Argentina, the country that gave us the tango, Evita, the Falklands War, soccer and tennis legends, and some of the best red wines from the Southern Hemisphere, has also given us the first economic depression of the twenty-first century. What began in late 1998 as a mild recession by mid-2002 had become one of the most harrowing economic crises in Argentina's history.
The features of this depression are daunting: a default on government debts, a nearly 75 percent devaluation of the peso, an economic contraction that sent the GDP back to 1993 levels, an unemployment rate of 22 percent, the collapse of the banking system despite a freeze on bank deposits, and the creation of more than one and a half million new poor in just six months.
The toll on politics has been no less dramatic: between October 2000 and August 2002, there were five cabinet crises, two presidential resignations, (1) one Senate crisis, (2) and five ministers of the economy. The streets in downtown Buenos Aires are now full of abandoned retail stores and angry protesters. **Que se vayan todos! (Kick everyone out!) reads the omnipresent graffiti.
The current crisis is perplexing to many Argentines (and scholars abroad) because, for the first time ever, Argentina in the 1990s seemed to have finally gotten its politics and economics right. On the economic front, Argentina introduced some of the most far-reaching market-oriented reforms in the world. In 1999, the Heritage Foundation, a conservative Washington think tank, ranked Argentina's economy as among the "freest" in the world. Politically, Argentina consolidated civilian control over the military and introduced stronger instruments of accountability, such as added powers for the legislature. Power was transferred peacefully, violent protests declined, and the leading parties negotiated a major pact to reform the constitution in 1994, ending a long period of interparty animosity. Consequently, Argentina between 1991 and 1998 achieved a long period of both political and economic stability not seen in the country since the early 1920s. As Harvard political scientist Steven Levitsky remarked, Argentina appeared to have turned toward "normalized" democratic politics. (3)
The stability of the 1990s was all the more remarkable given the tumult of the previous 60 years. Argentina at the beginning of the twentieth century was a country not unlike the United States. It had vast, rich agricultural lands, substantial foreign investment, and a relatively small population, which permitted the absorption of Europe's labor surpluses. But starting in the 1930s, Argentina succumbed to cycles of political instability that more or less followed a consistent pattern. A president would make crowd-pleasing promises on which he or she would fail to deliver. Protesters would rake to the streets, scaring civilians and prompting the military to take power. Eventually, the generals would return power to civilians, in part because they would also have failed to contain the popular discontent. Argentina had 24 presidents between 1930 and 1958--one new president every two years or so, on average. This political instability hurt the economy. Periods of growth were typically followed by longer periods o f spectacular collapses. During these same years, there were 58 ministers of the economy.
Just when Argentines were beginning to believe that they had left all of this behind them, the past came back with a vengeance. They had endured a decade of painful reforms, only to be cruelly rewarded with a brutal crash. This is why they now find their plight so disconcerting. It is also why the political climate in the country is so volatile. Today, Argentines exhibit a combination of ire, which has driven many of them to join the angry street protesters, and acute cynicism, which has driven many others to disengage from politics altogether.
A few years ago, Buenos Aires was a bustling city, famous for its vibrant nightlife. Nowadays, Buenos Aires's evenings are somber. People choose to stay home, not just because they cannot afford to go out, but because they want to avoid the "express kidnappings" (secuestros expres) in which a victim is typically held for a few hours, until a ransom is paid. In many neighborhoods, the only people out at night are the new poor, who wander through the streets sifting through the garbage left outside for collection.
The question of what went wrong in Argentina has become the subject of debate. Most analysts look only at the economic picture for answers, blaming the crash on two factors: external shocks and fixed exchange rates. Yet this focus on economics overlooks what is perhaps the most important explanation for Argentina's collapse: political shocks. The Argentine depression is an example of the serious consequences of two types of political shocks to which all weak democracies, not just Argentina, are susceptible.
The first shock was caused by what I call the state-without-a-party condition. This occurs when the president of a given democracy is at odds with the leading members of the ruling party. Although it occurs infrequently, the state-without-a-party condition is not a rare political illness. And it almost always results in economic mismanagement. In the 1990s, this problem crippled the administrations of Carlos Andres Perez in Venezuela, Juan Carlos Wasmosy in Paraguay, Rene Preval in Haiti, and Ernesto Samper in Colombia, to name a few, and is causing problems today for Vicente Fox in Mexico.
The second political shock to which Argentina was subjected was caused by international actors: the technocrats who came to the U.S. Treasury Department and the International Monetary Fund (IMF) in the late 1990s with new ideas about how to deal with economic crises. These technocrats are hesitant to offer rescue packages for economies in trouble for fear of eliminating incentives for self-reform (the "moral hazard" problem). The best way to help governments facing an economic crisis, they believe, is to offer limited help, and only after these governments meet conditionalities that are deliberately made tougher the deeper the crisis gets. This toughen-as-you-sink approach is a policy fraught with risks, and it is particularly dangerous for weak democracies. It caused havoc in Argentina.
The combination of this international political shock with the domestic political shock of the state-without-a-party condition is the reason that Argentina's mild recession of 1999 turned into a depression in 2002. The lesson of the Argentine crisis is that no political or economic reform, however enlightened, can withstand such shocks. These shocks impaired the capacity of Argentine authorities to end the recession. Investors spent most of the 1999-200 1 period sitting on their hands, waiting for signs of decisiveness from the government. However, without the support of its own ruling party, or from Washington, the government could not solve the credibility problem.
The debate about the causes of Argentina's depression has mostly focused on two economic issues: the susceptibility of open economies to external shocks and the merits of different exchange rate regimes. The first issue is predicated on the idea that external vulnerability is the curse of globalized states. (4) Openness to trade and financial flows expose emerging markets to the "flus" of other countries. (5) Since the mid-1990s, there have been plenty of powerful economic viruses around the globe: the Mexican crisis of 1994--95, the Asian crisis of 1997, the Russian devaluation of 1998, the Brazilian devaluation of 1999, the rise of interest rates in the United States in 2000, the Turkish devaluation and the global recession of 2001, the drop in non-oil commodity prices between 1998 and 2001, the drying up of foreign direct investment in emerging markets after 1998. Sooner or later, it is argued, Argentina, with its open economy, was bound to be infected. (6)
The problem with the external-shock hypothesis is that it invokes a systemic variable to explain a singularity. External shocks should have hurt many countries, and yet only Argentina (and Indonesia) sank into a depression. Thus, something else must have made Argentina susceptible. This is where the debates about exchange rates apply.
Among the market reformers of the 1990s, Argentina adopted the most inflexible exchange rate possible under the Convertibility Law of 1991. While the use of inflexible exchange rates to stabilize prices is common, Argentina's approach was extreme. It obliged officials to uphold a fixed exchange rate vis-a-vis the U.S. dollar and banned the central government from printing money. This system came with two tradeoffs. First, it purchased credibility (the government would not play dirty tricks with the exchange rate, such as announcing surprise devaluations) at the expense of competitiveness (the price of Argentine goods would become expensive relative to the prices of Argentina's trading partners). Second, it injected predictable rules (a non-changing exchange rate) at the expense of flexibility in fiscal and monetary policy. (7) Most trade economists agreed that Argentina's economy, in terms of its size and trading structure, was not ideal for such a straitjacket. What justified its adoption in 1991 was Argenti na's hyperinflation of 1989-91, which called for drastic measures. (8)
The debate about exchange rates centers on whether the currency regime should have been relaxed after stabilization. (9) Such well-known economists as Paul Krugman, and even some staff members of the IMF, insisted that the costs to competitiveness and flexibility were too onerous once inflation had been tamed. (10) Exports would stagnate, and faced with external shocks, authorities would be left without monetary policy tools--no gain, just pain. Some observers think that to stay afloat following the "sudden stop" of foreign capital after 1998, Argentina needed...