Wednesday, September 27, 2006

How Argentina Got Into This Mess

by Brink Lindsey

Brink Lindsey [0] is a senior fellow at the Cato Institute and director of the Center for Trade Policy Studies.

January 9, 2002

Argentina's miseries now cry out in the headlines: riots and violence, a farcical procession of presidents-for-a-day, and the gathering doom of default and devaluation. But behind the headlines lurk deeper ills that gnaw away at the foundations of the country's political and economic life. Those ills helped to bring about the current crisis, and they will persist long after the media spotlight now on Argentina fades away.

Argentina's woes are many, but underlying them all is the dilapidated state of its political and legal institutions. According to an annual index of corruption levels published by Transparency International and based on surveys of business people, academics and risk analysts around the world, in 2001 Argentina ranked a dismal 57th out of 91 countries. Worse, in other words, than Botswana, Namibia, Peru, Brazil, Bulgaria, and Colombia, and on par with notoriously corrupt China.

The same results came through in the 2000 Global Competitiveness Report, coproduced by Harvard University and the World Economic Forum, which surveyed business leaders from 4,022 firms in 59 countries on their perceptions of business conditions. Again, Argentina languished near the bottom: 40th for the frequency of irregular payments to government officials; 54th in the independence of the judiciary; 55th in litigation costs; 45th for corruption in the legal system; and 54th in the reliability of police protection.

It wasn't always this way. The disrepair of Argentina's institutional infrastructure is a legacy of its Perónist past. Look, for example, at the crucial question of judicial independence. Prior to the descent into statism, justices of Argentina's Supreme Court enjoyed long tenures undisturbed by political interference. At the beginning of Juan Perón's first administration in 1946, Supreme Court justices averaged 12 years on the bench.

It's been downhill since then. Since 1960, the average tenure has dropped below four years. After Perón (he left the presidency for the second time in 1974), five of 17 presidents named every member of the court during their term, a distinction that had previously been limited to Bartolomé Mitre, the country's first constitutional president (1862-1868). And so, while before Perón, it was typical for a majority of the court to have been appointed by presidents from the political opposition, that was no longer the case. The Supreme Court, the supposed bulwark of the rule of law, was reduced to a puppet of executive power.

The pro-market reforms of the early 1990s brought little improvement. President Carlos Menem, who deserves credit for stabilizing the currency and privatizing industries, nonetheless persisted in traducing the integrity of the country's institutions. Faced with a politically hostile Supreme Court, Mr. Menem responded with a court-packing scheme -- he expanded the court from five to nine members and filled the new slots with political supporters.

His transgressions did not stop there: Allegations of corruption swirled throughout his two terms in office. Those charges finally caught up with him in June of last year, when the former president was arrested for his alleged role in an illegal arms-shipments deal. But after five months of house arrest, Mr. Menem was set free by his hand-picked Supreme Court.

Corruption in Argentina extends far beyond Buenos Aires. To get a first-hand look at the problem, I visited the northwestern province of Tucumán earlier this year. During the "dirty war" of the 1970s, Tucumán served as a refuge for pro-Castro guerillas and was roiled by bloody fighting. Today it is better known as home to the world's largest producer of lemons, as well as a now-declining sugar industry, and its problems are more prosaic: bloated and corrupt bureaucracy, and a backward and unreliable legal system.

The public sector in Tucumán, for example, serves primarily to enrich politicians and fund patronage jobs. Out of a formal work force of some 400,000, there are nearly 80,000 provincial and municipal government employees and another 10,000 federal government workers. Elected officials siphon off small fortunes for themselves: The annual salary for provincial legislators is roughly $300,000.

Tucumán is by no means noteworthy for such abuses. In the impoverished province of Formosa on the country's northern border, about half of all formally employed workers are on the government payroll, and many show up only once a month -- to collect their paychecks.

Such profligacy lies at the root of Argentina's present financial crisis. Government spending as a percentage of gross domestic product climbed to 21% in 2000 from 9.4% in 1989 despite the fact that sweeping privatizations were alleviating significant fiscal burdens.

And while the country's mess may begin in the capital, free-spending provincial officials bear much of the blame as well. Operating expenses at the provincial level rose 25% from 1995 to 2000 even though inflation was nonexistent. The spending binge was financed by an unsustainable runup of external debt -- the reckoning for which has now arrived.

Meanwhile, as the public sector ballooned uncontrollably, vital government responsibilities went unfulfilled, among them the provision of a legal system that promptly and reliably vindicates the rights of the citizenry. As a result, the acute financial traumas that now beset Argentina are compounded by a business environment that is profoundly hostile to investment, dynamism, and growth.

In San Miguel de Tucumán, the capital of Tucumán province, I spoke with Ignacio Colombres Garmendia, the head of a major law firm in town. "The legal system is absolutely vital for our region's economic development," he noted, "but the politicians are blind to it. It's hard to see what doesn't happen because of a bad legal climate, and so nobody knows about it. But every day I see deals collapse -- I see potential investors who decide not to come to Tucumán -- because of the legal risks. They call and ask me about this or that legal issue, and I have to tell them, and they say 'Thank you very much' and that's the end of it. 'The world is a big place,' a client told me once, 'and we don't need Tucumán.'"

It takes an average of five years to foreclose on a commercial mortgage in Tucumán. And given the punishingly high interest rates that prevail now in Argentina, delays like that can render even excellent collateral insufficient to cover the amount ultimately due. In a vicious circle, the risks caused by delay and uncertainty serve to drive interest rates up even higher. And, lo and behold, the net effect of a system that leaves investors and creditors so badly exposed is simple: less investment, less financing, and less growth and opportunity.

Market Economy
It is fashionable now to blame Argentina's problems on the free market. The country's latest president, old-school Perónist and unabashed protectionist Eduardo Duhalde, has joined the anti-market chorus by vowing to break with the "failed economic model" of the past decade. But Argentina's tragic crack-up occurred not because pro-market reforms went too far, but because they did not go nearly far enough.

A healthy market economy requires not just the absence of statist controls; it requires the presence of sound institutions. And although the reforms of the Menem era made strides toward meeting the former requirement, they ignored the latter altogether. Today Argentina is suffering grievously from that oversight. Until it is corrected and the country's ramshackle political and legal systems are overhauled, there is little hope that a stable and prosperous Argentina can emerge from the wreckage.

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