Costly Lessons of Argentina’s Financial Folly

Once the poster child for Latin American market reforms, Argentina is now a cautionary tale, its deepening misery raising fears not so much of financial contagion but of ideological spillover that could dampen the region’s appetite for liberalization and democratization.

Just a few years ago, hopes were high that Argentina would become Latin America’s shining example of how foreign investment and the privatization of state monopolies could streamline an economy, and create prosperity. Those hopes are now buried under the political and economic debris from Argentina’s devaluation and abandonment of its currency’s one-to-one peg to the U.S. dollar.

Argentina illustrates how not even a flood of foreign investment can wash away institutional and political flaws, that there are right and wrong ways of selling off state-owned monopolies and that linking a nation’s fortunes to the dollar does not ensure stability.

Although the financial contagion of the sort caused by the Mexican devaluation and Russian default of the 1990s is unlikely, political fallout remains a danger. Brazil and Colombia will hold presidential elections this year, and within Argentina, leftists will seize on economic woes as an opportunity to rally voters against further privatizations and efforts to open markets to foreign investment.

“Everyone has known Argentina was going down the drain, and the financial world was prepared for it,” said Nancy Birdsall, president of the Center for Global Development in Washington and formerly the second-ranking executive at the Inter-American Development Bank. “But the risk of intellectual and ideological contagion is far more subtle and more important.”

How much Argentina’s problems spill over into other Latin American countries will depend on how the events of the coming weeks and months unwind. Appointed by Congress Jan. 1, President Eduardo Duhalde has embarked on the extremely delicate task of trying to bring the region’s third-largest economy back from collapse.

There are many who don’t think that he will succeed. “I’d give him no better than a 50-50 chance,” said Mauro Guillen, a political scientist at the University of Pennsylvania’s Wharton School.

Restoring political stability may be even tougher. Duhalde said Thursday that the nation is “one step away from a blood bath.”

Although most Argentines blame their leaders’ mismanagement for their current fix, many also blame the foreign companies who in the 1990s spent billions of dollars buying utilities and state-owned companies.

It’s hard to find an Argentine these days who has a good word to say about multinational companies here. Most seem to concur with the thinking of Buenos Aires psychologist Elsa Am.

“They have looted everything in this country with the complicity of the politicians,” Am said as she waited in line at a downtown exchange house Friday to buy dollars with her devalued pesos. “Everything could blow up in the next 10 minutes. There is no stability.”

Argentines on the street cite the bungled privatizations of former state-run services ranging from telephones to water, for having raised rates and their cost of living in a time of recession and high unemployment. Sporadic rioting has targeted the branches of multinational companies here.

“The main fallout from Argentina’s crisis is that there will be greater anti-markets, anti-globalization rhetoric,” said Sebastian Edwards, a professor at UCLA’s Anderson School and former economist at the World Bank.

That resentment toward foreign companies could spill into continuing violence and increase a political backlash against free-market reforms that some say is already in progress.

Political scientist Guillen notes that four leaders who were “champions” of privatization--Peru’s Alberto Fujimori, Chile’s Augusto Pinochet, Mexico’s Carlos Salinas de Gortari and Argentina’s Carlos Menem--are either in exile, having left the country in disgrace, or have been under house arrest.

Having abandoned the Argentine currency’s 10-year peg to the dollar, devalued the peso by nearly 30% and declared a default on $135 billion in public debt, Duhalde faces a painful process in which Argentines will see things worsen before they improve.

The disgust of Argentines is high. There already have been sporadic outbursts of violence in the capital. Deepening violence could cause further disenchantment with market liberalization if crowds continue to blame foreign investment.

This is all an unexpected turn of events for a nation that only three or four years ago exemplified the so-called Washington Consensus, whose underlying assumption was that opening markets to competition and foreign investment would cause reforms bringing improved productivity, human rights and better standards of living to all levels of society. The consensus refers to the school of economic and political thought that the best and shortest route to the First World is through free markets.

Argentina privatized everything from railroads and the post office to telephones and oil. For the first half of the 1990s, the flood of cash, mainly from foreigners, helped paper over Argentina’s structural problems involving labor laws, its pension system and the peculiar habit of Argentine provinces to spend more money than they collected in taxes.

But most Argentines and plenty of outside observers say the government mishandled privatizations by auctioning state services and companies at terms too favorable to the outside investors and not creating enough competition.

“The consumer was not at the top of the government’s priorities,” Wharton’s Guillen said.

“Privatizations gave too much to the companies, too much profits, beyond reasonable,” said Marcelo Fernandez, secretary of Proconsumer, an Argentine consumer advocacy group.