Argentina has experienced slow economic growth since the 1940s. By the mid-1970s long-term growth declined noticeably, and in the last half of the 1980s the country suffered its longest period of stagnation in the century. Savings and investment rates fell precipitously from the mid-1970s until 1989. Argentines, responding to the unstable macroeconomic environment, increasingly saved and invested abroad. Labor productivity fell ang poverty worsened. This economic performance was tranceable to chronic public sector deficits and endemic inflation. Public sector deficits in the late 1970s ranged from 10 to 14 percent of GDP, and in the early 1980s surpassed IS percent of GDP. After the return to constitutional democracy in 1983, public demands to control inflation were translated into four successive stabilization programs. All failed to eradicate inflation, and each ended in a more virulent inflation than the one preceding it. The main reason for these failures was the inability of the stabilization programs to redress rapidly and permanently the public sector structural deficit. Structural deficits emerged from the post-war organization of the economy. Economic policy from the 1940s was used to propagate rules and transfers favoring the interests of private groups with access to power. By the early 1980s public expenditures approached 40 percent of GDP. Unionized labor benefitted from high wages, guaranteed employment, and rigid rules governing hiring and dismissals. Industry benefitted from highly protected markets, tax exemptions through special promotion regimes, subsidized credit-or effective grants, as many loans were not collected-subsidized inputs from public enterprises, and high prices on sales to public enterprises. Housing contractors and middleclass home buyers benefitted from enormous public transfers through earmarked taxes and effective grants through the Housing Bank. Tobacco growers, sugar growers, the merchant marine, and other small interest groups enjoyed special tax breaks. Consumers enjoyed below-cost tariffs from public enterprise and lax collectioll practices. Provincial governments could avail themselves of costless credit from the provincial banks, which the central bank reimbursed. The military enjoyed expanding budgets, especially over 1976-82, as well as management perquisites in state companies they controlled. By 1989 subsidies through the budget, tax exemptions, agriculcural regulations, public enterprise tariffs, and central bank rediscounts were estimated to amount to roughly 8 percent of GDP--the equivalent of some $8 billion. The growth of the state and concomitant rents and subsidies, along with the capital flight provoked by an inconsistent exchange rate policy, were financed during the late 1970s largely by external borrowing through the expanding Eurodollar market at low or even negative real international interest rates. This permitted the government to run large deficits and sustain a revalued exchange rate with relatively low levels of inflation in the second half of the 1970s. An abrupt end to voluntary foreign commercial credit in the early 1980s and the sudden rise in real international interest rates provoked a financial collapse and placed additional pressure on public finances. The situation was complicated by the South Atlantic War. The loss of external finance and lack of adjustment meant the treasury had to resort to increased inflationary finance through monetary creation. The private sector, in an effort to avoid the resulting inflation tax, gradually withdrew its resources from the financial system and reduced its real holdings of currency ; this, together with the negative effects of inflation on real tax collections, made Argentina's economy progressively more unstable in the 1980s. Even though the deficit fell from near 20 percent of GDP in the early 1980s to an average of about 10 percent over 1987-89, the base for the inflation tax shrank even faster--efforts to reduce the deficit were not fast or permanent enough to convince the private sector that savings in domestic currency would not be eroded by inflation. Inflation became high and unpredictable, and the main impediment to the recovery of private savings and investment. The decade ended with two episodes of hyperinflation in 1989.

Post-1989 Structural Reforms

Tbe present administration took office in July 1989 during a traumatic hyperinflation--July inflation alone was 200 percent. This culminated a decade-long crisis in public finance. The new team inherited weak public institutions accustomed to deficit spending and with an institutionalized reliance on the inflation tax. In addition, claims on state revenues were far greater than its capacity to mobilize resources-in short, the Argentine state was insolvent. The government undertook stabilization programs in 1989 and 1990. Neither succeeded, principally because of the intractability of the fiscal deficit. The first terminated in a new hyperinflation at the end of 1989 and in early 1990. The second lasted from March 1990 to December 1990 and ended in a new inflationary outburst but, unlike the previous breakdowns, the economy did not spin into hyperinflation. Instead, a new fiscal package in February 1991 was sufficient to close the remaining fiscal gap. This was followed by the April 1, 1991 Law of Convertibility fixing the local currency to the dollar and effectively proscribing money creation other than to buy net foreign reserves. The convertibility program disciplines monetary policy and limits the power of the government to finance its deficit through inflation. The law markedly reduced the foreign exchange rate risk to investors and the inflation risk to business and labor--as long as the fiscal fundamentals are in place to support it. The February 1991 program was able to close the gap in large measure because the government's sustained structural reform efforts had progressively improved the foundations of public finance. The government had undertaken difficult to reverse reforms in the legal framework, institutions, and policies. These included institutional reforms of the federal government, public enterprises, and federal-provincial fiscal relations, and restructuring liabilities with domestic and foreign creditors to adjust them to serviceable levels. Other reforms have helped elicit efficient private investment, notably trade, deregulation, and financial sector reform.

Federal Government

The government undertook a major effort to improve revenues through the implementation of a much-broad- ened and uniform value added tax first to goods in February 1990, and later extended to services in Novem- ber 1990. The government also improved the efficiency of the tax administration in 1989, establishing a control system for the largest taxpayers that took effect in February 1991. The tax penalty law, adopted by Con- gress in 1990, provided much needed sanctions for tax non-compliance. The tax package of February 1991 improved the quality of revenue mobilization substan- tially because it eliminated export taxes, reduced pro- gressively during 1990 and early 1991, deducted higher taxes on financial transactions from the income/asset tax, and removed several minor taxes. In December 1992 subsidies to industrial promotion were substantially cut by replacing self-monitored tax deductions with a tax bond program. These efforts cumulatively produced dramatic rises in tax collections from the third quarter of 1991 on. The increase in value added tax collection allowed the government to eliminate inefficient taxes, such as the fuel tax and the stamp tax, in November 1992, and several specific sales taxes in May 1993. Federal employment decreased from 671,000 to 284,000, including 103,000 layoffs and 284,000 teachers and health workers transferred to provincial payrolls. This effort was based on a ministerial reorganization that focused federal activities on core objectives, and improvements in the civil service system through an improved salary structure and efficiency measures. The government was able to increase average salaries and partially restore salary differentials. The government took several measures to strengthen budgeting procedures and expenditure controls. By 1993 it had eliminated 105 of the 151 earmarked accounts extant in 1990, and reduced the coverage of earmarked taxes. The September 1992 Law of Public Financial Management will permit comprehensive budgeting, effective internal expenditure control, and provide for new external auditing The government has embarked on several reforms to separate the central bank from the nonfinancial public sector and establish it as an effective independent monetary authority. The elimination of the central bank's domestic short-term interest-bearing obligations by means of their conversion into external treasury bonds in January 1990 in effect was a first step toward recapitalizing the central bank. The Law of Convertibility established a money-creation rule that effectively limits monetary policy and central bank inflationary financing of public sector deficits. Since early 1991 the central bank has published financial statements that reveal its balance sheet; since April 1991 it has published its reserve position weekly so the public can monitor implementation of the Law of Convertibility. In September 1992 a new law strengthened the central bank's autonomy, and further restricted its ability to extend credit to the government and the banking system. This measure reinforces the convert- ibility law, and paves the way for an independent, disciplined, monetary authority. In addition, the cen- trai bank intends to complete the process of removing functions ancillary to the functions of a monetary authority by transferring legal authority for failed institutions to the courts.

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