TCS Daily

Celebrate Bad Times, C'mon!

By Diego Aycinena - December 20, 2002 12:00 AM

One year has passed since Argentina spiraled into an economic meltdown and there doesn't seem to be a light at the end of the tunnel. The Economist Intelligence Unit estimates Argentina's GDP has contracted by 13% over the past year, the peso has lost 250% of its value against the dollar, the savings of thousands of individuals have been wiped clean, and the real debt burden of many firms has multiplied, rendering countless businesses bankrupt. To make matters worse, the country recently defaulted on its debt payment to the World Bank, the president of the Central bank resigned a few weeks ago and, as if this wasn't enough, Argentineans are preparing to celebrate with another cacerolazo, the social protests, riots, and looting that took place a year ago, when thousands of people took to the streets banging pots and pans, ousting the government, and forcing Fernando de la Rua to resign as President. That's right, this is how they're celebrating.

Needless to say, riots, looting, and social unrest do not a good economy make. They will only narrow the slim possibility of recovery. But the most fundamental problem is not the way Argentineans are protesting, but what they are protesting. The purpose of the protest is to demonstrate support for "alternatives to the dictatorship of the markets" and promote alternative economic systems to capitalism.

Misspecification of the causes of crisis and populist solutions are common in Latin America, and blaming the market for any problem an economy faces is nothing new. In the face of the most recent crisis, Argentina is following suit.

With thousands of people behind the protests, and a year's worth of hindsight, it is worth taking a closer look at their claim. As one might expect, the culprit is not the dictatorship of the market or unbridled capitalism. Argentina's original sin - the one that keeps coming back to hurl a seemingly stable economy to the ground - is its excessive government expenditures and fiscal irresponsibility.

Argentina has a long history of fiscal deficits, which have translated into inflationary and often hyperinflationary episodes. Beginning in the early 1990s Argentina adopted a quasi-currency board arrangement to bring to a halt the ongoing hyperinflation and engaged in some minor free market reforms, without fixing the fundamental problem. These intermediate reforms are now bearing the brunt of the current outrage.

The so-called free market reforms, however, were used to a considerable extent to fuel increases in government spending. These took the form of "privatizing" utilities - effectively creating protected monopolies - as a means to obtain more resources for the government to spend. While waving a free market flag, Argentine government expenditures increased from 27% of GDP in 1991 to 35% in 2000, financing the increasing budget deficit with the funds obtained from privatization.

After all the revenues generated by privatization were spent, the only option for financing the deficit was through foreign debt. So Argentina started borrowing until it was indebted to the tune of $150 billion and its fiscal deficit reached 4% of GDP. The rest, as they say, is history. The modern day Argentine crisis ensued. The myriad causes include large budget deficits, increased government debt, and an unorthodox currency board system. Noticeably absent from the list is the "dictatorship of the market" and "unbridled capitalism". (But who ever went to the streets, pots in hand, to protest an ill-arranged currency board?)

The crisis deepened when the government froze bank deposits, which fueled the social unrest that gave Argentina five presidents in the months between December 2001 and January 2002.

The reforms adopted by Argentina during the 1990s addressed the symptoms of excessive government expenditures without altering the underlying framework. The high levels of government spending in Argentina can be blamed on a vicious incentive structure of centralized taxation and revenue sharing with decentralized budget determination and spending. Under this system, the provinces do not have to face the political costs of spending more, since their revenues depend to a considerable extent on the taxes raised by the federal government. When examined in this light, it's no wonder the provinces spend, spend, spend and then, like a spoiled child whose parents have been bled dry, beam with outrage when the money stops flowing.

Argentina's history is on par with any classic tragedy. One of the richest countries in the world for the first part of the twentieth century, it has managed to ruin itself through repeated periods of hyperinflation and financial debt, banking crises helped along by periods of political and social unrest, and several coups d'etat. But perhaps the greatest tragedy is Argentina's apparent inability to learn from its own history and understand the causes of its misfortunes: excessive government spending will invariably lead down the road to disaster. It makes little difference whether one travels via inflation or opts for government debt.

If Argentineans want to prevent future crises, they must engage in structural reforms that deal with these seemingly never-ending problems. They must fix their public finances by controlling government expenditures and make the provinces more responsible for their own tax revenues by reversing the fiscal relation of the federal government with the provinces. Let the provinces collect taxes and share a percentage of their tax revenues with the central government. This way, at least, the provincial governments will face the political costs, and if there are to be riots, they will be well targeted rather than aimed at some boogeyman notion of the market.

Diego Aycinena is a Social Change Research Fellow at the Mercatus Center at George Mason University and a member of the Economics Department at Mason. He received his undergraduate degree in Economics from Francisco Marroquin University in Guatemala.

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