaluation was not a possibility.
The impossibility was not an economic reality, it was a political reality. Judging from
32

33. Cavallo‟s paper, by the time the international community was adjusting its previous
beliefs, Argentina was cementing its faith in the old model. It truly became Argentina
against the international community. While Brazil‟s leadership was working with the
IMF Argentina‟s leadership was bickering with it--- worst of all, in a public economic
forum.
Concluding on the Collapse and Its Implications for Development in the 21st Century
What are the lessons from Argentina? It‟s time for everyone to withdraw from
their comfortable positions in economic philosophies. Development theorists all across
the spectrum will only continue to spur rigid and inefficient environments that will lead
to economic disaster. It‟s a wake up call to populations, politicians, bankers, and all
policy makers alike: You‟re not creating policy and indexing its „soundness‟ to outdated
philosophies. The rules of capital are the index of proper and improper economic policy.
In the international economy, to think that the rules of capital are stagnant, and that
numbers that meant one thing 20 years ago (or even 5) will symbolize the same thing in
the present is foolish, outdated, and a recipe for economic collapse. It is about structures
over everything else. Structures have transcended philosophy on its way becoming
capital„s main attraction. Again, where capital once looked for a home with an
environment built on a philosophy, it now searches for a home with an environment built
on structures. As Argentina showed, an economy built on philosophy has no safety, while
an economy built on structure can only far as fall as its structures allow it.
But, this is not the sole purpose of this paper. The purpose of this paper, then,
33

34. was to display this idea through Argentina‟s Economic Collapse. The proper economic
structures are created by political structures and development will only fail without
political harmony, responsibility, and function. Political harmony should not be taken as
political hegemony. It means politicians are trusted by the people, to the point that
political factions are beneficial in creating policy, not detrimental. By responsibility it is
meant that economic policy is not a political tool. Carlos Menem compromised the
basic foundations of the Argentine state in order to hold power for 10 years. This is an
attitude that ran through Argentina‟s political system in the 1990‟s. Menem‟s style
(political irresponsibility) was caused by a lack of alliances between Menem and other
political parties and the people (political disharmony). The confluence of these two
factors is a recipe for political dysfunction. It is a paradigm that defines the Argentine
Economic Crisis: Liberalization was irresponsible, because without harmony, the
necessary reforms to accompany it were not going to come due to political dysfunction.
This only added rigidity to the economy.
Rigid systems produce rigid results. Hence, Argentina experienced the polarizing
effects of meteoric economic boom and depressing economic collapse. If they created the
flexible safety net (like Brazil) to brace the fall of the boom then the consequences of
devaluation and recession would not have been as horrific. In reality, these reforms were
impossible in Argentina though. A politician is as good as his first step it seems, or at
least the political environment has constructed a pathos in which politicians feel better
hedged by “going for broke” then trying to explain the necessity of short-term sacrifice
and conflicting reforms. The power structure, from the federal to provincial level,
34

35. illustrates this. The fracture of government structure and patronage within each level of
power means that someone will always scratch the populations‟ itch at the expense of
stable and long lasting reform.
The crisis also begs investors to be responsible, in the sense that they need to pay
attention to politics. Not until the election of 1999 did investor confidence really start to
plummet. In hindsight, this economy never stood a chance in the political environment.
To flood an economy with investment and then remove your investment due to factors
that analysis could have foreseen is immoral and irresponsible.
The market is beginning to react to this problem. The Eurasia Group, one of the
most successful political risk consulting groups in the world, saw its profits rise $7
million dollars from 2001 to 2002. In May of 2003, they were projecting a possible 100%
increase in profits from 2002, which would leave them with $30 million by the end of
2003 if predicted correctly. A 2000 Business Week article touted the group‟s growth to
15 full-time employees. There are currently more than 15 people on the advisory board
and as of May 2003 there were 520 employees affiliated in Eurasia Group‟s network. Not
to mention the company has been expanding through mergers and acquisitions of smaller
political risk consulting companies.
The results of investing in a political structure, along with an economic structure
are yet to be revealed. But the facts point towards 21st Century capital decisions as being
something more than an economic decision, but a political decision as well. The
international economy has tied these two factors closer together than ever before. When
economic calculations become political calculations then the politics of instability take
35

36. root, and Argentina showed the devastation that could occur when politics dominates the
union of these two spheres.
36

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