Argentina: Free at Last

The economic turnaround of Argentina in the last two years constitutes one of the most remarkable free-market success stories of recent memory. As recently as 1989, Argentina's inflation rate was 5,000 percent, and the country was submerged in a decade-long depression. Throughout the 1980s, unemployment, capital flight, and national productivity were at their worst levels in the country's history.

Successive administrations, both civilian and military, could not reverse the downfall, until three years ago, when a new president, Carlos Saul Menem, identified the root cause: excessive government intervention in the economy. Menem has now taken the country through a dramatic economic U-turn, and the results thus far are quite impressive.

Argentina's economic woes can be traced as far back as the early 1950s. At that time, President Juan Domingo Peron and his wife Evita instituted a populist and protectionist government that centralized most economic decision making, nationalized basic industries, granted great political power to labor unions, and increased government spending to the detriment of the economy.

In nine years, Argentina went from a post-war boom to a serious recession, and Peron was ousted by a coup. Military rule alternated with civilian government until 1973. The military exacerbated the policies of centralization by exerting greater political control over the population while continuing Peron's failed economic strategy; the civilian administrations were unable or unwilling to reverse course. Meanwhile, the economy worsened.

In 1973, elections were held, and Peronism made a comeback: Peron and his third wife, Isabel, returned from exile to rule the country, he as president, she as vice president. Peron died shortly thereafter, and Isabel, accused of corruption and mismanagement amid further economic deterioration, was overthrown by a coup in 1976.

The military promised but did not deliver a change in policies, concentrating instead on persecuting the opposition. The economy continued on its downward trend, and when the ruling junta attempted to divert popular attention by invading the Falkland Islands in 1982, they were defeated by the British and voluntarily relinquished power.

A new democratic system was established in 1983. While Raul Alfonsin, who presided until 1989, improved the country's human-rights record, he made no serious attempt to reform Argentina's centralized and overregulated economic structure. Inflation soared, the country defaulted on its international obligations, and the economy hit bottom. Alfonsin's Radical Party then suffered a landslide electoral defeat.

Enter the administration of Carlos Menem. In July 1989, he promised to undertake a series of fundamental policy changes to reduce the role of the government in the economy and empower the private sector. Menem's policies centered on privatization of state enterprises, tax cuts, tax reform, deregulation, drastic reduction of government expenditures, and the opening of markets to foreign competition.

In spite of initial public opposition stemming mostly from organized labor, Menem kept his word. The government plans to have privatized most large, state-owned firms by the end of the year. Menem has abolished 36 regulatory agencies and lifted the restrictions on the import and retail sale of hundreds of products. He has slashed the federal work force by 20 percent.

Argentina has opened its borders, and it is now negotiating a regional free-trade pact with Brazil, Uruguay, and Paraguay. The country is also seeking to enter into a free-trade arrangement with the United States, modeled after the one expected to be signed by the United States and Canada with Mexico. To pave the way, Argentina has cut its industrial tariffs to 11 percent from 22 percent.

The government also cut the top marginal personal tax rate from 45 percent to 30 percent and slashed the top corporate tax rate from 33 percent to 20 percent. Argentina has eliminated the capital-gains tax for individuals as well as the capital-gains tax on stock and bond transactions by foreigners.

In what is perhaps the most significant move, the legislature early last year made it illegal for the government to print money to cover a public deficit; money creation is now limited by law to the sum of gold and foreign-exchange holdings of the government and a small increment of government bonds. A separate law bans government controls on prices and wages. In addition, all foreign-exchange transaction restrictions and rate controls belong to the past, as do all restrictions on business hours and days of commerce.

Tangible results have been quick and impressive. Income from privatization combined with spending cuts created a budget surplus of nearly $3.2 billion in 1991; a larger surplus is expected in 1992, due to additional privatization and growth in tax revenue generated by new economic activity. Real economic growth has revived, reaching 3 percent last year. Experts expect the economy to grow by more than 6 percent this year. In 1991 the inflation rate dropped to 15 percent for the consumer price index and 3.3 percent for the producer price index—a truly astounding achievement. Economists expect both rates to be halved in 1992.

The capital markets have responded enthusiastically: The Argentine stock exchange's capitalization exploded from $3.3 billion in 1989 to nearly $20 billion. Foreign investment is up 50 percent, to nearly $7 billion. Argentina has now resumed foreign-debt payments, and Menem decided to increase the payments so that the $26-billion foreign debt can be eliminated more rapidly. Moreover, the country is likely to obtain concessions on reducing its principal, perhaps by as much as 40 percent, in upcoming negotiations with creditors and the U.S. Treasury.

Confidence indicators among both Argentine and foreign investors have reached record highs. At home, Menem's Justicialist Party has consolidated its majority through substantial gains in all local and midterm congressional elections held last year.

These victories are especially significant because they took place despite a series of well-publicized political difficulties, namely Menem's womanizing and the alleged involvement of some of his advisers and members of his estranged wife's family in drug-money laundering. Confidence abroad is evidenced by the first successful placement of Argentine bonds in the Euromarket in late 1991, totaling $300 million. That the issue was placed at all suggests that fears regarding Argentina's credit worthiness are on the wane.

The Menem government has also been active in labor legislation, seeking to undermine the power of trade unions, which have provided the only source of opposition to his policies. In December 1991, a new labor code, which had been stalled in congress for the last two years, was approved. The law makes labor contracts more flexible, reduces severance payments, and sets a cap on worker's compensation. Before the reform, firms were reluctant to hire new employees because of the high cost of severance, particularly since labor courts invariably ruled against management. Economists now expect significant expansion in employment.

Undoubtedly, Argentina has undergone a remarkable turnaround that invites serious attention to its strong investment potential. The democratic character of the country adds to its appeal; it is a far cry from the military juntas and their related human-rights abuses of a decade ago, and the electoral system set in place in 1983 seems solid, as evidenced by the large turnouts and peaceful and honest outcomes.

President Menem's term runs to 1995, and he remains steadfastly committed to economic reform and economic growth. Economy Minister Domingo Cavallo is also a committed classical free-market supply-sider. He told Forbes magazine, "I'm often asked in Argentina, 'Why are you eliminating trade restrictions, reducing tariffs on imports, at the same time you see the Congress of the U.S. fighting for protection against Japanese imports?' [But] even though in some Western countries the trend is still to bigger government, if you look at the world as a whole, there is the bigger market economy, the smaller consolidated public sector. The trend is toward a market-oriented economy."

If present trends continue, and with per-capita income and employment now at substantially higher levels, every Argentine citizen may become a free-market champion soon.

Julio Marquez is an international banker specializing in Latin America.