Heritage Foundation Leadership for America

The irresponsible economic policies pursued by the government of Argentina in the wake of its sov­ereign debt default in 2001, and its debt restructur­ing offer in 2005, provide a vivid case study of the root causes of Argentina's steadily declining scores in the annual Index of Economic Freedom published by The Heritage Foundation and The Wall Street Journal.

In late December of 2001, Argentina declared a default on its massive sovereign debt—the largest such default in world history. In 2005, the country pre­sented bondholders with its final offer, a "take-it-or-leave-it" debt-swap proposal for bonds with an origi­nal face value of $81 billion. The offer required bond­holders to agree to a 70 percent reduction, the largest sovereign debt "haircut" on record. Holders of bonds amounting to about 76 percent of the national debt— many of them state-owned banks and other entities of the Argentine government with little say in the deci­sion—agreed to the swap. The remaining 24 percent— "holdout" bondholders—who rejected the offer include more than half of Argentina's foreign creditors.

The country's left-wing government, led first by Peronist Party leader Néstor Kirchner (president from 2003 to 2007) and now by his wife, President Cristina Fernández de Kirchner, has used revenues from commodities exports to finance the same sort of populist policies that have kept General Juan Peron and his political progeny in power in Argen­tina more or less continuously since the 1940s with a simple but economically destructive formula: wasteful welfare state handouts, a swollen bureau­cracy to redistribute wealth, and powerful closed-shop trade unions protected from foreign competi­tion, all generously lubricated with corruption.

Although Argentina had made an impressive eco­nomic recovery after the disastrous 2001–2002 crisis, the Kirchners thumbed their noses at conventional economic wisdom, imposing price controls and a 21st-century version of Juan Peron's "Import Substitu­tion" industrialization policy, as well as essentially lying about the true levels of inflation that their polices have created. Not only does an artificially low inflation figure overstate real gross domestic product (GDP) growth, it also permits the government to make lower interest payments to bondholders based on a consumer price index (CPI)-linked formula.

The Kirchners have also toed the party line of their only major benefactor—hard-left socialist president of Venezuela Hugo Chavez—and so they are rejecting advice on market-friendly economic reforms from the International Monetary Fund (IMF). In a cynical move in 2005, the government of Argentina repaid more than $9 billion in low-interest loans from the IMF ahead of schedule, greatly helped by revenue from high-interest bonds the Argentine government sold to Chavez (inflicting the resulting higher interest payments on Argentina's beleaguered taxpayers). With Argentina's loans paid off, the IMF has less lever­age over the Kirchner government. Chavez is using Venezuela's oil wealth as a weapon to undermine the IMF, which he accuses of being a tool of the Western imperialist powers (led by the United States).

At long last, the Kirchners' luck appears to be run­ning out. The economy is slowing and the Kirchners are finding it increasingly difficult to convince people in Argentina and around the world that the inflation figures reported by their government statistical office (INDEC) are correct. Although INDEC maintains that inflation in Argentina is running at an annual rate of 9 percent, most knowledgeable observers place the real figure at 30 percent—and growing.

Meanwhile, facing declining government reve­nues due to the economic slowdown they created, and the need to continue government handouts to their urban-poor political base, the Kirchners attempted to raise the already heavy taxes on exports of agricultural commodities, especially soybeans, in March 2008. That set off an unprecedented rebellion by Argentina's farmers that has hurt the country's image around the world and shredded Cristina's domestic approval rating. This has fueled concern that if the Kirchners do not address the debt issue (with the attendant rising inflation and low private-sector investment levels) and Argentina's economy slows, Argentina could be en route to another crisis and default as experienced in 2001.

Rule of law, secure property rights, transparent government, and vigilance against state corruption are among the most important measurements used to cal­culate the annual rankings of 179 countries in the Index of Economic Freedom. Argentina's score plummeted from 70.9 in 1998 (ranking 19th-freest economy in the world of 156 countries scored) to 55.1 by 2008 (ranking 108th of 162 countries). The Kirchners' Per­onist government has callously disregarded these free­doms in a classic case of an assault by a leftist-populist regime on the property rights of both Argentine citi­zens as well as foreign investors and bondholders.

The Kirchners' aggressive and antagonistic atti­tude toward the holdouts (refusing until only recently to even consider re-entering negotiations), as well as their collusion with Hugo Chavez in his campaign against the world financial system, poses a grave threat to global prosperity and threatens to undermine established and time-tested interna­tional lending norms, ultimately to the detriment of all developing nations. Hundreds of U.S. companies operate in or export to Argentina, employing tens of thousands of people, whose futures have been jeop­ardized by the Argentine government's refusal to settle with the holdouts. 

The country's investment climate has been dam­aged. This past August, Standard & Poor's cut Argentina's foreign-debt rating from B+ to B, which is five grades below investment grade and places Argentina into the same category as Belize and Burkina Faso, far behind neighbor and rival Brazil (which achieved investment grade in 2008). This lower rating will raise the cost of borrowing for Argentine businesses and make Argentina less competitive in the global economy.

The Kirchners must correct the deficiencies described in the 2008 Index of Economic Freedom, for the good not only of their own citizens, but of all South America. The Argentinean government must also be honest about the true rate of inflation and cease efforts to manipulate the value of the peso. The government of Argentina has an obligation to its citizens to reach an agreement with all external creditors so that it can regain full access to world financial markets.

As a leader of the globalized economy and the international financial institutions that have ensured prosperity for billions of people over the past 50 years, the United States has a special responsibility to prevent abuse of that system by Argentina or other rogue nations.

The U.S. Administration should insist that the IMF, the Inter-American Development Bank, and the World Bank withhold any future lending to Argentina until Argentina adopts free-market and good-governance reforms addressed in the Index of Economic Freedom.

The U.S. Congress should hold hearings on the threat to both the U.S. economy and the world financial system if more sovereign debtors were to follow the bad example of Argentina and repudiate their debts. Congress should also investigate possi­ble legislative remedies to prevent abuse of the legal system by sovereign debtors.

James M. Roberts is Research Fellow for Economic Freedom and Growth in the Center for International Trade and Economics (CITE) at The Heritage Foundation.