Argentina: A Casualty of the Free Market?

December 19, 2001 • Commentary

With Argentina’s economy on the verge of default and possible financial crisis, the free market is already receiving the blame.

New York Times columnist Paul Krugman claims that Argentina’s experience is “testing the libertarian credo that the great expansion in government’s role between the two world wars was unwarranted.” Mark Weisbrot, a vocal critic of globalization, refers to Argentina as “the poster child of neo‐​liberalism.”

Is Argentina really the victim of laissez‐​faire? The country did go far in privatizing and opening up to trade and investment in the early 1990s. It also established monetary stability by fixing the peso to the dollar. The result was an average per capita growth rate of 6.3 percent until 1995, when the country felt the effects of the Mexican peso devaluation. But, as in much of Latin America, the reforms of the first half of the decade did not continue into the second half.

Reform fatigue was accompanied by a dramatic growth in the size of government. Argentinean economist Pablo Guido explains that in the past 10 years, the gross domestic product grew by about 50 percent, while public spending grew by about 90 percent. In terms of spending as a share of the economy, the size of government grew by 28 percent, and now equals more than one third of the national output.

The increase in spending is matched by a heavy tax burden. The value added tax is 21 percent (about three times that of most sales taxes in the United States) and the combined payroll tax has until recent months averaged about 43 percent (compared to 15.3 percent in the United States) and remains high. Taking into account income and other taxes that Argentineans face helps explain the high level of tax evasion, not to mention the discouragement of growth.

Bureaucracy has also helped strangle the economy, especially in the provinces, which have seen virtually no reform. The government of San Juan province, for example, spends 85 percent of its $783 million budget on the wages of its 30,000 workers rather than on services. According to the Fundación Atlas, a think tank in Buenos Aires, the cost of bureaucracy is killing the provincial economies. Public spending equals 84 percent of Formosa province’s economy, 71 percent of Santiago del Estoro’s economy, and 69 percent of the economy of Chaco province.

Regulation continues to be a problem nationwide. To open a business in Argentina, for example, requires 12 bureaucratic procedures, 77 business days and $2,100 in fees. In Canada, by comparison, the same operation takes 2 days, 2 procedures and $280. Argentina’s extremely rigid labor laws, a legacy of the authoritarian Peronist era, also remain unreformed. The consequently high cost of labor is directly responsible for the country’s chronically high unemployment rates that have ranged from 14 to 18 percent in the 1990s.

Thus the partially liberalized Argentinean economy is suffering from severe mismanagement. The result has been a $155 billion public debt, more than three years of recession, and a fall in government revenues.

If the outlook lacked much promise, why were international and domestic investors eager to lend to Argentina? In large part, their behavior can be explained by the expectation of an International Monetary Fund bailout should things go wrong. And indeed, the IMF has backed more than $40 billion in bailouts to Argentina in the past year. But that credit has neither spurred reforms nor can it continue, particularly in a country whose immediate problem is debt.

Unfortunately, Buenos Aires has made a bad situation worse by failing to produce a credible debt payment plan and by tinkering with its fixed exchange rate system. Both factors fuel speculation that the government may devalue the peso. The resulting currency risk is raising interest rates and endangering an otherwise sound banking system. Indeed, since Argentineans are highly indebted in dollars, any devaluation would lead to widespread bankruptcies and a financial crisis.

To end currency risk, the best alternative for Argentina is to dollarize. As Johns Hopkins University economist Steve Hanke explains in a recent Cato Institute study, that move would avert a financial crisis and, by lowering interest rates, spur growth.

Even with dollarization, however, Argentina may not avoid default. Yet that outcome might be healthy. After all, the IMF’s well‐​known crusade to prevent default has encouraged the buildup of debt, discouraged reforms, and merely led to a transfer of resources from ordinary Argentinean taxpayers to international and domestic investors. As Adam Smith pointed out in The Wealth of Nations, an orderly default, like bankruptcy, is part of the market process and sometimes the wisest policy.

Dollarization and an orderly default may finally introduce some market discipline in a country where excessive government activism has been prevailing for too long.

About the Author
Ian Vásquez

Vice President for International Studies and Director, Center for Global Liberty and Prosperity