Argentina's clash of democracy and free market

Argentina's new president, Eduardo Duhalde, blames US-backed free-market policies for his country's economic crisis. Ex-President Carlos Menem says President Duhalde is incompetent. Conservative gurus declare that Argentina needs more, not less, free market.

Amid all the accusations and finger-pointing, one thing is clear: No one knows what to do. This bewilderment results from the reluctance of free-market advocates, international financial institutions, and the governments that support them to acknowledge the conflicting demands of electoral democracy and the free market.

The competing demands of politics and economics threaten other Latin American countries, too. Venezuela, one of the largest oil suppliers of the US, implemented free-market policies without regard to political fallout. Now, both its economic liberalization and democratic institutions are in jeopardy.

Colombia, Ecuador, and Peru nominally favor a free market, but don't have the political stability to support it. Even countries doing relatively well - Chile, Brazil, and Mexico - would find it difficult to reconcile free-market measures with stable politics in the case of an economic downturn. The dramatic and high-profile meltdown in Argentina, however, provides the clearest example of what can happen when both democracy and free-market policies are implemented without regard to the effect of each on the other.

Since 1983, Argentina has strived for both economic and political liberalization. Local markets were opened and undemocratic practices erased. With the Army in the barracks, public assets were privatized, inflation mastered, the peso pegged to the US dollar, and the government prevented from printing money.

Sound economic policy required fiscal restraint. But to remain viable, politicians needed money, so they borrowed - and borrowed. Foreign investors and international financial institutions kept lending. As the borrowing continued and the new economy failed to bring broad benefits, the gulf between what was economically desirable and what was politically attainable widened.

The privatization and liberalization of the Argentine market, wealthy in natural resources and human capital but too weak to compete internationally, followed an established pattern. International capital arrived, and public assets were transferred to private hands under terms that often reeked of corruption. Local industries were forced to compete with global prices, and cost control became the primary goal of production. Wages and benefits were minimized.

The largest local entrepreneurs worked out arrangements with foreign firms, while the rest were marginalized or run out of the market. The weakening of local businesses, together with the emphasis on cost control, was detrimental to widespread national economic growth.

As the pool of local entrepreneurs diminished, and as the income and benefits of laborers decreased or failed to grow, the professional classes serving them came under pressure. As the number of those at the top of the ladder increased somewhat and the ranks of those at the bottom increased substantially, the middle class shrank.

Although the overall wealth of the country grew, so did the inequity of its distribution. Whether the benefits of the new economy would eventually reach most people was, politically, a moot question. In an electoral democracy politicians must provide for their constituents - today. This is as true in Argentina as in the US.

Policies that created hardships for large parts of the population sent the politicians into a borrowing spree that undermined the country's finances. Corruption added to the problem. But it was the discordant requirements of the economy and politics that forced a tug-of-war between prudent economic policy and electoral survival.

Private capital cannot be concerned with the requirements of democracy, but the international financial organizations and governments of prosperous democracies must be. All the money and effort they spend on building a free market are wasted without a reliable political infrastructure.

In Argentina, much of the instability has been generated by the once-vital middle class. Since there is no dependable electoral democracy without a strong middle class, solving the Argentine crisis requires including social and political factors in evaluating loans and projects and finding ways - through incentives, not restrictions - to keep capital and profits from fleeing abroad. Economic dogmatism and political dogmatism, if unchecked, follow the same destructive path. Argentina tells us that democracy and free market, politics and economics, cannot be arbitrarily separated if the successful free-market democracies are truly committed to both.

• Francisco José Moreno is president and Alejandro Eggers Moreno is vice-president of Strategic Assessments, a political and economic consulting firm.