Argentina and the Challenge of Globalization — Address by Michel Camdessus
May 27, 199696/11
Managing Director of the International Monetary Fund
Academy of Economic Science
Buenos Aires, Argentina, May 27, 1996
Thank you for your kind words and your warm welcome to the Academy of Economic Science. In coming here today, I am reminded of the many important contributions that Argentines have made in the field of economics, beginning with the influential contributions of Raúl Prebisch and Julio Olivera, whose pioneering work is being carried on today by many distinguished Argentine economists—so many, in fact (many of them are here with us today) that it would take a long time to name them all.
This is now my fourth trip to Argentina as Managing Director of the Fund, and each time I come here, I am amazed by how much things have changed since I first took office—now nearly ten years ago. I need hardly remind you that, back then, there were still important doctrinal differences between Argentina and the IMF—about the appropriate roles of the state and the private sector, the merits of economic liberalization, the need for fiscal equilibrium, and the virtues of deregulation. More than that, I recall that the term "Fund orthodoxy" had a negative connotation in Argentina in those days and that Fund missions provoked considerable public debate.
Today, there is no longer any doctrinal divide, and the arrival of IMF missions no longer causes a stir. Personally, I am delighted by this change of events. Why is the atmosphere so different today? Clearly, because of the fundamental changes that have taken place in recent years—in Argentina, Latin America, and the world. But it goes deeper than that. There is now considerable commonality of views throughout Latin America, and in much of the rest of the world, about what constitutes effective economic policy.
We at the Fund see ourselves as a clearing house and forum for discussion of these new approaches. When we observe policies that work well in many countries, we try to bring these successes to the attention of other countries, so that they too can benefit from this positive experience. For a number of years, the Fund shared such lessons with Argentina—to spread the word about the "silent revolution" that was transforming countries from inward-looking, heavily regulated, undercapitalized economies into stable, outward-oriented, rapidly growing ones. And a few years ago, Argentina became part of this revolution, moving decisively to overcome structural impediments and eliminate distortions. As a result, Argentina is no longer an inflation-prone country on the verge of hyperinflation, but a low-inflation country with great economic promise. So now when I come to Argentina, I no longer see the dramatic symptoms of crisis, but rather what is in many respects a blueprint for success. My intention, then, is not so much to disseminate the lessons we have learned elsewhere—but to draw lessons from Argentina's experience that we can share with others. Against this background, I would like to take this opportunity to reflect upon some of the changes that have been taking place in Argentina, Latin America, and the rest of the world and to offer a few observations about what these changes imply for the future—for Argentina and the Fund. I am less concerned with focusing on recent theoretical innovations in our shared discipline; rather, mindful as I am of your Academy's interest in providing practical input for strategic thinking by Argentina's economic leadership, I will try to take a more down-to-earth approach toward the issues of the day.
Since the late 1980s, there has been a drastic shift in the orientation of economic policy in Argentina. The Convertibility Law established fiscal and monetary discipline as the centerpiece, and this, along with structural reform, including a more open trade policy, privatization, exchange and financial liberalization, deregulation, normalization of international financial relations, and restoration of access to international markets, made a decisive difference in your country's economic performance. Indeed, during 1991-94, Argentina's determined adjustment and reform efforts were rewarded with strong capital inflows, a sharp recovery in domestic demand, the overhaul and modernization of the production structure, and average real economic growth of over 7 1/2 percent per year.
Argentina's experience was part of a larger transformation that had been taking place throughout Latin America and the Caribbean over the last decade, as countries jettisoned economic strategies based on import substitution and a heavy government role in the economy and adopted comprehensive adjustment and reform programs. This process opened up opportunities that were firmly grounded in the region's resource base and the positive externalities of globalization. As part of this shift in policy, major changes were introduced in tax policy and administration, the quasi-fiscal losses of central banks were reduced, public enterprises were restructured and privatized, and public expenditure was reduced and redirected toward the development of human capital and infrastructure. At the same time, controls on interest rates and prices and cumbersome exchange restrictions were abolished, and trade and financial liberalization proceeded rapidly.
Make no mistake: the results of these reforms were dramatic. The region's overall fiscal deficit narrowed from an average of 4 1/4 percent of GDP in 1988-89 to about 1/2 percent of GDP in 1990-94. And, excluding Brazil, where economic adjustment has been more recent, the region's average rate of growth rose from 1 1/2 percent per year in 1985-89 to about 4 percent per year in 1990-94. Meanwhile, inflation declined from 150 percent in 1989 to 15 percent in 1994. On the external side, however, the region's current account deficit widened to about 3 percent of GDP per year in 1992-94, after averaging about 1 percent of GDP per year during several previous years. This was due in part to the relative weakness of domestic saving at a time of sharply increasing investment, including imports of capital goods needed for industrial modernization, which were facilitated by the increased access to international capital markets.
In my view, this sea change in policies and performance is associated with two phenomena of profound and universal significance; first, the changing role of the state, and second, the globalization of the international capital markets.
As regards the role of the state, it is now nearly universally accepted that the most effective economic strategies are private sector-led and outward-oriented. The strategies that have been systematically adopted in the OECD countries, with various shadings, have been the secret of success in East Asia, and they are in turn generating fresh opportunities in Latin America and other regions of the world. Conversely, there is ample evidence that when the state dominates the economy, resources are often misallocated, and private investment and growth suffer. To be sure, governments do have an important role to play, but it is mainly facilitating economic activity—not taking the place of private transactors.
The globalization of the international capital markets has also had far-reaching effects. Net private capital inflows to developing countries soared from an average level of $10 billion per year in the mid-1970s to over $100 billion per year in the first half of the 1990s. Although the most spectacular increase occurred in Asia, by 1994 private capital inflows to Latin America registered about $50 billion, or approximately one third of total private capital inflows to developing countries.
Clearly, the availability of such vast amounts of capital has opened up many new opportunities to increase investment, modernize technology, raise production, accelerate growth, and create employment in the developing countries. But over-reliance on external capital flows also entails risks. As last year's crisis in Mexico so amply demonstrated, a perceived lack of macroeconomic discipline can lead to a rapid and destabilizing reversal of capital flows. Moreover, given the high degree of financial market integration today, crises can quickly spill over into other markets, producing serious adverse effects on other countries as well.
What conclusions should be drawn from the experience in Mexico, which, given its features, I suspect may come to be regarded as the first crisis of the twenty-first century? Allow me to mention four of the most important.
First, the experience in Mexico—and indeed, the experience throughout Latin America since 1994—has reconfirmed that the quality of a country's economic policies makes a difference. Of course, we knew that sound economic policies were a key factor for sustained growth. But Mexico confirmed an important corollary: irrespective of past efforts or achievements, the loss of economic discipline in the face of other adverse developments can have a severe impact on market confidence, with devastating effects on output, employment, and future market access. Although the dramatic political events that occurred in Mexico in 1994 certainly helped trigger the crisis, it is clear that the policy response to those events also played a role. Indeed, the Fund had warned of the need for Mexico to increase domestic savings, reduce its current account deficit, and thereby reduce its vulnerability to a sudden reversal of capital flows.1 With the benefit of hindsight, we can see how valid those warnings were. At the same time, it was the efforts of the Mexican authorities to adjust their policies in the aftermath of the crisis, more than the announcement of major international financial support—which we at the Fund are proud to have arranged—that ultimately reversed the tide.
Second, the crisis reconfirmed that the consistent implementation of policies over time has an important effect on confidence. For example, the fact that Chile was largely unaffected by the spillover effects of Mexico's crisis clearly demonstrates the advantages of making an early start on reform and pursuing it steadfastly until success is achieved. And although the reform process came later in Argentina, your prompt and comprehensive action to strengthen your country's policy stance in the face of the Mexican crisis was decisive in preserving the economic progress already achieved and in restoring credibility.
Third, events since late 1994 have illustrated that once credibility is lost, it takes time to regain it, and the costs in terms of activity and employment can be extremely high. Indeed, notwithstanding the policy strengthening that has taken place in many Latin American countries, international investors continue to view the region with caution.
Fourth, the Mexican crisis exposed the vulnerability of the region's domestic financial systems. Inadequate supervision—at a time of high real interest rates and large private capital inflows—has led to serious problems in the banking systems of many countries. In Mexico, for example, the combination of recession and high real interest rates has caused loan arrears and collection problems and a deterioration in the quality of bank portfolios. In Argentina, the unprecedented loss of deposits in the early months of 1995 did, however, lead to a widespread restructuring as a result of which some financial institutions were closed, others were merged, and provincial banks began to be privatized. If, as I hope, this leads to a considerable strengthening of your financial system, your authorities will have demonstrated their leadership and vision, while making virtue out of necessity!
It has now been about a year and a half since the onset of the crisis in Mexico. Since then, there has been much reflection—at the Fund and in the region—about what countries can do to enhance their prospects for economic stability and growth in today's global economy.
It is abundantly clear, first of all, that in today's global environment, market perceptions are decisive in determining where capital will flow. Hence, countries that hope to attract private capital inflows must pursue policies that the market believes will result in economic stability and growth. It follows that emerging market economies face two related challenges. The first is to establish a climate of domestic economic confidence conducive to savings, investment, and production. The second is to convince economic agents, both domestic and foreign, that this climate will be an enduring one. How can countries achieve these two deceptively simple objectives? In my view, the strategy must be based on three key elements: first, consistent and stable macroeconomic policies; second, comprehensive structural reform; and third, good governance. Let me say a few words about each and how they relate to Argentina.
First, consistent and stable macroeconomic policies. Increasingly, the maintenance of low inflation rates has become a key criterion for evaluating the success of macroeconomic policy. There is near-universal consensus that this is the necessary condition for sustained and equitable economic growth. On that basis, a common perception is emerging with regard to the strategy needed to achieve this objective. In the first instance, it is vital to have a disciplined fiscal policy that encourages increases in domestic saving and provides room for a well-targeted social safety net. In addition, it must ensure a satisfactory level of public investment in basic infrastructure and human capital, and it must not crowd out the private sector, but rather enhance its effectiveness. There is also consensus regarding the need for a firm, anti-inflationary monetary policy and the maintenance of international cost competitiveness.
Second, appropriate structural policies. This is a particularly important area for emerging market economies for several reasons. To begin with, structural reforms, such as privatization, labor market reform, and measures to increase domestic competition, among others, promote greater efficiency and thus allow countries to make more effective use of their resources. Appropriate structural reforms are essential to foster a strong supply response to emerging economic opportunities by helping to ensure that markets are flexible and competitive and the economy is outward-oriented. Moreover, appropriate structural reforms in such areas as trade liberalization, privatization, and labor market reforms increase the chances that private capital inflows will take the form of productive, long-term investment; not only is such investment good for emerging market economies, it helps reduce the recipient countries' vulnerability to sudden reversal of capital flows. Finally, it is clear that if countries are to retain the confidence of markets, governments must be prepared to adjust policies when needed. This, in turn, points to the importance of strengthening domestic institutions in the budgetary and banking areas, so that the required measures can be adopted when the need arises.
Third, good governance. By this I mean establishing an institutional and legal framework that gives confidence to savers and investors. To do this, governments must demonstrate that they have no tolerance for corruption. In addition, they must fulfill the functions for which they are uniquely qualified, including providing reliable public services, establishing a simple and transparent regulatory framework that is equitably enforced, and guaranteeing the professionalism and independence of the judiciary. Good governance also involves establishing appropriate social policies to combat poverty and marginalization, including well-targeted social safety nets, and policies that promote greater equality of opportunity and income distribution. But we must not underestimate the importance of selective, high-quality public expenditure in reconciling equity and fiscal solvency. Further, good governance involves national dialogue, so that the public understands and broadly supports the policy framework in place. Indeed, the credibility of economic policy hinges on a sufficient consensus in favor of reform—so that the market will have reasonable confidence that the essential policy conditions for economic stability and growth will endure.
Where does Argentina stand vis-à-vis the strategy that I have just outlined? I am pleased to say that since 1991, Argentina has been making steady progress in establishing the three elements that I have just described in a context of virtual price stability. Indeed, the relative speed with which domestic bank deposits have been restored, the increase in stock and bond prices following their sharp losses in early 1995, and the renewed access to the international capital market in the wake of the Mexican crisis are all positive indications of how much progress has been made in building confidence in economic management in Argentina. What does this suggest about what should be Argentina's priorities for the near future?
We at the IMF fully agree with the Argentine authorities that Argentina should maintain—and strengthen—its present policy course. Indeed, this is the basic purpose of the program that the IMF has agreed to support with a 21-month stand-by arrangement. The recovery in output, which is just now beginning to take hold, depends mainly on continued strengthening of private sector confidence, and continued macroeconomic policy discipline is essential to achieve this. In this regard, the Convertibility Law has served an essential function over the last five years in reinforcing Argentina's commitment to fiscal discipline and price stability; accordingly, it is continuing to play a critical role in restoring confidence.
At the same time, Argentina wants to continue consolidating its fiscal position, both to underpin the Convertibility Law and to enhance confidence. Over the medium term, the goal should be to achieve a balanced fiscal position for the entire public sector, including provincial governments. Clearly, this will require major reforms to redress fiscal imbalances in many provinces. These reforms should seek to reduce nonproductive activities that burden the productive sectors, which in turn will necessitate a review of unnecessary bureaucracies and other key issues. The envisaged reforms will also entail rationalizing the provincial tax bases, privatizing banks and enterprises, and restructuring social services, including social security arrangements. Meanwhile, it will be important to ensure that the government's limited resources are used as effectively as possible—so that an appropriate balance can be struck between the fiscal prudence required to build private sector confidence and the expenditure needed to meet essential social needs; greater efficiency in social policies—in particular, employment promotion policy—should be the ultimate objective of this rationalization.
Unquestionably, it is this objective that requires the adoption of new structural reforms aimed at enhancing private sector confidence and reactivating the private sector. Successful privatization will help mobilize additional fiscal resources and allow the government to concentrate on those other functions that I referred to earlier that are more central to the proper role of the state: in short, having government do what it is truly able to do. In the banking sector, progress is being made in privatizing provincial banks and restructuring the smaller private banks; persevering with this process will help improve bank efficiency and lower interest rate spreads. Likewise, the reform of the labor code is increasing labor market flexibility. This is essential if the economy is to generate the kind of employment which the highly skilled labor force demands, bearing in mind that the participation rate—particularly among women—is now more closely approaching the levels found in the industrial countries. As fiscal consolidation takes hold, further action to help reduce the level of payroll taxes would also be desirable, as long as this is consistent with a sustainable fiscal position.
And finally, a word on governance. Without question Argentina has come a long way in deregulating its economy: establishing a more transparent regulatory system; introducing a legal system that is not only independent and impartial but swift to the task and in step with the times, thereby ensuring certainty as to the law; and otherwise enhancing the confidence of savers and investors. Nevertheless, there is still work to be done. Is it not reasonable to believe that this recovery of confidence also reflects to some extent the expectation that this process will continue to be strengthened? This expectation of good governance ought not to be disappointed in this new environment where all countries are competing for the market's confidence.
In closing, I would like to make a few final observations.
If the Mexican crisis has provoked a re-evaluation of country policies both here and in many other countries, what changes has it prompted at the Fund? Certainly the Fund's objectives have not changed. We are still taking action "...to give confidence to members..." and to provide them the "...opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity." This is in essence what we did with the Argentine Government in the aftermath of the Mexican crisis at end-1994. Allow me, if I may, to pay tribute here to the Minister who was the first in Latin America—when the crisis broke—to suggest to me point-blank that we jointly address an issue that today may seem obvious: how to turn this crisis into an opportunity.
Nevertheless, prevention is better than cure. Accordingly, the Fund has taken a number of steps to strengthen its surveillance over member countries' policies, so that emerging problems can be detected and addressed before they become full-blown crises. In this connection, we have sought to develop a more continuous and probing dialogue with member countries. We are also paying greater attention to the soundness of banking systems, to the sustainability of financial flows, to countries potentially at risk, and to countries where financial market tensions could have systemic spillover effects.
At the same time, we have clarified the procedures under which the Fund can respond rapidly to fulfill our mandate of giving confidence to members and the international monetary system. As our Executive Board has made clear, the use of such procedures must be limited to truly exceptional circumstances; our support must be decisive, when justified, while remaining conditional and catalytic in nature. Care should also be taken to ensure that the possibility of relying on the Fund is in no way regarded as a guarantee against sovereign default.
The Mexican crisis also led us to the conclusion that in a globalized world with large capital flows between countries, there is a premium on transparency. International capital markets function more smoothly when they have reliable, regular, and up-to-date information available on countries' economic performance. For this reason, the Fund has developed standards to guide members in the dissemination of economic and financial data, so that markets will be better informed—and less prone to surprises. The system has two tiers: there is a basic minimum standard applicable to all countries, while a more demanding "special data dissemination standard" has also been adopted, aimed primarily at countries seeking to tap the international capital markets. In Argentina, there has been a notable improvement in the availability, quality, and comparability of economic data in recent years, and we trust that your country will join those that have agreed to the more demanding standard.
Finally, Mexico also demonstrated that the Fund must have adequate financial resources so that it continue to fulfill its mandate in this globalized, and at times unpredictable, world. We were indeed fortunate to be in such a highly liquid state in January 1995!
At present, there are other major users of Fund resources in addition to Mexico, including Russia and, yes, Argentina—and this is reflected in the Fund's declining liquidity. Thus, we are taking steps to strengthen our resources. In this connection, work is underway on the Eleventh General Review of Quotas, and this will remain our top priority. Quotas are the main resource base for IMF lending, and we are aiming for a substantial increase in quotas—hopefully a doubling. In addition, as you may know, the G-10 countries are establishing parallel financing arrangements complementary to those already in place, with the aim of doubling the credit lines currently available to the Fund under this mechanism, which would enable us to have access to a total of approximately $50 billion for just such situations. I might also mention that we are also working to secure the necessary resources for the Enhanced Structural Adjustment Facility (the "ESAF") so that the Fund can continue to assist its poorest members on appropriate terms, namely, interest-free. Argentina has contributed to the ESAF in the past, thereby demonstrating that it regards solidarity with the poorer countries as a universal responsibility. We hope that it will continue to do so in the future.
The last eighteen months that have elapsed since the onset of the Mexican crisis have been trying times—certainly for Mexico, but also for many other countries, and with them for the Fund. Yet looking ahead, the prospects for a full recovery are favorable—both in Argentina and the region. This is because of the macroeconomic stabilization, structural reforms, and improvements in governance that Argentina and others undertook in the early 1990s and, indeed, because of the policies they are continuing to pursue today. In this world of such violent upheavals, we all must share a common duty: to persevere and maintain confidence in your future and in your country's future!
1. 1994 Annual Report, International Monetary Fund.