Argentina’s Dubious Boom
Argentina's economy has been coasting on its past successes. Don't be fooled.
When Argentina defaulted on its sovereign debt in 2002, few predicted that the country would soon bounce back — much less rank as one of the fastest-growing emerging economies over the next decade. Yet, aided by aggressive fiscal and monetary stimulus, Argentina has enjoyed an Asian-style 7.6 percent average annual growth rate since 2003, with commensurate gains in employment and declines in poverty. Indeed, Argentina’s success in thumbing its nose at foreign creditors has emboldened some observers to suggest that Greece and the other debt-ridden eurozone economies try default as an alternative to the harsh austerity prescribed by the IMF and the European Union.
It seems that Argentina managed to turn "Washington consensus" policy on its head and get away with it. Or maybe not: A closer look at Argentina’s post-crisis economy suggests the boom is living on borrowed time, that the chickens will soon come home to roost.
The model for Argentina’s post-crisis boom was the Perónist policies of the 1940s and 50s. Corporatist Perónism accommodated the interests of business, labor, and the poor through collective bargaining managed by the state. Resources were skimmed from the country’s highly productive agricultural sector to cover the cost of wages and profits in excess of competitive levels.
But Perónism promised more than it could possibly deliver. Expansionary macroeconomic policies led to ever-rising inflation, stagnant productivity, and battles among highly organized interest groups that spurred popular unrest and increasingly repressive government reactions. Argentina was left with anemic public services, crumbling infrastructure, profitless industries, and paralyzing union demands for wage increases unsupported by productivity gains.
Juan Perón was overthrown by a military junta in 1955. Yet the legacy of Perónism survived, its peculiar mix of corporatism, populism, and nationalism rising and ebbing across the tumultuous 1980s and 1990s. Argentina was especially hard hit by policy experiments designed to curb inflation that left the economy uncompetitive in global markets, burdened by a huge external debt and committed to an overvalued exchange rate pegged to the dollar. Its economic troubles culminated in a financial crisis in 2001-02, with the collapse of the fixed exchange rate and a sharp recession accompanied by fierce unemployment and a wave of bankruptcies.
The economic policies of the post-crisis administration of Néstor Kirchner (2003-2007) appear to have initially taken into account the hard lessons of unsustainable policies. While Perónist in spirit (and optics), Kirchner’s economics initially amounted to a pragmatic response to the massive income redistribution precipitated by the financial crisis and subsequent recession. On the one hand, the crisis wiped out household savings, increased unemployment to twenty-four percent, and impoverished large segments of the middle class. On the other, the depreciation of the currency made exporters (and domestic industries vying for market share with importers) more competitive and greatly reduced the burden of their debts denominated in pesos.
Kirchner suspended payments on the country’s sovereign debt, relieving the government budget of massive ongoing obligations. He also echoed Perónist tradition by favoring domestic industry through policies that maintained the now-grossly-undervalued peso exchange rate, by plowing huge sums into expanded social programs and by imposing price controls on key sectors (such as energy) to suppress inflationary pressures.
On their face, these policies hardly seemed sustainable. But in a stroke of luck, his programs coincided with the start of a global commodity boom that provided the government with windfall revenues from export taxes. As a result, Argentina was able to clear its debts to the IMF in 2005 (well ahead of schedule), freeing Kirchner from the IMF’s calls for fiscal prudence and its demands for a shift to more market-oriented policies.
A key element in Kirchner’s post-crisis recovery strategy was the preservation of the aforementioned undervalued exchange rate. Toward this end, the government once again pegged the Argentine peso to the dollar — though this time at an exchange rate that effectively protected domestic industry from foreign competition. The government maintained this rate by intervening in the foreign exchange market, even though the high prices of Argentina’s key commodity exports suggested that a market-driven strengthening of the peso was needed to fight inflation. Indeed, the exchange-rate peg was complemented by domestic monetary policies that fed the fires of inflation.
On other fronts, Perónist populism ruled the day. The government went to war with commodity exporters, protecting the purchasing power of Kirchner’s constituents in an inflationary environment by restricting food exports and imposing price controls.
When Kirchner decided not to run for reelection and handed the presidency to his wife, Cristina Fernández de Kirchner, in 2007, many hoped that she would begin liberalizing the economy. But that has not happened. And in what amounts to Perónist déjà vu, the failure to allow both currency and product markets to adjust to supply and demand is now exacting a toll on both Argentina’s productivity and it competitiveness in international markets.
The economic consequences are nowhere more apparent than with energy. Argentina has abundant deposits of natural gas: the country appeared on the verge of becoming a major exporter in the early-2000s. But price controls have reduced the profitability of investment in the sector to such an extent that domestic shortages are now forcing Argentina to import natural gas. Ironically, this has made it necessary for the government to subsidize imported gas, even as it refuses to allow natural gas producers to charge for the full cost of production. Recent estimates place the sheer waste associated Argentina’s energy policy at about $8 billion, or close to two percent of GDP.
The government’s tilt toward its urban industrial constituents has also taken a toll on farm output. Argentina has a clear comparative advantage in agriculture: the country’s vast fertile plains potentially make it an export powerhouse to rival the American Midwest. Yet early in Cristina Kirchner’s rule, farmers went on strike to protest the government’s efforts to skim the cream from the commodity boom by increasing taxes on exported wheat, soy, and meat.
Under Ms. Kirchner, the total tax on agricultural exports has risen to 75 percent, effectively curtailing new investment into the sector. Instead, investment is instead flowing into uncompetitive sectors favored by Perónist politicians and bureaucrats.
The most bizarre example is the government’s import-substitution program in frigid Tierra del Fuego. In 2009, Ms. Kirchner sought to create jobs in this desolate region isolated from markets by distance and geography by encouraging production of consumer electronics — that’s right, TVs and smartphones. To this end, she doubled the value-added tax on imported electronics (which largely come from Asia), a move she later backed up with restrictive import-licensing requirements. She also lowered the already-minimal taxes paid by electronics companies (notably, Samsung) that assemble products in the region. The baksheesh, including exemptions from the income tax, value-added tax and taxes on imported parts, have cost the Argentine treasury about $1.3 billion — more than $100,000 for each of the 10,000 jobs that have been created.
Argentina now faces the double whammy of a slowing global economy and productivity-sapping domestic economic distortions. The deteriorating balance of international payments is stimulating speculation about a new peso devaluation, while the country’s increased levels of protectionism are generating threats of retaliation from its regional trade partners.
Less tangible, but more ominous, there has been a decline in the quality of governance across the decade. Argentina has seen a marked deterioration in the World Bank’s measure of government effectiveness and the rule of law, even as the government’s increased reach has produced a significant drop in most dimensions of economic freedom.
Argentina’s post-crisis model is thus coming unraveled, and the economy appears on course for another reality check. As in past run-ups to disaster, Argentine wealth is fleeing the country despite the government’s tightening of capital controls. A new financial crisis could be especially devastating because the country’s differences with foreign debt holders (other than official lenders like the IMF) are still unresolved, effectively freezing it out of global capital markets.
Plainly, this unsustainable economic model holds little promise for debt-strapped eurozone countries seeking a fresh start. However, Argentina’s initial post-crisis successes do offer some insight into the applicability of the Washington Consensus approach. IMF-type stabilization programs that focus on austerity are extremely expensive in terms of lost output and falling living standards. By contrast, aggressive Argentine-style stimulus in the wake of a large devaluation could offer an attractive, short-run solution.
Note that emphasis. It is imperative to make the transition from a demand-oriented strategy to one focused on expanding production for external markets as soon as recovery is well underway. In Argentina, the lingering power of Peronist interest groups has led Argentina to miss this transition window — although recent moves to reverse subsidies suggests that the government is beginning to realize the seriousness of the country’s economic plight. One can only hope that this realization has not come too late.