Commentary: Another Emerging Market in Too Much of a Hurry

Argentina failed to take the time to finish reforms before inviting in global investors

By Pete Engardio

Was Argentina done in by bad advice from the International Monetary Fund or by its own profligate politicians? Did Buenos Aires open its markets far too fast or far too slowly? Was the policy of anchoring the peso to the U.S. dollar flawed from the beginning? Or would the strategy have worked had Buenos Aires finished all its reforms? In the wake of Argentina's brutal devaluation, economic pundits are scrambling to put their own spin on the demise of yet another bold 1990s experiment in financial-market liberalization.

This blame game is pointless. As with other spectacular blowups of the past decade--Thailand, Indonesia, Russia--the truth is that there are too many culprits to count. In Argentina's case, the currency and economic policies of the early 1990s, and the many mistakes that followed, were the work of popularly elected politicos. The IMF and the U.S. Treasury indulged Buenos Aires with money and public endorsements even after the country lost financial discipline. The thousands of foreign creditors who pumped $141 billion into the country should have known the risks--and now deserve to pay the price.

If there's one lesson from the collapse of Argentina and many other IMF clients, it is this: Radical attempts to turn closed, ill-managed emerging markets into sturdy free-market economies in a few short years rarely work. Economists can argue until they turn blue that Argentina's currency board, or Russia's shock therapy, or Indonesia's IMF reform package, would have worked fine had these countries only done this or that. But to succeed, such strategies require near-flawless execution. In the real world, developing-nation policymakers face too many political and economic constraints to pull everything off overnight, even with IMF help. And investors who stampede into such markets based on promises of reform often end up financing unsustainable booms.

Argentina's tragic experience with the currency board is a case in point. Desperate to halt hyperinflation, President Carlos Menem adopted a policy to back all pesos in circulation with dollars held in reserves. That halted inflation but also meant the only way to finance deficit spending was to lure new dollars through exports, direct investment, or debt. Firing up the printing presses was out. So Menem privatized most state-owned companies to raise funds. Investment flooded in, and the economy surged.

But when investment inflows slowed and the 1995 Mexican crisis pushed Argentina toward recession, foreign borrowing took off. And to win reelection, Menem allowed free-spending provincial governments to run big deficits. Also, he shelved labor reforms that would have made it easier for companies to lay off workers. Then, in 1999, neighboring Brazil devalued its currency by 30%, laying bare how overpriced Argentina had become. But the government hung on to the peg, figuring devaluation would be too painful. Imports flooded in, investment dried up, companies could not restructure, and Argentina couldn't repay its crushing debts. "The problem is that Menem didn't seize the opportunity to finish reform. And the capital markets took their cues from the IMF and U.S. Treasury, which stood behind Argentina," says Columbia University economist Charles W. Calomiris.

Argentina should have ditched the dollar peg when it became clear it couldn't maintain the fiscal discipline needed to make it tenable. The economy and investors would have taken a big hit, and the IMF again would have been embarrassed. But Argentina might well have recovered from the crisis so long as it continued reform, as Mexico, Russia, and South Korea have done. True, this process could have taken many years, given Argentina's record. But it probably wouldn't be facing the catastrophe it faces now.

It would be a shame if other nations cite Argentina as an excuse to turn back the clock on globalization. But it would be good if this meltdown marked the end of an era when developing nations, the IMF, and international investors bet the bank on overly complex, big-bang liberalization schemes.

Engardio reports on global business and economics from New York.

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