Democracy Lab

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.



Why Would Anyone Want to Join the EU?

The European Union is flailing, feckless, and fundamentally undemocratic.

Following Croatia's vote (albeit on only 44 percent voter turnout) in January to join the European Union, Serbia has now also been accepted as a candidate for membership. This is its reward for agreeing to a compromise with Kosovo, mediated by the EU, whereby Kosovo will be written with an asterisk at international and regional meetings to highlight the disputed status of the breakaway province.

This leaves Kosovo's future still something of a mess, especially because all the young country was offered by the EU for its agreement with Serbia was a "feasibility study" on integration. But the larger question is why the EU should want to absorb Balkan countries at all, given its troubles over Greece. More to the point, why should any country want to join the European project, which is itself in shambles?

The answer seems to be sheer desperation. The EU wants to prove that it is still attractive to someone, while Balkan countries, viewing EU members as richer and more stable than themselves, hope some of that residual wealth and stability will rub off.

Another curious case of EU membership that may soon arise is Scotland. First Minister Alex Salmond has promised a referendum on Scottish independence within the EU. This, of course, is a contradiction in terms because Scotland would become a separate but minor province of the EU under this plan rather than a truly independent state. Salmond assumes that an independent Scotland would not have to apply for membership because it is already in the EU as a part of the United Kingdom.

True, Salmond now says he wants to retain the pound sterling as the currency for Scotland and not (as until recently) the euro. Whichever he chooses, however, his independent Scotland would still have its interest rates set by a foreign bank (the Bank of England in London or the European Central Bank in Frankfurt) and would depend on Brussels for almost all policy decisions (the EU generates 84 percent of domestic legislation in Germany, according to the country's Federal Ministry of Justice). In the weighted system of EU majority voting, moreover, Scotland's mere handful of votes would count for nothing. Yet Scots will soon be offered this tartan pig in a poke.

Superficially, the EU seems to have made great progress since the 1957 Treaty of Rome. Almost every aspect of policy is now determined by bureaucrats in Brussels in combination with the European Council and the European Parliament. The EU even has its own foreign service and is struggling to create its own intelligence and federal police services. No wonder it impresses Arabs and Africans, whose own struggles for unity have, relatively speaking, gone nowhere.

The trouble, however, is that the EU as a whole is in absolute demographic decline and relative economic and technological decline, and its major policies -- whether the common fisheries and agriculture policies or the euro and monetary union -- have failed. In terms of foreign and security policies, it is an international joke. It spends next to nothing on defense, and even its main contributors in this area, Britain and France, have seen their armed forces so severely cut recently that in the Libyan war, where Europe "took the lead," they were entirely dependent on U.S. logistics and supplies. If the EU boasts of its reliance on "soft power," that is because it has no choice. Its head of foreign affairs, the British baroness Catherine Ashton, has been called "the world's highest-paid female politician," yet she remains anonymous and has no influence on world events whatsoever. Her position sums up everything that is wrong with the EU -- expensive but ineffective.

The fundamental problem with the EU, however, is that the people of Europe have no faith in it and do not identify with it. A 2010 Eurobarometer poll found that only 49 percent of EU citizens think their country's EU membership is a "good thing," while only 42 percent trust EU institutions. Meanwhile, those institutions, like the EU's whole ethos, are positively anti-democratic. Its key decision-making bodies -- the European Council, Court of Justice, and European Commission -- are, for all practical purposes, unelected, unaccountable, and removed from the people (commissioners are usually washed-up has-beens whose political careers in their home states have ended in failure). Their decisions are irreversible in national parliaments, and the European Parliament, while vested with powers of co-decision-making with the European Council, is also remote. The Parliament is a glorified debating society -- not a government with an official opposition -- and its parties cannot promise any fundamental policy changes in their election manifestos; indeed, its election outcomes rarely have an impact on the course of EU politics. Its members are unknown and despised as opportunists who merely seek inflated salaries, perks, expenses, and pensions. Voter turnout in the EU's parliamentary elections is low and falling, reflecting the widely held belief among EU citizens that the EU doesn't protect or represent their interests.

One of the most egregious examples of the lack of democracy in the EU is the practice of making small states that vote "no" in EU referenda vote again. Denmark had to vote twice on the Maastricht Treaty, while Ireland was forced to go two rounds on the Nice Treaty and the Lisbon Treaty. Big states are not immune from this kind of bullying treatment, either. When voters in France and the Netherlands rejected an EU constitution in 2005, European leaders tweaked about 4 percent of the original wording, renamed the document the Lisbon Treaty, and then rammed it through the French and Dutch parliaments despite the popular votes. When then Greek Prime Minister George Papandreou suggested a referendum on the Greek bailout last year, he was maneuvered out of office within days.

The EU does not believe in the tolerant British saying, "When in Rome, do as the Romans do." Instead, its policy is, "When in Rome, do as the Germans do." Altogether, the outlook in Brussels and Berlin is like that of Napoleon in George Orwell's Animal Farm: "He would be only too happy to let you make your decisions for yourselves. But sometimes you might make the wrong decisions, comrades, and then where should we be?"

The official German attitude is summed up by the regular fury from German politicians and the German media whenever an EU country calls for a referendum on initiatives from Brussels. When Ireland announced in February that it would hold a referendum on the EU's new fiscal treaty, Der Spiegel marveled, "The Irish Again!" while Süddeutsche Zeitung declared that if the Irish fail to realize that the fiscal pact "is in their national interest," Germany "will not be able to help them." Perhaps nothing captures Germany's elitist attitude better than an essay last summer in Der Spiegel by German political scientist Herfried Münkler titled, "Democratization Can't Save Europe: The Need for a Centralization of Power." Münkler argues that elections and referenda cannot be trusted in Europe because "the European population has never been and still is not a European people." EU elites, he adds, "need to improve -- and power has to be taken away from the periphery." Can you imagine a leading U.S. magazine printing such stuff about American elites and voters in certain states?

But this is exactly what is happening in Europe today. Power is being taken away from the periphery by centralizing elites. But these elites are failing. The EU's key policy -- monetary union -- has been a disaster. The simple fact is that you cannot have a successful monetary union without a political and fiscal union, with monetary transfers between rich and poor areas legitimized by democratic institutions. (In a currency union of disparate economies where changes of interest and exchange rates are forbidden to members, weaker economies have no means of competing with stronger ones if there is no legal arrangement for democratic agreement among members that stronger economies will bail out weaker ones when they get into debt.)

In the EU, however, there is no appetite for political or fiscal union or for larger monetary transfers -- particularly not in Germany. So the only solution to the productivity gap between the north and south in the eurozone, if it is to not break up after a series of defaults, is for the southern states to deflate themselves through austerity to the level of Chinese peasants in order to become competitive with Germany (according to the World Economic Forum, Germany is the world's sixth-most competitive country, while Greece ranks 90th). Greece, for example, will see a 25 percent drop in GDP by the end of next year. Already, more than 1 million Greeks out of a workforce of 5 million are unemployed, suicides are going up along with homicides, barter is becoming the means of exchange in rural areas, and public support for extreme left- and right-wing political parties is growing.

Unsurprisingly, some now accuse the Germans of once again being bent on domination, because they have called the Greeks dishonest, doubted their ability to run their own economy, suggested a takeover of the country by a European commissioner, proposed the postponement of parliamentary elections, and called for the creation of a separate national account for the payment of debts to Frankfurt before any money can be spent on Greece itself. The quarrel, in any case, will probably be settled by Greece's exit from the euro, which Germans would certainly now prefer.

In the meantime, similar problems are looming in Ireland, Portugal, and Spain. These have been assuaged temporarily by the policies of the new Italian head of the European Central Bank, Mario Draghi, whose long-term refinancing operation has given more than 1 trillion euros to European banks to encourage them to buy bonds from states that could yet go bankrupt. Berlin and Brussels are headed in another direction and are staking everything on the ratification of the new European fiscal compact, which has been signed by 25 out of the European Union's 27 member states and forces EU members to have their budgets approved by Brussels.

The problem, of course, is that the compact needs to be ratified. And, once again, democracy is rearing its ugly head. The probable winner of France's forthcoming presidential election, François Hollande, promises to tear up the treaty. The hard-luck Irish may well vote "no" in a referendum. No one knows who will be ruling Greece or Italy within a year. The Spanish have just unilaterally rejected the latest deficit-reduction target set for them by the EU. Even in Germany, it now turns out that Chancellor Angela Merkel will need a two-thirds majority of both houses of parliament -- in other words, support from opposition parties who will demand concessions -- to pass the fiscal pact. The whole initiative will likely be overtaken by events.

This is the European Union that Serbia is a candidate to enter. We wish the country well.

JOHN THYS/AFP/Getty Images