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Finance & Development
A quarterly magazine of the IMF
September 2005, Volume 42, Number 3

Book Reviews

How things went wrong in Argentina

Paul Blustein

And the Money Kept Rolling In (and Out)
Wall Street, the IMF, and the Bankrupting of Argentina

PublicAffairs, New York, 2005, 178 pp., $27.50 (cloth).

Paul Blustein has done it again. In 2001, he published The Chastening, a fascinating account of the currency and financial crises that began with the collapse of the Thai baht in 1997. Based heavily on interviews with the main participants—officials of the crisis-stricken countries, those of the major industrial countries, and those of the IMF—it sought to explain how and why so many costly mistakes were made in responding to the crises. In his new book, And the Money Kept Rolling In (and Out), Blustein turns to the Argentine crisis of 2001, relying once more on interviews with the key participants, but rounding out his story with vivid accounts of the terrible hardships suffered by the victims of the crisis.

Yet Blustein’s subtitle, which suggests outsiders are to blame for Argentina’s fall, is rather misleading. There is much in the book about Wall Street, especially about the all-too-familiar conflicts of interest besetting Wall Street analysts in investment banking firms that peddled Argentine debt, as well as the perverse incentives facing institutional investors who feared being "underweight" in the country’s debt. There is much in the book about the IMF and the debates within the Fund as Argentina’s plight grew graver. And Blustein is perfectly right to argue that Wall Street and the IMF made big mistakes. Wall Street, in the person of David Mulford, proposed a $15 billion "megaswap" that had the effect of reducing Argentina’s maturing debt but hugely raised the interest cost of subsequent debt service. The IMF, in the person of its Managing Director, Horst Köhler, gambled imprudently in August 2001, when, with the support of the U.S. Treasury, he decided that the IMF should lend an additional $8 billion to Argentina, of which $3 billion would be used in ways unspecified to catalyze a "voluntary" debt restructuring.

The main mistakes, however, were those made by Argentina, and the first one was made a full decade before the onset of the crisis. At the start of the 1990s, Argentina faced rapidly rising inflation, and Domingo Cavallo, the new Economy Minister, adopted a drastic response. On April 1, 1991, a new peso was introduced and was pegged at par with the U.S. dollar. Furthermore, the country’s central bank was constrained to operate much like a currency board; it could swap dollars for pesos but always had to hold enough dollars to "back" all of the pesos outstanding. The new regime served its immediate purpose—bringing down inflation and holding it down thereafter—but it was ill-suited to the country’s long-term needs. Argentina trades heavily with Brazil and Western Europe. Therefore, the depreciation of the Brazilian real vis-à-vis the dollar and the initial weakness of the euro made Argentina’s exports less competitive in the country’s most important markets. There is a dispute about the size of this effect, and Blustein sides with those who minimize its impact, but there can be no dispute about the terrible costs imposed by the flight from the peso late in 2001 and by the very disorderly way in which the peso-dollar link was severed.

Blustein is more critical, and rightly so, of Argentina’s addiction to debt. The IMF called repeatedly for fiscal reform, including reform of the strange arrangements that allowed the governors of Argentina’s provinces to hijack the tax revenues of the central government, but borrowing was easier than fiscal reform. And when, in the end, Argentina couldn’t issue additional debt, it adopted a draconian fiscal policy, cutting public sector wages as well as old-age pensions, at a time when the economy was contracting sharply. Blustein is perfectly right to blame Wall Street for lending too much to Argentina, but he would be equally right to blame Argentina for borrowing too much from Wall Street.

This is a remarkable book, rich in detail and very well written. It tells a tragic tale of dubious policies crafted by domineering personalities. Like The Chastening, however, it lays too much blame on outsiders and too little on those whose pride in their accomplishments led them to discount the grave risks they were running.

Peter B. Kenen
Senior Fellow, Council on
Foreign Relations
New York

Chasing the data as much as the money

Peter Reuter and Edwin M. Truman

Chasing Dirty Money
The Fight Against Money Laundering

Institute for International Economics, 2004, 226 pp., $23.95 (cloth).

The AML regime is no longer all about drugs." With these words, Peter Reuter and Edwin Truman reveal the new realities of the fight against money laundering. No longer focused solely on combating the drug trade, anti–money laundering (AML) regimes are now fighting everything from terrorist financing to corruption and tax evasion.

For those not familiar with the topic, the book’s early chapters serve as a primer. The authors define money laundering as the "conversion of criminal incomes into assets that cannot be traced back to the underlying crime." They review money laundering methods, markets, the estimated volume of money laundering activity, and existing preventive measures and enforcement tools.

According to Reuter and Truman, an ideal AML regime would be based on "national and international building blocks, a firm legal and enforcement foundation, and close interaction between the public and private sectors," whose overriding goal would be to ensure "uniform enforcement and seamless cooperation across national jurisdictions." But this ideal is not attainable because each country has its own institutions, perspectives, and priorities, they say.

Chasing Dirty Money is most compelling in its discussion of data on money laundering—or rather the lack thereof. The authors describe their attempts to find data to support their analysis in a number of areas, including the global scope of money laundering in real dollar terms; the financial and nonfinancial costs of money laundering to governments, the private sector, and individual consumers; and the effectiveness of prevention and enforcement. In all these cases, Reuter and Truman were unable to obtain information—raising questions about the effectiveness of current money laundering regimes, which are based largely on assumptions and anecdotal evidence.

The book is driven by the U.S. experience, which the authors believe is justified both because of the leading role the country plays in AML efforts and because the U.S. AML regime is the most advanced in the world, or so they say. But the authors present no facts to back up this last claim—for example, nowhere is there a robust comparison with other systems. The bias is not absolute, however, as the book does criticize aspects of the U.S. system. In the end, the reader is left to conclude that there is no perfect system, with the authors suggesting that more should be done to improve international cooperation, review existing laws, and strengthen enforcement.

Tanya K. Smith
Financial Sector Expert in the IMF’s Monetary and Financial Systems Department

Don't forget transaction costs

Arun Shourie

Governance and the Sclerosis that Has Set In

ASA/Rupa, New Delhi, 2004, 265 pp., Rs 395 (cloth).

Assessments of economic policy in developing countries often take for granted that the government, its institutions, and the legal framework will ensure good governance. This presumption is now being challenged by the new "transaction cost political perspective," pioneered by Avinash Dixit (Princeton University). Economic policy has to be negotiated at each stage—from formulation to implementation—with each concomitant cost being determined by the layers of institutions and procedures. Efforts to reduce these costs can be formidable when the work culture and ethos of existing institutions are at odds with the demands of economic development.

The insights of the transaction cost theorists are exceedingly well captured in Arun Shourie’s terse and episodic narrative of India’s transition from controlled to market economy. Shourie’s multidimensional personality as academic, international civil servant, passionate pro bono crusader, and idealistic disinvestment and planning minister makes this book instructive reading. He shows how first-best economic policies often fail for want of effective governance. For instance, he recounts the fate of many loss-making public enterprises that were slated for closing by the reconstruction agency: "Governments have not been able to act on the recommendation. Political pressure has been mounted to prevent closure. Stay orders have been secured from all courts. Pledges have been made that new revival schemes will be explored. And all the while the public exchequer has continued to be bled—to keep the corpses around."

State governments unable to raise resources because of caps on their borrowing do so surreptitiously by guaranteeing loans raised by corporations in their jurisdictions. And when public enterprises suffer heavy losses, the Indian government tinkers with "revival packages" that end up costing taxpayers millions of rupees. Despite strictures by government auditors, public sector enterprises carry on regardless of losses. This leads the author to formulate Shourie’s Law: "The more governmental an enterprise, the more unaccountable it is; the more unaccountable an enterprise, the more uncompetitive it is."

Equally egregious is Shourie’s example of a case of disinvestment as it worked itself through India’s labyrinthine system. A decision was made to disinvest some of the government-owned hotels. But the process dragged on for many reasons: the workers’ union would not allow the disinvestment advisers to visit the hotels; it proved impossible to figure out who owned the land on which the hotels had been built and what the terms and conditions were for the lease; and then there was the interministerial squabbling. In the end, only a few hotels were divested and with enormous cost and waste of resources. Shourie also recounts the attempt of the finance ministry to draft a model tender document for civil projects for which international bids were invited. Committee after committee was set up over 12 years to settle the issue, ignoring the fact that standard bidding documents for international bidding were already being used in all World Bank-assisted projects.

If weak governance and institutions can imperil economic progress in India, a poster child for shining growth, where does that leave very poor countries with ill-educated populations and endemic social conflicts that lack historical, legal, and institutional culture? Shourie’s book contains chastening lessons for international financial institutions that blithely put the cart of well-chiseled macroeconomic policies before the horse of indispensable microeconomic preconditions (including those related to appropriate institutions and good governance); for the bemused missionaries of massive foreign aid to lawless countries; and for the new breed of development economists who see virtue in homegrown programs—the latest buzzword in countries lacking an effective autonomous policymaking apparatus.

Deena Khatkhate
Former Assistant Director of
the IMF’s Monetary and
Financial Systems Department