Economic History of Argentina - Free-market Reforms

Free-market Reforms

The Peronist Carlos Menem was elected president in May 1989. He immediately announced a new shock programme, this time with more fiscal adjustment in view of a government deficit of 16% of GDP. In November 1989 agreement was reached on yet another standby with the IMF, but again the arrangement was ended prematurely, followed by another bout of hyper-inflation, which reached 12,000% per year.

After the collapse of public enterprises during the late 1980s, privatisation became strongly popular. Menem privatised almost everything the state owned, except for a couple of banks. In terms of service there were indisputable improvements. For example, before the telephone privatisation, to get a new line it was not unusual to wait more than ten years, and apartments with telephone lines carried a big premium in the market. After privatisation the wait was reduced to less than a week. Productivity increased as investment modernised farms, factories and ports. However, in all cases, there were large outlays of employees. In addition, the process of privatisation was suspected of corruption in many cases. Ultimately, the privatised enterprises became private (rather than public) monopolies. Their tariffs on long-term contracts were raised in line with American inflation, even though prices in Argentina were falling.

In 1991, economy minister Domingo Cavallo set out to reverse Argentina's decline through free-market reforms such as open trade. On 1 January 1992, a monetary reform replaced the austral with the peso at a rate of 10,000 australs for 1 peso. The cornerstone of the reform process was a currency board, under which the peso was fixed by law at par to the dollar, and the money supply restricted to the level of hard-currency reserves. After a lag, inflation was tamed. With risk of devaluation apparently removed, capital poured in from abroad. GDP growth increased significantly and total employment rose steadily until mid-1993. During the second half of 1994, the economy slowed down and unemployment increased from 10% to 12.2%.

Although the economy was already in a mild recession at this point, conditions worsened substantially after the devaluation of the Mexican peso during December 1994. The economy shrank by 4%, and a dozen banks collapsed. With the labour force continuing to expand and employment falling sharply along with aggregate demand, unemployment rose by over 6% in 6 months. But the government responded effectively: it tightened bank regulation and capital requirements, and encouraged foreign banks to take over weaker local ones. The economy soon recovered and, between 1996 and 1998, both output and employment grew rapidly and unemployment declined substantially. However, at the beginning of 1999, the Brazilian currency underwent a strong depreciation. The Argentine economy contracted 4% in 1999, and unemployment increased again.

Exports grew from $12 billion in 1991 to $27 billion in 2001, but many industries could not compete abroad, especially after Brazil's devaluation. The strong, fixed exchange rate turned the trade balance to a cumulative US$22 billion in deficits between 1992 and 1999. Unable to devalue, Argentina could only become more competitive if prices fell. Deflation came from recession, falling wages and rising unemployment. Interest rates remained high, with banks lending dollars at 25%.

The share of public spending in GDP increased from 27% in 1995 to 30% in 2000. Some poorer provinces had depended on state enterprises or on inefficient industries, such as sugar, which could not compete when trade was opened. To quell social unrest, provincial governors padded their payrolls. The government had embarked on a pension reform with costs reaching 3% of GDP in 2000, as it still had to pay pensioners but no longer received contributions.