IMF 'cure' is adding to crisis in Argentina

 

WORLDVIEW: When Argentina's financial crisis first exploded, I pinned the primary responsibility on Argentina itself, rather than on international institutions such as the IMF. Now, half-a-year later, the balance of responsibility needs to be reconsidered. Even though Argentina is, in the last analysis, mainly responsibility for its fate, the IMF is not helping.

The problem is not only, or even mainly, the IMF's delay in providing money to Argentina. The bigger problem is the paucity of correct ideas coming from the IMF.

The IMF lacks a clear idea about what to do in Argentina. It continues to pound on one theme alone: that Argentina's economic crisis is the result of fiscal profligacy, the result of a government living beyond its means. So it emphasises the need for Argentina to cut budget expenditures.

As Argentina's crisis worsens, indeed with output possibly collapsing by 10 to 15 per cent this year and with unemployment soaring, the IMF keeps asking for deeper cuts. This is something like the 18th century medical practice in which doctors "treated" feverish patients by drawing blood from them, weakening the patients further and frequently hastening their deaths.

This IMF approach was abandoned in rich countries about 70 years ago during the Great Depression. When output crumbled due to a profound banking and financial crisis (linked to the collapse of the gold standard), tax revenues plummeted in the US and Europe, and conservative governments tried to cut budget spending to limit budget deficits.

As they cut, output fell further and economic misery deepened. In 1936, John Maynard Keynes demonstrated the futility of trying to balance the budget in the midst of an economic depression.

The IMF is tragically ignoring this logic in Argentina. Argentina's widening budget deficit is mainly the result of its economic collapse since 1999, not the cause of it. The deficit was relatively mild until 1999, when the economy went into recession.

Yes, budgetary waste exists, but it is not the cause of an extreme macroeconomic crisis. The recession was mainly caused not by budgetary spending, but rather by Brazil's sharp devaluation of its currency in February 1999, a step which made Argentina's own peso uncompetitive and led investors (rightly, it turned out) to expect a similar devaluation in Argentina.

As investors fled the country because of fear of devaluation (in a period in which the Argentine government was promising never to devalue the peso, fixed at one-to-one with the US dollar), interest rates rose and bank deposits fell. This deepened the recession in 2000 and 2001 and led to a rising budget deficit because of declining tax revenues. Argentina's government of the time (under President de la Rua) and the IMF tried the Depression-era false "cure" of budget cuts, but there was no way that austerity could keep up with falling tax revenues. The budget deficit continued to widen as the economy collapsed.

The correct approach to solving Argentina's problems in 2001, and now, would have been to end speculation over devaluation. I favoured the approach of "dollarisation", or replacing the peso by the US dollar and thereby ending the fear of a future change of the exchange rate.

Instead, the government closed down the banking system, so that depositors could no longer convert their pesos into dollars. Closure of the banking system led to a full collapse of confidence in the country. Now, Argentines are emigrating to Europe and the US in large numbers and are trying to convert pesos to dollars at any opportunity. The peso is collapsing in value, and the bank system remains frozen. The economy is "dead in the water".

The correct move now is to restore confidence in the banking system and the currency. This can best be accomplished by dollarising the economy, just as Argentina should have done last autumn. In addition, the international community should offer emergency funding to help provide deposit insurance for the banking system, thereby re-establishing a modicum of confidence in financial institutions.

INTERNATIONAL banks in Argentina should work with the government to restore banking functions within days, not months. Argentina should be given a year's full suspension of payments on its foreign debts, to be followed by a deep reduction in overall indebtedness. With banks reopened, a currency that works, and suspension of debt servicing, some short-term IMF loans could boost confidence and help the country overcome its crisis of confidence. Only then should the Government pledge a responsible path of budget spending, but not extreme cuts.

Instead, the IMF recommends antiquated and phoney solutions. By focusing on the budget deficit, it is chasing symptoms, not causes. It is putting forward economically and politically impossible recommendations, telling Argentina to cut public services to the extreme, when schools and hospitals are already on the verge of collapse.

For centuries, doctors weakened or killed their patients in large numbers through bleeding, until medicine became a science. It is high time the IMF approached its mission scientifically and recognised that it is on the wrong track in Argentina. As a result, the IMF must increasingly share responsibility and blame for Argentina's havoc.

Jeffrey D. Sachs is Galen L. Stone Professor of Economics, and Director of the Center for International Development, Harvard University. Copyright: Project Syndicate, April 2002