I was in Argentina in mid-April after over a decade. I had first visited Argentina when I was Research Administrator at the World Bank in the mid-1980s, when the country was facing hyperinflation. I still have a 1 million-peso note, worth a few US cents, which I have produced for students to show the visible effects of loose fiscal and monetary policies. On a visit to the governor of the Central Bank of Argentina, I had asked him how they had engineered an 80 per cent increase in the money supply over the previous month. He looked at me as though I was an idiot and said, “We have a printing press.”
This Alice in Wonderland world changed when Carlos Menem, tutored by my old friend Domingo Cavallo, set up a currency board, opened up the capital account and fixed the peso exchange rate to the dollar. An anchoring of inflation expectations and fiscal prudence helped bring inflation under control, and Argentina enjoyed nearly a decade of rapid and stable growth.
When I last visited Argentina in the late 1990s, it was booming, thanks to the favourable terms of trade. Cavallo, seen as the architect of this boom, was planning a presidential campaign on the basis of this record. When I met him, I said that Argentina needed to have an exit strategy from the fixed exchange rate because, given their historical volatility, if Argentina’s terms of trade worsened, devaluation would be needed to assist the necessary adjustment. He demurred, and the rest — including the shattering of his presidential hopes — is history, with the deep Argentinian crisis at the end of the 1990s and its default on nearly $100 billion foreign debt. There are ominous signs of this long-standing Argentinian cycle being repeated.
The euphoria I saw in April in Argentina, based on eight per cent growth for a long period, was followed by Cristina Fernandez’s resounding victory with 54 per cent of votes in the recent election. But the danger signal is out. The recovery was based on what Fernandez termed “The Model” devised by her late husband, former president Nestor Kirchner. Its essential element was to maintain trade and fiscal surpluses to counteract Argentina’s loss of access to international capital markets after its debt default. A competitive exchange rate and tight fiscal discipline allowed Argentina to sustainably ride the commodity price boom for its agricultural products, flowing from rapid Chinese growth. It also allowed a vast expansion in government entitlement programmes, including free laptops for everyone, child benefits, increase in public sector pay and pension hikes.
But since 2007, fiscal discipline has weakened. The fiscal surplus has disappeared and state spending has increased by 35 per cent a year. The unacknowledged incipient fiscal deficit has been bridged by raiding pension funds and foreign exchange reserves. Predictably, this has led to inflation, independently estimated to be above 20 per cent, though officially it is only nine per cent. Anyone who challenges this official estimate is subject to persecution and fine. The reason for enforcing this lie: nearly half of Argentinia’s domestic debt is index-linked. To avoid overt devaluation, which would fuel inflation, a complex system of matching imports with exports has been introduced. There is growing capital flight, since wealthy Argentinians fear another state raid on their savings. If Argentina’s terms of trade — already at a historic high — deteriorate, with a fall in the price of two-thirds of its exports which consist of agricultural commodities, as the world and Chinese economy cool, Argentina will find itself in the midst of another economic storm.
Yet, despite all these signs of impending disaster with regard to “The Model”, Ms Fernandez was re-elected by a resounding majority. It often amazes me how Argentinians have failed to learn from past mistakes and have been taken in by their leaders’ promises of continued state largesse, which they know cannot be paid for, leading inevitably to an economic-cum-political crisis. Perhaps the clue lies in the collective schizophrenia from which the Argentinians suffer, summed up by a wit on my April visit as follows: “Argentinians are Italians who speak Spanish, live like the French and want to be English.”
How else would you explain why a fabulously resource-rich country, which at the turn of the 20th century was poised to overtake the US as the world’s most affluent country, now has an economy one sixth of Brazil, a third of Mexico and is likely to be overtaken by Colombia. The populist Peronism, which seemed to have ended with the conversion of Menem to the “Washington Consensus”, has re-emerged under the neo-Peronista Kirchners.
This was apparent at the end of a meeting of the Mont Pelerin Society in Buenos Aires, which I had attended. On the last day, when the participants were returning from a visit to a hacienda reminiscent of English country houses, we encountered a huge police contingent. It was holding back a large demonstration outside our hotel. We later learnt that it was organised by various trade union supporters of the president. We all thought that they were protesting the presence of one of the participants, Maria Vargas Llosa, a particular bete noir of Cristina. But when someone translated the slogans being chanted in Spanish and the names being denounced (including, alas, of this columnist, many distinguished Argentinian economists and former policy makers), it became clear that they were protesting against the purported “neo-liberal” agenda of the meeting.
But, it is becoming increasingly clear that Cristina needs to heed this “neo-liberal” advice, given the storms that the “The Model” may face. Drunk on the subsidies it offered the country in good times, Argentina has seemingly endorsed “The Model” in the recent presidential election. It is as if Eva Peron has returned. But to me, Argentina looks like a nonchalant surfer riding the crest of a wave that, as it ebbs, will once again throw the country off its skateboard. This has a lesson for India, as its populist politicians create an ever-expanding entitlement economy.