What Argentina Needs?

This article "What Argentina Needs" by Mary Anastasia O'Grady appeared in The Wall Street Journal on Tuesday, July 17th, 2001 on page A18.

Last week, Argentina's capital markets crashed, increasing international fears of an Argentine default or devaluation. The government has responded by promising, yet again, to cut its fiscal deficit. But the real problem is that the Argentine economy isn't growing - and it isn't likely to until there's a radical shift in the country's economic policies.

Argentina's risk premium shot through the roof last week when investors demanded a 14% annualized rate of return on three-month bills, well above the 9% return in the last auction two weeks earlier and the 12% rate that the market has expected. Investors concluded that domestic interest rates would remain high, that the three-year-long economic recession would continue and that Argentina was rapidly moving closer to the day when it would be unable to service its $128 billion in public-sector debt. When the International Monetary Fund then announced that no new aid was planned for its star pupil, the statistical probability of default went up further.

Free Fall

A free fall in Argentina's capital markets ensued. By the end of the week, overnight Argentina's interest rates had touched 400% and the country's benchmark floating rate bond fell 20%, to yield 35%. Economy Minister Domingo Cavallo had hoped to create a virtuous cycle of confidence when he took over in March; by Friday afternoon, all confidence was gone.

Argentina is now promising to cut its budget by $1.4 billion, and to erase deficit spending by paying public-sector salaries only to the extent that revenues are available. But the political consensus necessary to carry this out is still uncertain. Some voices inside the ruling Alliance coalition - which has opposed wage cuts - now have agreed to support the measures in principal. But many labor leaders, congressmen and opposition party provincial governors remain uncommitted.

Yet even if all the players in this drama climb aboard the austerity wagon - and that's a big "if" - it is doubtful the strategy will produce the confidence shock needed to jump-start the economy.

For its nearly three years of recession, Argentina has followed conventional IMF advice, focusing on the fiscal deficit as the source of all evil and trying to force tax increases and spending cuts on a limping economy. This has not only failed to close the deficit, but has alienated investors looking for pro-growth, low-tax environment for their capital.

Despite a rapid increase in government spending over the past decade, it is economic stagnation, not an oversized debt load, that is the nub of the problem. In fact, at 45% of gross domestic product, the country's public-sector debt isn't unreasonable. Moreover, Argentina has a relatively healthy capital structure, with only about $9 billion in debt to roll over in the second half of 2001. Compare this to Brazil, which will roll over about $29 billion by year end.

It is the languishing economy that makes the public-sector debt a worry. To make matters worse, some economists from up north are now calling for a devaluation on the grounds that printing local currency is the policy tool needed to stimulate the economy. (This would require an undoing - either legally or by decree - of the 1991 convertibility law anchoring the peso to the U.S. dollar and prohibiting the printing of pesos without dollars to back them.)

Devaluation is a bad idea, and not only because the country's balance sheet is so heavily dollarized or because of Argentina's history of hyperinflation. The real trouble with devaluation is that it will allow the privileged classes to one again mask the inefficiencies of the closed and heavily regulated economy, and to pass the costs on to the poor through inflation, as they did for many years before convertibility.

Instead, Argentina should officially dollarize. This will get rid of the uncertainty surrounding the government's commitment to the convertibility law, a major variable adding to the country's high risk premium. It's not clear why the government is resisting this, unless of course it wants to hold on to its option to pull the rug out from under peso holders. Mr. Cavallo's decision last month to create a separate exchange rate to subsidize exporters and punish importers didn't help. Rather, it served as a reminder of the time-honored Argentine tradition of sacrificing private property rights for the "public good."

In fact, efforts to monkey around with the stable Argentine peso underscore the country's most fundamental problem: There is no rule of law, only a rule by majority which grants government unlimited power to arbitrarily transfer wealth according to popular will.

The political system in Argentina has grown dysfunctional precisely because the government has habitually granted privilege in return for power. French economist Frederic Bastiat warned in his 1850 publication "The Law" that such practices eventually corrupt a system. "Under the pretense of organization regulation, protection or encouragement, the law takes property from one person and gives it to another; the law takes the wealth of all and gives it to a few - whether farmers, manufacturers, shipowners, artists or comedians. Under these circumstances, then certainly every class will aspire to grasp the law, and logically so."

It followed, said Bastiat, that the less privileged would also demand to use the law for their own profit, which would entail the right to relief - "to organize Beggary on a grand scale." Bastiat rightly anticipated how difficult it would be to change once socialism had enshrined the taking of property in the law.

Argentina's socialist-democracy is squarely at odds with the convertibility law. which since 1991 has blocked politicians from tampering with the peso and sneakily shifting the cost of inefficiency to the public at large. Stripped of its power to create money, the government has resorted to any number of other assaults on private property and competition - including aggressive and complex tax measures and increasing economic protection for domestic producers - in order to sustain its generous entitlement  system and archaic labor laws. This warring against economic freedom has chased away capital. And so now international socialist retreads are back, waving the banner of devaluation.

Two important symbols of a broader Argentine unwillingness to acknowledge market forces are Banco Nacion, the state-owned bank with a long history of corruption scandals, and Mercosur, the highly protectionist customs union that has perpetuated Argentine inefficiency, discouraged investment and made the country especially vulnerable to Brazil's beggar-thy-neighbour currency policy. But despite piles of evidence that these institutions undermine growth, they remain stubbornly protected.

Restructuring

International market forces are pushing Argentina to control government spending. They are also demanding a reversal of the country's long tradition of hostility toward capital, private property and competition. Advocates of a modern economic restructuring believe that this crisis may force the change. But the possibility also exists that Argentina's  socialist politicians and intellectuals, who are now blaming the crisis on globalization, might succeed in reversing the gains of the past decade. This would be devastating for U.S. interests.

The current crisis calls for U.S. leadership to support the good guys by playing its only card: international trade. A bilateral free-trade agreement for Argentina could, in one fell swoop, dethrone protectionists, reaffirm the dollarized economy and rejuvenate confidence. The alternative is unthinkable.

Ms. O'Grady edits the Americas column.