Courtesy of Vox España (CC0)

By Sebastian Tofts-Len

This piece first appeared as a featured article in volume 95, issue one of Pelican. You can view our print archive here.

A century ago, Argentina was one of the richest countries in the world. In fact, it was widely seen to be a future economic superpower on par with the United States. Then, beginning in the 1930s, something went terribly wrong. Argentina began a long economic decline; crisis after crisis caused low growth and high inflation. A sharp decline in living standards followed. Today, more than four in ten Argentines live in poverty.

This decline was not inevitable. Economic policy determines economic performance. And over the past several decades, Argentina has been plagued by disastrous economic policy. The country has defaulted on its sovereign debt nine times, including three in the past two decades. This has led it to be shut out of international capital markets, forcing the government to resort to the central bank to fund deficit spending. Irresponsible monetary policy through an expansion of the money supply has driven inflation into the triple digits. Price controls—which have been imposed on consumer goods to combat high inflation—only acted to distort markets and create widespread shortages. Powerful trade unions institutionalised rigid labour markets that make hiring prohibitively costly. Protectionist policies driven by populist sentiment—including import licensing and high tariffs—have only served to insulate domestic producers from competition, reduce the quality of goods and services, and drive prices higher.

A new era

Enter Javier Milei, the newly elected President in December 2023. Milei has begun what will undoubtedly be a painful period of structural reform to get Argentina’s economy back on track. This consists of both microeconomic reform and macroeconomic stabilisation. The new government is pushing to massively deregulate the economy, reduce subsidies, abolish price controls and privatise many government activities. The labour market will be liberalised to make wage setting more flexible. At the same time, the framework for macroeconomic policy is to be reformed. Government spending will be massively reduced, combined with some tax increases to reduce the budget deficit. On the monetary policy front, the central bank will be abolished in favour of dollarising the economy in an attempt to reduce sky high inflation.

If Milei’s government succeeds in seeing through the entire reform package, Argentina will go from being one of the most protected and regulated economies in the world to one of the least. This pursuance of market reforms was dramatic in the 1980s across the world; notably Britain under Margaret Thatcher, Australia under the Hawke-Keating Government and New Zealand under the fourth Labour Government. Although economists today largely agree that structural reforms have been mostly successful in other countries, the proposed reforms in Argentina have attracted widespread criticism. Almost all agree that doing nothing is not an option. However, many feel that the reforms will go too far and too fast, at great social cost (notably through increased inequality) for little or modest economic benefit.

This argument does not stand up. If anything, large reform is essential. Firstly, the idea that these economic reforms are radical only seem that way because Argentina’s economy is so tightly regulated in the first place. According to the Heritage Foundation’s 2023 Index of Economic Freedom, Argentina ranks 144th out of 176 countries. It is precisely for this reason that reform needs to spread far and wide to be effective. Secondly, the suggestion that these reforms are coming too fast and should be implemented in small, one-step-at-a-time packages would almost certainly guarantee failure and see them wound back. No reform would be bad enough, but beginning reform and having it undone by an uncourageous government, unwilling to bear the initial pain for the long-term rewards, would arguably be even worse. The adjustment costs from floundering back and forth would be great.

The reasoning for implementing reform as far and as fast as possible lies in the past success of a small, far-off country across the Pacific Ocean: New Zealand. From the 1950s through to 1984, New Zealand sowed the seeds of economic crisis: rising unemployment, enormous budget deficits and mounting inflation masked by price controls resulted in declining living standards. Then after 1984, market reforms were spearheaded by finance ministers Roger Douglas (from 1984 to 1988) and Ruth Richardson (from 1990 to 1993). During the first wave of reform under Douglas, the dollar was floated, the financial sector was deregulated, many government activities far and wide were privatised, the tax base was broadened, import licensing was abolished, and tariffs were reduced and subsidies were phased out almost overnight. During the second wave under Richardson, social spending was cut to concentrate welfare on the truly needy and the labour market was liberalised to move away from the old Soviet-style system of centralised wage bargaining. The reforms are widely acknowledged to have saved New Zealand from the brink of economic collapse. As a result, today it stands as one of the richest countries in the world.

While Argentina’s circumstances certainly differ, there are valuable lessons—universal principles—to be learnt from the New Zealand experience. While the design direction of Milei’s proposed economic policies—namely those policies which improve the efficiency and competitiveness of the private sector and improve governance of the public sector—are sound, the execution—in particular, the speed and coverage of the policies—are where the key lessons matter.

Comprehensive reform at breakneck pace

Roger Douglas, widely considered one of the greatest economic reformers of the 20th century, authored The Politics of Successful Structural Reform in 1989. In that paper he rightly argued that the reforms in New Zealand were successfully implemented in large part because they were delivered as a massive and broad package, which prevented special interest groups from mobilising to oppose the reforms. For example, it would have been impossible to scrap subsidies to the agriculture industry without abolishing import licensing and export incentives at the same time. By ensuring the reform covered all industries, everyone was affected at the same time. Douglas summarises the logic: “It is hard to complain about damage to your own group when everyone else is suffering at least as much. Whatever its own losses, each group has a vested interest in the success of the reforms being imposed on all the other groups”. This is not just rhetoric. Subsequent empirical evidence has borne this out. Research from the International Monetary Fund (IMF) found that large fiscal adjustments which covered a lot of ground had a better prospect of success than smaller ones which timidly tinkered around the edges first.

Due to decades of economic mismanagement, Argentina has a bevy of special interest groups who are protected by intervention. A recent article from The Economist summarises some of these entrenched interests: “Lawyers are furious about plans to fast-track divorces through the civil registry without requiring their services. Doctors hate a new requirement for them to preferentially prescribe generic medicines. Arty types are protesting about gutted funds and the closure of the national theatre institute. Fishermen are cross about permit deregulation. Sugar producers are railing against plans to remove import tariffs.” Ensuring their privilege is removed broadly and swiftly will be the key to success.

The second critical ingredient to successful structural reform is speed. Firstly, political systems and all its entrenched bureaucracies tend to be inherently slow. It takes time to put in legislation and get it passed. Starting with the removal of unnecessary regulations that the government has direct control over (i.e. those administrative rules and regulations that do not require legislative backing) is low-hanging fruit to commence speedy momentum. As former IMF deputy managing director Anne Kreuger has observed, making these easy changes first can advance the time at which payoffs become apparent, leading to increased support for reforms that require legislative backing. Secondly, and more importantly, by implementing large reforms swiftly, this sends a message to the wider community that the government is serious about reform and will not be for turning back. Big bang reform creates a sense of necessary urgency—slow reform leads to drifting. Instead of people using all their effort to try convince the government to revert back to the original state of affairs, they instead focus on adjusting to the new state of affairs. In Douglas’ words, the community’s “confidence depends on maintaining the conviction that the government will drive reform to a successful conclusion”. This establishes political credibility, which is essential to maintain support for inevitable tough times ahead. Indeed, the World Bank has looked at the experience of structural reform around the world and found that strong reforms which were pushed with speedy conviction were more likely to stick. Weak reforms often experienced a backflip with severe adjustment costs.

Remember: structural reform almost always produces losers and pain, particularly in the short run. The costs tend to mount and concentrate immediately while the benefits take time to manifest and spread widely. People can easily recognise short run costs but usually have difficulty perceiving the long run benefits. If the reforming government goes too slow, the benefits will take too long to become visible. It will only take one small error for the government to lose its credibility as social tensions run high from the short run costs. The inevitable result will be that the original consensus for reform will break down, leading to a loss at the next election. In the past, Argentina has attempted economic liberalisation with little success. Under President Mauricio Macri, a slower and more methodical reform package was introduced. It failed precisely because the reforms were inconsistently applied to industry, not credible, and too slow. The result? Macri was voted out in the following election, and his reforms were quickly reversed. Half-hearted measures that, say, deregulate the capital account without any effort to deregulate the goods market—or being too slow to deregulate other sectors of the economy—will fail as they have done so in the past.

The sequence of reform

The only concern that can come with this structural change is that it will almost inevitably be done in the wrong order—at least according to economic theorists. There is a wide and varied technical literature on the sequencing of structural reform. It is generally argued that domestic economic distortions and inefficiencies should be tackled before exposing an economy to international competition. In this vein, economic theory would suggest that governments should seek to deregulate product and labour markets as much as possible before embarking on reducing budget deficits and inflation, and then lastly opening up the economy to free trade. If done in the wrong order, the adjustment costs of structural reform will increase. For example, if the labour market remains tightly regulated through centralised wage bargaining (which renders wages inflexible to economic change), then unemployment is certain to soar higher than necessary if the economy is opened up to international pressure. If the foreign exchange market (as part of financial sector deregulation) is opened up too early, this could cause large capital inflows, which in turn puts upward pressure on the exchange rate. This appreciation makes a country’s exports more expensive, which decreases the competitiveness of domestic firms and compounds their commercial struggle if goods and labour markets are not yet deregulated.

However, experience across OECD countries suggest the labour market is the last and often most difficult to reform. This is acutely the case in Argentina where powerful labour unions have institutionalised a resistance to flexibility in wage setting. Milei will eventually need to tackle wholesale labour market reform head on, which will require dismantling the powerful and enduring trade union movement. The evidence is overwhelming that the only way to achieve a sustainable low rate of unemployment is to remove rigidities in the labour market.  However, this is unlikely to happen first. Douglas argues (contrary to “armchair theorists” who like to emphasise the order in which to implement reform) that in a fast-changing political landscape, a perfect sequencing as described in the academic literature is not possible. This is compounded by the fact that some reforms will take years to be fully implemented. If the Milei government tries to figure out how to perfectly sequence their economic package, it will almost certainly end up becoming a missed opportunity. If the opportunity is there immediately, is politically feasible and makes sense in the long term, it should be taken without delay.

Experience in Australia also suggests that there could be a silver lining to turning the order of structural reform on its head. Under the Hawke-Keating Government in the 1980s, opening up the border to foreign goods, services and capital was done first, contrary to the economic literature. The unconventional ordering was arguably successful because it exposed large inefficiencies within the domestic economy, which generated political pressure to reform the labour market. As former chairman of the Productivity Commission Gary Banks summarised, “In political economy terms, therefore, a lesson from Australia’s experience is that external liberalisation has distinct advantages as a first-mover strategy.”

Endowed with rich natural resources in energy and agriculture, Argentina was destined to be an economic superpower. Unfortunately, decades of policy failure which has over-regulated the economy has driven the country away from its original destination. Make no mistake, under the Milei government, Argentina faces tough times ahead. By removing price controls on consumer goods, the price of groceries will have to temporarily rise to adjust distortions in supply and demand. By phasing out subsidies in transport and energy, the price of gas and electricity will likely skyrocket in the short run before moderating. By privatising a swath of government owned enterprises, thousands of public sector workers will have to be laid off as private sector chief executives restructure those enterprises to be more efficient. However, the alternative would be an unsustainable path which would entrench economic crisis and widespread poverty as the norm. If Argentina’s structural reform is to be successful this time, it should: implement giant packages across the board (i.e. cutting tariffs across all industries as opposed to only some industries), ensure the reform happens as fast as possible (i.e. cutting tariffs overnight as opposed to gradually), and must not waste valuable time and credibility worrying about the order (i.e. cutting tariffs despite the labour market not being liberalised first).

By doing this, Milei may just pull off one of the greatest economic turnarounds in modern history.

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