The coronavirus and the government responses with shutdowns and lockdowns, along with restrictions on international travel and disruptions of the global supply chains that crisscross countries and continents, have made a fuller and more rapid recovery difficult in the Western industrialized countries, but even more so in many places in what used to be called during the Cold War, the underdeveloped nations of the “Third World.” The question is what may be the best domestic and trade policies for these countries to follow in such trying times?
By 2019, out of a world population of around 7.7 billion people, less than 9 percent of humanity still lived in poverty. The declines in the poverty figures, while not uniform in all places in the developing world, were amazing, compared to the 1970s when it was closer to 40 percent. But a United Nations report issued in December 2020 suggested that as many as 100 million people will have been pushed back into the poverty category during this last year. Due to the political and economic responses to the coronavirus by governments around the world, the estimate was that the number living in poverty would, again, rise to at least a billion people. This is also the first increase in world poverty since 1998.
Huge Negative Effects from Government Lockdowns
Another United Nations report issued in February of 2021 said that as a result of the full or partial lockdowns in the spring of 2020, well over 2.7 billion workers globally suffered total or partial losses of employment. Remittances from foreign workers to their home countries fell by an estimated 20 percent last year. Due to orders to stop work and reduce or halt production, and the limits or prohibitions on international commerce and travel during a good part of last year and into 2021, the declines in Gross Domestic Product (GDP) were huge. According to this UN report, in South Asia, the fall in GDP was about 9 percent; for Latin America and the Caribbean, the decline in GDP came to around 8 percent; in Western Asia about 6 percent; and in Africa almost 5 percent.
Showing the resilience of even partly market-oriented economies, all regions of the world have seen degrees of economic recovery as soon as the shutdown and lockdown restrictions have begun to be lifted. The United Nations report suggests that world GDP may rise by around 4.5 percent in 2021.
But, nonetheless, the political and ideological currents around the world are once more pushing in the direction of greater government spending, taxing, and regulation. Once governments extend networks of existing regulations and controls, and introduce a plethora of new ones in the face of a “crisis” situation, reversing course becomes difficult. This is especially reinforced in times like the present when across the political spectrum, in the mass media, and in the academic halls of the “experts,” the tune heard over and over again is that markets have “failed” in this moment of crisis and only governments have the wisdom and humanity to set things right.
Ludwig von Mises’s Advice for Mexico’s Developing Economy
To where and to whom might we turn for some advice for these developing countries in the aftermath of the economic disaster caused by governments due to their responses to the coronavirus? I would like to suggest that one place to start might be with the policy recommendations offered by the Austrian economist, Ludwig von Mises (1881-1973), about 80 years ago, when he was asked to present an agenda for economic reform and growth for Mexico after he completed an extensive stay in and study of that country’s situation and possibilities.
Ludwig von Mises and his wife, Margit, had arrived in the United States in August of 1940 from Geneva, Switzerland, where Mises had been teaching at the Graduate Institute of International Studies as a professor of international economic relations since 1934. With the fall of France in June 1940, friends had suggested that perhaps he should seriously think of leaving Europe, because if the German Army were to invade Switzerland, he was on the list of notable enemies of the Nazi regime, with his likely arrest and deportation to a concentration camp in Eastern Europe, if not simply being shot on the spot. Being Jewish and an outspoken opponent of National Socialism, no other fate could be in store for him. (See my article, “Celebrating the Arrival of Ludwig von Mises in America”.)
In December 1941, Ludwig von Mises was invited to spend most of January and February of 1942 in Mexico, lecturing at the School of Economics of the National University of Mexico. There he delivered a series of lectures on “The Organization of Social Economy,” and two seminar series – “The Role of Economic Doctrines in Present-day Political Antagonisms” and “Fundamental Problems of Money and Credit.” He also delivered two lectures at the Independent Law School in Mexico City. In total, Mises gave twenty-three lectures over that six-week period.
The following year, in June 1943, Mises finished a monograph on “Mexico’s Economic Problems,” which he had prepared for a market-oriented business association in Mexico City. His purpose was to develop a series of detailed economic policy proposals that a country like Mexico could follow with two underlying goals in mind: to foster that nation’s industrial development and to integrate that nation’s economy into the global system of division of labor. (Published in Selected Writings of Ludwig von Mises, Vol. 3, pp. 203-254)
Sound Long-Run Policies for Economic Betterment
Mises started out by emphasizing that regardless of the policies of other countries and the general international conditions, sound economic policy always begins at home and never loses sight of the long run:
The distinctive mark of a sound economic policy is that it aims at the establishment of a durable system resulting in a continuous improvement of the nation’s wellbeing. There can hardly be imagined a worse principle of government than that of the short-run policies of the last decades. It brought about economic depression, unemployment of millions of workers, social unrest, revolutions, and war. It led to the disintegration of world trade and the international money market . . . A policy that, indifferent about tomorrow, strives after ephemeral success and carelessly sacrifices the future is not progressive but parasitic . . . There is but one means to improve the economic wellbeing of a whole nation and each of its individual citizens: The progressive accumulation of capital. The greater the amount of capital available, the greater the marginal productivity of labor and, therefore, the higher the wage rates. A sound economic policy is a policy that encourages savings and investment and thereby the improvement of technical methods of production and the productivity of labor.
Mises presented his ideas in the context of a knowledgeable overview of Mexico’s economic status as it then existed. He evaluated its major agricultural areas and potentials, considered the technical and economic possibilities of its natural resource base, including mining and oil production, and the opportunities for the development of small business and tourism. Mexico’s advantages included its geographical location in the center of the Western Hemisphere with long coastlines facing both the Atlantic and Pacific, its raw material reserves, and a population that over time had the ability to become more educated and skilled. The country’s disadvantages came from its lack of capital, its relatively large and low-skilled labor supply, and its political heritage over several decades of anti-capitalist policies that had resulted in confiscation of foreign-owned properties and domestically owned large estates, heavy-handed regulations and controls, and burdensome taxes that acted as a disincentive for both domestic capital formation and foreign investment.
He explained the counterproductive consequences for Mexico resulting from the country’s intellectual and political leadership having accepted many of the premises of socialist and interventionist ideology. Wrong ideas had prevented Mexico’s economic development. What Mexicans had to realize was that, “The only way toward an improvement of Mexico’s economic situation is economic liberalism, that is, the policy of laissez-faire; what Mexico needs is economic freedom.”
Integration into the Global Marketplace, Not Self-Sufficiency
In the long run Mexico could only prosper and grow through its integration within the international division of labor. Trade would provide the markets for its natural resources that could serve as a source of earnings to accumulate capital to develop its industrial potential and offer an improved standard of living through importation of consumer goods. Mexico need not, and could not, hope to improve its economic status through agriculture; the country did not have the cost advantages to compete with the many agricultural countries on the world market, nor could it supply all of the agricultural commodities demanded by its own population in the quantities or at the prices at which foreign producers could offer them.
Industrial processing and production would have to be the avenue to economic betterment over the long run. But here, too, many other industrial nations held a comparative advantage. Mexico, therefore, would have to search out that factor in which it had the cost advantage. That advantage was its potentially low labor costs because of its large unskilled labor force. Mexico’s relative overpopulation had no outlet because of the immigration barriers that had been imposed all around the world, especially in the United States. With extremely limited freedom of movement, wage discrepancies between the United States and Mexico could not be reduced through shifts in the relative supplies of labor between the two countries. Therefore, Mexico’s economic improvement pointed in the direction of lower-cost, labor-intensive lines of production.
Mises contrasted two methods for Mexico’s path toward industrialization, what he called the “closed door” and the “open door” methods. The closed-door method is what became widely known in the post-World War II period as the import-substitution method of industrialization. Under this approach, industrialization was to be forced through trade restrictions and high tariff barriers behind which domestic industries would be stimulated into existence at artificially high prices, far above those in the general global market. Mises pointed out that countries implementing such policies inevitably made their own people poorer and less productive.
Reducing imports would also reduce exports, since potential buyers of Mexican goods would lose some of their ability to earn the Mexican revenue that would have provided them with the financial wherewithal to purchase Mexican exports. Mexico would be locked out from maximizing the income it could earn from exporting those goods for which it had the greatest comparative advantage in the international market. And consumers would have to pay the cost of such a method of “hothouse” industrialization through a lower standard of living due to the higher prices and lower qualities of the domestic substitutes they would be forced to purchase on the Mexican market. Closed door, or import-substitution, methods of economic development merely represented a modern version of the eighteenth-century mercantilist fallacies that failed to appreciate that the only real benefits from exports are the imports that export-earnings enable a country to buy from abroad.
Instead, Mises argued, Mexico needed to follow the “open door” approach to industrialization, initially selling mostly raw materials and resources on the world market, and thereby earning the means to import capital and so raise the standard of living of its workforce, from which domestic saving and investment would be generated over time. Many sectors of the Mexican economy could make a fairly easy and smooth adjustment to an immediate shift to a free trade policy, he estimated. But there were, admittedly, other sectors that had become significantly dependent upon the tariff walls behind which they had developed over the years. Of course, he went on, “A sound industrialization program for Mexico has to repeal all import duties.”
Rejecting Interventionism for Market-Based Entrepreneurship
What the Mexican government and political parties needed to do immediately was to publicly declare that henceforth economic policy would be based on: (a) no expropriation of private property; (b) no confiscatory taxation of profit; (c) no controls or restrictions on the foreign exchange market; and (d) no direct or indirect interference with the management and decision-making of private businesses. It was important to attempt to recreate confidence in the Mexican business climate to attract foreign investors as well as creating a sense of security for Mexican entrepreneurs. Said Mises:
It is hopeless to build up a prosperous industry in a country that considers every entrepreneur as an exploiter and tries to penalize his success . . . It is a common weakness of man to envy the success of luckier fellow citizens. But an honest patriot should not look askance at the wealth of efficient entrepreneurs. He must understand that in the framework of capitalist society, the only means to acquire riches is to provide the consumers in the cheapest way with all the commodities they ask for. He who serves the public best profits the most.
Effective private management in the resource and infrastructure markets was essential, too. Mises clearly believed that these industries – mining, oil fields, public utilities, and the national railway system – should be privatized, but at the same time he fully appreciated that this was a delicate issue in the Mexican political climate. He suggested that public utilities – power plants – preferably should also be run by private enterprises to attract private capital for expansion of electrification throughout the country. But whether this was possible or not, and even if public utilities remained in government hands, it was crucial that public utility prices be set at levels to fully cover all costs of production, since the country could not afford to have the treasury tax or borrow to cover losses.
Free Labor Markets and Unburdened Businesses
If Mexico was to succeed in its market-driven industrial development it was essential that neither government legislation nor trade union power be used to artificially raise wage rates above those set on the market, and most certainly there should be no attempt to raise them to comparable United States levels. Mexico was a capital-poor country, Mises emphasized, with a relatively large supply of unskilled labor. That necessarily meant that labor productivity was far lower than that of American workers. To be competitive Mexican workers had to specialize in those lines of production in which they had a cost-advantage in international markets.
Setting wages above market clearing levels would result in unemployment by pricing some workers out of the market, or creating “disguised” unemployment in the form of portions of the population having to remain in rural agriculture earning less than they could have if competitive job opportunities in the industrial sectors had been allowed to emerge.
For similar reasons, Mises argued that the private sector should be neither taxed nor expected to directly provide workers with social insurance of any kind. If the employer is burdened with financing social insurance schemes, the cost of employing workers rises, since the full cost of hiring is both the money wage agreed to as well as the taxes for or the direct costs of providing social security, public housing, medical care, and so on. These additional labor expenses result in some workers again being priced out of the market or some jobs never being created.
Equally important, Mises said, is that mandatory social insurance limits the freedom of the employee. “It only restricts his freedom to spend his earnings ad libitum. It forces him to provide for illness, disability, and to spend a minimum for housing and so on,” whether or not this reflects the worker’s personal preferences about how best to allocate his income as he understands his own circumstances.
Fiscal Restraint and Non-Inflationary Monetary Policy
Finally, on monetary and fiscal matters Mises argued that Mexico should establish a functioning gold standard that would secure a stable currency not open to direct or easy manipulation and abuse by the government. A stable, gold-based currency would also help to create a market climate more likely to attract foreign investment, without which Mexico’s climb to industrial development would be that much more difficult. With this goal in mind, the government had to maintain a balanced budget by keeping expenditures within the bounds of taxes collected, and with those taxes being kept generally low. Mises emphasized:
[T]axes paralyze the spirit of entrepreneurship. No capitalist embarks upon a risky undertaking if he cannot expect sufficient compensation for the risk of losing. The system of private enterprise cannot work if there is no reward for success, only a penalty for mal-investment . . . A country suffering from an insufficient supply of capital, like Mexico, must not adopt such suicidal policies. The first principle of Mexican taxation has to be the aim not to discourage saving and capital accumulation. Income taxes have to be kept, even in the upper income brackets, at a moderate level. Besides that, part of a man’s income which is not consumed, but invested, has to be subject to an even lower rate. Moderation should be applied with regard to all taxes, too, especially corporate and inheritance taxes . . . Confiscatory taxation of the wealthy citizens – a small group in every country, and a very small group in Mexico – and of corporations by preventing capital accumulation does more harm than good to the masses.
Deficit spending can only be financed in one of two ways: printing money or borrowing money. The first method threatens inflationary distortions and instability that retard a country’s development. The second threatens to crowd out private sector borrowing because the government absorbs portions of the country’s pool of savings and prices some private borrowers out of the market by the resulting higher rates of interest.
Economic development is not easy for a capital-poor country such as Mexico with its relatively large and unskilled population, especially when that country has to strive for industrialization in a world in which other nations practice economic nationalism, including immigration barriers. But, Mises said, “It is indispensable to see things as they really are, not as one would wish them to be.” Through free markets and free trade, Mexico could successfully traverse the path to development and material well-being for its population. But to do so it must be understood that, “Private ownership of the means of production and free enterprise are the foundations of our civilization and of political democracy. The profit motive is the vehicle of progress.” Mexico, therefore, needed a reorientation in the ideas and attitudes that had been dominating its policies. “The main issue is intellectual and moral,” Mises concluded, “the spirit is supreme in this field, too.”
Almost 80 years since Ludwig von Mises penned these words and advice, it may be said that they remain as true and important now as in the 1940s, for any country wishing to improve the economic circumstances of its people. Indeed, his warnings about misguided government policies remain just as relevant if not more so today, as we see in our own time a new push for increased interventionism, expanded welfare statism, and renewed calls for socialist-style centralized planning. As Mises said, if we want, peace, freedom and prosperity, there is no alternative to the free market economy respectful of competitive entrepreneurship and consumer choice.
This article was originally published at The American Institute for Economic Research.
The post Post-Covid Policy Advice from Ludwig von Mises for Developing Countries appeared first on The Future of Freedom Foundation.
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