ARGENTINA'S ECONOMIC REFORMS: A SCORECARD

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00990R000100760001-7
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 12
• Document Creation Date: December 27, 2016
• Document Release Date: January 2, 2013
• Sequence Number: 1
• Publication Date: July 28, 1988
• Content Type: REPORT

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Central Intelligence Agency
Washington. D. C. 20505
DIRECTORATE OF INTELLIGENCE
28 July 1988
Argentina's Economic Reforms: A Scorecard
Summary
Over the past three years, President Raul Alfonsin
has frequently emphasized the need'for structural
changes to secure long-term economic growth for
Argentina, but rhetoric has far outpaced reality.
Although Buenos Aires has taken many small steps toward
reform, it has, for political reasons, avoided the
thorough changes many experts judge necessary for major
economic improvement--such as comprehensive
privatization, a free exchange rate, and structural
reform of the labor market. As a result, the
cumulative effect of Alfonsin"s halfhearted steps has
been deteriorating public confidence in his management
of the economy, the reappearance of triple-digit
inflation and a current account that is in chronic
deficit. We believe Alfonsin is unlikely to step up
the pace of reform significantly. Moreover, given the
proximity of presidential elections--they may be held
as early as 28 May 1989--and the very real possibility
This typescript was prepared by
South America-Caribbean Division, Office of African and Latin
American Analysis. Comments and queries are welcome and may be
directed to the Chief, South America-Caribbean Division, ALA
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that a statist-oriented Peronist may win, even bold
changes at this late date would probably be
insufficient to stimulate private investment-
A Sector-by-Sector Look
In our view, President Alfonsin was particularly well
positioned to push sweeping economic reforms, and his failure to
do so both represents the loss of an historic opportunity and
clouds the prospects for such change during the next
administration. Alfonsin's election in 1983 represented a
thorough repudiation of military rule and a mandate for change on
many fronts. While the strong influence of Argentina's major
interest groups makes reform exceedingly difficult under any
circumstances, we believe Alfonsin's incomplete understanding of
economics and his pursuit of an ever-elusive political consensus
for his actions led him to pass up at least two timely occasions
to launch far-reaching structural reform.
-- Alfonsin's popularity immediately after the June 1985
implementation of his Austral stabilization program gave
him a mandate to take more sweeping action on the
economic front. Instead, he exploited high public
approval ratings and the ensuing political honeymoon to
pursue constitutional and military changes.
-- Alfonsin also failed to take the opportunity provided
after the 1987 off-year elections, which the government
lost because of the deteriorating economy, to take bold
measures that could have boosted his party's chances for
the next presidential contest. Since he cannot run
again, such steps would have incurred little personal
Instead, since 1985, Alfonsin has implemented reforms only
gradually and on a piecemeal basis, in various sectors of the
economy--often at the urging of the World Bank. The initial
results of most of his changes, such as his original effort to
stimulate investment in the oil sector, were disappointing.
Although several subsequent moves have shown promise, their
cumulative effect has been insufficient to offset investors'
perceptions that Alfonsin's heart is not in the reform program
and that his economic team is operating only on a day-to-day
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The Tax Problem
Collecting taxes is an especially vexing problem. Although
Argentines frequently complain about the myriad taxes imposed,
most simply refuse to pay income tax, and evasion of the
value-added tax on goods is estimated at 70 percent, according to
press reports. Businesses also regularly evade taxes. A mere
one percent of Argentina's 30,000 industries accounts for 80
percent of the government's income from the corporate earnings
tax. A mindset that values independence and defiance of
authority--and not civic responsibility or conforming with the
law--encourages such evasion, as does the interrelated fact that
at least half of all economic activity occurs "underground."
Argentines, moreover, complain that government-provided services
are not worth paying for. These attitudes partly explain why, in
one recent poll, 70 percent of the Argentines surveyed regarded
taking a pencil from the office as wrong, but only 50 percent
Because Argentines so successfully avoid paying taxes,
governments have been obliged to resort to levies that are easier
to collect but are inefficient or impede productivity. Thus,
Argentina has taxes on exports, financial transactions, and
"forced savings," which require the relative handful of
individuals and corporations already paying taxes to deposit
additional sums with the government, theoretically to be returned
in five years, after accruing interest far below market rates.
President Alfonsin's limited efforts to increase the meager
tax take have included an amnesty--the eleventh one since 1970--
the computerization of the Directorate of Taxation, and the
hiring of additional auditors. From time to time, he also
shepherds tax increases through Congress. However, much of the
revenue from his most recent packages--a new forced savings plan,
a major increase in the tax on fuels, and higher taxes on checks
received Congressional approval in January, while increases in
the levies on cigarettes and savings accounts were approved in
May--was. earmarked for specific increases in spending rather than
to close the fiscal deficit. Because of increasingly rapid
inflation, which causes the real value of tax payments to shrink
before they can be collected, real tax receipts actually
decreased last year.
Reforming State-Owned Enterprises
Reforming state-owned enterprises represents a particularly
difficult challenge because they are so numerous, have
entrenched, politically powerful sources of support, and
fundamentally affect vital areas of the economy. Argentina has
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over 300 such firms, the largest of which dominate the oil, gas,
electricity, telephone, mail, railway and airline industries.
Notoriously inefficient, they typically provide inferior-quality
goods and services, employ too many people, overpay private
suppliers for purchases by at least one-third, according to a
recent government study, and regularly fail to cover their own
costs. Their losses account for at least half the federal budget
deficit and their borrowing constitutes one-fourth of the foreign
debt.
President Alfonsin has wrestled with the problem of
reforming state enterprises since the inception of his Austral
Plan. He began by freezing public hiring, and then created two
new secretariats to oversee the restructuring of the sector. In
a major policy address in February 1986, Alfonsin announced plans
to privatize the state steel company as well as five
petrochemical firms; several months later he submitted to
Congress legislation that would grant the executive branch
greater leeway in selling state enterprises. During the
remainder of that year, the secretariats were unable to overcome
bureaucratic resistance to change, while stiff union resistance
blocked the sale of the steel firm and the privatization
legislation failed in Congress. Buenos Aires recently announced
new plans to privatize the petrochemical companies.
In December 1986, Alfonsin gave up on the secretariats,
replacing them with a semiautonomous holding company tasked with'
increasing the efficiency of the thirteen largest state firms.
Some progress occurred last year as Buenos Aires privatized a
small airline and began soliciting private-sector participation
in areas previously monopolized by the state-owned enterprises.
Since the beginning of 1988, Buenos Aires has offered minority
participation in the telephone company and the major state
airline to foreign firms, and promised to end Treasury subsidies
to state firms by the end of the year. The US Embassy reports,
however, that two key government officials may be receiving
pay-offs from a state enterprise supplier to block the telephone
deal, and we believe Buenos Aires is likely to experience
difficulty obtaining Congressional approval. for the airline
proposal. The government has already backed away from its
promise to end subsidies.
The decline of Argentina's petroleum. industry
dramatically points up the weaknesses of Argentina's
state-owned enterprises. Argentine oil production has
decreased each year since 1982, culminating in the
politically embarrassing need to import oil in 1987--
after several years of self-sufficiency. Although the
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state-owned oil company (YPF), Argentina's first state
enterprise, is an important national symbol and a great
source of pride, it is also one of the few oil
companies in the world that consistently loses money.
Alfonsin started to restructure the oil industry
in 1985 with the unveiling of his so-called Houston
Plan, an unprecedented opening of large tracts of land
to foreign investment in oil exploration and
development. He hoped to generate a huge inflow of
cash to supplement the limited YPF budget. These
efforts were hindered by interest groups ranging from
the YPF bureaucracy to private sector firms that
benefited from their business relationships with the
company. As a result, early tenders offered terms
unattractive to potential investors and drew little
interest. After Alfonsin replaced top personnel in the
energy sector, YPF developed more favorable contract
terms that generated stronger investor participation in
the most recent offering. Because of extensive delays
in final contract approval by a multitude of government
officials, however, only two firms are near the
drilling stage. Most of the other successful bidders
for exploration blocks are still tied up in contract
negotiations that have dragged on for up to two years,
and future tenders are on hold until the administrative
logjam is cleared. Given the time involved in bringing
oil projects to fruition, results of the program will
not be apparent for several years even if Buenos Aires
can smooth out its bureaucratic problems.
To make short-term gains against declining
production, Alfonsin announced in June 1987 that
private firms agreeing to raise production levels above
their current contractual obligations would be offered
substantially higher prices for their oil. Fifteen
such contracts were signed last month, but the
investment needed to boost output will delay much of
the effectiveness of the plan into next year.
Authorities are also completing a plan that will offer
private firms the right to pay a user fee and extract
oil from current YFF operating areas. While the US
Embassy does not believe this option is sufficiently
attractive to generate much international interest, it
will offer participants the free disposition of oil
produced--current production must be sold to YPF--and
could be an important first step in the deregulation of
the industry.
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Spurring Agriculture
Agriculture, a much-neglected engine of growth for the
Argentine economy, has been a victim in recent years of low world
prices and developed country subsidies, as well as an Argentine
mindset that views farmers as a rich and privileged class to be
taxed for industry's benefit. In 1986, Argentina received its
first major structural adjustment loan from the World Bank after
promising to replace agricultural export taxes with a land tax
designed to spur production on underutilized property. Shortly
before the September 1987 elections, Alfonsin eliminated export
taxes on grain and significantly reduced them on other products.
On the other hand, the federal land tax--opposed by farmers who
already pay local land taxes--died in Congress, leaving the
decrease in income from export taxes inadequately offset by new
sources of revenue. Alfonsin also temporarily imposed price
controls on live cattle and meat, causing ranchers to question
whether they should rebuild cattle stocks, despite strong
Deregulating Industry
Argentine private industry--most heavily concentrated in the
food processing, chemical, automotive, machinery and equipment,
and textile sectors--has long enjoyed government subsidies and
has been protected from foreign imports by "infant industry" and
"buy Argentine" arguments. Industrial promotion programs
offering tax incentives, export financing schemes--which the US
Embassy judges have done little to augment industrial exports--
and "sweetheart" deals to supply state firms ensured them healthy
profits. "Prior consultation" regulations allowed Argentine
manufacturers to prevent the import of goods manufactured
domestically.
Under the aegis of a $500 million trade policy reform loan
from the World Bank finalized in 1987, Buenos Aires has made some
headway in dismantling regulations. Argentina is allowing goods
to enter duty-free provided they are used to manufacture products
that are subsequently exported. Buenos Aires is also simplifying
procedures at ports--paperwork now takes several weeks--and has
transferred 1000 out'of the list of 7000 categories requiring
"prior consultation" to the automatic.export list. Last February
Argentina announced the "opening" of the petrochemical and
iron/steel sectors by transferring products from these sectors
off the prior consultation list and imposing a uniform 25 percent
tariff on related imports. Moreover, Buenos Aires recently
changed its "buy Argentina" regulations to substantially shorten
the time period during which domestic manufacturers can petition
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state enterprises to purchase their products rather than imports,
and require petitioners to place a deposit with the government
while it investigates their claims.
Restructuring Banking
Argentina's ailing banking system suffers from fundamental
structural problems, according to US Embassy and World Bank
studies. Most important among these are government ownership
and subsidization of banks and over-regulation of banking
activity, as well as official and private bank lending on the
basis of political rather than economic considerations.
Moreover, chronic high inflation and excessive labor costs have
contributed to exceptionally uncompetitive spreads between
deposit and loan rates. These systemic difficulties are
compounded by. the Central Bank's lack"df independence, regulatory
capacity, and control over money supply. They also contribute to
Argentina's economic troubles: government subsidies to banks
help fuel inflation, and the inability of the system to mobilize
domestic capital effectively has been at the root of Argentina's
dependency on foreign financing.
President Alfonsin, using conditions attached to a $400
million World Bank banking sector loan as a guideline, has
implemented a number of reforms over the past 20 months which,
although modest in scope, have led to some progress. These
reforms have included the elimination of "regulated" interest
rates, a decrease in the availability of subsidies to federal and
provincial banks, a crackdown against fraudulent banking
practices, and the closing, merger, or liquidation of troubled
private banks. However, at the behest of the Peronist Party--
which controls 17 out of 22 governorships--Buenos Aires is at
least temporarily replacing Central Bank subsidies to profligate
provincial banks with Treasury loans.
The Road to Comprehensive Reform
In our view, substantial reform is still needed to
place Argentina on a path toward long-term economic growth.
Far-reaching change is particularly difficult in a society as
highly politicized as Argentina's, with strongly entrenched
interest groups that can readily defy the Federal government.
Academic literature and recent experiences with structural reform
in the UK and even chronically troubled Bolivia indicate,
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however, that interest group objections can be overcome when
comprehensive reform is implemented swiftly and decisively.
Labor--militant and well-organized--epitomizes the problem
of an entrenched interest group in Argentina. Over the years,
the unions' power has enabled them to perpetuate the overstaffing
that is a prime factor in running up expenses and impeding
productivity and innovation. The growing replacement of
blue-collar jobs with white-collar ones, however, and public
irritation over the frequency of strikes, may open a window of
opportunity for a reformist-government. Significant workforce
reductions, tempered by an unemployment' insurance program
sponsored by an organization such as the World Bank, would enable
private and state enterprises to lower costs, contributing to a
drop in inflation. Diminished job security--and inflation--
might dampen the Argentine workers enthusiasm for frequent
strikes. Moreover, employers could redirect a portion of the
money saved by a reduction in workforce to finance pay increases
for the workers who remain to spur productivity and eliminate a 25X1
key motivation for corruption. In turn, a simultaneous drop in
inflation and a decrease in bribe-taking by better-paid auditors
would immediately increase tax receipts.
Regarding state-owned enterprises,
An light of the numerous forces positioned to
thwart incremental change--nothing short of 100-percent
privatization will stem government losses. Moreover, recent
opinion polls show that a majority of the public--exasperated
with highly unreliable telephone and train service--supports the
sale of most state firms with the exception of the oil company.
The privatization of railroads, grain terminals, and the national
shippping fleet would generate a positi.v-e ripple effect
throughout the agricultural and industrial sectors. Simultaneous
deregulation of previously monopolized sectors would, in our
view, be needed to ensure the competitive provision of goods and
services. The wholesale elimination of reams. of government rules
and regulations would also decrease the opportunity for
corruption and help nudge workers out of the. untaxable
"underground" economy.
On the trade front, experience elsewhere-indicates that a
floating exchange rate and a much greater reduction in
protectionist measures would benefit both agriculture and
industry. Moreover, Argentina would probably do well to follow
Chile's example and diversify its agriculture by producing more
fruits and vegetables for Northern hemisphere markets. Lastly,
Argentina will need to maintain a set of consistent, free-market,
pro-export policies over a long period of time to encourage
farmers and businessmen to make long-term investments.
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Much remains to be done if the Argentine banking system is
to become a net contributor to economic growth. In our view,
closing the provincial banks and either privatizing or closing
the federal ones would lead to far greater efficiency. Over
time, Argentina would also benefit from lowering reserve
requirements, allowing private banks to maintain positive real
interest rates and enabling banks, rather than the government, to
act as the primary conduit for credit. A self-insurance scheme--
already on the drawing board in the World Bank's loan proposal--
is needed to ensure that the taxpayer does not pay for banks'
poor investment decisions. Such changes would foster a greater
availability of domestic capital for investors. In addition, a
reduction in inflation and staffing costs would enhance bank
competitiveness and profitability. Finally, making the Central
Bank independent of the Executive office would minimize the
influence of day-to-day political constraints.
Outlook and Implications
Given Alfonsin's mixed track record to date, he is far more
likely to continue a piecemeal approach to economic reform than
to implement proposals like those outlined above. Worker
lay-offs, in particular, would probably consign his Radical Party
to defeat in the presidential elections.
Even if Alfonsin were to initiate far-reaching structural
changes, however, the possibility that Carlos Menem, the
Peronists' nationalist, populist candidate for office, might gain
the presidency next year and undo many of those reforms will
likely keep investors on the sidelines. Menem believes the state
should continue to play a major role in the economy and opposes.
privatization. He generally favors heavy regulatory and
protectionist policies and believes that the government should
direct credit by exerting full control over bank deposits. Menem
also opposes the idea that worker lay-offs may be needed to
promote efficiency and that fiscal deficits cause inflation.
Menem's electoral prospects are enhanced by the belief among some
Argentines that the current economic deterioration proves that
On the other hand, should Eduardo Angeloz, a member of the
Radical Party's more conservative faction, win the presidency, we
expect a greater commitment to reform. Although he would have to
deal with the same powerful interest groups that have stunted
changes to date, as well as Peronist control of at least one and
possibly both houses of Congress, Angeloz believes far more
deeply in reform than Alfonsin and would work much harder against
vested interests. On the campaign trail, Angeloz has already
taken the politically controversial stand that workers should not
be paid while on strike. He has shown himself to be an able
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administrator as governor of Cordoba--one of the few Argentine
provinces that is in the black. In our view, Angeloz's election
would ensure the logical continuation of the reforms that
Alfonsin has only tentatively implemented.
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SUBJECT: Argentine Economic Reforms: A Scorecard
28 July 1988
Distribution:
External
Original - Michael Skol, Director, Andean Affairs, Department
of State
1 - Charles Siegmon, Federal Reserve Board
1 - James Black, National Intelligence Advisor,
Department of the Treasury
1 - Stephen P. Farrar, Director for International
Economics Affairs, National Security Council
1 - Carlos Montoulieu, Director, Brazil-Southern Cone
Division, Office of South America, Department of
Commerce
1 - DIAC Building
1 - Martin Kohn, Chief, International Economics
Division, Department of Commerce
1 - Thomas Forbord, Vice President, Country Risk
Analysis, Export-Import Bank of the United States
1 - Luigi Einaudi, Director, Office of Policy Planning
Coordination, Bureau of Inter-American Affairs,
Department of State
1 - Peter Field, Director, Office of South America
International Trade Administration, Western
Hemisphere
1 - Robert S. Gelbard, Deputy Assistant Secretary of
State for South American Affairs, Department of
State
1 - Richard Howard, Director, Office of Southern Cone
Affairs, Department of State
1 - Robert Pastorino, Senior Director for Latin
American Affairs, National Security Council
1 - James Buchanan, Chief, South America Division
Office of Analysis for Inter-American Republics,
Bureau of Intelligence and Research, Department of
State
1 - John Caulfield, Argentina Desk Officer, Department
of State
1 - Roger Merletti, Analyst, The Pentagon
1 - Michelle Powers, Export-Import Bank of the United
States
1 - Lewis Laun, Assistant Secretary for International
Economic Policy, Department of Commerce
1 - Captain Paul Howard Donaldson, US Navy, South
America Branch, Joint Chiefs of Staff, The
Pentagon
1 - Commander Jack Smith, Chief, South America Branch
Defense Security Assistance Agency, The Pentagon
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DDI
O/DDI
NIO/LA
NIC/AG
PDB Staff
C/PES
DDI/CPAS/ILS
D/ALA
ALA/PS
ALA Research Director
CPAS/IMC/CB
C/ALA/SCD
DC/ALA/SCD
C/ALA/SCD/EB
C/ALA/SCD/Files
C/ALA/SCD/Files
NIO, Economics
Assistant NIO, Economics
(28 Jul 88)
DI/ALA/SCD/EB
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