The word on Wall Street has long been that the departure of Argentina's flamboyant finance minister, Domingo Cavallo, could easily trigger a Mexican-style currency crisis. For the time being, at least, the Argentines have proved otherwise.
After Mr. Cavallo's summary removal from office by President Carlos Menem on July 26, the country's famed "convertibilty plan" - which firmly fixes the peso to the US dollar - held steady. Moreover, the Argentine stock market even rose when informed that Cavallo would be replaced by a technocrat of lesser stature but with an even more orthodox University of Chicago PhD. Yet, as the country sighs in relief, we wonder if this isn't the calm before a storm.
Having purged the economy of inflation since 1991, and having survived the "tequila effect," which provoked billions of dollars of capital flight from Latin America in the wake of Mexico's 1994 peso crash, Argentine policymakers are still taking bows for having stabilized the macroeconomy. Yes, inflation is down, foreign reserves are up to an impressive $18 billion, and the country's relatively low fiscal deficit would be the envy of US legislators.
The country, in short, seems to be right on track - but is it? With official unemployment ranging from 18 percent in greater Buenos Aires to as high as 25 percent in the provinces, the flip side of Argentina's "rosy" macroeconomic scenario is a deterioration in income distribution that is generating a wave of poverty-related unrest.
Early August brought the largest labor protest of Menem's six-year presidency, including a general strike which paralyzed public transit and a demonstration in Buenos Aires that met with police repression.
Demands for free food
Meanwhile, youth gangs are terrorizing patrons in the country's fancier restaurants, and the elderly on fixed incomes are occupying local supermarkets until their demands for free food are met. Something is clearly awry.
What underlies these dismal labor market and social trends?
A key factor is the exchange rate itself. One-to-one parity between the Argentine peso and the US dollar turned out to be an unexpectedly effective way to finally halt an inflationary spiral that had peaked at nearly 5,000 percent in 1989.
Unfortunately, as Mexican policymakers found out the hard way, a fixed exchange rate yields external stresses. The pre-Cavallo trade surplus of $8.6 billion in 1990 swung to a deficit of $5.8 billion in 1994 - a shift on the order of 8 percent of GDP - and Argentina's attempt to restore trade balance in 1995 produced a 4.4 percent decline in output.
As in Mexico prior to the peso crash, Argentine policymakers have a well-rehearsed explanation as to how the problem of trade imbalance and currency overvaluation can be corrected by increases in foreign direct investment and total productivity.
But despite the country's sweeping program of liberalization, deregulation, and privatization in the 1990s, and the tremendous restructuring that has occurred, low value-added agricultural products still dominate Argentina's exports.
Misfiring employment engine
Moreover, while some significant productivity gains have been registered in the industrial sector, most of these reflect the one-shot employment downsizing that occurred in response to the opening of the economy. Meanwhile, small and medium firms that have traditionally been the source of widespread employment and supply flexibility have been severely weakened by heightened import competition and tight credit.
To hear them tell it, the incoming economic team is dead set against the design of any social or employment policy that could alleviate the country's distributional stress. Part of this is ideological - the orthodox notion that such stresses are best resolved by the market. The other part is political, reflecting a struggle of technocrats against the more "populist" impulses within the traditional wing of President Menem's Peronist party. This leaves Argentina with better than European-style unemployment rates, but worse than European-style social cushions.
US policymakers have been heartened by Argentina's "success" story and its recent ability to survive the departure of Cavallo. We should recall, however, that the US also feted Mexico at the 1994 Miami summit as among the most advanced of Latin free traders - only days before the peso crashed, throwing that country into economic and political chaos. A little realism and a lot more policy flexibility could help the Argentines begin to tackle their accumulated "social deficit" - and help the US avoid yet another financial bailout of a "stellar" reformer.
*Manuel Pastor is chair of Latin American and Latino Studies at the University of California, Santa Cruz. Carol Wise is on the faculty at John's Hopkins University's School of Advanced International Studies in Washington.