When Argentina defaulted on more than $80 billion of its debt in December 2001—the largest sovereign debt default in history—it was but the culmination of decades of addiction to debt-based development. The International Monetary Fund’s willingness to provide the Argentine government with long-term credits disguised as short-term adjustment loans sustained that model of development and encouraged private sector participation.
During 1957-99, Argentina relied on the IMF’s financial morphine a total of 33 years. The ratio of debt to gross national product rose from 29 percent in 1993 to 41 percent in 1998 and 50 percent in 2000. Excessive government spending was at the core of that debt buildup. Economists at the Latin American Economic Research Foundation (FIEL) in Buenos Aires estimate that, when correctly measured, total government spending in dollar terms nearly doubled between 1991 and 2001, while GDP grew only 57 percent.
The primary source of excessive government spending was the inefficient provincial governments with large public payrolls. Under the so-called co-participation plan, the federal government covered provincial deficits. Most of the resulting debt was funded in global capital markets leveraged by implicit IMF guarantees for future “emergency” credits. Much of the debt was dollar denominated.
Since December 2001, Argentina has continued to accumulate debt. Total government debt stood at $144 billion at year-end 2001 but had risen to $177 billion by the end of 2003. Buenos Aires has shown little interest in dealing seriously with what should be its policy priorities: structural reform to constrain future deficit spending; renegotiation of foreign debt; fixing the politicized banking system now saddled with government debt of uncertain value; and restoring property rights, especially through impartial enforcement of contracts.
The Argentine people will not easily forget the past. How can they trust government when their deposits were frozen, the peso devalued, and dollar deposits converted to pesos at exchange rates that imposed significant wealth losses? How can businesses and banks have confidence in government when it broke contracts and forced pension funds and banks to hold its bonds?
Is there a way for Argentina to throw away its IMF credit card, introduce neglected reforms, and reenter international capital markets?
The answers to those questions require some soul-searching by Argentine politicians and foreign investors alike. President Nestor Kirchner is right when he says that those who invested in Argentine bonds should face up to the risks they were taking and not expect to be fully compensated for poor foresight. And Economy Minister Roberto Lavagna is correct in calling for reform of the co-participation program and for reducing taxes on investment.
But if Argentina is to achieve sustainable growth, it needs to take responsibility for pushing such policy priorities forward. Rather than shield itself from the discipline imposed by the market-as, for example, through its support of short-term capital controls that increase the cost of capital-Buenos Aires should embrace market-friendly policies.
One powerful way of achieving that end is to abandon the model of debt-led development that has kept Argentina from reaching its full potential. As the experience of rich countries tells us, when debt is used to finance profitable private-sector investments, development can occur. But in the case of most developing countries-including many that have introduced market reforms-the debt is often used to finance government profligacy and maintain the status quo.
Without IMF support, Argentina would have to act responsibly or face the consequences in global capital markets. Accountability in the market is more apt to promote sound policies in Argentina than IMF surveillance and future credits. The IMF cannot change domestic politics or bring about fundamental reform simply because it wants to.
Indeed, a recent IMF report noted that IMF-supported fiscal targets “were not met in a large number of cases,” and when some progress was made it occurred “in the first year of the programs with little progress thereafter.”
Today, Argentina is once again experiencing economic growth and low inflation. But how long will it last without institutional reform? The end of convertibility means that the central bank must now maintain a credible monetary policy and let the peso float. Mexico’s fairly open economy has so far succeeded in holding down inflation under such a regime. But is it realistic to expect that Argentina, with its relatively closed economy and IMF support, will be as successful?
As Anna J. Schwartz of the National Bureau of Economic Research wrote in the Cato Journal: “Perhaps the time has arrived to abandon debt-based development; to encourage the conversion of debt to equity; to set countries on a different path than one that leads to unsustainable debt, crises, and debt restructuring; and to rely on equity investment for development.”
Simply, it is time to reduce government’s role in building up debt. Doing so is far more likely to lead to better policy decisions, wiser investments, and actual development.