Prior to economic stabilization-Argentina in 1991, Brazil in 1994-both countries were clearly caught in a vicious cycle of failed choices. Since then, Argentina has shifted to a virtuous cycle of mostly successes, especially after the convertibility plan and hard budget constraints on provinces passed some critical tests in the mid 1990s and increased their credibility. In Brazil, the stabilization has been more recent, and even up to 1998 it was still being tested, for instance by states testing the firmness of their budget constraints with the federal government.

# Argentina's story

The past 10 years have seen dramatic macroeconomic events in Argentina. In the late 1 980s macroeconomic instability reached the point of hyperinflation. This was followed by a highly successful stabilization plan (1991) and three years of rapid growth. In December 1994, events in Mexico (the Tequila event) caused a sharp recession. GDP fell 4.4 percent in 1995.

The 1991 reforms followed a long series of failed economic stabilization programs. Their main failure was the inability to reduce the public sector's deficit. Since the 1940s, economic policy favored powerful interest groups. Unionized labor benefited from high wages, guaranteed employment, and rigid rules governing hiring and dismissals. Industry (capital) benefited from highly protected markets, tax exemptions, subsidized credit, subsidized inputs from public enterprises, and high prices on sales to public enterprises. Provincial governments could avail themselves of zero- or low-interest credit from provincial banks, which would rediscount to the central bank. Poor tax collection and the Tanzi-Oliviera effect reduced the real tax revenues of both provincial and federal governments.6 Indeed, inflation hurt provincial revenue more, because the shared taxes were domestic and collected with longer lags, while the exclusively federal trade taxes were denominated in foreign exchange. It did not seem strange that the provincial as well as federal governments came to depend on seigniorage and the inflation tax. By 1989 subsidies to subnational governments and others were estimated at about $8 billion-more than 5 percent of GDP and close to half of the overall public sector deficit: The growth of the state [deficit], along with capital flight provoked by an inconsistent exchange rate policy, had been financed during the late 1970s largely by external borrowing, though the expanding Eurodollar market. This permitted the government to run large deficits. However, the abrupt end to voluntary foreign commercial credit in the early 1 980s, the decline in commodity prices, and the sudden rise in real international interest rate provoked a financial collapse. [World Bank 1996a, p. 11 In 1985 President Alfonsin introduced the Austral Plan. It consisted of a devaluation, tariff reductions, and a partial deindexation of wages. In the short term, this reduced the fiscal deficit and inflation. Political support for the plan weakened, however, as real wages dropped precipitously. In 1987 the Radicals lost control of the chamber of deputies and most governorships. The Justicialista party reemerged as the dominant political force but was split between reforrn and orthodox wings. The orthodox wing pinned its presidential hopes on Menem, governor of the poorest state, who had cofounded the reform wing but then fell out with its cofounder. With no support from the traditional party structure, Menem garnered popular support by advocating income distribution toward wage earners and a moratorium on foreign debt. The reform wing, in contrast, became increasingly indistinguishable from the Radicals who themselves were becoming increasingly discredited. In 1988 Alfonsin introduced a new plan, known as the Spring Plan, that failed almost immediately. Currency speculation increased. On the eve of elections, real wages dropped precipitously. Inflation in one week reached 17 percent, and a banking crisis was imnminent. The government was virtually bankrupt due to its inability to collect taxes (Peralta-Ramos 1992).

In 1989 Menem won overwhelmingly, and the Justicialista party took both houses of congress. Menem sought to reassure liberal sectors of the economy and the intemational community by, among other 14