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Argentina's economic dilemma — and ours
Trump's Peronist approach is the wrong formula
Kate and I went to Argentina a little over 10 years ago, and while Buenos Aires was an incredibly fun city to visit, it was apparent even then that the country’s macroeconomic policies were off track. I haven’t followed the situation closely since then, but the broad economic trajectory has been pretty clearly “the same kind of problems but more so,” and the issues that were evident back in 2012 help us understand why an outsider rightist candidate is gaining steam on a platform that includes ending the country’s central bank and adopting the dollar.
The biggest indicator of a problem on our trip was that almost everyone we met, from our Airbnb host to the guy working at the corner store, wanted to trade us pesos for dollars at a better rate that we could get through official channels. The government had used its bank regulatory powers to establish an official exchange rate that priced the peso higher than if it were allowed to float freely. And the gap was large enough that it was worth Argentines’ time to engage in these kinds of black market exchanges.
The best deal we got was from a guy working the cash register at a supermarket near our apartment. Argentina, at the time, had imposed a very high tariff on imported smartphones as some kind of industrial policy aimed at bolstering a local electronics industry.
My cashier explained to me that he was set to fly to Miami soon to buy iPhones and was looking to accumulate as many U.S. dollars as possible in advance of the trip. Then he would come back to Buenos Aires with a bag full of black market iPhones and sell them for less than the tariffed-up price. Swap pesos for dollars on the black market, fly to the U.S., swap dollars for iPhones, fly back, swap iPhones for pesos on the black market, and repeat.
The government at the time was also cooking the books on the official inflation stats. You could see this looking at the “Big Mac Index,” a funny feature The Economist used to publish that would just literally show the price of a Big Mac in different countries. They called it a quick and dirty version of a Purchasing Power Index, and the upshot was basically always that in countries with strong sectoral bargaining, fast food workers earned higher wages and Big Macs were more expensive. But in the case of Argentina, you could also see that the price of Big Macs was accelerating much more rapidly than the official rate of inflation. So the government started leaning on McDonald’s to avoid raising the price of Big Macs, which McDonald’s agreed to do — but then the company responded by ceasing any advertising or promotion of the existence of the Big Mac. I read about this before going and checked it out in person — Big Macs were super cheap (cheaper than a Quarter Pounder!), but to find out that they existed at all you had to dig deep into the menu fine print.
This was all before the current wave of economic crisis that pushed the annual inflation rate to over 100%. But it illustrates the basic predicament: when a government goes beyond making some policy mistakes and makes secondary and tertiary policies trying to cover the mistake up, that sets the stage for a downward spiral of the sort that has pushed Argentina to the brink of disaster.
A true fiscal catastrophe
Javier Milei is a charismatic right-wing television personality who’s making a big splash in politics, so he naturally draws comparisons to Donald Trump. He’s chosen to welcome those comparisons, so he’s been slotted into the global political narrative as a “Trump-like” figure.
But despite some real commonalities, his core policy message is very different from Trump’s. Milei’s argument, which I think is basically correct, is that Argentina needs a round of scathing fiscal austerity. It’s similar to what Paul Ryan was arguing back in 2010–2012 — the message that Trump got the GOP to drop or downplay in favor of a focus on immigration. But the difference is that Ryan was calling for austerity at a time of low inflation and low interest rates when it made no sense, while Milei is calling for it in the context of a genuinely ruinous fiscal situation. It’s not even that Argentina’s formal debt and deficits are all that high so much as that the central bank did several rounds of printing money to cover deficit spending in a way that wrecked all confidence in the currency.
Years and years of parallel exchange rates and the normalization of black market currency shenanigans created a situation where it’s normal for everyone to dump pesos as soon as possible and conduct as many transactions as possible in dollars.
And one consequence is that inflation has pushed well past the point of being an annoyance to something that actually dominates economic thinking and acts as an independent drag on activity. Nobody was happy with 9% inflation in 2022, but the U.S. dollar and our banking system continued to function perfectly well. You could show up anywhere in the country with a couple of pieces of plastic in your wallet and buy whatever you wanted. Argentina’s not like that. People are spending a lot of time thinking about exchange rate and currency issues, which is further impeding productivity and further making it difficult for the country to cover its bills. The only way to fix this is going to involve fiscal and monetary austerity, and dollarization appeals because it’s a way of burning the government’s ships and essentially guaranteeing an austere course.
What dollarization does
Several other Latin American countries, notably El Salvador and Ecuador, have adopted the U.S. dollar as their currency, so there is precedent for this.
But there are a lot of technical and logistical issues, starting with the basic fact that Argentina is much bigger than Ecuador and so would actually need a lot of dollars to pull this off. An exchange rate peg would be a simpler plan. Under a peg system, pesos would continue to circulate locally, but anyone who wanted to exchange pesos for dollars could do so at a guaranteed fixed rate. Under that kind of peg system, your central bank ideally doesn’t actually need all that many dollars because people are confident they could get dollars if they needed them, so they don’t actually do the exchange. The key, though, is confidence in the integrity and stability of the system. Argentina doesn’t have that for several reasons.
One is that the government has not acted with integrity. Another is that Argentina had a currency peg system in the late 20th century that collapsed, so people have specific reason not to trust this. And a third is that on a superficial level, a dollar peg sounds a lot like the dual exchange rate system that my black market traders were exploiting.
Technically, though, it’s supposed to be the opposite. Under the dual rate system, if you want to buy pesos legally you have to buy them at the fixed (inflated) rate. But you can’t just swap pesos for dollars at the inflated rate; there are capital controls designed to limit people’s ability to take their money out of the country. A peg would be the reverse — unlimited right to exchange pesos into dollars at the fixed rate, and the central bank has to set interest rates high enough to raise enough dollars on international financial markets to cover that. The upshot is an exchange rate peg can force you to adopt a very austere policy, which is in fact what happened right before the demise of Argentina’s previous peg — so to avoid austerity they ditched the peg, which makes it very hard to create a credible new peg.
Dollarization, whatever its logistical challenges, would blow all that up.
With no central bank and no sovereign currency, prices and interest rates would be stabilized automatically via outsourcing to the Fed. The government would have no choice but to live within its means, and in practical terms, Argentina would need to run a trade surplus — exporting mostly agricultural products and tourism and importing whatever can be bought with the dollars that earns.
Then comes the hard part
Described at that level of abstraction, I think this is a pretty appealing formula.
But, you see lots of examples around the world of this failing. From the point of view of policymakers in Italy and Spain, the adoption of the Euro was supposed to have exactly these benefits. National governments would be binding their hands, no longer able to address economic problems by devaluing the currency. Inflation would be cured by, essentially, outsourcing monetary policy to Germany. Budget discipline would be ensured, and prosperity would follow.
Realistically, though, macroeconomic policy can’t ensure prosperity.
To be prosperous, you need productivity growth. You need to adopt the best technologies invented abroad. You need to cultivate domestic industries that succeed in export markets. You need your most efficient companies to grow, putting their less-efficient rivals out of business and taking over their real estate and labor assets. How exactly to do all this is difficult and controversial, but policymakers at places like the International Monetary Fund and the European Central Bank at least think they have a playbook of “reforms” to accomplish it. What macroeconomic policy can do is use fiscal and monetary stimulus to reduce unemployment. And what happened in Italy and Spain and elsewhere in Europe when the Great Recession hit is that they couldn’t use fiscal and monetary stimulus to reduce unemployment. So you had tons of people in the ultra-low-productivity sector of idleness, and you had a lot of talk about how “well, really you should do a lot of good reforms.”
But either the countries in question didn’t do enough reforms, or the reforms that were recommended weren’t good, or they picked bad reforms off the list because whatever you may say about 2009–2019, there was no “southern European productivity miracle.” The prosperity gap with the U.S. and Germany grounded in that region’s lower productivity just got larger because southern Europe also had higher unemployment.
By the same token, Argentina abandoned its prior currency peg because it was forcing tons of people into unemployment, which has a lot of obviously undesirable properties. Talking about currency changes as a way to generate prosperity sounds nice because it’s very high-level. But the core problem in Argentina is their productivity has been stagnating since the mid-1990s, and they need to do something to fix that.
The Peronist bargain
I don’t think it would be useful for me to play Argentina economy expert, and if there were obvious ways for middle-income countries to become rich ones, you’d see more rich countries.
But it’s noteworthy that Argentina has some very unusual policies in place, like hefty taxes on exports. Debates rage on over the wisdom of import taxes designed to protect domestic jobs and industry, but who taxes exports? Well, Argentina does. The latest round of tax hikes on exports is supposedly designed to combat inflation by depressing the domestic price of food. But more broadly, the whole long trajectory of Peronist politics in Argentina has been about trying to redistribute resources from Argentina’s lucrative agricultural sector toward urban workers.
That’s not a totally crazy idea. You can think of the entire Hamilton/Clay tradition in American politics running through Abraham Lincoln and the Gilded Age Republican Party as promoting industrialization through a protective tariff and investments in infrastructure. And that worked out pretty well.
But Argentina keeps failing to develop a successful industrialization strategy. That’s because for this kind of thing to work, a country needs to practice what Joe Studwell calls “export discipline” — shutting down companies that don’t succeed in gaining traction in foreign markets. The tariffs on imported smartphones, for example, did not succeed in generating a globally competitive smartphone industry. Instead, Argentina’s political economy has followed a purely redistributive logic with the result that productivity has stagnated. From 50,000 feet, it does seem like the country needs a kind of free market shock therapy to unwind that social compact. But if you think through the details, it seems very politically challenging, especially because the productive sector is agriculture, and it’s not like you can just build more ranches and absorb tons more workers.
The status quo is really bad, but reworking all of national policy to serve the interests of landlords is also bad. As best I can tell, Milei is mostly eliding a discussion of what shock therapy would look like in practice with culture war stuff (he wants to make it easier to get a gun and harder to get an abortion) and over-the-top anti-leftist rhetoric. But I think what external observers need to know is that the success or failure of any new policy regime in Argentina is ultimately going to come down to whether they can generate productivity and growth.
The danger of Trump redux
Like all self-respecting Americans, I mostly care about foreign politics in order to shadow box about American issues. Milei is on the right and is in some ways coded as a Trumpy figure. A curious aspect of the U.S. political discourse (at least on the internet) is that American Democrats tend to be very interested in Keynesian economics and worried about things like how Europe austeritied itself to death, while American Republicans tend to be very interested in anti-Keynesian ideas and concerned about the dangers of falling into an Argentina-like spiral of deficits, money-printing, and inflation.
But in actual American politics, it’s Ronald Reagan and especially George W. Bush and Donald Trump who consistently grounded their politics on fiscal profligacy.
Bill Clinton balanced the budget, Barack Obama cut deficits and sought more austerity than the congressional Republicans would agree to, and the Biden administration has at least proposed ideas for deficit reduction, while the GOP presidential candidates have nothing useful to say on this.
Trump in particular has a very Peronist approach to economic policy, albeit without the specific rural-to-urban transfer element. A typical Trump move was raising tariffs on foreign manufactured goods and then, when the subsequent trade war hurt American farmers, using some creative legal moves to give farmers huge direct payments with no offsetting spending cuts. His big policy innovation in GOP circles was cutting taxes while also promising to avoid cutting Social Security and Medicare. This all worked out okay during Trump’s administration because interest rates were low. Right now, he’s running on nostalgia for the good macroeconomic conditions that prevailed for the first three years of his administration, which is a good message in the sense that conditions genuinely were good. But all he really did was inject big bursts of stimulus — taxes went down and domestic spending went up and entitlements were allowed to keep growing and some of the ACA taxes were repealed without repealing any of the spending — into an economy that still needed stimulus.
If you were to actually repeat this policy dynamic under current conditions, you wouldn’t get an Argentina-scale disaster, but you would be moving in an Argentina-like direction. If you want to avoid that in a way that’s consistent with the GOP tax-cutting agenda, then you need to enact big cuts to Social Security, Medicare, and Medicaid. Right now, Republicans are doing a good job of pretending this tradeoff doesn’t exist, and the press is covering everything but the concrete policy stakes in the campaign. Ultimately, though, politics doesn’t just matter for its symbolic culture war value — some people would even say that the concrete material impact on hundreds of millions of people is even more important!