Provinces key to Argentine fix

Argentina has a big obstacle in its path to economic recovery. Actually, 23 big obstacles.

The struggling South American giant's loose federal structure puts most of the nation's spending power in the hands of the 23 provincial governors. Historically, the governors have acted like lords over their fiefdoms, spending with abandon, printing their own currencies, and doling out the cozy jobs to cronies. This has often created massive debt and crippling inflation.

Whether or not Argentina's federal government can reverse 200 years of history and bring reform to this free-wheeling culture may determine whether the country sinks or swims. Four representatives from the International Monetary Fund are here this week demanding that governors trim spending and stop printing money as conditions of restoring bail-out funds.

Last December, the IMF suspended funding after Argentina failed to meet previously agreed upon spending reduction targets. That decision forced the country to default on $141 billion in foreign debt, and led to deadly riots and five presidents in two weeks. Since taking office in January, President Eduardo Duhalde has repeatedly sought to persuade the IMF to help his country's crumbling economy.

But pivotal to any deal is whether Argentina's federal government has the strength to influence the governors.

At independence in 1810, rural landowning strongmen, or caudillos, resisted control from Buenos Aires. As a result, Argentina's Constitution vests great powers in provincial leaders. In the 19th century, presidents got what they wanted by ruling with the sword, in some cases literally. These days, however, the executive is obliged to rule by consensus, and can only cajole governors into falling in line.

"Since the beginning of the Argentine republic, each province has functioned as an independent political unit," says Julio Burdman, director of research at the New Majority Studies Center, a political research group. "The federal government has little power to impose its will on the provinces."

Argentina's provincial governments collect, on average, only 35 percent of the money they spend – the poorest provinces rarely collect more than 10 percent – and get the rest from federal taxes that are apportioned out and sent to the provinces. The system works if the provinces limit spending to the money coming in. Should the provinces overspend, however, the government is left footing the bill.

Between 1995 and 2000, spending in the provinces rose by 25 percent, even though inflation was nonexistent. The spending binge forced the government to build up an unsustainable volume of external debt. "There is no federal oversight, none at all," says Mr. Burdman. "The provinces do not collect taxes, but they spend without control. They have total autonomy and no responsibility."

The results are predictably ridiculous. "Inconsistency and poor planning, at all levels, have become ingrained over many years," says Diana Mondino, managing director of Standard & Poor's in Argentina. "In education, which is decentralized, there are more teachers per class than average in some schools and no teachers at all in others. Or two bridges will be built over one river, and none over the next."

Corruption, too, plays a part. The local media frequently uncovers instances of provincial officials awarding contracts at inflated rates to business associates, or giving jobs to family members or political allies.

In the impoverished province of Formosa on the country's northern border, about half of all formally employed workers are on the government payroll, and media investigations have demonstrated that many show up only once a month – to collect their paychecks. The 30 provincial legislators themselves each collect a whopping $12,000 a month in salary.

To add to the mess, federal tax collection is woefully inefficient: the government estimates value-added tax (sales tax) evasion at 40 percent and income tax evasion at 50 percent.

Until recently, this waste was hidden by a stream of foreign capital and loans, particularly as Argentina opened up to investment during the 1990s under President Carlos Menem. Since the default, Argentina's credit rating is in the tank and foreign investment has all but dried up. With the economy in free fall - it's expected to contract by 15 percent this year - provinces literally printed money to pay state workers. They issued some $1.75 billion in public bonds, equivalent to almost one in every two pesos in circulation, that quickly became de facto currencies.

The IMF has pressed Duhalde to either impose federal control over provincial spending, or press provinces to collect taxes and pay their own way. They are also pushing for the retirement of the 20 unofficial currencies now circulating in the provinces.

"Argentina should put together an economic plan that's coherent and consistent," says Francisco Baker, the IMF's spokesman on Argentine issues. "They need to bring down the deficit in the provinces and stop using the so-called funny money they've been using."

IMF insiders say its stance on Argentina's provincial elite is part of a get-tough policy ushered in by a new management team. The Bush Administration has also said it is in favor of more crisis prevention and fewer bailouts. IMF officials say that a 10 percent cut in spending by each province would translate into a 60 percent reduction of the federal deficit.

Duhalde, who was himself accused of using poverty-relief to buy votes as governor of Buenos Aires province, has floundered for solutions. The president is urging his former gubernatorial colleagues to voluntarily cut payrolls. But with unemployment at 20 percent and rising fast, the governors are stalling.

"The IMF is asking the government to use its federal power to exert some control on the provinces," says Burdman. "The federal government is, in effect, replying 'We can't do it. You do it for us.' "

Despite rising social chaos in Argentina's towns and cities, the IMF team appears determined to see real reform. "The IMF view is that if Argentina's political class can't get it together, then so be it," says a senior Western diplomat. "They'll come in afterward and pick up the pieces."