Argentina Doubts Market Wisdom Crisis Weakens Region's Embrace of Capitalism

By Anthony Faiola

Washington Post Foreign Service

Monday, August 6, 2001; Page A01

BUENOS AIRES -- Rusting hulks of abandoned factories line the barren industrial landscape of this metropolis. On one desolate stretch of highway, a few lights still shine in the sparse office of Pablo Siano, the mustachioed, stocky director of the La Candeuse mattress factory, who is trying to keep his company afloat as Argentina faces a roiling financial crisis.

"Look outside my window and you can see all the reasons we have lost faith in the free market," said Siano, motioning to the roadway where jobless workers warmed their hands over a fire in the Southern Hemisphere winter air. "Here we all are now, back struggling to survive."

The bleak tableau offers a glimpse of a powerful sentiment now running through Latin America. After a decade of free market reforms, many workers, politicians and business leaders are deeply discouraged by the outcome, and doubting the very wisdom of the capitalist model they once embraced.

The backlash is especially acute here in Argentina, which is teetering on the edge of default on its $128 billion debt, threatening a global financial crisis that could shake neighboring Brazil and other such emerging markets as Russia and Turkey. On Friday, the managing director of the International Monetary Fund, hoping to bolster investor confidence, announced the lender was preparing to grant a $15 billion emergency line of credit to Brazil and accelerate a $1.2 billion loan installment to Argentina that is part of a $13.7 billion package already approved. But some analysts say Argentina may need billions of dollars more in fresh loans to climb out of its difficulties.

The disillusionment with free markets in Argentina and elsewhere could influence how the United States and international financial organizations respond to the latest crisis. It could also deal a blow to the Bush administration's proposal for an expansion of market principles in a massive initiative called the Free Trade Area of the Americas, stretching from Tierra del Fuego to the Arctic Circle, to be put in place no later than 2005.

Leading economists and political analysts now say that if Argentina defaults on its debt or is forced to devalue its currency -- which would plunge the country and perhaps the region into a deeper crisis -- the anger and disappointment with market reforms could spread.

"If Argentina collapses, we're not talking about just an economic contagion in emerging markets, but a political one," said Daniel Artana, chief economist at FIEL, a Buenos Aires-based research organization. "The real danger is that rather than see it as just one nation's failure, restless left wingers will point to Argentina, a country that went full thrust with the free market, and say it is evidence that capitalist reforms simply don't work."

Free Trade Protests

Today, Latin America is battling its highest unemployment rate in almost two decades, and its third major economic slowdown in six years. Many countries in the region are coping with ailing industries and, in some cases, soaring poverty rates.

The current troubles stem in part from the faulty implementation of free market policies, many economists say, including runaway public spending and pervasive corruption. They say it will take more time for Argentina and other countries to recover from decades of inefficiency and the big-state model that drove their economies into the ground before reforms were embraced.

But with globalization linking emerging markets as never before, countries such as Argentina have also faced severe setbacks from crises in Asia, Russia and other Latin American nations.

That has also soured political moods on capitalism. A public opinion poll by Equis Consultants shows opposition to a further reduction in trade barriers in Argentina is now running at 70 percent, the highest in a decade. Meanwhile, another survey, by the Ipsos-Mora y Araujo firm, showed that public support for the privatization of state-run companies had sunk to 50 percent, down from more than 70 percent only four years ago. Across Argentina, anti-free market demonstrations, general strikes, and transit roadblocks set up by the jobless are happening more often and producing more violence, with three people killed and dozens wounded over the past three months.

Domingo Cavallo was once hailed as a free market champion who, as economy minister, orchestrated the opening under former president Carlos Menem. Cavallo was brought back to the same post in March to help rescue the country, but now has become the target of biting satire in editorial cartoons and on television. One cartoonist recently depicted the pudgy economist clad only in the U.S. flag.

The backlash to reform has surfaced in novels, television plots and plays. One Buenos Aires theater is now showing "Los Albornoz," a black comedy about a middle class Argentine family sunk into poverty during the reform era, and whose unemployed father finally turns his children into prostitutes to make ends meet.

In Brazil, Latin America's largest country, which is also going through a slowdown, 40,000 anti-free market demonstrators marched on the capital in June. Luiz Inacio "Lula" da Silva, a longtime populist from Brazil's Workers' Party, has jumped to a strong lead in opinion polls for next year's presidential race.

During a national radio broadcast this weekend, Venezuela's populist leader, Hugo Chavez, attacked the upper classes and stingingly berated the free market. "The voice of the people is the voice of God; the market is not God," Chavez said. "That is what they have tried to convince us of here."

"Where is the progress we were promised?" said Gladys Waimar, 35, a teacher from Buenos Aires who joined a demonstration against a severe government austerity package passed last week.

This month, the measures will slash her $520 monthly salary at a time when she is already supporting her unemployed husband and a daughter, 13. All I see is a never-ending cycle of things getting worse," she said.

State-Run Sell-Off

Argentina's massive privatization effort was launched by Menem, who had his roots in the pro-union and left-leaning Peronist Party. He did a political about-face and embraced the free market, in large measure because he needed to end the hyperinflation that was draining the government and threatening severe social unrest.

Desperate for cash, Menem sold off state-owned companies, often through presidential decrees and backroom deals. In a number of infamous cases, the sales were greased with bribes and other forms of official corruption. Today, dozens of Menem's relatives and former ministers are under arrest or investigation. Menem, whose term ended in 1999, was placed under house arrest in June on arms trafficking charges.

During the privatization project, little was asked of buyers in terms of long-term investment. In one case still winding through the Argentine courts, the contractor who was awarded the privatized Argentine Post Office in 1997 took over operations, then promptly refused to pay the $80 million yearly fee.

Perhaps the most notorious example, however, is that of Aerolineas Argentinas, the national airline.

According to government and corporate records, in 1991 the company had 28 airplanes, the largest pilot training center in Latin America and luxury offices from New York's Rockefeller Center to Rome's Via Veneto. The airline was valued at $636 million and had an operating profit of 5.6 percent. It was sold through a presidential decree to Iberia Airlines, then owned by the Spanish government, for $260 million in cash and $1 billion in bonds. Sources familiar with the deal say the Menem government allowed Iberia to use the planned sale of one of Aerolineas Argentinas' own Boeing 747s as part of its down payment.

The company, once one of the region's largest carriers with numerous routes to Europe, the United States and Australia, was then picked apart. Iberia executives -- several of whom have since been charged with corruption and dismissed from the company -- sold off the Argentine carrier's flight center, its prime retail offices around the globe and all but one of its jets. In Europe, most Aerolineas Argentinas routes were eliminated, essentially turning the carrier into a South American feeder for Iberia's hub in Madrid. Today, the shell of what is left of Aerolineas Argentinas is on the verge of liquidation, saddled with $950 million in debt.

"Iberia sucked out most of the assets for their own purposes," said Andres Ricover, a Buenos Aires-based air transport specialist. "There was deliberate mismanagement, funneling out Aerolineas Argentinas resources until the company was done in."

Even so, there is plenty of evidence that privatization also helped modernize Argentina.

Before reforms, for instance, it took two or three years to get a telephone installed in Buenos Aires. It now takes a few hours. In 1990, this teeming metropolitan area of 13 million had 3.1 million phone lines, compared with 7.7 million in 2000. Spain's Telefonica and France Telecom, the two main phone companies operating here, have invested $17 billion over the past decade in desperately needed upgrades to a dilapidated, state-subsidized system. Additionally, the sale of the electric company -- one of the few done through a bidding process -- improved service dramatically, ending severe power shortages that plagued the country during the late 1980s.

In selling off monopolies, Argentina imposed little government oversight on prices or service. For instance, during its three-year recession, Argentina has been in a period of deflation, with salaries and prices both falling. But phone company rates have continued to rise, and consumer studies have shown that the lack of competition in the international long-distance market has kept prices in Argentina relatively higher than those in the United States, Europe and many Latin American neighbors.

"We have adopted a free market, but not a fair market," said Carlos Raimundi, a member of the Argentine congress.

Flood of Foreign Goods

The liberalization of trade was also difficult for Argentina. The country was flooded by consumer goods, and hundreds of domestic businesses were forced to close. Although economists say this is an inevitable process of weeding out uncompetitive industry, the shock waves for Argentina still linger -- and have contributed to the backlash against market principles.

Only a few are suggesting a full reversal to the inefficient, heavily subsidized economy of the 1980s, but many politicians and business leaders in Argentina and other parts of Latin America are now calling for a return of higher trade barriers. It is one of the most visible signs of the backlash against free markets, although economists warn that new restrictions will only bring more misery in the long run.

The move to liberalize trade was a serious blow to Alpargatas, a textile and food conglomerate that had been a leader in the Argentine clothing industry since 1885. A symbol of industrial pride during the 1940s era of Juan and Eva Peron, the firm, with nine factories and 11,000 employees, churned out everything from gaucho shoes to tango suits, surviving military coups, war with Britain and hyperinflation.

But Alpargatas nearly went bankrupt after a barrage of cheaper imports from poorer countries such as China and India. The company, like hundreds of others here, fell into decline. In January, burdened by debt and facing a painful third year of Argentina's recession, the company was seized by its creditors.

Guillermo Gotelli, president of Alpargatas, insists companies here were not given the conditions to compete. The government did not control "dumping" of cheap imports from Asia and poorer nations in Latin America, he said. Additionally, there was virtually no protection from a surge of counterfeit goods that copied the Alpargatas products. Nevertheless, he said the company tried to buckle down, shedding almost half of its workforce and successfully setting up export operations to Brazil and the United States.

Many economists say that Argentina, with a long history as having the region's best-educated and best-paid workforce, needs to move beyond aging textile factories to survive in today's global marketplace. It needs new, competitive industries. Alpargatas is trying again with a new business plan to do just that, launching a line of processed hake from its foods unit rather than merely shipping raw fish for canning abroad.

"It is the only way we will be able to evolve into countries such as Italy and Spain . . . rather than see ourselves fall in our standard of living to what you see in China or other parts of Latin America," Gotelli said.

One serious hurdle for exporters, however, has been Argentina's currency, the peso. To defeat hyperinflation in 1991, Cavallo came up with a plan, for which he is widely known, to link the peso to the dollar on a one-for-one exchange rate. It worked: With confidence that every peso was backed by a dollar, hyperinflation subsided.

But when economic turmoil hit East Asia and Latin America in 1997, Argentina kept the dollar-peso rate constant, making its exports less competitive. The exchange rate was rigorously defended in part because many economists still said the peso-dollar peg was viable in the long term if productivity and efficiency improved, while public debt was reduced.

The political and social costs of devaluation were also considered too high. A devaluation of the peso would have a devastating impact on the middle class, which maintains much of its personal loans in dollars. So the peso remained rigidly locked to the dollar.

Then, the devaluation in 1999 of the currency in Brazil, Argentina's largest trading partner, further battered the economy. Dozens of factories, considering the costs of being in Argentina too high, moved across the border. It was easy to see why. Today, Gotelli said, the cost of making a pair of sneakers in Argentina is almost twice the cost in neighboring Brazil, where labor is cheaper and the currency has plunged 75 percent over the past two years.

Argentina, a country that once enjoyed a standard of living akin to parts of Mediterranean Europe, is now suffering a sustained increase in poverty and a declining standard of living for millions. The promise of prosperity from free markets and an open economy seems a distant dream for many.

"Argentina now has to live up to its promise," said Artana, the economist, "to focus on not only paying down its debt and emerging from this crisis of confidence, but on making serious reforms of the state, reducing costs and becoming globally competitive. We can't go back in time and fix the mistakes of the past, but we can make sure we don't repeat them in the future."