At the beginning of the 20th century, Argentina was the fifth largest economy in the world. Many at the time expected it to rival the US economy. In the 1950s, Argentina’s gross domestic product per capita was twice that of Spain and three times that of Japan. Today, Argentina is a completely different story. It has defaulted nine times in total and three times in the 21st century alone. What went wrong for Argentina? How did it lose its way?
A prosperous Argentina went down the wrong path with economic policies starting from 1946. Juan Perón became president and pursued the policy of trying to be self-sufficient. The economy became inward-looking. Perón rejected open trade and looked at foreign direct investment suspiciously. Tariffs were very high and Argentina started taxing exports. It tried to industrialise and be less dependent on other countries.
Foreign direct investment was unwelcome and resulted in the underuse of Argentina’s resources. Chile and Argentina both have copper but, while Chile is the largest copper exporter in the world, Argentina severely lags. Argentina spends a large amount on price subsidies with energy subsidies alone amounting to 2% of GDP in government spending.
Perón focused on an intrusive state with a strong labour movement. This resulted in higher wages and large welfare programmes, which the government could not sustain. A large portion of the working population works for the government, resulting in government revenues being spent on paying salaries and pensions. This results in critical capital spending in areas like education, technology and infrastructure being curtailed.
Argentina has a history of hyperinflation. Its inflation rate has been over 100% since the beginning of this year. A key reason for this has been excessive monetary financing by a politicised central bank to finance large fiscal deficits and the government’s borrowing. One third of the International Monetary Fund’s lending has been to Argentina. Inflation has also resulted in Argentinians saving in dollars mostly.
But the key policy that led Argentina down this path has been its trade protectionism.
After the second world war, Argentina’s economic policies related to trade became influenced by its most famous economist, Raúl Prebisch, who became executive director of the United Nations Economic Commission for Latin America. The Prebisch-Singer hypothesis stated that primary goods tend to decline relative to prices of manufactured goods over time. A solution for this was to impose import substitution policies whereby local industries would be protected through import barriers so they could grow. Prebisch influenced not only Argentina but also Latin America.
Argentina largely closed its economy and wanted to be self-sufficient. This meant that large businesses in Argentina focused on producing for the local market in a protected economy. They lost the incentive to be innovative and improve their productivity, resulting in lower quality and higher production costs. This made Argentinian exports less competitive in the global markets.
Import substitution also meant that Argentina was trying to produce products that it did not have a comparative advantage in. This not only resulted in higher prices and lower quality products for the local population but also meant that the resources were diverted away from producing goods in which Argentina did have a comparative advantage. For example, Argentina’s agricultural sector was neglected due to the focus on industrialising.
As import substitution led to inefficient industries and a decline in traditional exports, Argentina had to turn to external debt to sustain itself. This has led to rising debt, which has been unsustainable due to exports being non-competitive. Argentina has defaulted nine times and has experienced a series of recessions and currency devaluations.
Import substitution laid the foundation for Argentina’s economic crisis from which it has not recovered even after 75 years. Trade protectionism and a focus on import substitution is again beginning to rear its head as the US shows signs of interest with its new industrial policy. Argentina will continue to be a lesson for many countries when making economic policy decisions on trade.
Talal Rafi is an Economist and an Expert Member of the World Economic Forum. He is a Fellow at Oxford Global Society and a Visiting Lecturer at the Centre for Banking Studies, Central Bank of Sri Lanka.