Path-dependent import-substitution policies: the case of Argentina in the twentieth century

3.1 The long-run equilibrium

In the long-run equilibrium, firms hire capital and labor competitively and produce according to their production functions, while consumers sell their endowments to the firms and buy the produced goods with the proceeds. In the appendix, we solve for the long-run equilibrium of this economy (see Sect. 7.1). Here, we will highlight our results.

Each pair (π, τ) is associated with one and only one of these equilibria; therefore, under the assumptions made, we can represent the areas or regions that correspond to each of these types of long-run equilibria in the (π, τ) plane:

Notice that, for a given tax rate τ, as the terms of trade worsen (π decreases), the economy moves from specialization to diversification and trade, to autarky and, finally, to a reversal of the patterns of trade. For higher levels of taxes τ, the autarky region is larger.

Consider the share of capital employed in the secondary sector: κ = K _m/(K _m + K _a). This is a measure of industrialization that will be useful in our discussion about preferences for protectionism. Figure 2 shows how this share varies in the long-run equilibrium for different configurations of terms of trade and taxes. A figure for λ = L _m/(L _m + L _a) would look similar.

Notice that the specialization region in Fig. 1 coincides with the region where κ equals zero in Fig. 2. Under specialization and trade, capital and labor employment in the secondary sector are zero.

In the autarky region, the tax rate is set high enough so that the country will not trade with the rest of the world; consequently, changes in π or τ will have no marginal effect on the resulting allocation of resources in the economy. For any point in the region, the factor allocation is the autarky allocation, which we denote as κ _aut and λ _aut (see Sect. 7.1.1 in the appendix). The autarky region in Fig. 1 coincides with the region with κ = κ _aut in Fig. 2.

In the diversification and trade region, the manufacturing sector employs capital and labor. As we move upward and to the left within this region, both κ and λ increase from zero, as in the frontier with the specialization and trade region, up to κ _aut and λ _aut in the autarky region. The diversification and trade region in Fig. 1 coincides with the region where κ is increasing in Fig. 2.

Finally, in the reversal of patterns of trade region, the tax rate on agricultural exports has no effect on the real economy. As π decreases, the secondary sector grows and employs more resources. The reversal region in Fig. 1 coincides with the leftmost region in Fig. 2. As the terms of trade worsen, the share of capital in the secondary sector approaches one; however, the share of labor, λ, converges toward an upper bound that is less than one, since some workers are always employed in the tertiary sector.

It seems appropriate to make two remarks about our model and its usefulness in analyzing the Argentine economy. First, we have simplified the analysis to two tradable sectors. Therefore, our model does not allow for an equilibrium in which some manufactures are exported while others are imported. This is due to the assumption that manufactures are a homogeneous good. A careful interpretation of our model is nonetheless helpful in building our narrative of Argentina’s economic history. The manufacturing sector should be interpreted as comprising the activities that compete with imports, the primary sector as the set of activities oriented toward the international market and the tertiary sector as the services and manufactures that are naturally protected from external competition. Thus, our model assumes that exportable activities are intensive in capital and land, import-competing manufactures in labor and capital, and non-tradables in labor.

Second, we should interpret the autarky equilibrium as representing a situation in which the economy has exhausted its possibilities of import substitution, rather than as an actual autarkic situation. During the period under consideration, Argentina was never in actual autarky; however, it took its import-substitution strategy almost all the way to its technological limit. Of course, there were some inputs that had to be imported because it was simply not feasible to produce them domestically.³

3.2 Political economy

Our assumption that each agent owns a single type of input allows us to group agents according to the input they own and the industry where they are employed. As we show below, the tax rate τ affects the real remuneration of each of these groups in a different way. Some groups will gain from an increase in protectionism (higher τ), while others will lose. Thus, there is a distributional conflict around protectionism.

Notice that no conflict would arise in an economy where each agent owns the same bundle of inputs. Yet, agents endowed with different resources have conflicting interests. The essence of the rivalry between proponents of free trade and advocates of protectionism lies in the assumption that each agent can be identified with one of the socioeconomic groups based on the inputs that the agent owns and the industry in which the agent is employed.

The reader will recall that we have assumed that tax revenues are distributed in lump-sum transfers to agents; thus, the agents’ attitudes will also depend on the share of total tax revenues that each one of them expects to receive. Since we do not specify who the recipients of the lump-sum transfers are, we should bear in mind that, even if a group’s real remuneration is reduced by an increase in export taxes, its overall utility might increase if the group receives a disproportionately bigger share of tax revenues. We should also bear in mind that, given the first welfare theorem, it is impossible to put each and every agent in a better off position by increasing the tax rate and redistributing the revenues.

In analyzing the effect of changes of τ on each group’s welfare, we consider the short-, medium- and long-run time horizons. In the short run, no reallocation of factors takes place. In the medium run, only labor is allowed to move between the secondary and tertiary sectors. In the long run, all factors can be reallocated, and the economy fully adjusts to its new long-run equilibrium.

In Appendix 1 (Sect. 7.2.1), we show that the diversification and trade region is particularly prone to distributional conflict. This is because, in the other regions, either all interests are aligned (under specialization) or a marginal change in the export tax rate has no real consequences (under reversal of the pattern of trade and autarky). Therefore, we will focus on pairs (π, τ) such that the economy will be in the diversification and trade region.

In the short run, protectionist policies will benefit owners of factors employed in the secondary sector and will harm those employed in the primary and tertiary sectors. Since the proportion of factors employed in the secondary sector increases as we move upward and toward the left in the diversification and trade region, protectionist policies have more short-run support as we move closer to the autarky region and less support as we move closer to the specialization area (see Proposition 3 in Appendix 1).

In the medium run, landlords and capitalists with investments in the primary sector will oppose protectionism, while capitalists with investments in the secondary sector will support it. Workers will now have a homogenous attitude toward τ; either all workers will prefer protectionism or all of them will oppose it. We show that the pairs of (π, τ) at which workers switch from opposing protectionist policies to supporting them lies in the diversification and trade region (see Proposition 5 in Appendix 1) (Fig. 3).

In the long run, landlords will always oppose protectionist policies and will benefit from improvements in terms of trade (Proposition 6, Appendix 1). One of our key results is that workers will also prefer a zero tax rate if π is sufficiently high (Proposition 7, Appendix 1). In this case, workers prefer to be employed in the tertiary sector where they can take advantage of the high level of national income induced by high terms of trade. The result for capitalists is similar; for a sufficiently high π, farsighted capitalists will also support free trade policies.

The key insight that we want to convey here is that agents will support or oppose policies according to their source of income and their relevant time horizon. In the diversification and trade region, agents’ attitudes toward protectionism exhibit an interesting pattern. Landlords oppose them in all cases; capitalists employed in the manufacturing sector support them both in the short and medium terms.⁴ Who prevails in this struggle depends on several factors that are beyond the scope of this paper; however, our analytical model gives us some mileage in answering this question. It seems fairly reasonable that the size of the capitalist faction that supports protectionism will be positively correlated with the likelihood of these policies being enacted. Moreover, in a democracy, workers could be the pivotal faction that shifts the balance of power.

Clearly, as we move upward and to the left in the diversification and trade region, protectionist policies will enjoy wider support. As we move in this direction, both workers and capitalists will be more likely to advocate these policies. In the short run, there will be more workers and capitalists employed in the manufacturing sector. In the medium run, workers as a whole group are also more likely to prefer taxation.⁵

This model can also generate endogenous pressure for the enactment of free trade policies in a protected economy that experiences favorable terms of trade or high levels of productivity in the primary sector. As π grows, farsighted workers will stand to benefit greatly from free trade policies. Landlords’ remuneration under free trade is greater when π is large, and they will therefore support these policies more actively. Consequently, if the economy is trapped in the autarky equilibrium, higher π will intensify the distributional conflict because those who want to challenge the status quo have more incentives to do so.

3.3 Path-dependent import-substitution policies

We will now discuss how, starting from a situation of specialization, a significant and exogenous worsening of the terms of trade may lead to an incipient industrialization process, change the “political equilibrium” and lead to the introduction of an import-substitution policy. Interestingly enough for our case study, even if the terms of trade were to later rebound to the previous level at which the economy operated under specialization, new endogenous political forces may have developed that prevent the economy from returning to its initial stance. As in the cases of path dependence discussed in the literature on inefficient institutions (see, among others, North 1990), there are self-reinforcing mechanisms for the persistence of import-substitution policies.

Suppose that the economy is specialized in the primary sector. In that case, the preferences of all agents in the economy are aligned; they all agree on a zero export tax rate. Naturally, this does not mean that they agree on the level of redistribution by other means such as an income tax, but we are abstracting from the analysis of these issues here. Suppose that the terms of trade worsen significantly and that the country naturally initiates an incipient industrialization process, i.e., the economy moves into diversification and trade. Initially, protectionist policies will lack support, since most of the capital is still employed in the primary sector and most workers produce services. If workers take into account the medium-run prospects, they may favor an increase in τ; however, for most of them, it is likely that the short-run costs of a tax increase would outweigh the medium-run benefits.

As the process of industrialization deepens, either because of a further deterioration in the terms of trade or because of capital flows from the primary to the secondary sector, the short- and medium-run support for protectionist policies increases and eventually these policies may be implemented. Protectionism tends to be self-reinforcing, since now more capital and labor will flow to the secondary sector. New waves of demand for protectionism drive the economy toward autarky, which might be characterized as an import-substitution strategy. Notice, however, that for this to happen, either the economy has to have a high level of capital—i.e., to be rich enough—to transfer capital from the primary sector to the manufacturing sector, and the shock has to be sufficiently long-lasting to allow the economy to accumulate enough capital in the manufacturing sector to give rise to a protectionist coalition.

Suppose now that, once the economy is industrialized and the import-substitution strategy has driven the economy close to autarky, the terms of trade improve. In the short run, this harms all the agents who have switched to the secondary sector. However, if these agents hold political power, they will not allow capital to flow back to the primary sector; instead, they will increase the export tax. If the tax is increased to levels that ensure autarky, the improvement in the terms of trade will not have any real effect. The economy will be trapped in a situation where every improvement in the terms of trade will be neutralized and nobody will gain (or lose) from it.

If the terms of trade improve, the distributional conflict becomes more intense. Workers may benefit from a reduction in the tax rate in the long run. Moreover, landlords’ incentive to exert influence in the political arena will increase, because the benefit of reducing the level of protectionism increases with the terms of trade. They will be opposed by industrial capitalists and shortsighted workers who benefit from protectionism. This distributional conflict may grow in intensity, destabilizing the political equilibrium and, depending on how the conflict is resolved, spurring liberalization. Similarly, the distributional conflict will also become more severe if the productivity in the primary sector increases.

The next subsection deals with other forces that may give rise to trade liberalization, not through increased distributional conflict, but by weakening the protectionist political coalition of workers–capitalists.

3.4 Forces leading to trade liberalization

Events that reduce the proportion of workers and capital in the manufacturing sector will weaken the coalition that supports protectionist policies. We have discussed how an increase in the price or productivity of the agricultural sector may generate enough distributional conflict to prompt the formation of a coalition of landlords and longsighted workers that supports liberalization. In this subsection, we show what other kinds of events can shift employment and capital allocation when the economy has traveled far enough down the road of protectionism.

In our basic model, protectionism will lead the economy somewhere near autarky. The assumptions of Cobb–Douglas preferences and technology imply that the shares of labor and capital (λ and κ) in autarky depend only on the Cobb–Douglas shares (α, β, ϕ _m and ϕ _a) and not on factor endowments or productivity (see Sect. 7.1.1 in Appendix 1). This will not be the case if we relax the Cobb–Douglas assumption. We can first relax the assumption of unitary elasticity of substitution in preferences and technology. We can go even further and relax the homotheticity assumption. We note that, if preferences are elastic but technologies are not, the share of workers employed in the secondary sector decreases with both population growth and productivity in the primary sector.

Finally, we conjecture that labor unions that were created or empowered to maintain and support protectionist policies also generated frictions in the labor market that ended up depriving them of their most vital input: unionized workers.

3.5 Lessons from the model

The key result of our model is the finding that protectionist policies are path-dependent. A land-rich economy that is well integrated into world markets may embark upon an industrialization process in response to poor terms of trade, especially if the new prices are not a transient shock. This incipient industrialization process is possible if the economy has enough capital—i.e., if it is rich enough—and labor; otherwise, the secondary sector will not be profitable and the economy will not be able to cushion the negative terms-of-trade shock.

Starting from the onset of the industrialization process, capitalists and workers recently employed in the industrial sector have incentives to lodge demands for protectionism. As the process advances, the political power of these groups grows and, eventually, their demands may be met. As a consequence, the industrial sector receives a new boost at the expense of the primary and tertiary sectors, and the economy gradually becomes closed to world markets. Moreover, the political coalition supporting protectionism gains power. As a result, anti-trade policies become entrenched and the economy moves closer to autarky. Even if the conditions that gave rise to the endogenous industrialization subside, the economy remains closed, since the alliance of capitalist and workers retains its power.

However, the anti-trade alliance is not unbreakable. Secular trends in labor supply, frictions between workers and capitalists or a strong improvement in terms of trade can push the economy back into a free trade equilibrium:

Under more general preferences and technology, population growth and higher productivity in the primary sector can shift the factor allocation and lead to increased demands for free trade. In both cases, under some conditions, a greater share of workers will be employed in the service sector. Therefore, more workers will support liberalization.

Similarly, if services gain in importance in the consumption bundle, more workers will be employed in the tertiary sector. As a result, there will be greater support for liberalization. Moreover, even the owners of inputs employed in the secondary sector will have weaker incentives to support protectionism if this shift toward services occurs at the expense of the consumption of the exportable good.

Once the economy is near autarky, capitalists and workers will not be able to use their coalition’s political power to pursue further industrialization. Besides, they will be extremely vulnerable to negative shocks in industrial productivity (e.g., an increase in the price of a non-modeled importable input). Under these circumstances, unions may be tempted to use their power against capitalists, thereby weakening their alliance. We have discussed how unions, in their zeal to keep wages from falling in the short run, may introduce distortions that reduce their power in the long run.

Finally, an improvement in terms of trade or an increase in agricultural productivity increases the incentives for landlords to intervene in the political process. The economy will be able to escape the anti-trade trap if landlords are successful in challenging the coalition of industrial workers and capitalists.

4.1 The Belle Époque

In 1860, Argentina was a fairly empty land. As in the rest of Latin America, the pace and characteristics of Argentine expansion were fundamentally determined by the success with which some of its regions became exporters of primary products (see Cortés-Conde 1979). The period from 1870 to 1914 was one of free trade and market integration and during this period the country benefited from its marked comparative advantage in the primary sector due to its vast amount of highly fertile land (O’Rourke and Williamson 1999). The dramatic decline in transport costs during the late nineteenth century led to a trade boom and commodity price convergence internationally. In Argentina, the scarcity of labor and abundance of land, relative to Europe, induced a high marginal product of labor. The wage differential between Argentina and some European countries attracted a colossal flow of overseas immigrants, who came to constitute the majority of Argentina’s labor force. A similar process also triggered a massive flow of capital into the country (see Cortés-Conde 1979).

During the second half of the ninetieth century, a large proportion of Argentine land was settled and divided up into latifundia (Adelman 1994). The sharp increase in the availability of land spurred an expansion in livestock raising, primarily because it was a non-labor-intensive activity that could be launched at a time when labor was a scarce resource.

With the pattern of land ownership determined by political history, and with prices of exports, imports and capital set by international markets, total rents depended on the labor supply. Therefore, immigration policy became the critical policy variable under the control of the government (Díaz-Alejandro 1984). Not surprisingly, the Argentine elite chose to promote immigration. The expansion of agricultural activities and a pro-immigration policy paved the way for a very substantial increase in the urban population, especially in Buenos Aires. In addition to its administrative functions as the capital of the country, this city developed an increasingly large and sophisticated service sector.

The export-oriented growth made possible by an expanding international market raised per capita income in a sustained and substantial way. Indeed, the growth process was closely related to successive booms in the exports of land-intensive commodities, with land having a very low opportunity cost. The economic usefulness of the pampas was not discovered overnight, as an oil deposit might be, but instead arose as the result of the combination of a growing European need for primary goods, technological progress in transport and an increasing interest on the part of Argentine policymakers in promoting exports, foreign investment and immigration. By the beginning of the twentieth century, however, the Argentine growth process had become less dependent on the discovery of new resource-based export commodities and on the performance of any one export. It still relied heavily, however, on a steady expansion of exports based on the growth of the world economy and on the completion of the adjustment by which primary production was being transferred from Europe to more recently settled countries (see Díaz-Alejandro 1970).

The early manufacturing sector was closely linked to the primary sector and supplied the domestic market with products that were naturally protected from external competition, (e.g., wine, meat and flour). There also was a smaller industrial sector that competed with imports (e.g., clothes, cigarettes, perfumes). These industries were granted some degree of protection after the passage of the Customs Act of 1876. However, the level and extent of protectionism were rather limited compared to what was yet to come (Gómez-Galvarriato and Williamson 2009). First, the main goal of these customs duties was to obtain revenues for the government, which was a widely accepted practice in Latin America at the time (see Brambilla et al. in this volume). Second, the protected activities accounted for a small share of total economic activity and, to a large extent, the policy was geared toward protecting regional products as a means of preserving the federalist model adopted by the country. Thus, this specific departure from free trade can be more accurately interpreted as a means of securing revenues and of sustaining a political order that, on the whole, was pro-export oriented.

Thus, in our view, the period from 1870 to 1914 was one of specialization in production, with the country specializing in the production of primary goods, importing manufactured goods and employing its workers mainly in the primary sector and the services industry. This was therefore a period in which the political views of the majority of economic agents were aligned against protectionist policies.

4.2 Globalization backlash

It is not clear whether Argentina could have sustained its fast pace of growth under specialization (see Llach in this volume) if the world had remained widely integrated, as it was during the Belle Époque. However, there is no reason why it should not have diversified its production and exports of agricultural and manufactured goods under a policy of free trade. Had the terms of trade remained favorable for Argentina, even if the productivity of the primary sector had not kept increasing rapidly, some manufacturing sectors would have eventually become competitive and taken off. What is more, if the economy had continued to expand, it would have begun to meet an increasing (but previously inexistent) domestic demand for many manufactured goods, thereby encouraging their domestic production, particularly in view of the existence of natural barriers. The same reasoning applies to services (see Galiani et al. 2008).

Instead, the country’s fortune took a sharp turn for the worse in the 1930s. World trade collapsed after the Great Depression. The 1932 Ottawa Conference marked the end of multilateralism in international trade. Great Britain, Argentina’s foremost trading partner, shifted its trade to members of the Commonwealth. A protectionist pandemic spread throughout the world. As a consequence, the ratio of world trade (export plus imports) to GDP declined from 22% in 1913 to 9% in the 1930s. Though there was a recovery toward the end of the decade, international trade was again disrupted during the Second World War, when it was geared toward war requirements. Trade opportunities did not start to improve until after the Second World War under the Bretton Woods system and with the signing of the General Agreement on Tariffs and Trade (GATT). Then world trade began to recover and, by 1950, it had surpassed pre-war levels, mostly thanks to the growth of trans-Atlantic and intra-European trade.⁷ There is a consensus that, after the Second World War, a second globalization era began (see, among others, Baldwin and Martin 1999; Williamson 2002). Nevertheless, the move toward multilateralism was gradual and was not achieved, for all practical purposes, until the 1990s (see Brambilla et al. in this volume for a fuller discussion of these issues).

The breakdown of the economic order was transmitted to Latin America first of all through a sharp change in relative prices: dollar export prices collapsed more steeply than dollar import prices. According to Clemens and Williamson (2002), the magnitude of the decline was around 30% for Asia and the Middle East and 40% for Latin America. This decline in the terms of trade was used as a strong argument in support of the move of the developing world toward autarky in the 1940s and 1950s, within the context of a highly interventionist industrialization strategy.

In Argentina, the terms of trade deteriorated considerably even before the collapse of the international economic order in the early 1930s (see Fig. 4). During the 1920s, on average, the terms of trade were approximately 30% below the pre-First-World-War level of 1913. Such a shock alone merits the label of a reverse of fortune. For a country with a ratio of exports to GNP of one-to-three, a 30% deterioration in the terms of trade represents a loss in real income of about one-tenth, assuming no change in physical output. The 1930s show some recovery in relative prices, which still were, on average, about 16% below their 1913 level. This reversal of fortune, with some pronounced fluctuations, continued throughout the rest of the twentieth century. Just to put this into perspective, the average terms of trade for the period 1930–1999 was 20% below the average relative prices for the period 1890–1913. Nevertheless, in recent years the terms of trade have improved substantially.

The protectionist measures enacted by most countries in the world and the increased risk of sending goods overseas during wartime reduced trade opportunities beyond what would be expected as a result of the terms of trade. To sum up, in the late ninetieth century, Argentina had highly auspicious opportunities to trade with the rest of the world: favorable terms of trade, peace and the application of free trade policies by its trading partners. The terms of trade did not start to decline until early in the twentieth century and were then followed by war and protectionist policies.

4.3 Endogenous industrialization

The deterioration in the terms of trade during the 1920s severely damaged the economy. At the same time that the profitability of the primary sector was plummeting because of low export prices, opportunities in the secondary sector flourished thanks to the natural protection provided by high import prices. As indicated by the research of Villanueva (1972), the 1920s were a particularly active period in terms of the development of the industrial sector in Argentina. International conditions worsened again in the 1930s, leading to another wave of endogenous industrialization. As the economy began to produce goods that it had imported in the past, it naturally began to close itself off from the world economy.⁸

The decline in the terms of trade harmed both service workers and landowners. However, the situation was less appalling for workers, since capital and labor were shifting to the secondary sector. The flow of workers to the urban secondary sector was primarily composed of people from rural areas. Their welfare began to increase as capital was reallocated to its most productive uses and as new manufacturing activities prospered. In the model presented in the previous section, this is reflected by a shift from specialization in production toward diversification and trade.

The early industrialization process of the inter-war period was accompanied by the consolidation of the labor movement. Argentine unions date back to 1877, but active unionism did not start until the twentieth century. Union demands centered on basic improvements in working conditions, some sort of insurance for work-related injuries and the prohibition of child labor. As industry blossomed and wages rose during the 1920s, the unions succeeded in having their demands met (see Galiani and Gerchunoff 2003). The Great Depression put an end to the workers’ bonanza, however. Unions tried, without much success, to prevent wages from falling, but they did succeed in retaining most of their achievements in terms of working conditions. The union movement was seen by employers as a lesser evil that would maintain industrial peace, while workers saw it as a reliable tool for protecting their rights. Unions thus emerged as an institutional device for coping with the conflict of interest between capitalists and workers in the incipient process of industrialization during the inter-war period. The battleground was the shop floor, and the conflicts were mainly about the improvement of working conditions and wage stability.

It is somewhat ironic that the debate about protectionism became a permanent fixture in the national dialog in the wake of the Roca–Runciman Treaty, which was devised to protect the Argentine primary sector and ensure exports to Great Britain. In exchange, Argentina promised to reduce tariffs on British imports and made other concessions to British companies that operated in the country. Although the treaty was not fully honored by Argentina, it did spur the debate about the role of industry. For the first time, industrialists began to call for economic independence, self-sufficiency and autarky as Argentina’s answer to the new international order and continued to do so during the uncertain period of the Second World War.

This process of import substitution intensified during the Second World War under the shelter of the trade barriers associated with the war. By the end of the war, the manufacturing sector was playing a significant role in the economy, but manufacturers were arguing that a strong policy of commercial protection and subsidies was needed for them to survive, especially if the terms of trade were likely to improve. It was under the leadership of General Perón, in the midst of a major political shift, that these demands were to be fulfilled.

4.4 A new Argentina

The 1930s world economic crisis had profound effects on the economic and political life of Argentina. Certainly, much of the development of Argentine foreign trade seen during the 1930s, 1940s and early 1950s can be seen simply as a consequence of trade agreements and exogenous shocks coming from the rest of the world. The crisis and its immediate consequences were also a shock for the political life of the country. By the same token, the economic changes that were occurring also triggered major changes in the socioeconomic structure which ultimately created conditions conducive to the development of a populist mass movement.

Argentine politics was monopolized by the landowning elite until 1916, when a major political shift occurred thanks to an electoral reform law passed in 1912 which ushered in universal adult male suffrage (though it restricted the right to vote of the large number of unnaturalized immigrants), secret ballots and compulsory voting. Despite its apparently democratic implications, this reform was designed to perpetuate the prevailing oligarchic system by extending the vote to the urban middle class, whose members had taken part in the economic expansion in the sense that they were working in the service sector, although they had been excluded from the strongholds of power. Not surprisingly, the oligarchic elite that ruled the country believed that middle-class workers were committed to maintaining the existing political and economic structure.

This experiment in limited democracy (the new electoral law gave voting rights to nearly one million adult males, but this was no more than approximately 40% of the adult male population) was interrupted in 1930, when the army carried out a coup and installed itself as the dominant factor in Argentine politics. Over time, the popular base of the democratic system expanded. In 1946, 3.4 million adult males had voting rights (see Cantón 1968). Thus, the voice of the people in the Argentine political system grew substantially between 1916 and 1946, despite the intervening military coup. By 1946, the economic configuration had changed dramatically. The political alignment between landowners and workers had broken down. Instead, workers—now mainly employed in the secondary sector—found their perfect ally in the capitalists of the manufacturing sector, because their political preferences were aligned both in the short and in the medium terms (see Sect. 3.2). Under Peronist policies, more capital and labor shifted to the secondary sector, thereby furthering the process of industrialization and consolidating both this alliance and the urban–rural conflict.

At that point, distributive conflict between urban factors of production and landowners emerged and paved the way for the possibility of populism as an equilibrium point. Rogowski (1989), among others, argues that backward economies with abundant natural resource endowments in which both labor and capital are relatively scarce are likely to display political cleavages that are protectionist in nature. The urban manufacturing sector will seek to protect itself, by taxing both exports and imports, against rural activities. However, this analysis, which was widely applied to Argentina during the Perón era, is at best incomplete, as our model demonstrates. This prediction holds only for certain configurations of the parameters of the model and certain histories. In particular, we stress that protectionism and protectionist cleavages arise in resource-rich economies after the potentially protected activities are initiated spontaneously in response to changing market conditions (see also Galiani et al. (2010) for a discussion on the role of skilled labor and unskilled labor in the formation of political coalitions in this context).

By 1940, the labor movement had matured; moreover, industrial capitalists had been aspiring to self-sufficiency and economic independence ever since 1930. Conditions were therefore ripe for Perón to build a mass workers movement. He started to engineer this when he was the Labor Secretary, right before he was elected President in 1946. Industry-wide bargaining was instituted; labor courts were set up to enforce the rather progressive new labor laws, social security coverage was greatly expanded, minimum wages were increased and the system of aguinaldo (1 month’s extra pay at Christmas time) was introduced. Finally, Professional Associations Act was adopted in 1945, which provided for the withholding of union dues by employers, recognition of only one union organization per branch of activity and direct union participation in political activity under state supervision. As a result, the growth of union density during the 1940s was astonishingly rapid, rising from 10% in 1936 to 40% in 1948 and to 49% in 1951 (see Galiani and Gerchunoff 2003).

In this manner, a new national populist coalition was brought to power in 1946 under the leadership of Perón. The Peronist coalition left behind the traditional dispute between radicals and conservatives that had marked the political arena since the electoral reform. This pattern of opposition was replaced by one which had a greater share of class content and was rooted in the expansion of social rights and the political and social integration of the working classes. Indeed, the political history of Argentina in the twentieth century is divided into two: before and after the emergence of Peronism (see Torre 2002).

4.5 The Peronist era (1946–1955)

By 1950, most of the countries of Latin America had implemented an import-substitution strategy. Although it was a pragmatic endogenous response to the conditions created by the Great Depression of the 1930s and the Second World War, this strategy was not necessarily the optimal response to the new international conditions of the post-war era. To a great extent, the decision as to what sort of strategy would be the best depended on what could be expected of the future evolution of the international economy. By the late 1930s, it was reasonably clear that the laissez-faire approach was finished in international economic relations. In this context, the import-substitution strategy can be seen as a defensive measure against an uncertain future of trading relations.

Clearly, world market conditions were more favorable to Argentina in 1943–1955 than in 1929–1943. After the war, policymakers had an option which they had not had during the Great Depression: to guide economic growth on the basis of expanding exports of both rural and manufactured products (see Díaz-Alejandro 1970). Indeed, this was explicitly attempted under the economic leadership of Federico Pinedo during the early 1940s. Pinedo’s plan was a well thought out attempt to recover the dynamism of the agricultural sector and to promote export-led industrialization (see Llach 2002). However, Pinedo’s strategy failed to take hold. One of the reasons for this failure is that it was opposed by the new dominant electoral coalition formed by urban capitalists and workers, who stood to benefit from a deepening of the import-substitution strategy (see Sect. 3.3). This electoral coalition would elect Juan Perón as President of the country in 1946 in what were arguably the first truly free and democratic elections with universal male suffrage.

Perón decided to consolidate the social base of his movement by redistributing income to the working classes. In fact, he saw industrialization as a mean of achieving the goals of his nationalistic and populist policy of increasing the real consumption, employment and economic security of the masses of workers (see Gerchunoff 1989).

Indeed, as Fig. 5 shows, the share of wages on GDP peaked during the Peronist era. It is clear from the figure that the share of wages in GDP is lower when the economy is integrated into the international economy than under autarky when the secondary sector has exhausted its possibilities of import substitution. Notice that this stylized fact is consistent with our model. In the long-run, the equilibrium workers’ share is equal to (1 − ϕ _a − ϕ _m) + (1 − β)(Y _m/GDP), i.e., the share of services in consumer preferences plus the share of labor in the secondary sector times the share of industrial output in total GDP. Notice that in the long run, and perhaps even in the medium run, workers not necessarily are better off under autarky (see Sect. 3.3 and Proposition 7).

The Peronist policy of import substitution was not an integrated, well thought plan. Rather, there was a great deal of improvisation in its application as policymakers reacted to short-run economic and political pressures. Clearly, toward the end of the war and during the early post-war years, the government’s main concern was to defend the industries that had arisen and expanded prior to and during the war, regardless of their efficiency (Díaz-Alejandro 1970). The protectionist measures that were used included not only high tariffs on imports of goods that were also produced domestically, but also the requirement that farmers sell their crops to a state trading monopoly⁹ that would profit from the difference between world prices and the prices paid to producers.

Import substitution gave the Peronist state control over resource allocation in the economy. By deciding which industries to protect and where to channel national credit, the Peronist government was able to discipline industrialists and determine the destination of investment. Either industrialists complied with the demands of the government or they were forced out and their capital was nationalized. The nationalization of private capital and Perón’s military ambitions explain why the government became so deeply involved in the economy. Labor was also kept in line by the Professional Associations Act. Only one union was allowed to operate in each branch of activity; obviously, the government was entitled to decide which one could do so if two or more unions vied for the same branch. Outlawed unions had their bank accounts frozen and their offices closed.

As a result, the Peronist government cemented a closed-economy and import-substitution model for the years to come. The most important government intervention during the period 1945–1975 was the introduction of a relative price system which favored industry (and particularly labor-intensive industry) at the expense of the agricultural sector. As a consequence, internal relative prices diverged from international market prices, thus generating a sharp differential (which put the agricultural sector at a disadvantage) between the internal and external terms of trade (see Díaz-Alejandro 1970; Mallon and Sourrouille 1975). The triumph of the industrialization model under a closed economy, over time, and even after the demise of Perón, led to the adoption of a scheme of industrial integration which consisted of completing every step of the production process, from capital goods and inputs to final goods, inside the country’s borders, in evident contradiction with the post-war tendency of developed countries, whose trade was and continues to be mainly intra-industry (see Llach 2002).

Behind these economic policy decisions, there was an alliance of economic and political interests formed by unions, industrialists and the armed forces. Unions consolidated their power by delivering better wages, working conditions and social protection to their members. Industrialists had achieved a considerable level of protection from competition. Finally, the military took the development of the steel and oil industries under its wing. Although this alliance was evidently born after the Peronist years, it had sufficient resilience to last even through the military governments and the periods of political proscription of Peronism (see, among others, Halperín Donghi 1994; Llach 2002).¹⁰

Up to now, we have been assuming that the economy operated near the efficiency frontier. This is reasonable if we assume that capital allocation and employment decisions were made in a decentralized way by profit-maximizing agents. However, during Peronism and the years that followed until the collapse of the import-substitution model, the assumption is hard to maintain. Capital was allocated on the basis of political rather than economic considerations. Labor allocation was no less distorted: public employment was used as a means of combatting unemployment; moreover, unions regulated quantities and prices in their members’ labor markets to the extent that they were politically able to do so.

Not surprisingly, income redistribution and industrial promotion policies rapidly ran up against a formidable constraint: exports stagnated (see Brambilla et al. in this volume). It is true that the stagnation of Argentine exports can be partly attributed to the global closure of markets and to the protectionist policies applied by industrial countries in agriculture that favored self-sufficiency (especially in Europe). However, it is also true that Argentina underperformed even in comparison to other countries that shared the same markets.

Argentina accounted for more than one-third of all Latin American exports in 1928, one-fourth in 1938 and only one-eighth in 1954. It exported mainly primary goods: corn, wheat, linen, wool and meat. The joint share of these five goods in world trade declined from 8.6% in 1926–1929 to 3.9% in 1960. Nevertheless, the fact that Argentina’s market share was halved during that period provides evidence of Argentina’s decline relative to other agricultural exporters. Overall, if we consider the world exports of these five primary products, Argentina accounted for 1.8% of those exports in the late 1920s and for only 0.4% in 1960. If we analyze export trends by product, we see that, in that same period, Argentina’s market share in corn decreased from 57% to 21%, in wheat from 20% to 9%, in linen from 73% to 40% and in meat from 40% to 24%, while its market share in wool remained unchanged at around 6% (see Llach 2006). The stagnation of Argentine exports placed an inescapable constraint on the country’s growth.

In sum, during Peronism Argentina embarked on an ambitious import-substitution industrialization process backed by a coalition of industrial capitalists and workers. In the language of our model, the protectionist policies drove the economy from the diversification and trade area to a near-autarky situation.

4.6 A nation in Deadlock (1955–1973)

Toward the end of the 1950s, it was becoming clear that the world was entering a new free trade era and that the woes of the inter-war mercantilist period were over. However, taking advantage of the new international conditions required a painful period of readjustment. In terms of our model, as capital flows back to the primary sector, industrial capitalist and workers suffer the most, whereas landowners benefit greatly. At the domestic level, it was also clear that the shift toward the consumption frontier for mass-produced, labor-intensive domestic goods had come to an end. Steel, machinery, motor vehicles and petroleum were the activities that were being protected and promoted during this new phase of import substitution in Argentina, and all of these industries were more capital intensive than those targeted during the initial state of import substitution (see Mallon and Sourrouille 1975).

Perón himself, after being reelected by a landslide, was seeking an economic alternative that would have inevitably entailed major economic and social readjustments. Nonetheless, Perón had taken notice of the political risks of departing from the path that had until that point driven him toward the amplification of redistributive policies and import-substitution strategies. Indeed, Perón was ready to abandon nationalism to attract the foreign capital needed to sustain the deepening of the import-substitution model, but not to revert the improvement in the distribution of income achieved under that model. Under these conditions, the armed forces abandoned their alliance with the unions and industrialists. High-ranking officers were becoming increasingly worried about the path that Argentina was taking under Perón’s rule. They silently plotted against Perón and forced him to withdraw in 1955.

Interestingly enough, all the governments between 1955 and 1973 tried, to the extent of their possibilities, to deepen the import-substitution process, which was still backed by an increasingly weakened coalition of workers and industrialists. The social revolution embodied by Peronism created a new society that took on a life of its own and that, even though it had no way to survive, simply refused to die (Halperín Donghi 1994).

On average, export incentives were larger during the period 1955–1973 than during the first post-war decade. But the policy tilt toward import substitution and away from exports remained a feature of the Argentine economy during the period 1955–1976. Argentina’s effective rates of protectionism remained the highest in Latin America (Díaz-Alejandro 1984). Protectionism and hostility toward the rural producers of the pampas were hardly limited to the Peronist movement, neither was a strong nationalist stance toward foreign capital. As with export incentives, governments zigzagged in their policies toward foreign capital during this period. However, foreign corporations were nonetheless used as key instruments in expanding industrial production in consumer durables and in intermediate and capital goods (Díaz-Alejandro 1984).

These years also saw a steep increase in the consumption of services, many of which were provided by highly educated workers, for whom there was a strong demand in this sector. These educated workers began to break down the rural–urban political cleavage (see Galiani et al. 2010). As a result, the shift toward the promotion of more capital-intensive industries and the growth of a services sector catering to high-income and upper-middle-income groups gradually eclipsed distributionist protectionism.

Over time, sustained growth required more government intervention. The state had to finance the deficits run by public-sector enterprises, subsidize the substitution of capital-intensive imports and promote non-traditional exports. Yet it became less and less able to do so as trade revenues began to shrink under increasing autarky and as the surplus enjoyed by the social security system created under Perón melted away, turning into a deficit by the mid-1960s. The inflation tax thus became the adjustment variable for an increasingly conflict-ridden and inviable society (see Mallon and Sourrouille 1975).

The alliance between industrialists and workers began to grow stale. Labor unions faced a dilemma, since preventing wages from going down required limiting the supply of workers, and they knew all too well that having fewer members implied less power. They also knew, of course, that new investment in unionized activities would allow them to achieve both higher employment and higher wages. In sum, they needed modern and capitalized industries, but their own power kept capitalists away. The solution to the dilemma was direct government intervention and direct investment in industrial activities.

The alliance between workers and industrialists was also unstable. They both wanted high protection for industry, and hence their interests were aligned in this respect. However, their interests conflicted with respect to real wages. Thus, from time to time, when the economy needed to adjust to its consumption possibilities, the alliance would break down for a time (see O’Donnell 1977).

To complete this dim picture, some workers became increasingly disappointed with their union leaders and found hope in the promises of a “socialist fatherland” made by leftist groups. These groups accused the landowners of serving foreign interests and being unpatriotic. To differing degrees, depending on each group’s political orientation, they proposed various strategies, with the most extreme one being the outright expropriation of land and its redistribution among the people by means of revolutionary violence.

To sum up, chronic inflation and recurrent cycles of recession and recovery—associated with substantial changes in income distribution arbitrated by the state (see Mallon and Sourrouille 1975; O’Donnell 1977)—were salient economic features throughout this period (and even beyond it). At the same time, social and political divisions grew increasingly tense, reaching such a point that violence dominated the political and economic life of the country. As a result, Argentina failed to regain its prosperity and to achieve a consensual political order; instead, it was stumbling along in a volatile stalemate. The successive administrations proved unable to prevent the progressive institutional decay of the country. Nevertheless, the darkest hour for Argentina was yet to come.

4.7 Crisis and reforms (1973–2010)

The intervention of the state in the economy increased substantially during the Peronist era and the next 20 years. There is a stark contrast between the industrialization process of the period 1920–1945 and that of 1946–1975. In the former, the private sector reacted to the shortage of foreign manufactured goods and led the way toward endogenous industrialization. In the latter, the state took an active role in deepening the import-substitution process. This led to decisions based on political expediency rather than economic rationality.

The industrialization process was guided by an alternation of administrations with different strategic objectives, so it is not surprising that, overall, we find that it failed to achieve self-sufficiency or even a more rational or coherent industrialization process. This led to an essentially disproportionate development process that promptly ran into binding constraints: (a) the inadequate growth of exports was a very serious obstacle to the industrialization process, which required growing inputs of capital and intermediate goods; and (b) the intensification of the industrialization process, especially the development of heavy industry, required larger subsidies that needed to be financed in some way. The government’s inability to accomplish this task with fiscal resources drove inflation up to levels that were inconsistent with a healthy economic performance.

A final populist experiment (under President Perón and then his wife) in the early 1970s ended up in economic and political disorder. On the political side, it failed to curb the spiral of violence that leftist guerrillas had ignited in the late 1960s. On the economic side, the oil crisis exposed the weakness of the import substitution strategy. The increase in the price of imported oil, a vital input of the manufacturing sector, fueled inflation and reduced real wages.¹¹

A top-down disciplinarian military administration then took its place. The main economic objective of this government was to reduce inflation. A significant, although gradual and partial, market-oriented financial and trade liberalization program was also implemented. This time, the military government was quite intransigent in its attitude toward the other groups within the weakened industrialist alliance. In disciplining the unions, the military government not only suppressed collective bargaining and other union rights, as it had at other times in the past, but actually used its military might against union leaders, some of whom became victims of kidnappings and forced disappearance at their hands. Nevertheless, the unions were not entirely decimated and, after the return to democracy some years later, they were again a very powerful social force in the country. Industrial businessmen were also disciplined through trade liberalization measures.

The discipline imposed on both labor and capital was not reflected in fiscal austerity. With favorable international conditions for credit, the military–industrial complex was empowered, and public spending on infrastructure soared. Large business groups were also able to modernize considerably thanks to their easy access to cheap credit. Over time, both inflation inertia and the prevalence of large fiscal deficits made the exchange rate system of pre-announced gradual devaluations, which had been adopted to control inflation, unsustainable. Between 1979 and 1981, capital flight amounted to around 20% of GDP, leaving the government (which absorbed private sector external debt) with a hefty external debt that has influenced the country’s economic performance ever since.

The country’s extraordinary debt rates paved the way for a fiscal and balance-of-payments crisis that dominated the political and economic scene during the 1980s. Throughout the 1980s, the Argentine economy posted the worst performance it had turned in at any time since the end of the Second World War. Investment collapsed. Per capita GDP decreased by approximately 20% between 1980 and 1989. Inflation was above 100% for every year except 1986. Both the external debt and the debt-to-exports ratio rose at an ominous pace. The dollarization of the economy deepened, increasing its financial fragility. Ultimately, in the presence of severe uncertainty at a time when the country was making its first democratic transition in decades, its high inflation gave way to a short but devastating bout of hyperinflation.

It was only after a brutal episode of hyperinflation that a comprehensive reform process was adopted (see, among others, Acuña et al. 2007). In the wake of its trade and financial reforms of the 1970s, Argentina had embarked upon a process of integration into the international economy. This was substantially deepened during the 1990s, when the Peronist administration privatized state enterprises and drastically reduced import tariffs and export duties. Labor unions, which had blocked free trade policies since 1955, were unable to effectively oppose these reforms (see, however, Acuña et al. 2007, for a discussion of how the government seduced union leaders into supporting the reformist agenda).

Although not without large social costs, measured by a substantial increase in poverty and inequality (see Alvaredo et al. in this volume), this reform process finally moved the Argentine economy toward a rational form of integration into the world economy. The recovery of the agricultural sector and the growth of exports have been spectacular (see Brambilla et al. in this volume). The surviving industries are realistically competitive and largely oriented toward the manufacturing of the natural resources with which the country is abundantly endowed (see Brambilla et al. in this volume).

The Peronist party (Justicialist Party) continues to dominate the political arena, having held office for 18 years in the period 1990–2010. Its support base has changed somewhat though. Now, its supporters can be found not only among unionized workers and public employees, but also among a large number of informal service workers and small rural producers. The challenge of the twenty-first century for the Peronist party is to build an alliance with landowners and rural producers in the pursuit of an export-led form of growth without losing the support of the vast number of people living in poverty as a result of 50 years of economic stagnation and a painful trade liberalization process. The prospects are not bright—the Peronist party has increasingly used political clientelistic practices to retain the support of the poorest segments of the population.

In the language of our model, the reform process initiated in the 1990s redirected capital to the primary sector and labor to the tertiary sector within the area of diversification of production and trade. The balance of power shifted away from the industrialists and toward the coalition of agricultural producers and service providers. During the 2000s, the improvement in terms of trade has helped them to consolidate their power. The distributional conflict has not disappeared; there are urban sectors that would benefit from an increase in protectionism. However, the pro-agricultural coalition appears stronger than in the past. Indeed, in March 2008 a government attempt to increase export taxes on soybeans and sunflower was met with a nationwide lockout by farming associations. The proposal was finally defeated in Congress after 4 months of large-scale demonstrations in urban areas and road blocks in rural areas.¹² However, as we learned from the country’s experiences in the early twentieth century, such coalition between landowners and service workers is viable only under favorable external conditions and it is politically weak.

5.1 Argentina and Australia

There are a number of similarities between these two economies that make this exercise of comparative history worthwhile. First, their initial endowments, that is, the relative scarcity of labor relative to land, determined their position as exporters of agricultural goods. Second, there is the natural emergence of manufacturing sectors in response to the natural protection provided by exogenous international conditions and the distance of main industrial centers. Third, there is the demand for protectionism by urban manufacturing interests. As a result, both countries relied heavily on tariffs and quantitative restrictions to trade to provide protection for their manufacturing sectors. These policies were blamed for the relatively poor performance of these economies and were eventually abandoned by the end of the twentieth century, although not without opposition from vested interest groups.

Anderson (2002) states that “seven decades of import-substituting industrialization cost Australia dearly in terms of its comparative standard of living. In 1900, Australia was arguably the highest-income country in the world on a per capita basis. But by 1950 its rank had slipped to third; by 1970 it was eighth; and by the 1990s Australia was not even in the top twenty” and that “Australia’s comparatively poor growth performance for most of the twentieth century contrasts with that of the final decade, when Australia out-performed all other advanced economies other than Ireland and Norway". The author claims that part of that success is attributable to the “belated opening of the Australian economy to the rest of the world”.

The differences between these two cases start to appear when we focus on the intensity of the distributional conflict and the institutional settings where this conflict needed to be resolved. We claim that the Argentine distributional conflict was more intense and that its institutions were weaker. As a result, while Australia was able to overcome its conflict, Argentina was overwhelmed by it. Moreover, international and geopolitical conditions helped to ease the Australian anti-trade, trap but not the Argentinian one. In what follows, we stress some key differences between these two economies and show how they contribute to our argument.