Argentina: A Casualty of the Free Market?


With Argentina’s economy on the verge of default and possible financialcrisis, 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 rolebetween the two world wars was unwarranted.” Mark Weisbrot, a vocal criticof globalization, refers to Argentina as “the poster child ofneo‐​liberalism.”

Is Argentina really the victim of laissez‐​faire? The country did go far inprivatizing and opening up to trade and investment in the early 1990s. Italso established monetary stability by fixing the peso to the dollar. Theresult was an average per capita growth rate of 6.3 percent until 1995, whenthe country felt the effects of the Mexican peso devaluation. But, as inmuch of Latin America, the reforms of the first half of the decade did notcontinue into the second half.

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

The increase in spending is matched by a heavy tax burden. The value addedtax is 21 percent (about three times that of most sales taxes in the UnitedStates) and the combined payroll tax has until recent months averaged about43 percent (compared to 15.3 percent in the United States) and remains high.Taking into account income and other taxes that Argentineans face helpsexplain the high level of tax evasion, not to mention the discouragement ofgrowth.

Bureaucracy has also helped strangle the economy, especially in theprovinces, which have seen virtually no reform. The government of San Juanprovince, for example, spends 85 percent of its $783 million budget on thewages of its 30,000 workers rather than on services. According to theFundación Atlas, a think tank in Buenos Aires, the cost of bureaucracy iskilling the provincial economies. Public spending equals 84 percent ofFormosa province’s economy, 71 percent of Santiago del Estoro’s economy, and69 percent of the economy of Chaco province.

Regulation continues to be a problem nationwide. To open a business inArgentina, for example, requires 12 bureaucratic procedures, 77 businessdays and $2,100 in fees. In Canada, by comparison, the same operation takes2 days, 2 procedures and $280. Argentina’s extremely rigid labor laws, alegacy of the authoritarian Peronist era, also remain unreformed. Theconsequently high cost of labor is directly responsible for the country’schronically high unemployment rates that have ranged from 14 to 18 percentin the 1990s.

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

If the outlook lacked much promise, why were international and domesticinvestors eager to lend to Argentina? In large part, their behavior can beexplained by the expectation of an International Monetary Fund bailoutshould things go wrong. And indeed, the IMF has backed more than $40billion in bailouts to Argentina in the past year. But that credit hasneither spurred reforms nor can it continue, particularly in a country whoseimmediate problem is debt.

Unfortunately, Buenos Aires has made a bad situation worse by failing toproduce a credible debt payment plan and by tinkering with its fixedexchange rate system. Both factors fuel speculation that the government maydevalue the peso. The resulting currency risk is raising interest rates andendangering an otherwise sound banking system. Indeed, since Argentineansare highly indebted in dollars, any devaluation would lead to widespreadbankruptcies and a financial crisis.

To end currency risk, the best alternative for Argentina is to dollarize. AsJohns Hopkins University economist Steve Hanke explains in a recent CatoInstitute study, that move would avert a financial crisis and, by loweringinterest rates, spur growth.

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

Dollarization and an orderly default may finally introduce some marketdiscipline in a country where excessive government activism has beenprevailing for too long.

Ian Vásquez

Ian Vásquez is the director of the Cato Institute’s Project on Global Economic Liberty and editor of Global Fortune: The Stumble and Rise of World Capitalism (2000).