The Argentine collapse raises questions of the International Monetary Fund’s responsibility for the disaster. Its policy recommendations were ostensibly value-neutral, but in reality had a ratchet effect, causing the inexorable expansion of the Argentine public sector. It was this, as much as a misguided monetary policy, that pushed Argentina over the edge.

IMF advice, as currently delivered, normally does considerably more harm than good.

The IMF has been involved in Argentine policy throughout the 1990s, consistently recommending a tightening of Argentina’s fiscal stance, without specifying whether that was to be done by raising taxes or by cutting public spending. This apparently value-neutral stance in fact had a perverse effect. From 1995-2000, in a period when Argentine gross domestic product rose 10.1 percent, or 1.9 percent per annum, and the IMF was continually monitoring the situation and imposing its conditionality, Argentine central government spending rose by 18.1 percent, or 3.4 percent per annum, from 18.9 percent of GDP to 20.3 percent (state and local spending add around another 10 percent of GDP to the total.). This was not value-neutral restraint, it was a ratchet, with IMF pressure to reduce the budget deficit being reflected in a continuing escalation of taxes to meet the demands of spiraling spending.

As I wrote in a previous column some months ago, by examining OECD public spending and growth statistics back to 1960, high and rising public spending as a percentage of GDP is highly correlated with declining GDP, with the two factors of public spending and its rate of change explaining about 50 percent of all variations in economic growth rates, across the globe as a whole.

This is particularly the case in a country like Argentina, where monetary policy was artificially tight due to the currency board mechanism, and resources available for economic growth were limited. In real terms and using 1993 prices, Argentine GDP grew $26.2 billion over the 1995-2000 period. Additional central government spending absorbed 34 percent of this growth, and one can reasonably guess that provincial spending-controlling it has been a problem, took public sector capture of the country’s economic growth above 50 percent.

Of course Argentina ran into trouble. The only question is why it didn’t happen earlier. There are in any case structural problems. The country seems congenitally incapable of exporting anything but primary agricultural products, which are subjected to the endless inventiveness of U.S., EU and Japanese protectionism. The Argentine public sector always has been too large, for a middle-income developing country, since the rule of president Juan Peron (1945-55). Argentine trade unions are famously strong and militant.

Argentina’s Gini coefficient (the standard measure of economic inequality), at 0.49, is considerably higher than in the United States and far higher than in either western or eastern Europe, or the emerging economies of Asia, and Brazil’s is higher still.

This is not, in Argentina these days, the result of a tiny oligarchy oppressing the masses. It is the result of a bloated trade union system fattening unionized labor at the expense of the rest of the population. High Gini coefficients are indeed Latin America’s dirty secret; the statistic demonstrates that the social democracy universally espoused in the continent does nothing whatever for the truly poor.

Nevertheless, the IMF was a substantial contributor to Argentina’s problems (as well as delaying the inevitable by arranging huge infusions of western taxpayers’ money in 2000-2001) and it is worth examining the structural reasons why this was so.

As pointed out in a study last year by Morris Goldstein, of the Institute for International Economics, IMF loans have over the last 20 years become far more tightly conditional, with South Korea’s 1998 loan program having 70 conditions, Thailand’s 90 and the loan program for the Philippines 140. These conditions inevitably restrict the movement of the client economy, and in a situation such as Argentina’s where monetary policy is also restrictive can become a problem simply by their existence.

However, there is a further philosophical problem in IMF staffers micro-managing client economies, which is the question of why they are thought competent to do so. IMF officials are highly educated, generally from top schools, and come from around the world, thus preventing any undue “Western bias” except to the extent that the Western countries, as principal funders of the institution, naturally claim a considerable say in its activities.

IMF conditions are negotiated with client governments and central banks, thus there is to a limited extent an opportunity for democratic input into their details.

The defects of the IMF conditionality system can best be seen by considering an interesting market fact: IMF officials, supposedly the best and brightest of their generation, are paid no more than a modestly successful used car dealer in Ozark, Ala. As usual, the free market is trying to tell us something.

What the market is telling us is that there are other skills, not taught in the elite colleges, that the used car dealer has and IMF officials lack: a sense for the market; an ability to understand their customers’ needs; and an ability to “hustle,” pulling together two parties to a transaction to close a deal. People with both the IMF officials’ skills and the used car dealer’s skills are, of course, top investment bankers, and paid far more than either the IMF official or the used car dealer. Nevertheless, even investment bankers are in the business of profit maximization for their institution and themselves, not that of economic development. Thus IMF/client government negotiations are to a large extent the blind leading the blind. Neither party to the negotiations has a true grasp of how markets work, nor of the conditions necessary for an economy to flourish.

This problem can be solved from both ends. First, the IMF badly needs to leaven its inventory of PhD’s with some traders and salesmen with practical experience of how markets work and how deals are done. The IMF negotiation teams sent to a client country should include both an academically competent economist and a good trader/salesman, preferably with experience of the real economy and not just finance. In this way, solutions that involve market-destroying policies, such as the fiscal and monetary policies of Argentina, 1991-2001, can be shunned.

Second, the IMF team needs to talk to the local private sectors, beyond just the banks (to whom they do talk, to a limited extent.) There is a horrid tendency in the international lending institutions and aid agencies to regard emerging markets’ private sectors as nests of crooks and gangsters.

While certainly the standards of probity and disclosure in a typical Third World company will not be the equal of those at IBM, the Enron example, and those of the dot-coms, have demonstrated that crookery, opacity and self-delusion are not a monopoly of the Third World private sector.

In any case, if local ethical standards in the client country are suspect, whatever makes the IMF think they are better in the public sector? Local entrepreneurs and managers of well established companies in emerging markets generally have a keen idea of what is needed for their companies to prosper, and if the IMF wants to provide a policy mix that actually benefits the local economy, it is essential that it listens to them.

Talking to the public sector alone, IMF staffers will inevitably perceive a world in which tax cutting is impossible, and public sector growth provides much needed infrastructure and social services. The economic reality, in general, is the opposite of this. Tax cuts, freedom from onerous labor regulations, and wholesale abolition of red tape are normally the principal factors behind economic success stories.

It is essential that the IMF, to the extent that it imposes conditionality, imposes conditions that provide a long-term benefit to the client economy, and not those that merely result in creeping aggrandizement of the local public sector. If this cannot be managed, better the institution be closed down. Before 1914, the world managed very well without it.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.