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In Capitalism Socialism and Democracy, published in 1942, Schumpeter had predicted that capitalism would inevitably succumb to socialism. More importantly, he explained “the thesis I shall endeavor to establish is that the actual and prospective performance of the capitalist system is such as to negative the idea of its breaking down under the weight of economic failure, but that its very success undermines the social institutions which protect it, and inevitably creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent.”

Joseph A. Schumpeter

Paul Samuelson, who was Schumpeter’s student at Harvard, for a long time believed this prediction was wrong. In an article published in the magazine Swedish Now in 1971, he wrote:

Thirty years ago, my old teacher Joseph Schumpeter, in his Socialism, Capitalism and Democracy, predicted that the very successes of the mixed economy would produce alienation in its young. He was wrong in his timing, so very wrong.

However, in Samuelson’s view it was not only a matter of timing. The definition of socialism proposed by Schumpeter was not right. Samuelson believed that the worst fate that awaited the modern mixed-economies of the Western World was not the type of socialism proposed by the Webbs or Oskar Lange:

“The shadow on the wall for all of us, I fear, is not the totalitarian revolution of a Lenin or a Mao. It is not a relapse into the laissez-faire of Queen Victoria or President Coolidge. Argentina I dare to suggest, is the pattern which no modern man may face without crossing himself and saying: “There but for the grace of God”. I suspect the answer has to be found in populist democracy. If in the time of England’s industrial revolution men had had the political power to try to rectify within a generation the unconscionable inequities of life, in which a privileged few live well off the sweat of the multitude, it id doubtful that the industrial revolution could ever have continued… The outcome would have been legislated increases in money wages of as much as 40 percent per year… pretty much like that we have seen in those Latin American countries which have reached the brink of economic development, while being so to speak, fully or overly developed in the political sphere.”

The prophecy made by his master continued to attract Samuelson’s interest. In August 1980, he delivered a paper at the International Economic Association in Mexico City titled “The World at Century’s End”. In those days the Iron Curtain was still up and nobody foresaw how ten years later it would come crashing down. Moreover the advanced, Western economies seemed mired in hopeless stagflation. The future of capitalism did not seem bright.In such a world, the dire predictions of Joseph Schumpeter did no longer seem so far-fetched. This prediction was the starting point of Samuelson’s paper:

The dark horoscope of my old teacher, Joseph Schumpeter, may have particular relevance here. When I was a precocious student I didn’t think much of Joseph Schumpeter…. when I reread Schumpeter’s Capitalism, Socialism and Democracy I find new meaning in it.

Paul A. Samuelson (1915-2009)

Samuelson pointed out that although Schumpeter had been wrong in his belief that capitalism was economically stable but politically unstable, he was right in believing “that populist democracy would alter the nature of the market economy.” This last statement is quite intriguing given that Schumpeter never even used the term “populist democracy” in his book or indirectly refer to it. Samuelson provided his own definition of what a “populist democracy” was:

The same gasoline that classical economists thought ran the laissez faire system, namely self-interest, will in the context of democracy lead to use of the state to achieve the interest of particular groups. It is a theorem of von Neumann’s theory of games that this should be the case. Long before Marx, John Adams and Thomas Macaulay warned that giving votes to all would mean that the poorest 51% of the population would use their power to reduce the affluence of the richest 49%.

According to Samuelson, stagflation was an inherent feature of the mixed economy. In fact, he believed “it was rooted in deep in the humane nature of the welfare state”. Moreover, there was no guarantee that the forces of democracy would “converge” to optimal government interventions in the economy and forsake “all other temptations that involve deadweight loss and distortion.” Basically, the mixed economy had turned into a zero-sum game. Schumpeter’s ideas about what socialism meant were confused, said Samuelson:

He really did not expect the mixed economy, whose evolution he correctly perceived, to be a well functioning and stable way of running the railroad of modern social living. The fact that Schumpeter was, on the whole, wrong in this regards for the third quarter of the century should not blind us to the possibility that some of the malfunctionings he feared may be looming up more closely ahead in the last quarter of this century.

Samuelson reformulated Schumpeter’s prediction to mean that the most likely evolution of the mixed economy that prevailed in North America and Western Europe was not toward socialism in any of its accepted definitions, but toward populism Latin American style:

To understand the future there may be a more useful paradigm than that suggested by Scandinavia, the Netherlands, or a typical mixed economy of Western Europe or North America. I am not proposing that we concentrate on the Yugoslavian experiment or on the patter of an Eastern European economy such as Hungary or Poland. Instead I have in mind the Latin American example… Is it far-fetched, as we try to peer into the decades just ahead and do so against the backdrop of the 1970’s era of worldwide stagflation, to fear that many of our mixed economies will begin to suffer from their own version of the Argentinian sickness?

In a follow-up article published a few months later, Samuelson insisted with his prediction:

It may be the Argentinian pattern that presages what is waiting for us ahead. This was a pessimistic point of view to enunciate. For Argentina is par excellence an example of an economy whose relative stagnation does not seem to stem from climate, race divisions, Malthusian poverty or technological backwardness. Its society, not its economy, seem to be sick. Its political system does not function in a way conducive to productivity. And these sickness in sociology and government do impair the economic health of the Argentine economy.

A few months after Samuelson delivered his paper, Reagan won the US presidency. Thanks to privatization, deregulation and lower taxes, the mixed economies of the Western World were given an injection of Schumpeterian creative destruction. The “zero-sum economy” scenario gradually vanished.

After the fall of the Berlin Wall and Deng’s reforms in China, it seemed that both Samuelson and Schumpeter were wrong about the future of capitalism. Very wrong. The Argentine scenario seemed as far-fetched as the impending collapse of capitalism. Samuelson was also wrong on another count. He predicted that Pinochet’s Chile (or what he described as Chicago economics imposed by force) would never evolve into a democracy:

History records no known case where fascism succeeds even on its own economic terms for any sustained period. Alas, such systems cannot evolve into normal democracies.

As it turns out, Chile did indeed evolve into a democracy and not due to a revolution but to the decision made by Pinochet. And the governments freely elected after 1990 did not give up on Chicago economics. In fact, thanks to this decision Chile became the most economically advanced democracy in Latin America. The gains were not limited to the economy. Institutional quality improved, poverty levels dropped and education and health improved. In contrast, after an attempt in the early nineties to emulate its neighbor, Argentina suffered an acute relapse of populism from which is still struggling to recover.

Despite Samuelson’s poor track record in forecasting, in recent years, and particularly since 2016, the scenario he predicted in 1980 seems more plausible than ever. Populist governments of all varieties have emerged in Europe, North America and Latin America. The chart below from Bridgewater Associates/Ray Dallio shows the share of populist/anti-establishment parties during since the beginning of the 20th century (ends in 2017).

Does this mean that the Argentine sickness is finally spreading out? If it is, what can we learn from the Argentine experience? Before answering both questions, we need to define what populism is. Sociologists and political scientists have debated for decades what is the its proper definition. It can be useful to view populism as the painless, simplistic and arbitrary “solution” to society’s structural problems that a charismatic and opportunistic politician promotes using an antagonistic narrative that appeals to chauvinism and certain predominant beliefs, prejudices and anxieties. A majority of voters finds this narrative convincing and emotionally appealing and votes for the “populist solution” when those structural problems lead to widening divergence between its expectations and reality. This divergence is what I call the “frustration gap”. (For an expansion and clarification of this definition see here.)

With this simple definition, let’s explore in which ways the Argentine experience of the last seventy years can be relevant to understand the meaning and implications of the populist wave that has spread over the world in recent years.

Juan Domingo Perón (1895-1974)

Perón introduced populism in Argentina in the mid 1940s. His main objective was to stem the rise of communism. So, as he himself admitted many years later, he resorted to Marxist rhetoric to seduce the masses. Despite the fact that in 1943 Argentine workers had among the highest levels of purchasing power and standards of living in the world, Peron promoted the view that they were enslaved and exploited by business and the oligarchy.

Peron’s brand of populism was unique in its incoherence. He appealed to both right wing and left wing elements of Argentine society. This incoherence also helps to explains its resilience. Peronism can mean anything that is functional to securing power.

The puzzling aspect of Peron’s rise is that Argentina in 1945 was the 7th wealthiest nation in the face of the earth, the most developed in Latin America, with the largest and best educated middle class. When the Second World War started, the purchasing power of Argentine workers was among the highest in the world. In the early 1940s the economy was becoming increasingly industrialized. In 1943, the manufacturing sector exported 20% of its production. The main challenge facing Argentina at the time Perón made its appearance on the political scene was completing the transition to a modern industrialized nation. And as Samuelson explained in his Mexico conference, the conditions to do that were ideal:

Suppose someone in 1945 had asked: ‘What part of the world do you expect to experience the most dramatic take-off in the next three decades?’ Probably I would have given an answer something like the following: ‘Argentina is the wave of the future. It has a temperate climate. Its density of population provides a favorable natural resource endowment per employee. By historical accident its present population is the fairly homogeneous progeny of Western European Nations. And Argentina is in 1945 at that intermediate stage of development from which rapid growth is most easily expected.’

But as Harvard economist Arthur Smithies explained in a comparative study of the Argentine and Australian economies, “a diabolus ex machina appeared in Argentina” after 1945: Juan Perón. In his article, Smithies neatly summarized peronomics and its effects:

Argentina began the postwar period with the possibility and the promise of a period of industrial expansion comparable to that of Australia. It had laid the foundation for industrialization and the world was hungry for its major exports. In fact, from 1943 to 1949 industrial production increased by about 40 percent and industrial employment by about 30 percent. Peron’s policy, however, was not simply industrialization. It was designed more to increase the numbers of the urban masses and to win their political support. A major instrument for pursuing both objectives was to increase real wages. In fact, real wages were doubled between 1943 and 1949… Any sophomore could have told Peron that he was raising real wages far above the marginal product of labor at full employment. But unfortunately no sophomore had his ear.

Perón completely misdiagnosed the structural problems facing Argentina. The country was at a turning point and its economy was undergoing a structural transformation, moving away from a reliance on agriculture to manufacturing. Therefore the populist “solution” that he proposed and effectively implemented not only did not solve the underlying problems faced by Argentine society but also aborted the structural transformation of its economy. It proved impossible to dismantle the legacy of peronism. As a result, today Argentina ranks 70th in GDP per capita rankings. No other country except Venezuela has experienced such an abrupt decline in its economic fortunes. In both cases thanks to populism.

What created a frustration gap in Argentina at the time of Peron’s rise? Basically, growing inequality in the distribution of economic and political power in an economy that had slowed during a process of industrialization. First, the top 1% increased its share in national income from 17% in 1933 to 26% in 1943, in line with what both Arthur Lewis and Simon Kuznets predicted would happen in an economy undergoing industrialization. Second, at the same time, an elite that partly benefited from this distribution of income had chosen the president of Argentina by resorting to fraudulent elections (although an opposition party dominated in Congress). Third, the Argentine economy started to lag behind not only countries that for a long time it had been compared to like Australia and Canada but also other large countries in Latin America. This trifecta was a lethal cocktail.

Spruille Braden (1894-1978)

The irony is that Peron did enter politics to defend democracy but to eliminate it. He was the leader of a pro-Axis military coup in 1943 to prevent free elections from taking place and confronted the Allied Powers even when it was obvious they would emerge victorious from the war. For a long time, Argentina was the only country in Latin America that refused to break relations with Nazi Germany. When social pressure forced the military regime to call for free elections, Perón took advantage of his position in government to prop up his presidential candidacy. He covered himself with the mantle of social justice and actively resorted to clientelism, handouts to labor unions and propaganda. His presidential candidacy was also helped by the Catholic Church and the US Government. The former viewed with sympathy a movement that supposedly followed Catholic “social doctrine” and adopted a “third way” equally distant from communism and liberal democracy. As to the US State Department, it was an unwitting ally of Peron, whom it considered its worst enemy in the Americas. Sprite Braden, US ambassador in Buenos Aires, tried to interfere publicly in Argentina’s political affairs. His British counterpart remembered in his memoirs, that Braden had come to Buenos Aires “with the fixed idea that he had been elected by Providence” to overthrow Peron and the military regime. Braden’s conduct during his brief stint as ambassador was completely counterproductive. He became the ideal “enemy of the people” in the narrative proposed by Peron, as it tapped a deep-rooted resentment against the US. Perón’s landslide election in February 1946 was a foregone conclusion.

Driven by a misguided and suicidal nationalism, Perón had confronted the Allied Powers during the Second World War and after 1945 he gave refugee to high-ranking Nazi criminals. But instead of hurting his popularity, Peron’s anti-American rhetoric strengthened it.

Extreme nationalism is a form of collective or group narcissism. Both Sigmund Freud and Erich Fromm explored in some detail its political implications. Collective narcissism provides the psychological substratum of populism. A narcissist believes that everything positive that happens in his life is due to his own efforts and everything negative is caused by the action of “others”. When a narcissist’s self-esteem is threatened, the reaction is usually violent. The same happens at the social level. Populist rhetoric feeds off frustrated or threatened collective narcissism.

Sumner Welles (1892-1961)

To understand how Argentina’s extreme narcissism affected its domestic and foreign policies it is worth reading the memoirs of Sumner Welles, US Under Secretary of Inter American affairs during the period 1937-1943. Welles devoted several pages to Argentina and its conflicting relationship with the US during the Second World War.

Welles had started his career as a diplomat in Argentina in the early 1920s and understood its people and politics very well. Until his ouster from Foggy Bottom he was in charge of US policy toward Latin America (many times in conflict with his boss, Cordell Hull, who was Secretary of State). Therefore his insights are particularly valuable to understand this period of Argentine history.

Argentina is a country which is in many ways unique. Throughout her independent life, she has been one of the richest agrarian nations of the world, with only a recent spurt towards industrialization, and yet more than two thirds of her nearly fourteen million inhabitants live in large cities. Her foreign trade has been the highest per capita of any country on earth. But of her exports only 10% have been shipped in normal times to the US and of her imports only some 15% came from this country. These facts help to explain why Argentina has always regarded herself as far closer to Europe than to the rest of the Western Hemisphere… There is no more vigorous and assertive people of the New World, nor is there a more adult people in the Americas. Pride of nationality and faith in the destiny of the Argentine nation are so powerful that the second-generation Spaniards and Italians who comprise the bulk of recent immigrants are just as devout exponents of “argentinidad” –the privilege of being part of the life of Argentina– as are the descendants of the colonial pioneers. Like all Spanish Americans, the Argentine people are exceedingly individualistic. But beyond all others they are given to an exaggerated nationalism. This quality stems in part from the heritage of Spanish civilization which colors every aspect of Argentine life and in part from their belief in their special star as well as from their remembrance of the valor and determination with which in the earlier decades of their national history they successfully repelled all attempts at alien control, whether Spanish, French or British.

According to Welles (and this is obviously a self-serving interpretation), the policy followed by the State Department after he was forced to resign in 1943 completely misfired and “aroused a revulsion of feeling” not only in Argentina but also in the rest of Latin America.

By its new course the Department of State not only brought about a violent popular reaction against the United States, but also materially increased popular support for the dictatorship. By intensifying blind nationalism, it undermined the attempt of the democratic parties to create a cohesive body of public opinion in opposition to the dictatorship.

This is no way justifies Peron’s policies. He is solely responsible for the many mistakes he made. Like most successful populist leaders, Peron embodied in an exaggerated manner certain traits, values and beliefs typical of the median Argentine voter: narcissism, caudillismo, anomy and strong sense of entitlement. To this he added an unguarded admiration of the Nazi regime, whose workings he had witnessed first hand during a visit to Germany in 1940.

The Peronist regime evolved as could be expected. After a short-lived bonanza sustained by a boom in the price of agricultural commodity (main source of export revenues for Argentina), it entered into a crisis phase and then became increasingly autocratic. In 1955 a military coup supported by the Catholic hierarchy put an end to it. It could be said that the Peronist regime started with the Church’s blessing and ended with its condemnation (the turnaround is explained by Peron’s increasing megalomania, his hostility towards the clergy and his decision in 1954 to allow Argentines to divorce).

This ignominious finale contributed to forge a legend that became politically invaluable to Perón and his followers. A vast portion of the electorate never forgot the sense of abundance it experienced during the bonanza years of the regime. Peronism created the conditions for its own continued electoral success. Argentina never managed to complete the structural transformation of its economy and as a result the frustration gap kept growing. In the populist narrative, the Argentine failure –a rich country growing poorer every year– could be explained in very simple terms: it was the result of a conspiracy of the oligarchy and foreign imperialism to exploit “the people.”

Argentina’s experience may seem too idiosyncratic culturally and historically to offer any guidance to the advanced democracies of the Western World. However, it does offer some valuable lessons. First, frustrated (or threatened) collective narcissism is a powerful social force that can be harnessed by an opportunistic and unscrupulous politician. Second, no democracy can remain immune to populism while the right to vote is restricted in the face of economic stagnation and growing inequality. What matters is not absolute inequality but relative inequality. In particular, how equidistant from rich and poor the middle class perceives itself. Finally, structural problems require structural solutions. With the costless, simplistic and arbitrary solution proposed by populism, be it of the right-wing or left-wing variety, the frustration gap inevitably grows and can trigger a vicious cycle that is difficult to break.