A history of economic trouble in Argentina

Argentina’s new president faces a formidable task in fixing his country’s economy. Tom Bailey takes a look at exactly how the South American nation found itself in its current condition

 
Supporters of Mauricio Macri celebrate in November 2015. Decades of poor economic policy mean that Macri can expect to face a number of challenges during his presidency  
Author: Tom Bailey
March 10, 2016

Argentina was once one of the world’s richest economies. Only as recently as the turn of the 20th century, Argentina, along with several European and North American economies, was part of an elite club of prosperous countries – a club that, following the rapid rise of China and other emerging market economies, has grown in size in the decades since.

It is popular to talk about the ‘rise of the rest’. Although the US remains preeminent in its economic sway for the time being, European economies have gradually fallen behind in terms of GDP size as other countries have steadily caught up, rising among the ranks of the world’s largest and most dominant economies. A few years ago, Brazil overtook the UK in terms of total GDP, while Germany recently saw Russia’s economy eclipse its own. For the most part, however, this was to be expected: European nations comprise a small corner of the earth, and as larger nations turn their subsistence farmers into industrial workers (and then service sector employees), overtaking the old powers of Europe is inevitable. It is less of a fall and more of an expected correction and relative decline.

Argentina, however, really has fallen: while a century ago it was one of the world’s most prosperous economies, it has now, according to the World Bank, been downgraded to an upper-middle income country. This rating is still better than that of the majority of countries today, but its relative position is a far cry from scarcely 100 years ago, when its wages rivalled those of the UK. In terms of prosperity, the nation has failed to maintain its position among the European and North American economies it once rivalled. Income per capita is now on average 43 percent of that of the world’s richest nations, among whom it once ranked (see Fig. 1).

A republic on the rocks
Behind this rise and fall has primarily been poor economic policy: a reliance on exports led to both the nation’s initial rise and later decline, while a subsequent attempt to seal itself off from the world economy merely furthered this descent.

Argentina has recently elected a new president, however: the former mayor of Buenos Aires, Mauricio Macri, of the centre-right Republican Proposal party. Since its fall from grace, Argentina has seen persistent poor policy and economic management from its leaders, creating a continually rising and falling economic pendulum (see Fig. 2). As such, the new leader has a formidable task ahead of him. Macri will have to grapple with both a historical legacy of Argentinian economic decline and the country’s currently poor economic performance, which largely comes thanks to his predecessor, Cristina Kirchner.

Argentina fig 1According to the World Bank’s Latin America and Caribbean Regional Outlook report, which was published in January, the country faces a number of challenges in the coming months and years: while the Argentinian economy saw a modest rebound of growth to 1.7 percent in 2015, the report noted that this was largely due to a surge in government spending. This increase, and the resulting rebound in growth, was unleashed by the previous administration in the run-up to election in the hope of buying the support of the electorate, but was ultimately unsustainable. As such, projected GDP growth for Argentina in 2016 is 0.7 percent.

Net exports, as noted by the report, have been falling, while private consumption is weak. Argentina has also been seeing soaring inflation, reaching over 15 percent in the first half of 2015 and around 14 percent in later months. This figure currently stands at around 20 percent.

Argentina fig 2Imported difficulties
Of course, some of the problems being faced by the Argentinian economy are cyclical: across the world there are fears of a new global downturn, while Argentina in particular is being hit by the economic troubles of neighbouring Brazil. The Portuguese-speaking giant is Argentina’s largest trading partner, and so some of its economic sectors, including the automobile industry, rely on Brazil for up to 80 percent of their trade. As the World Bank noted in its report: “Growth declines in Brazil tend to have measurable or statistically significant spill-overs to its South American neighbours. A one percentage point decline in Brazil’s growth tends to reduce growth in Argentina, after two years, by 0.7 [percent].”

Yet the country’s woes are not all imported: investor confidence in Argentina is particularly low at present as a result of unease over the nation’s fiscal and monetary policies, particularly with regards to its afflicting debt levels (see Fig. 3). Since the 1980s, the country has defaulted multiple times on its debt obligations; most notably, but not most recently, in 2001, when it failed to pay creditors a total of $95bn – the biggest default in history.

The nation’s credit grade remains consistently low, being at the bottom of ratings compiled by financial advisory service Standard & Poor’s. Furthermore, since the mid-2000s, the country has been locked in a long-running dispute with so-called ‘holdout creditors’ – those holding bonds who refused debt swap options following Argentina’s multi-debt restructuring efforts. This has made Argentina something of a pariah on international bond markets, from which it is effectively barred.

On top of the world
This reputation is in stark contrast to how the Argentinian economy was performing and perceived in the past. Writing in 1905, economics observer Percy F Martin heaped praise upon the future of Argentina in his essay Through five republics of South America: “In spite of its enormous advance, which the republic has made within the last 10 years, the most cautious critic would not hesitate to aver that Argentina has but just entered upon the threshold of her greatness.”

He optimistically predicted that Argentina’s “next generation is destined to see as great a rate of progress in this country’s trade as the past 20 years have witnessed”, while he also showed admiration for the “common sense of the cosmopolitan commercial population”. This cosmopolitan population was made up of waves of European immigrants. While the story of the huddled masses of Europe seeking opportunity in the US now dominates historical memory, many also made a similar journey to Argentina – so many, in fact, that in the early 20th century, half of the capital’s population was foreign-born. These migrants went to find work in the country’s booming agricultural and cattle industry.

In the late 19th century, in the lead-up to the outbreak of the First World War, Argentinian GDP surged at an annual growth rate of 6 percent. Although the world has since seen growth rates much higher than this, at the time it was the fastest rate of growth recorded anywhere on the planet.

This impressive growth rate allowed the country to rank among the 10 wealthiest nations on earth at the time, ahead of France, Italy and even Germany. At the time, Argentina had a per capita income that was 50 percent greater than Italy’s, and nearly twice that of Japan’s. According to The Economist: “Income per head was 92 percent of the average of 16 rich economies.” Furthermore, Argentinians were four times as wealthy as Brazilians.

However, as The Economist starkly noted, “it never got better than this”. Since these glory days, Argentina’s “standing as one of the world’s most vibrant economies is a distant memory”. After a long decade of relative decline, while much of the rest of the world excelled, Argentinians ended the 20th century with an income that was less than fifty percent of that of the Italians and Japanese.

President of Argentina, Mauricio Macri, following his swearing-in ceremony on December 10, 2015
President of Argentina, Mauricio Macri, following his swearing-in ceremony on December 10, 2015

Argentine decline
The country’s great wealth was based on a boom in global trade. The period before World War One was an era of unprecedented globalisation and free trade, of which the Argentinians took full advantage, most notably through the export of beef. The country’s abundant supply of various resources allowed it to find prosperity through exporting to the rest of the world – yet this possibility turned to dependency, putting the country’s fortunes at the behest of the rest of the world. When the era of free trade and economic liberalism fell victim to war and depression, Argentina began its long decline.

For a nation so reliant upon exports, the tariffs and blockades of war were a disaster. They also underlined a fundamental problem with the Argentinian economy: despite being one of the richest in the world prior to the war, it was not a modern, industrialising power like those that it surpassed in terms of wealth were. This meant that it was hit especially hard by the external shock of the new, war-torn era.

This was not unique to Argentina – the period of 1914 to 1945 was a catastrophe for most economies around the world. However, as much of the rest of the world subsequently went through an era of economic reconstruction, Argentina was for the most part left by the wayside.

Then, in 1946, Juan Perón came to power. His political philosophy, now known as Peronism, was a form of corporatism, chiefly favouring large state enterprises and an overbearing regulation on the economy. Of course, state protectionism itself isn’t always responsible for economic failure: South Korea and Taiwan both favoured protectionism in order to foster domestic industries in the 20th century, with the intent of using the method to build up industries to compete on the world market – which they did, very successfully. However, the protectionist policies of the two East Asian tigers and that of Argentina were very different.

Protectionism in Asia was intended to foster industry and ready it for the world market, while Argentina’s was an attempt to withdraw from the world economy and its fluctuations. The present fortune of each country speaks for itself. Under the command of Perón, the state even went so far as to monopolise all foreign trade, a policy generally associated with countries east of the Iron Curtain. The Asian countries also had a greater degree of political stability at the time, boasting secure property rights – something that Argentina was, and still is, sorely lacking.

Argentina fig 3Argentina attempted to liberalise in the 1970s, but without any industry able to meaningfully compare with international competitors, this only served to precipitate another decline. Peronism had allowed some industries to grow, but they were massively inefficient, shielded from the world market. Any local industry that had been fostered by protectionism was no match for the outside world, and so its products were outcompeted by foreign goods entering the market.

Manufacturing had seen growth in the period of protectionism, but now started a long period of decline. Ultimately, turning in from the world had merely created inefficient industries, rather than providing a protected space in which industries could grow. Between the 1970s and 1990, Argentinians experienced a real per capita income drop of over 20 percent.

The long road ahead
After a century of decline, the Argentinian economy approached the 21st century with a brewing financial crisis, with poor economic policy once again taking a toll on the fortunes of Argentinians. Following a huge build-up of public debt and a period of high inflation in the 1980s, in the following decade the Argentinian Government decided to peg their currency to the US dollar. This was intended to reduce inflation and allow imports to become cheaper through currency appreciation.

While an appreciation of the Argentinian peso was indeed needed, pegging it to the US dollar meant that it overshot the mark. This had a disastrous effect on Argentinian exports, and by the late 1990s Argentina had entered into a deep recession, with unemployment sitting at 15 percent. Along with longer-term issues such as poor tax collection and corruption, the recession resulted in a rise in state spending and a diminished revenue base.

By 1999, creditors had lost confidence in Argentina’s ability to service its debts, leading Argentinian bonds to appreciate. The response was a round of austerity cuts at the behest of the IMF, yet this only further deepened the Argentine recession. By 2001, Argentina had defaulted on its debts and did away with its currency peg: this was the only option afforded to the country, but the subsequent devaluation further impoverished Argentinian citizens.

As capital fled the country, consumer spending collapsed and savings were wiped out. The economy, however, was able to start to rebound after the devaluation, with Argentinian exports once again picking up (see Fig. 4). Furthermore, the onset of a boom in commodity demand in the 2000s also arose, largely fuelled by Chinese and emerging market demand.

Argentina fig 4

However, this once again caused Argentina to become reliant upon exports and vulnerable to external shocks – something that has just recently happened again with the global collapse of commodity prices. Add to this crisis the poorly thought out policies of the previous administration, and the formidable economic task facing Argentina’s new president becomes clear.

The last few years under the presidency of Cristina Kirchner included polices such as “instituting capital controls, running down foreign exchange reserves, [and] in effect having the central bank print money to finance a public deficit”, according to the Financial Times. While these wrongheaded policies were for a while hidden by a world commodity boom, after commodity prices went into the doldrums, the full extent of Kirchner’s economic mismanagement has become apparent.

It would be churlish to expect the new president to be able to completely rectify this century of economic decline: Argentina will not return to its once high-ranking place among the world’s economies anytime soon, nor will the legacy of certain economic calamities be swiftly overcome. However, Macri can set about addressing certain problems with the economy, particularly with regards to cleaning up the mess left by his immediate predecessor.

Argentina has defaulted multiple times on its debt obligations – most notably in 2001, when it failed to pay creditors a total of $95bn

As the World Bank’s report noted, Macri’s new administration is “expected to implement monetary and fiscal tightening in 2016”, which is hoped to lead to a pick up in growth in 2017 “as investment slowly strengthens on renewed investor confidence and leads the recovery”. Along with this, the government has announced that it will make efforts to reach a compromise with holdout bondholders from Argentina’s previous defaults, with the hope that Argentina will lose its pariah status among international creditors. Macri has also pledged to end the policy of capital controls and bring the country’s exchange rate to a more realistic level, while the country’s central bank is also expected to finally move to combat inflation, tightening monetary policy by increasing interest rates.

This will be a tough task, as exports will undoubtedly be hit by such policies and ordinary Argentinians will feel the pinch. Yet it is hoped that the new regime will begin to restore some normalcy to the economy and reinstate confidence in it for businesses. The new fiscal and monetary policies of Macri, after countless years of economic mismanagement, should lay the foundations for a much-needed reversal of fortunes for Argentina. However, none of this will see Argentina return to its former economic glory anytime soon: such a turnaround will require a long-term compromise between being either entirely export dependent or overly protectionist and inward-looking – both of which it has been, and suffered from, in the past.

Argentina must become neither dependent on nor cut off from the world economy, but find a middle ground that allows it to take advantage of world trade, while being able to deal with any external shocks that may arise. Only then can Argentina hope to regain – and sustain – the economic prosperity that it lost a century ago.