For poor and rich nations alike–The Way to Economic Progress

Dean of the Free Law School of Mexico, Dr. Velasco is a former president of the Mexican Bankers Association, and founder of the Mexi­can Institute for Social and Economic Re­search.

This article, based on remarks at the an­nual meeting of the Mont Pelerin Society at Princeton University in September 1958, was first published in the November 21, 1958 is­sue of U.S.A. magazine, P. 0. Box 134, Lenox Hill Station, New York 21, New York.

At present in economics, there is no subject so popular as the plight of the underdeveloped countries, if one is to judge by the number of studies and books about it.

I am not at all sure, however, that this interest is a healthy one—that it will turn out to be bene­ficial to the underdeveloped coun­tries. This doubt stems from my belief that, from an economic point of view, underdeveloped countries are fundamentally similar to de­veloped ones. According to my def­inition, an underdeveloped coun­try is a poor country considered to have a possibility of becoming less poor.

Now, a poor man wishing to make his way up in the economic scale does not have to follow rules different from those followed by a man who is already well-off but wants to become richer. If there is any difference in these rules, it is only that the poor man will have to work harder, to be more careful in his conduct, and to be thriftier.

Similarly, I find that underde­veloped countries are not subject to a set of economic principles dif­ferent from those to which the ad­vanced countries are subject. The problems of the former are funda­mentally similar to those of the latter. Certainly, these problems are very much like those affecting Great Britain, the United States, and France a century and a half or two centuries ago, before the Industrial Revolution took place.

Beyond a Tourist’s View

It is by no means my intention to play down the differences of all kinds—economic, political, and so­cial—which exist between Mexico and the United States, for instance. But I believe the scientist should look far deeper than the tourist into the real situation, discerning the similarities as well as the true differences.

To cite a simple illustration: Two years ago, my good friend, Professor Louis Baudin of Paris, France, visited us in Mexico City. As he and I were driving from the airport to a hotel, he saw lines of people waiting to go into movie houses and asked whether we had price control over admission tick­ets. Indeed, the municipal authori­ties have imposed a maximum price of $4.00 (32¢ in United States money). Of course, this control has increased the demand for seats. Incidentally, it also forces us Mexicans to travel to the United States to see our movie star Cantinflas in Around the World in 80 Days, because this picture cannot be shown in our country at the official price.

There may indeed be a special problem for underdeveloped coun­tries in international politics. But on the economic plane, I believe their problem is a general one and that it applies to all nations, poor and rich alike.

I am loathe to speak in the cur­rently fashionable way of “eco­nomic growth” or “economic devel­opment” because, as Professor S. Herbert Frankel of Oxford Uni­versity rightly said in a recent lecture in Mexico City, there is a tendency in our underdeveloped countries to think that our prob­lems will be solved if we grow physically, i.e., if we just build enough new factories or engage in new activities, regardless of whether they will be profitable or whether they are being created artificially through protective du­ties or subsidies, and thereby in reality decreasing instead of in­creasing the income and well-be­ing of the people.

I therefore prefer to use the term “economic progress.” And if critics assert that this term is neither special nor new, I would reply that this is an advantage and not a disadvantage.

The Fanciful Theories

On concrete grounds, I would say that the similarity between the underdeveloped and advanced nations is made greater by the ten­dency to follow social and economic theories fashionable at a given moment. Perhaps because the ca­pacity of underdeveloped countries to develop original thinkers is still limited, we imitate the more pros­perous nations, not only in their many good features but also in their dubious and even frankly bad ones.

To me, this is conclusive proof that it is not facts, not realities, which determine the actions of men, but rather the ideas which they form of things, the theories which they fancifully elaborate in order to guide their conduct and to be supposedly “better off.”

Mexican Welfare State

Mexico is beset by each and every one of these fanciful the­ories. We have the Welfare State. It is growing daily and creating all sorts of difficulties. For in­stance, there is resistance to a bus fare increase of five centavos (two-fifths of a cent in United States money) in Mexico City. The people have become accustomed to not paying for economic goods and services, or to paying less than their cost, so that the inevitable rise in fares becomes a political instead of an economic question. This leads to a very serious politi­cal situation because the govern­ment, victim of the same mental­ity, neither speaks out clearly nor acts forcibly.

We have inflation—not yet a hyperinflation such as we had in 1916 when our money system was completely wrecked—but sufficient to have multiplied the money sup­ply by 17 times and to create al­most an eight-fold rise in prices during the last 22 years. This in­flation (perhaps because we, like the Germans, were once badly burnt) has led to widespread dis­satisfaction and to lack of con­fidence in the Mexican peso.

In our country, we have labor unions with special privileges and exemptions from ordinary legisla­tion. We have corrupt labor leaders, participation of unions in politics, minimum wages, and con­tinuous pressure by unions and government to raise nominal wage rates, supposedly “to im­prove workers’ living conditions” and make “a more just” distribu­tion of national income.

Finally, we have had land re­form with the disappearance of the old “haciendas,” and the re­vival of the semicommunal sys­tem of land ownership that ex­isted during colonial times. Of course, this tremendous change—I would almost say “upheaval”—resulted in a sharp drop in agri­cultural production from which we have been emerging only in the last twelve years, but which has left us with a heritage of very difficult problems.

As you can see, underdeveloped countries may be poorer and weaker from an economic point of view than the developed ones, but the painful symptoms from which they suffer are the same, and the disease is the same, no matter whether it is called “intervention­ism,” “statism,” or “collectivism.”

Middle-of-the-Road Inflation

In the problem of inflation, I would say that we occupy a middle position; we are not among the worst offenders. We do not belong within the better group of nations. In spite of this, we have had con­tinuous inflation since 1936, with prices steadily going up although lagging behind the increase in the supply of money according to the official price indices.

Our inflation has sometimes pro­ceeded at a more rapid pace, as it did between 1937 and 1946; some­times more slowly, as it did be­tween 1946 and 1952 (I cite the years coinciding with the changes of our government administra­tion); or still more slowly, as it has since 1952. Nevertheless, the fact is that we have been unable either to stop inflation or even to approach a rate of “merely 3 per cent a year” which is looked on by some economists as not too harmful.

Worse still, the effects of this long inflation have been cumula­tive, especially the psychological ones. Although I believe the job can be done, few people think that the trend will be reversed, that prices will cease to rise, and that the government will succeed in preventing another devaluation of the peso.

Underlying Causes

Generally and basically, I be­lieve that Mexico has had and still has inflation because it has lived beyond its means. More specifi­cally, I find that the underlying causes of our inflation are:

1. The Welfare State

2. The desire for economic bet­terment

3. The desire for economic de­velopment.

Permit me to comment briefly on the foregoing causes of infla­tion:

·          Our budget, i.e., our tradi­tional budget, has been balanced over the last six years. But outside this budget, we now have dozens of independent establishments and economic agencies providing eco­nomic goods or services free or at less than cost. Some of these agen­cies have deficits because of ineffi­cient management; others must be subsidized to make ends meet; most of these agencies or estab­lishments go in for extensive de­velopment and investment plans. In many cases, the Bank of Mexico has had to grant loans or absorb their issues of securities either directly or through a development bank called Nacional Financiera. Naturally, it also helps to sustain them by pegging their prices and buying them when offered for sale.

·          In relation to the desire for economic betterment, the labor unions exert constant pressure—and so does the government—toward the raising of money wage rates. In Mexico, collective labor agreements have to be revised every two years. In general, unions succeed in securing approximately a 15 per cent rise every time. Of course, I do not believe that this is a direct cause of inflation. It is still necessary for the monetary authorities to add to the money supply. But this union pressure has created the climate in which the money authorities have made the increase and have relaxed their measures against credit expan­sion.

• The desire for economic de­velopment does not, I believe, per se produce inflation, and it does not have to be accompanied by in­flation, as has sometimes been said in our underdeveloped coun­tries. (Incidentally, I must here remark that we in the underde­veloped countries accept all the bad theories propounded in the advanced countries and even add some of our own!) Inflation arises from economic development as the result of a tendency to over invest, both on the part of the govern­ment and of private enterprise. As I pointed out, the building of new plants—whether profitable or not—is confused with real economic progress.

Socialism Creates Inflation

There is a plain connection be­tween the Welfare State and infla­tion. It is interesting to note that in Mexico they appeared simul­taneously, or more exactly, syn­chronously.

We began to try out socialistic measures in 1935 under President Cardenas. The next year, the budget had a large deficit and the only way to cover it was through an overdraft in the amount that the Bank of Mexico was author­ized to lend to the government. Over the years, budget deficits were the most important cause of our inflation. And though during the present Administration, the traditional budget has been bal­anced, it is a fact that the so-called social and government banks and economic agencies are still being helped by the Bank of Mexico.

Often, discussion of the Welfare State centers around the subjects of social insurance and medical services. However, the concept of the Welfare State, at least as I understand it, embraces much wider subjects. I think we have this admirable scheme (admirable, of course, if the government could be a sort of third-dimensional Santa Claus) whenever the gov­ernment provides some goods or services free—in whole or in part—or when it forces some members of the community, such as prop­erty owners of housing, to provide services and goods free to others, such as tenants.

If this concept is correct, then in Mexico we have not only gen­eral social insurance and medical services for those persons em­braced by the Welfare State (up to now, artisans, domestics, and agricultural workers are not covered by the insurance system), but also a multitude of other prestations sociales, as the French say rather elegantly, or of “hand­outs” as in American slang.

“Welfare” and the Rule of Law

There is a particular point about the Welfare State that I, as a lawyer, am greatly interested in bringing out. I believe that the Welfare State is incompatible with the Rule of Law, or, to use the European expression as it is written in French, with “L’Etat de Droit et le Principe de Legalité.”

Unfortunately, in our century, the legal profession and teachers of law have failed miserably—as Professor F. A. Hayek has stressed—in their duty to defend this prized feature of Western Civili­zation.

I can bear witness to this. Last year, I attended a meeting of the International Association for Juridical Science, held under the auspices of UNESCO at the Uni­versity of Chicago, which dealt with the Rule of Law. One of the subjects discussed there was “The Welfare State and the Rule of Law.” The official conclusion—set forth in a report—was that there is no conflict, no incompatibility, between the two ideas.

Among the distinguished gath­ering of leading professors of con­stitutional and administrative law at the UNESCO conference, I was the only one to speak out publicly against the report, though several of the persons present told me privately that they were in agree­ment with my view. Perhaps I spoke up because, even though I am not an economist, I am proud to be counted among “the ignorant and vociferous minority”—as the delegate from Poland called some economists who, he said, are the only ones to oppose the Welfare State.

Economic Life or Death

It has been said very rightly that free enterprise can take an awful lot of punishment. I be­lieve it was Benedetto Croce who wrote that the spirit of freedom is always reviving and assuming new forms despite all obstacles.

Permit me to point out that a healthy strong man can indulge in a great deal of alcoholism or lead a most dissolute life before the ill effects finally get the better of him; but a frailer man, or an adolescent beginning development, can take no such liberties without suffering immediate bad results.

Such is the case with the un­derdeveloped countries. Measures causing only some inconvenience or harm to giants like the United States or Great Britain may well prove fatal for us. The advanced, well-developed countries have more social and political stability, and even stronger traditions, than we, although even in Great Britain, which is the motherland of con­stitutional government and of the Rule of Law, we have seen the weakening effects of socialism and of the Welfare State.

Need for Good Examples

As a final point in considering the economic progress of our un­derdeveloped countries, permit me to say that it is up to the developed countries to set good examples for us. Parents should not lead dis­orderly lives and then blame their children for imitating them.

We have already one bad enough example wherein the State was going to wither away and the people would rise to unheard-of stages of prosperity and happi­ness. Surely if India has a social­istic development plan and if Egypt expropriates the Suez Canal, it is not solely because of this single bad example.

I am aware that the task before us is a common one, and that it devolves on us all—great or small, developed or undeveloped—to pre­serve and perfect our civilization. But I also believe that if the greater nations of the West wish to regain their leadership, they must first of all be our spiritual and intellectual guides. They must again believe sincerely and prac­tice wholeheartedly the principles of freedom under which they led the world until a generation ago.

The way to achieve economic progress, for poor and rich nations alike, is to follow the principles of economic freedom.

Where the Road Leads

The inevitable consequences of Wel­fare State policies Dr. Velasco de­scribed above are further verified in this excerpt from the December 29, 1958 issue of The Situation in Argen­tina, monthly bulletin from the Buenos Aires branch of the First National Bank of Boston.

To show the downward drift in the economy he [Argentine Presi­dent Frondizi] pointed out: that money in circulation had risen in ten years from 7,600 million pesos to 70,000 million pesos, while per capita production had remained al­most stationary; that during the past fifteen years Argentina has spent far more than it earned; that it has omitted to facilitate basic capital investment and allowed in­debtedness abroad to rise sharply. At the end of World War II, net gold and exchange reserves stood at 1,300 million dollars while by the end of April foreign debts ex­ceeded gold and exchange reserves by 1,100 million dollars.

He did not vacillate in stating that the country was close to being unable to fulfill its foreign obliga­tions and that the Central Bank has outstanding commitments covering authorized imports which duplicate prevailing reserves equivalent to 104 million dollars. To these must be added 200 mil­lion dollars due during the coming year in interest and amortization of foreign credits. Since January 1, 1955, to date, the country has accumulated a foreign trade deficit of 1,000 million dollars.

Referring to the government-owned enterprises, the President confirmed that they are losing un­told millions yearly, with the rail­ways alone showing a deficit of 14,000 million pesos on total ex­penditures of 20,000 million pesos, this without providing for amorti­zations or replacement of ma­terials. The National Treasury since 1946 has withdrawn money from the National Pension Fund to the extent of 55,000 million pesos, with many of the compo­nents presently lacking the means to meet payments.

Bureaucracy has expanded to such an extent that state, munici­pal, and provincial employees now number 1,800,000 and with de­pendents total 7,000,000—out of a total population of 20,250,000. Over 80 per cent of the national revenue is used to pay salaries, leaving no funds for building houses, roads, schools, and even for providing adequate mainten­ance, while the cities are dark for lack of power. State expenditure amounts to 100,000 million pesos annually, of which barely half is covered by revenue.

The cost of living in ten years has risen over 600 per cent without any growth in productive capacity, creating a steady process of im­poverishment. As was the case thirty years ago, the President stated, the country is still depend­ent on its grain and pastoral in­dustries which, however, are yield­ing ever smaller exportable sur­plus. Meanwhile, little was done toward developing petroleum and coal resources, building new sources of electric power produc­tion, mineral wealth, and the ex­pansion of steel and other heavy industries. The material and fi­nancial resources which could have been used to fulfill these objectives were wasted.