Argentine Economic Crisis 2001

The Argentine debt crisis was unique in several ways in such that it was not just the failure of the local and international economic institutions and international trade but also a socio-political failure.  It set precedence on how a bad government can bankrupt one of the traditionally richest countries in the world. It is however hard to pick one incident that sparked Argentina’s downward economic spiral. Like most crisis a number of factors over a long period of time culminated into its bankruptcy in 2001. It is a topic of hot debate on what these factors were.

Brief History of Argentina’s Economy Leading to the Crisis:

Argentina started off as a very rich country at the point of independence in 1816. It had abundant land to cultivate, great natural resources and a steady stream of workers that kept flowing into the country from the troubled European states. Post great depression however, Argentina was subjected to military dictatorship of Juan Peron for many years which adversely affected the social, political and economic institutions. Between the 1930’s and 70s most countries in Latin America used import substitution industrialization (ISI) model to build industries and reduce dependency on imports from foreign countries. This greatly hampered the employment situation of the countries and lead to obscene levels of unemployment. Near the end of dictatorship the unemployment figures were close to 18%.  Industrialization for the sake of cutting off from the world was clearly not working. The heavy protectionism offered to industries not only from outside competition but also domestic competition showed a lack of insight in economic policy making.

Protectionism reached such extreme measures that the government not only taxed the imports but the exports as well. The high export tariff made exports uncompetitive and Argentina started to face huge balance of payment problems (Beattie, 2009). The bid for autarky had failed. Adding to the woes there was wide spread corruption of state officials and the states direct interference in judicial processes. (Alejandro & Roberts, 2005)

In 1983 democracy was restored with the election of Raul Alfonsin. Inheriting a foreign debt crisis exacerbated by high global interest rates, Alfonsín had to also contend with shattered business confidence and record budget deficits. Alfonsin’s government planned to introduce a new currency called austral for which new loans had to be taken. Argentina failed to pay the interest on this debt and faith in the austral collapsed. Unable to control inflation the inflation rate hit an all time high of 700%. Loses among state enterprise and wide spread tax evasion led to a deficit of 10 billion USD. In the year 1989 the inflation reached a record 5000%. The real wage of the people halved and president Alfonsin was forced to resign from office 5 months before his term was over.

Carlos Menem was the next in line to tackle the crisis of hyperinflation. 1990s was the age of globalization and Argentina wanted to lead that change. Menem chose a cabinet of technocrats to get Argentina out of the hyperinflation crisis they were stuck in and his policies wanted to end the economic isolationism that Argentina had come under. He linked the Argentine peso to the US dollar. This meant adopting US interest rates and fixing the amount of pesos circulating in the economy in the country to the amount of dollars held in the government foreign exchange reserves.

A wide scale privatization program followed with the advice of IMF. However the policy to link pesos with the dollar proved to be disastrous. Due to the financial crisis in South-East Asia and Russia investors started to pull their money out of foreign markets. Dollars started to be taken out of Argentina. Argentina had borrowed too much when it was easy for it to survive. As dollars flowed out of the country the supply of pesos had to fall too.  In countries that controlled their own currencies, like the US, the severity of the worldwide economic slowdown in 2001 could be minimized by rapid cuts in interest rates. The US Federal Reserve slashed the cost of borrowing only in 2001, ensuring that the American economy would go through only a brief and shallow recession despite huge falls in the inflated share prices of technology companies.  In Argentina, whose currency was tied to another, a shortage of dollars in its reserves drove up interested rates to punishingly high levels as demand for the limited supply of hard currency sky rocketed.

The Crisis of 2001:

Argentina was caught in a death spiral. Higher interest rates crushed businesses and bankrupted families. In desperation, Buenos Aires doubled up its bets, borrowing billions of dollars from the IMF in hope that the economy would pull of its dive. It failed to convince the investors on whom Argentina depended, and December 2001 the IMF pulled the plug, Argentina was forced into the largest government bankruptcy in history. (Beattie, 2009)

Income per head dropped by nearly a quarter in three years. The central government had no money to bail out provinces. Instead, some provinces started using their own currency. Five presidents came and went within two weeks. Wide scale protests started to take place across Argentina against the austerity measures imposed. The protests turned violent against European and American companies and their store houses were ransacked and burnt. The Argentine president at the time, De La Rua was forced to escape the capital in his helicopter. Rudi Dornbusch an economist at MIT insisted that Argentina be taken over by international committees of experts to run the disastrous finances of Argentina. By the end of November 2001, people fearing the worst began withdrawing large sums of money from their bank accounts, turning pesos into dollars and sending them abroad, causing a run on the banks. On 2 December 2001 the government enacted a set of measures, informally known as the 'corralito' that effectively froze all bank accounts for twelve months, allowing for only minor sums of cash to be withdrawn, and initially announced being of just $250 a week. (Krauss, 2001)

In 2002 Argentina abandoned the 1-to-1 peso-dollar parity. The peso lost its value in a matter in the unregulated markets. The exchange rate at the start was fixed at 1.4 pesos per dollar. The economic situation became steadily worse with regards to inflation and unemployment during 2002. By that time the original 1-to-1 rate had increased to nearly 4 pesos per dollar, while the accumulated inflation since the devaluation was about 80%; these figures were considerably lower than those foretold by most orthodox economists at the time. The quality of life of the average Argentine was lowered proportionally; many businesses closed or went bankrupt, many imported products became virtually inaccessible, and salaries were left as they were before the crisis. Agriculture was also affected: Argentine products were rejected in some international markets, for fear they might arrive damaged from the poor conditions they grew in, and the USDA put restrictions on Argentine food and drugs arriving at the United States.

Effects of the Crisis: 

A great social rebellion took hold across Argentina. The rebellion was the rejection of austerity measures as well as rejection of the political system as a whole. The main slogan of the rebellion was, “they must all go” which underlined the apathy of the people towards the ruling class. A great solidarity took place at this time between the middle class and poor against the draconian measures. The social revolutionaries started experimenting with different forms of political representation and one of the main outcomes was the re-implementation of a fair and respectable Supreme Court.

During the economic collapse, many business owners and foreign investors drew all of their money out of the Argentine economy and sent it overseas. As a result, many small and medium enterprises closed due to lack of capital, thereby exacerbating unemployment. Many workers at these enterprises, faced with a sudden loss of employment and no source of income, decided to reopen businesses on their own, without the presence of the owners and their capital, as self-managed cooperatives The workers and trade unions took over around 200 abandoned factories and started having a greater say on how things would run and subsequently the inequality in the country was reduced over the following years.  (Lewis, 2004) The biggest tile making factory in Latin America located in Zanon is run by a worker managed cooperatives and not businessmen. (Dangl, 2005)

Recovery:

The most interesting part about Argentina’s recovery is that it did not adopt orthodox economic policies as economists were coxing it into doing. The general feeling was that if Argentina did not adopt orthodox economic policies it would mean that hyperinflation would surely follow, the peso would become worthless, investment and foreign reserves would vanish and any prospect of growth would be strangled. (Rothner, 2004) But 3 years after the record debt default of more than 100 billion USD Argentina’s economy grew very strongly at around 8% for two consecutive years. The exports increased and the currency finally stabilized.

The Peronist government rather than trying to take the usual route of satisfying Bond holders, international banks and IMF instead decided to first stimulate internal consumption and told creditors to wait their turn. In a span of 3 years more than 2 million jobs were created. Unemployment declined from 20 percent to about 13 percent and the number of Argentines living below the poverty line fell by almost 10 points from the record high of 53.4 percent early in 2002. (Rothner, 2004)

Nestor Kirchner, the president of Argentina in 2003 who was to lead the financial recovery followed a strict fiscal regiment. His main aim was to move away from the neo-liberal economic policies that were prescribed by the IMF pre default years.  He proposed a larger government intervention in the economy in order to stabilize it and it seems to have paid dividends.  However, the drawback of the interventionist policies is that Argentina has become less relevant at world stage. (Webber, 2011) One of the main saviors in the trade front that brought in great amounts is the high price of soy in international market with China becoming a major buyer of Argentine soy products.  Agricultural products brought in over 100 billion dollars of revenue into Argentina in a span of 4 years (2007-11) leading to economic stabilization.  (Webber, 2011) The high price of commodity markets has been the back bone of Argentine recovery.

Argentina may have made a miraculous recovery but it is yet to be seen whether it can be sustained in the long term or not. The isolationist policies have proven fruitful in re-stabilizing the economy but other factors such as pensions, education system and health care have suffered.  Lucio Castro of Cippec, a Buenos Aires based think tank believes “In 20 years, history will ask us: ‘What did you do with the [commodities] bonanza?’ Was there an increase in consumption, public companies and wages or investment in infrastructure, health, education and saving for a rainy day? ….We are not doing our homework and becoming a developed country.” (Webber, 2011) However if the trade surplus that Argentina enjoys in commodity market are maintained then it is only natural that with good governance the social institutions of the country also progress further.

Bibliography

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Beattie, A. (2009). False Economy. Penguin Books.

Blustein, P. (2005). And the Money Kept Rolling in (and Out). Public Affairs.

Dangl, B. (2005). Occupy, Resist, Produce: Worker Cooperatives in Argentina.

Krauss, C. (2001). Argentina Limits withdrawls as banks nearely collapse. The New York Times .

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