NAME: ANANDE SITHEBE

LECTURER: DEVON WINDVOGEL

DUE DATE: 22 APRIL 2024
MODULE: INTRODUCTION TO ECONOMIC CONCEPTS
TITLE: ASSIGNMENT 1- ESSAY 2
The 2001 Argentine economic and financial crisis has many parallels with the problems
that some European countries are facing today. Prior to the crisis, Argentina was
suffering a deep recession, large levels of debt, twin deficits in the fiscal and current
accounts, and the country had an overvalued currency but devaluation was not an
option( Kiguel, M., 2011). In this essay, we will be looking at the nature and causes of
Argentina's economic crisis.
ECONOMIC GROWTH:
Argentina emerged as a pivotal example of pro-globalization economic strategies in the
early 1900s. However, the belief in globalization’s irreversible nature was challenged by
the tumultuous events of the December 2001 economic crisis and subsequent social
unrest. This crisis culminated in the downfall of two presidents within a mere week and
the catastrophic collapse of the Argentine economy. A shift in focus towards the
domestic market was necessitated to navigate the nation out of a prolonged recession,
marking a departure from the prevailing pro-globalization narrative as internal matters
took precedence over external economic policies. In the United States, there was a
prevalent sentiment attributing the crisis to Argentina’s failure to adopt what were
deemed as “appropriate” macroeconomic measures by official circles. The country had
been widely commended as a leading proponent of Washington Consensus policies
during the 1990s, encompassing fiscal discipline, trade and financial liberalization,
privatization of state-owned enterprises, economic deregulation, and restructuring of the
pension and energy sectors (LIXXIX, pp. 100-117, 2014). These measures were
reinforced by a fixed exchange rate policy, mandated by law in 1991 and maintained for
a decade until the severe economic upheaval of 2001–2002. This policy compelled the
Argentine peso to be pegged at a 1:1 ratio to the US dollar, under the guise of
promising low inflation, economic growth, technological advancement, enhanced
productivity, trade surplus, and increased consumption through neoliberal reforms
advocated by the authorities.
Conversely, the aftermath of a decade of trade liberalization, fixed exchange rates, and
global market-driven pricing led to the decimation of the country’s industrial base. The
government’s response in December 2003 included substantial wage cuts, pension
reductions, educator salary slashes, and widespread job terminations, marking a drastic
turn in economic policy. Surprisingly, Argentina witnessed a resurgence in economic
activity by late 2002, albeit grappling with persistent social and economic challenges like
high poverty and unemployment rates. To avert defaulting on its obligations to the
International Monetary Fund (IMF), Argentina entered a short-term transitional
agreement of $6.8 billion on January 16, 2002, yet remained in default concerning its
private debt. This arrangement facilitated the rollover of IMF repayments until August
2003, contingent on devising a sustainable medium-term solution by September 9,
2003. Following a credible election with substantial voter participation (80%), Governor
Nestor Kirchner emerged victorious, providing the stability necessary to conclude the
interim presidential term. Argentina initiated reform measures even before Kirchner’s
tenure, underscoring the ongoing need for sustained reforms to foster enduring
economic growth and stability. Subsequent judicial decisions led to the unfreezing of
bank deposits, replacing alternative currencies with pesos, and reinstating fiscal
oversight. While Argentina’s economy has exhibited signs of stabilization, further
structural overhauls are imperative to fortify its economic foundation and ensure lasting
stability.
UNEMPLOYMENT:
The study by John Edward Hernandez and Blanca Zuluaga (2022) highlights that the
impact of unemployment was not evenly distributed among households due to varying
abilities to withstand economic shocks. Vulnerable households, including those with
more children, male heads, lower education levels, and employment in the private
sector, experienced significant income reductions during the crisis period. The
escalation of unemployment rates and prolonged joblessness, particularly evident
towards the end of 2001, affected males, self-employed individuals, and those with
limited education and experience the most. Conversely, public sector employees were
relatively insulated from the labour crisis’s effects. Argentina’s response to the surge in
unemployment and poverty, known as Plan Here’s and implemented in May 2002, acted
as a safety net that helped prevent some families from falling into poverty. Despite its
success in this regard, the ongoing nature of the program, which provides benefits to
eligible unemployed individuals indefinitely, may have unintended consequences.
During this period, aside from those involved in emergency relief work, the
unemployment rate surged from 12.4% in 1998 to 38.3% in 2001, subsequently falling
to 23.6% in 2002. Concurrently, the poverty rate increased from 25.9% in 1998 to
38.3% in 2001 and soared to 57.5% in 2002.
Mario (2003) states that during the economic crisis of December 2001, wealth in
Argentina was dramatically affected in a variety of ways: Asset depreciation: During the
crisis, the value of assets including real estate, equities, and bonds fell dramatically.
Individuals and families who had invested in these assets suffered significant financial
losses as a result. Currency depreciation: During the crisis, the Argentine peso
depreciated dramatically, resulting in a sharp drop in the purchase power of individual
savings and assets denominated in the local currency. The devaluation had a
considerable influence on wealth and financial stability. Job losses and income
reductions: During the crisis, many people lost their jobs or saw their earnings drop
drastically. This resulted in a direct loss of wealth and financial security for individuals
and families that relied on their earnings to get by. Bank closures and withdrawal
restrictions: During the crisis, many banks in Argentina restricted cash withdrawals,
causing people’s savings and financial assets to be frozen. This worsened financial
hardship for individuals and families, limiting their access to wealth. Wealth
concentration: The economic crisis disproportionately afflicted the middle and lower
classes, whereas the wealthiest individuals and families fared better during the storm.
This resulted in a concentration of wealth among Argentina’s elites, hence expanding
the country’s wealth disparity. Overall, the December 2001 economic crisis had a
substantial influence on Argentina’s wealth, resulting in asset depreciation, currency
devaluation, job losses, income reductions, withdrawal limits, and wealth concentration
among the ruling class.
INFLATION:
Real terms exhibited volatility and an upward trend, reflecting economic instability after
adjusting for inflation. While stable initially, the rates began to rise as inflation and fiscal
challenges in the country worsened throughout the decade. Argentina’s prolonged
economic struggles during the crisis prompted the IMF to augment the initial assistance
package by $7.0 billion (equivalent to SDR 5.2 billion) on January 12, 2001. This
comprehensive support included $5.0 billion in loans from the World Bank and the Inter-
American Development Bank (IDB), alongside voluntary debt refinancing worth $20
billion from the private sector and an additional $1.0 billion from Spain. Subsequently, a
third proposal amounting to $7.4 billion (SDR 5.6 billion) was introduced on September
7, 2001, following the IMF’s overestimation of a 2.5 percent growth in the Argentine
economy for 2001. This proposal hinged on stringent fiscal and revenue-sharing
reforms, as outlined in the “Zero Deficit Law” of July 29, 2001, requiring provinces to
comply to secure the aid (Damill, 2002).
Argentina’s default was primarily attributed to the exorbitant debt burden, economic
recession, and uncertainties regarding the government’s capability to implement
necessary adjustments despite IMF assistance. To address the deficit, the government
faced the challenging task of cutting expenditures. Avoiding the abandonment of the
convertibility system and refraining from printing money, the government believed that
tax reductions might not swiftly generate sufficient revenue to offset the losses.
Furthermore, concerns about market tolerance for increased debt led to the inevitable
decision to raise tax rates as a last resort. Surprisingly, the administration’s move to
raise taxes had an adverse impact on public confidence and hindered private sector
growth, which generates substantial tax revenues for the government. Argentina’s
failure to maintain currency pegs and manage its debts culminated in the country’s
largest default of $95 billion. By December 4, the yield on Argentine bonds surged 34%
higher than US Treasury notes, escalating to 42% by December 11(Mario 2003). A
significant bank run ensued in late November 2001, as depositors rushed to withdraw
dollars, triggering a currency crisis. The peso’s real appreciation posed a significant
challenge to the currency board, initially stemming from Argentina’s higher inflation
rates compared to the US. These challenges exacerbated between 1995 and 1999,
aggravated by the appreciation of the US dollar, which further strengthened the peso
against trading partner currencies. The widening disparity in the currency account
signalled a concerning trend where imports gained preferential terms while Argentine
exports faced declining competitiveness. Brazil’s economic landscape was also
impacted by its currency devaluation in January 1999, falling commodity prices, and
escalating interest rates. The external pressures, coupled with the global economic
downturn in 2001, compounded Argentina’s internal policy shortcomings, exacerbating
the crisis significantly.
BALANCE OF PAYMENTS:
The balance of payments and reserve accumulation underwent significant shifts from
the early nineties until the first quarter of 1994. During this period, net capital inflows
consistently exceeded the current account deficit, enabling a steady build-up of foreign
reserves. This accumulation facilitated a sustained rise in monetary aggregates and
domestic reserves, thereby stimulating aggregate demand and domestic credit
expansion. However, a notable change occurred in 1994 when capital inflows
decelerated, halting the growth of foreign reserves and foreshadowing substantial
capital outflows in 1995. Despite this, a return to the previous pattern of positive capital
inflows and reserve accumulation ensued shortly thereafter. Nevertheless, starting from
mid-1998, capital inflows exhibited a downward trajectory, turning negative in 2001:1.
Frenkel (2002). The correlation between these capital movements and the cyclical
fluctuations in economic activity is evident. In terms of the trade balance, the economic
upsurge in the early nineties, fuelled by capital inflows, had an immediate impact on
trade dynamics. A discernible negative relationship between the country’s position in the
economic cycle and the trade balance is observed. This relationship is reflected by the
“defended real output” line, obtained by contrasting actual GDP with its Hodrick-Prescott
trend, and the trade balance. The surge in imports and output levels during the early
nineties led to a prolonged negative trend in the trade balance, transitioning from a
surplus to a deficit. Notably, periods of trade surplus were only achieved during
economic downturns in 1995 and 2000/2001. The shift observed between 1990 and
1994 is particularly noteworthy, as exports declined proportionally to GDP while imports
surged significantly.
Regarding net interest payments and the current account, while the trade balance
exhibited a counter-cyclical pattern, the rest of the current account displayed a clear
trajectory throughout the nineties. Net interest payments and net investment income
payments abroad steadily rose until late 1998, after which net interest payments
stabilized during the late nineties recession. The current account consistently recorded
deficits during the convertibility period, averaging 3.6 percent of GDP between 1993 and
2000. This deficit pattern, influenced by trade flows, increased between 1990 and 1994,
decreased in 1995, rose during the second nineties economic expansion, and
decreased again following the recession post-Russian crisis. In the year 2000,
Argentina encountered a significant challenge linked to the structural limitations of its
currency board, resulting in a policy dilemma. In nations with flexible exchange rates, a
persistent current account deficit, left unfunded by capital inflows, would typically prompt
a depreciation of the exchange rate. This adjustment corrects currency overvaluation,
enhances competitiveness, and eventually reinstates equilibrium. Due to subdued
productivity growth and Argentina’s inability to devalue its nominal exchange rate, the
avenue to enhanced competitiveness involved facilitating the outflow of dollars, thereby
shrinking the money supply and inducing a decline in domestic prices, effectively
instigating a de facto deflationary policy. However, this process could span several
years to restore competitiveness, establish a new growth equilibrium, albeit at a
substantial social cost, evident in Argentina’s deepening recession and escalating
unemployment.
GOVERNMENT INCOME AND SPENDING:
Pessino (pp.304-325) states that Argentina’s efforts to resolve its financial issues have
included a long-standing engagement with the International Monetary Fund (IMF), which
dates back to the Latin American debt crisis in the 1980s. Argentina frequently used
IMF resources in increasing amounts. Notably, Argentina’s current $6.8 billion
“transitional” IMF stand-by arrangement, which lasts eight months, was requested by
President de la Dua and replaces the lengthy arrangement from February 4, 1998. To
get financial help from the IMF, Argentina promised fiscal adjustments, including
cutbacks in transfers to provincial governments and a commitment to cut municipal
budgets as part of a larger revenue-sharing reform plan. Between 2003 and 2009,
Argentina saw a significant increase in social expenditure as a percentage of GDP,
climbing 7.6 percentage points. An examination of marginal benefit incidence for 2003,
2006, and 2008 shows that cash transfers helped to reduce income inequality and
poverty, particularly after the introduction of a non-contributory pension scheme – the
pension moratorium – in 2004. Between 2003 and 2009, the expansion of non-
contributory pensions, which amounted to 2.2 percentage points of GDP, encouraged
income redistribution to the poor at the expense of seniors in the formal sector who
received pensions exceeding the minimum threshold. Furthermore, increases in public
investment on education and healthcare, while effective in lowering gaps, were quite
minor. Nonetheless, maintaining these redistributive measures may prove difficult
unless non-social spending is significantly reduced. Previous economic expectations for
Argentina, such as 3.5% growth in 2000 and 4.0% in succeeding years, have not come
to fruition (Hornbeck 2003).
The Argentine government's economic estimates. In 2003 were likewise below
expectations. Faced with unsolved economic imbalances, President de la Rua, under
the leadership of Minister of Economy Domingo Cavallo, took unusual and desperate
measures to meet immediate financial obligations. Notably, in June 2001, a significant
chunk of short-term debt totalling $29.5 billion was refinanced with longer-term debt with
higher interest rates, with the expectation that strong economic development would
allow for the payback of increased debt service. Furthermore, Argentina staged a 7%
depreciation of the peso for foreign trade, trying to increase competitiveness, but at the
risk of significantly weakening faith in the currency board. Rising risk perceptions
resulted in higher interest rates and tighter liquidity, compelling both federal and
provincial governments to issue scrip bonds to pay public wages, injecting quasi-
currency into circulation and further disrupting the monetary system. Capital inflows
were critical in altering Argentina’s macroeconomic performance in the early 1990s,
resulting in increased access to international finance. This phenomena was ascribed to
a favourable change in worldwide financial markets, which saw a considerable drop in
global interest rates beginning in late 1989.The decline in financial investment returns in
rich countries shifted flows to emerging economies, with Argentina and Mexico
emerging as major beneficiaries in the early 1990s. Following a decade of credit
restraints, Argentina had significant net inflows of funds, peaking in 1993-94 at around
$13.1 billion per year, equivalent to 5.3% of GDP on average. Notably, over 20% of
these inflows came from foreign direct investment (FDI) funnelled through the
privatization of public assets between 1992 and 1995.
WEALTH DISTRIBUTION:
According to Edward Zuluaga (pp. 345-371, 2022), the concern was that the
government would freeze bank deposits, as it did in 1982 and 1989, due to its inability
to refinance its debt. During the freezes, the government effectively took a portion of
bank depositors’ funds in order to fund itself and repay some foreign loans. Banks put a
deposit freeze on large-scale withdrawals, which halted much private sector activity
because businesses and individuals were unable to use their deposits to pay anyone
other than fellow depositors at the same bank. Argentina’s national statistical bureau
calculated that monthly economic activity declined by 15.5 percent year on year, the
most since the series started. Argentina's wealth distribution was extremely unequal
during the economic crisis that began in December 2001. The crisis, which was defined
by high inflation, rising poverty rates, and significant social upheaval, worsened the
country's already existing inequities. The wealthiest individuals and families in
Argentina, who were primarily members of the elite class and had enormous financial
resources, fared remarkably well during the crisis. They protected their assets by
diversifying their investments and having access to offshore accounts. In contrast, the
economic crisis impacted Argentina's middle and lower classes the hardest. Many
people lost their employment, had their savings depleted, and struggled to buy basic
necessities. Argentina's poverty rate skyrocketed during this period, with many people
slipping below the poverty line. Overall, the December 2001 economic crisis worsened
Argentina's wealth inequality, with the wealthiest individuals and families keeping their
wealth while the rest of the population suffered as a result of the crisis.

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