Argentina could be a rich country. In terms of basic resources, it had most of the advantages of the United States—plentiful fecund land, an influx of immigration labor through the 20th century, long coasts that positioned it for trade. In the late 19th and early 20th centuries, Argentina was what Japan was in the 1980s. It was supposed to be the future. And indeed, it enjoyed periods of encouraging growth. Today, it maintains its advantageous natural resources and human capital. But it’s not a rich country. In 2010, per capita GDP was $14,700. A few years earlier, half the population was below the poverty line, according to the World Bank. Why?
My curiosity piqued by my recent trip, I read fairly extensively on Argentine economic history, so you don’t have to!
The easiest way to explain this is to approach separately the (1) political instability of Argentina’s post-war period, and (2) the financial crises that have prevented it from ‘catching up’ after its ultimate transition to democracy.
Argentina did not fully participate in the massive growth in standards of living in the Western world during post-WWII period, primarily due to enormous political instability. I count at least 10 attempted or successful coups from 1943 to the restoration of democracy in 1983. That doesn’t count the periods in which a single government remained in place, but waged terror campaigns and death flights against its political opponents. These shocks and the constant uncertainty they created are reflected in the country’s schizophrenic GDP growth rates in this period.
From 1983 through 1991, Argentina had spurts of growth (7.9% in 1986), followed by devastation created by a fiscal crisis (-7.5% GDP growth in 1989)—which shouldn’t have been entirely unexpected in this nascent democracy in this early period of financial globalization.
From 1991 through the late 90s, Argentina appeared to be finally living up to its promise. But of course in 2001 and 2002, it experienced a fiscal crisis and default from which it has not fully recovered.
Here’s how the Argentine financial crisis of 2001 happened:
- Beginning in 1991, Argentina adopted a monetary policy of “convertibility”—i.e., its currency was pegged to that of the U.S. dollar at a fixed exchange rate—in order to ease investors’ fears of inflation.
- Pegging the AR peso to the dollar got rid of a significant portion of “sovereign risk”—i.e., the possibility that the government would inflate (devalue) its currency to lower the real value of the payments it would owe its debt-holders. At the time, investors’ nervousness over “sovereign risk” was seen as the major impediment to growth in developing nations.
- This worked very well for a while. It helped draw investments to Argentina, allowing it to increase its productivity and real income. This was part of a larger vogue for emerging markets in the 90s.
- It only slight negative effects on Argentina’s exports at first.
- Things were good for the time; Argentina even made it through the Mexican ‘tequila crisis’ of 1995 relatively sound. But the pegged currency made Argentina inflexible, which would hurt it later in the decade.
- First, the Asian financial crises and the Russian default of 1998 decreased investors’ appetite for risks in emerging markets.
- Irrational exuberance about Argentina was replaced with irrational pessimism. There were huge capital outlfows.
- Worse, in 1998, Brazil devalued its currency, which made its agricultural exports—which competed with Argentine exports—much cheaper on world markets. Because the Argentina peso was pegged to the dollar, it could not be devalued to restore Argentina’s competitiveness vis-à-vis Russia.
- At the same time, because of the tech boom in the U.S., the dollar was actually appreciating (that is, since investors needed to purchase dollars to play in the booming U.S. stock market).
- As the dollar—and hence also the dollar-pegged peso—were appreciating, Argentina’s actual productivity was decreasing due to suffering exports and capital outflows. When a country’s currency appreciates while its productivity decreases, this means that its currency is overvalued.
- Furthermore, because the dollar-pegged peso was perceived as overvalued, investors anticipated future devaluations, which would radically damage the value of their investments in their home currencies. So capital outflows accelerated.
- This hurt Argentina’s real productivity growth, causing a recession and spike in unemployment.
- The recession increased the government’s budget deficit. Combined with of the other problems, this spooked investors, who demanded higher interest rates on new Argentina’s government debt.
- This, of course, initiate a vicious cycle, with higher interest rates increasing Argentina’s debt burden, further spooking investors, raising debt yields even more.
- The Argentine government was loath to devalue the peso, which would have eased its debt burdens, because many domestic industries had obligations denominated in other currencies, and such devaluation could have devastated them, setting off a vicious downward spiral.
- The Argentine government, under pressure from international investors and the IMF, announced austerity measures intended to reduce deficits, thereby initiating a virtuous cycle of improved confidence, reduced yields, productivity growth, and thence more lower deficits. The president, Fernando de la Rua, announced enormous payroll cuts. Protests erupted on the streets of Buenos Aires.
- Investors, essentially, didn’t buy de la Rua’s austerity measures. Domestic political constituencies ultimately hold the power in any democracy, and it didn’t seem likely that Argentine voters would accept these measures when the unemployment rate was already over 10%.
- Ironically, government debt yields actually increased after the announcement of these austerity measures. De la Rua was forced to resign.
- The new government defaulted.
There are encouraging signs in the Argentine economy today. Its natural beauty and location, combined with the weak currency, have brought tourists and their disposable income. The rising tide that is being drawn by Brazil is lifting all boats, including Argentina.
But there are other fault lines, as well. True to Peronist tradition, Argentina’s unions are aggressive, disruptive, and very expensive. Strikes shut down Buenos Aires on a semi-regular basis. Argentines continue to distrust their government—anyone who gets rich in Argentina tries to park the money in U.S. dollars as soon as possible. The government has responded with aggressive capital controls. The government is damagingly protectionist—no Argentines may own iPhones—in a way that reduces its dynamism. Illegal immigration from Bolivia and elsewhere is becoming a disruptive source of political controversy. Its universities aren’t spectacular—at least they are hardly loci of innovation. Inflation is high.
My prediction is that the days of biennial coups and hyper-inflation are behind Argentina, but quick improvement is unlikely.