Oct 10, 2018

Q&A: Why Argentina Declined, and How It Can Rise Again

Rok Spruk Assistant Professor of Economics, University of Ljubljana – Laibach, Christian McGuire Former Communications Associate

The following is a Q&A with Rok Spruk, assistant professor at the Faculty of Economics, University of Ljubljana - Laibach and author of the Mercatus Center working paper The Rise and Fall of Argentina.

Argentina doesn’t seem to come up too often in discussions about economics—what got you interested in its economic history?

One of the most cited quotes in economics, originally written by Simon Kuznets, says that there are four types of countries: developed, underdeveloped, Japan, and Argentina. In the field of development economics, Argentina is perhaps the most interesting and perplexing of these cases. Development economics asks questions like: “Which types of policies and what kind of institutional framework foster inclusive and broad-based long-run development?” Argentina is one of the few countries which attained splendid levels of wealth but subsequently decayed into underdevelopment. Argentine economic history offers numerous lessons on what kind of policies, institutions and other growth confounders not to adopt.

Argentina also teaches us that, once attained, long-run development cannot be taken for granted. It can be easily undermined if powerful interest groups bend the institutional framework to their own advantage through distortionary policies, which tend to destroy the foundations of sustained development. In growth and development field, there is a consensus on what drives the differences in the wealth and poverty of nations, but little is known about why countries’ growth rates come to a halt or decline in a similar way to Argentina. My study also explores the other side of the coin: how to adopt a resilient institutional framework to encourage development.

An interesting comparison between the US and Argentina comes up several times in your study. Nineteenth-century Buenos Aires, for example, has been christened the “Chicago on Rio de la Plata” by some scholars. How were the two countries similar? How were they different?

There are a couple of non-trivial similarities between the United States and Argentina. Even today, Argentina and Chile boast the highest level of inequality-adjusted human development in the Americas, after Canada and the United States. Both countries massive immigration from Europe and other parts of the world in the early 19th century. In Argentina, Spanish and Italian immigration starting in the mid-19th century heavily marked the development of informal institutions. Hundreds of thousands of poor peasants arrived from Spain in pursuit of better economic opportunities in Argentina. Italian immigration was similarly significant. On the eve of World War 1, the Italian-born population represented about 25 percent of the total population in the city of Buenos Aires.

What separates Chicago from Buenos Aires is that early 20th century Buenos Aires lacked the social foundations for sustained liberal democracy. For example, in 1895, the literacy rate in the city of Buenos Aires reached 71 percent. By contrast, cities such as Boston, which Argentine founding fathers admired greatly, were almost fully literate by 1850. Even though the literacy rate in Buenos Aires was exceptional compared to the rest of Latin America, it implied that the presence of the middle class was too thin to prevent the takeover of politics by well-organized and politically powerful social groups. Compared to Chicago and the cities in New England, the weakness of the middle class and extraordinary inequality between the rich and non-rich laid the seeds of Argentina’s subsequent “back-and-forth” between democracy and dictatorship.

You attribute the majority of Argentina’s decline to institutional problems. When did Argentine institutions start to weaken? Or were they weak during Argentina’s more economically successful periods as well?

In 1912, Argentina passed the famous Sáenz Peña Law (SPL), which created secret and open ballots, expanded suffrage, and furthered electoral transparency. The SPL is viewed as the starting point of Argentina’s transition to a US-style system of checks and balances. Even though SPL can be credited for bringing some democratic accountability, it also encouraged widespread populist redistribution. The government proceeded to expand artificial employment opportunities in the public sector for non-existing jobs and freeze urban rents, which was one of the first policy measures adopted by the government of Hipolito Yrgoyen in 1916. We can easily conjecture that the expansion of political freedom vis-á-vis SPL came at the price of lower economic freedom. But the key turning point in Argentina’s institutional development came with the 1930 military coup d’etat against the Yrigoyen government. The coup failed to overhaul the institutional framework that bred income and wealth redistribution from the rich to the poor.

Instead, the military overthrow of the democratically-elected government turned out to be a violent populist takeover establishing a de facto fascist government with a repressive state apparatus that systematically harassed the regime’s political opponents. Moreover, the political elites behind the military coup were hostile to open markets and free trade under a genuine rule of law. From 1930 to 1933, the average import tariff rose from 16 percent to 28 percent. In the 1930s, the military regime began manipulating the exchange rate to protect local industrialists. The government even created a dual exchange rate, which distorted its economy and further hampered its growth prospects. In 1932, the government established market boards to regulate the production of meat, cereals, and a few other resource-intensive products, which further increased state power over the economy. Although many countries in the 1930s relied on protectionism, including the United States under Roosevelt, the policies of the Argentine military regime were particularly harmful. The 1930 coup d’etat is perhaps the most important institutional change in Argentina’s economic history, and can be considered a turning point in Argentine institutional development as it laid the seeds for the populist takeover by Péron and his allies in 1943, and helped create a vicious cycle of populist divide-and-rule politics which characterize Argentine society to the present day.

In your study, you mention that a number of alternative explanations have been suggested for the Argentine underdevelopment. The closing of the Pampas frontier, immigration, and low national savings are all cited. To what degree, if any, did these and other occurrences contribute to the phenomenon you studied?

Institutional breakdowns are not the single explanation of Argentina’s 20th century economic decadence. As with Canada and Australia, Argentina’s vast tract of land made labor scarce, which pushed wage levels significantly higher than elsewhere in Latin America. The expansion into the Pampas led to substantial increases in agricultural production. But the bulk of Argentina’s immigrants from Europe lacked the human capital and sophisticated knowledge to modernize agriculture with technology and innovation. Coupled with a markedly unequal distribution of land and a concentration of economic power in the hands of a few producers, the closing of the Pampas frontier led to the absence of any meaningful productivity-enhancing alternatives.

Another factor could be Argentina’s unrestrictive immigration policy, which failed to foster labor scarcity and made low-productivity agricultural tenancy a norm. Some scholars trace the seeds of Argentine decline to the set of political traditions brought by European immigrants, including a hostility to open markets and a more favorable view of state intervention. Culture and ideas also mattered. The doctoral thesis “State and Economic Development” by Aldo Ferrer, one of the leading proponents of industrial protectionism and the Minister of the Economy in the years 1970 and 1971, served as a powerful policy blueprint of trade and industrial protectionism. As a policy advisor, Ferrer announced a series of state-led subsidies to local industry, higher domestic components in automobile and other durable goods investments, increased collective bargaining and various “buy domestic” campaigns. Such policies were not overhauled by the military junta in the tumultuous period between 1974 and 1983 but were further accompanied by the rise of crony capitalism, where powerful business interests were closely allied with the political elite, which placed Argentina squarely in the underdeveloped countries’ club.

In contrast, Chile during and after the Pinochet rule relied on economists trained at the top US universities to serve as policy advisors. They were educated at the universities such as Chicago, MIT, and Berkeley, and advocated the policies diametrically opposed to the ones practiced by the Argentine governments in the same time period. Compared to Argentina, Chile witnessed a period of rapid economic growth and a dramatic improvement of living standards, and it comes as no surprise that Chile became the first Latin American country to enter the rich country club.

You mention that when institutional change occurs, buy-in from a significant number of interest groups is important. It seems like that would be best promoted through democracy. But you seem to characterize Argentina’s shift to democracy in a rather ambivalent manner. Why?

Argentina embarked on the path to a democratic transition without fundamentally changing the culture of crony capitalism and subversive rent-seeking that were the major culprits behind its 20th century decadence. The populist takeover by the Kirchners in 2002 posited a mere continuation of the policies and institutional norms lingering from the 1930 coup d’etat through the Péronist rule until the end of the military dictatorship. Relatively flat de jure distribution of political power under democratic rule enabled the Kirchners to launch a massive income and wealth redistribution similar to the ones pursued by Péron. Hence, Argentina after 2002 adopted a vicious blend of democratic rule combined with the persistence of crony capitalism and widespread rent-seeking. These activities came at the expense of slower economic growth, insecure property rights and high transaction costs for the non-elites.

How is government favoritism related to institutional strength and economic success? How did that play out in Argentina?

Government favoritism leads to rent-seeking endeavors and a reliance on political connections. Even in a society with a relatively modest level of inequality, non-elites respond to persistent government favoritism with demands for greater redistribution and regulation. That’s because they perceive wealth and business success not as something earned through honesty, hard work and clever management of market risk, but as a result of either luck or political connections. Government favoritism comes at the price of increased transaction costs and insecure property rights for the non-elites suffering from the highly uneven, or sometimes completely absent, access to economic opportunities. In the long run, if government favoritism is not counteracted by a vibrant middle class, low growth rates accumulate into a pervasive economic decline vis-á-vis the Argentine detour.

Has Argentina solved the institutional problems it faced? Have they made any progress, or are there promising signs for the future?

Argentina will only solve the problem of weak and easily subverted institutions once the culture of cronyism and rent-seeking is done away with. Changing the surface of formal institutions without changing the informal foundations will not solve the problem. In the case of Argentina, institutional changes came either as a series of abrupt military coups or as a sheer continuation of policies based on government favoritism. The first juncture came with the onset of forced resignations of Supreme Court justices during the first Péron term, which de facto ended judicial independence. The second juncture came with the 1974 military dictatorship when violence in various parts of civil society was widespread, to the detriment of sustained long-term economic growth. It takes a strong and powerful middle class to tackle weak constraints on the executive and the culture of rent-seeking and property rights violations which lie at the core of Argentina’s economic decadence in the 20th century. Once these constraints are established by aligning informal institutions, especially culture and level of trust, with the proper formal institutional framework, Argentina will be ready for the economic takeoff.

What should policymakers take away from your study? Are there concrete changes that countries should make to avoid a similar decline?

Populist takeovers, which have become increasingly common throughout Europe and the United States, often encourage institutional breakdowns. Such takeovers enable well-organized interest groups to relax formal constraints on executive power to meet the demands of their constituents. The institutional breakdowns can be avoided by nurturing strong cultural norms to prevent the populist takeovers. These norms include active and robust political participation based on open dialogue and non-exclusionary policy discussion. When a critical mass of groups demands inclusive institutional changes, populist takeovers become costly for the incumbent elites. Therefore, cultural norms act as informal executive constraints and enhance the resilience of the de jure and de facto institutional framework against the threat of the populist takeover. On balance, widespread populist tendencies distort investment incentives, undermine the security of property rights, and keep transaction costs high.

Once begun, populist redistribution typically continues regardless of elites’ political ideology, because changing the populist policies is very costly. For example, upon his exile to Spain, Péron secretly made a pact with the trade unions to make Argentine ungovernable in his absence. Without populist takeovers, Argentina’s abundance of production factors and relatively high levels of human capital would easily keep it in the ranks of the richest countries after World War I. Down to the present day, continuous populism has led to a painful drop in Argentine income compared to the frontier countries.

Most importantly, Argentine decline could have been avoided if the short-lived transition to checks and balances following 1912 Sáenz Peña Law had not been counteracted by large-scale populist redistribution. Such costly and inefficient redistribution is more likely to occur in societies undergoing rapid economic growth since interest groups have higher stakes. Providing access to political and economic opportunities to non-elites on equal grounds would have been much less likely to avail the powerful interest groups who took advantage of institutional breakdowns.

Photo credit: David Fernández/EPA-EFE/Shutterstock

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