[Economic Policy: Thoughts for Today and Tomorrow (1979), Lecture 5 (1958)]
Some people call the programs of economic freedom a negative program. They say, "What do you liberals really want? You are against socialism, government intervention, inflation, labor union violence, protective tariffs.… You say no to everything."
I would call this statement a one-sided and shallow formulation of the problem. For it is possible to formulate a liberal program in a positive way. If a man says, "I am against censorship," he is not negative; he is in favor of authors having the right to determine what they want to publish without the interference of government. This is not negativism, this is precisely freedom. (Of course, when I use the term "liberal" with respect to the conditions of the economic system, I mean liberal in the old classical sense of the word.)
Today, most people regard the considerable differences in the standard of living between many countries as unsatisfactory. Two hundred years ago, conditions in Great Britain were much worse than they are today in India. But the British in 1750 did not call themselves "undeveloped" or "backward," because they were not in a position to compare the conditions of their country with those of countries in which economic conditions were more satisfactory. Today all people who have not attained the average standard of living of the United States believe that there is something wrong with their own economic situation. Many of these countries call themselves "developing countries" and, as such, are asking for aid from the so-called developed or even overdeveloped countries.
Let me explain the reality of this situation. The standard of living is lower in the so-called developing countries because the average earnings for the same type of labor is lower in those countries than it is in some countries of Western Europe, Canada, Japan, and especially in the United States. If we try to find the reasons for this difference, we must realize that it is not due to an inferiority of the workers or other employees. There prevails among some groups of North American workers a tendency to believe that they themselves are better than other people — that it is through their own merit that they are getting higher wages than other people.
It would only be necessary for an American worker to visit another country — let us say, Italy, where many American workers came from — in order to discover that it is not his personal qualities but the conditions in the country that make it possible for him to earn higher wages. If a man from Sicily immigrates to the United States, he can very soon earn the wage rates that are customary in the United States. And if the same man returns to Sicily, he will discover that his visit to the United States did not give him qualities which would permit him to earn higher wages in Sicily than his fellow countrymen.
Nor can one explain this economic situation by assuming any inferiority on the part of the entrepreneurs outside the United States. It is a fact that outside of the United States, Canada, Western Europe, and certain parts of Asia the equipment of the factories and the technological methods employed are, by and large, inferior to those within the United States. But this is not due to the ignorance of the entrepreneurs in those "undeveloped" countries. They know very well that the factories in the United States and Canada are much better equipped. They themselves know everything they must know about technology, and if they do not, they have the opportunity to learn what they must know from textbooks and technical magazines which disseminate this knowledge.
Once again: the difference is not personal inferiority or ignorance. The difference is the supply of capital, the quantity of capital goods available. In other words, the amount of capital invested per unit of the population is greater in the so-called advanced nations than in the developing nations.
A businessman cannot pay a worker more than the amount added by the work of this employee to the value of the product. He cannot pay him more than the customers are prepared to pay for the additional work of this individual worker. If he pays him more, he will not recover his expenditures from the customers. He incurs losses and, as I have pointed out again and again, and as everybody knows, a businessman who suffers losses must change his methods of business, or go bankrupt.
The economists describe this state of affairs by saying "wages are determined by the marginal productivity of labor." This is only another expression for what I have just said before. It is a fact that the scale of wages is determined by the amount a man's work increases the value of the product. If a man works with better and more efficient tools, then he can perform in one hour much more than a man who works one hour with less efficient instruments. It is obvious that 100 men working in an American shoe factory, equipped with the most modern tools and machines, produce much more in the same length of time than 100 shoemakers in India, who have to work with old-fashioned tools in a less sophisticated way.
The employers in all of these developing nations know very well that better tools would make their own enterprises more profitable. They would like to build more and better factories. The only thing that prevents them from doing it is the shortage of capital. The difference between the less developed and the more developed nations is a function of time: the British started to save sooner than all other nations: they also started sooner to accumulate capital and to invest it in business. Because they started sooner, there was a higher standard of living in Great Britain when, in all other European countries, there was still a lower standard of living. Gradually, all the other nations began to study British conditions, and it was not difficult for them to discover the reason for Great Britain's wealth. So they began to imitate the methods of British business.
Since other nations started later, and since the British did not stop investing capital, there remained a large difference between conditions in England and conditions in those other countries. But something happened which caused the headstart of Great Britain to disappear.
What happened was the greatest event in the history of the nineteenth century, and this means not only in the history of an individual country. This great event was the development, in the nineteenth century, of foreign investment. In 1817, the great British economist Ricardo still took it for granted that capital could be invested only within the borders of a country. He took it for granted that capitalists would not try to invest abroad. But a few decades later, capital investment abroad began to play a most important role in world affairs.
Without capital investment it would have been necessary for nations less developed than Great Britain to start with the methods and the technology with which the British had started in the beginning and middle of the eighteenth century, and slowly, step by step — always far below the technological level of the British economy — try to imitate what the British had done.
It would have taken many, many decades for these countries to attain the standard of technological development which Great Britain had reached a hundred years or more before them. But the great event that helped all these countries was foreign investment.
Foreign investment meant that British capitalists invested British capital in other parts of the world. They first invested it in those European countries which, from the point of view of Great Britain, were short of capital and backward in their development. It is a well-known fact that the railroads of most European countries, and also of the United States, were built with the aid of British capital. You know that the same happened in this country, in Argentina.
The gas companies in all the cities of Europe were also British. In the mid 1870s, a British author and poet criticized his countrymen. He said, "The British have lost their old vigor and they have no longer any new ideas. They are no longer an important or leading nation in the world." To which Herbert Spencer, the great sociologist, answered, "Look at the European continent. All European capitals have light because a British gas company provides them with gas." This was, of course, in what seems to us the "remote" age of gas lighting. Further answering this British critic, Herbert Spencer added, "You say that the Germans are far ahead of Great Britain. But look at Germany. Even Berlin, the capital of the German Reich, the capital of Geist, would be in the dark if a British gas company had not invaded the country and lighted the streets."
In the same way, British capital developed the railroads and many branches of industry in the United States. And, of course, as long as a country imports capital its balance of trade is what the noneconomists call "unfavorable." That means that it has an excess of imports over exports. The reason for the "favorable balance of trade" of Great Britain was that the British factories sent many types of equipment to the United States, and this equipment was not paid for by anything other than shares of American corporations. This period in the history of the United States lasted, by and large, until the 1890s.
But when the United States, with the aid of British capital — and later with the aid of its own procapitalistic policies — developed its own economic system in an unprecedented way, the Americans began to buy back the capital stocks they had once sold to foreigners. Then the United States had a surplus of exports over imports. The difference was paid by the importation — by the repatriation, as one called it — of American common stock.
This period lasted until the First World War. What happened later is another story. It is the story of the American subsidies for the belligerent countries in between and after two world wars: the loans, the investments the United States made in Europe, in addition to lend-lease, foreign aid, the Marshall Plan, food that was sent overseas, and other subsidies. I emphasize this because people sometimes believe that it is shameful or degrading to have foreign capital working in their country. You have to realize that, in all countries except England, foreign capital investment played a considerable part in the development of modern industries.
If I say that foreign investment was the greatest historical event of the nineteenth century, you must think of all those things that would not have come into being if there had not been any foreign investment. All the railroads, the harbors, the factories and mines in Asia, and the Suez Canal and many other things in the Western hemisphere, would not have been constructed had there been no foreign investment.
Foreign investment is made in the expectation that it will not be expropriated. Nobody would invest anything if he knew in advance that somebody would expropriate his investments. At the time when these foreign investments were made in the nineteenth century, and at the beginning of the twentieth century, there was no question of expropriation. From the beginning, some countries showed a certain hostility toward foreign capital, but for the most part they realized very well that they derived an enormous advantage from these foreign investments.
In some cases, these foreign investments were not made directly to foreign capitalists, but indirectly by loans to the foreign government. Then it was the government that used the money for investments. Such was, for instance, the case in Russia. For purely political reasons, the French invested in Russia, in the two decades preceding the First World War, about twenty billion gold francs, lending them chiefly to the Russian government. All the great enterprises of the Russian government — for instance, the railroad that connects Russia from the Ural Mountains, through the ice and snow of Siberia, to the Pacific — were built mostly with foreign capital lent to the Russian government. You will realize that the French did not assume that one day there would be a communist Russian government that would simply declare it would not pay the debts incurred by its predecessor, the tsarist government.
Starting with the First World War, there began a period of worldwide open warfare against foreign investments. Since there is no remedy to prevent a government from expropriating invested capital, there is practically no legal protection for foreign investments in the world today. The capitalists did not foresee this. If the capitalists of the capital exporting countries had realized it, all foreign investments would have come to an end forty or fifty years ago. But the capitalists did not believe that any country would be so unethical as to renege on a debt, to expropriate and confiscate foreign capital. With these acts, a new chapter began in the economic history of the world.
With the end of the great period in the nineteenth century when foreign capital helped to develop, in all parts of the world, modern methods of transportation, manufacturing, mining, and agriculture, there came a new era in which the governments and the political parties considered the foreign investor as an exploiter who should be expelled from the country.
In this anticapitalist attitude the Russians were not the only sinners. Remember, for example, the expropriation of the American oil fields in Mexico, and all the things that have happened in this country (Argentina) which I have no need to discuss.
The situation in the world today, created by the system of expropriation of foreign capital, consists either of direct expropriation or of indirect expropriation through foreign exchange control or tax discrimination. This is mainly a problem of developing nations.
Take, for instance, the biggest of these nations: India. Under the British system, British capital — predominately British capital, but also capital of other European countries — was invested in India. And the British exported to India something else which also has to be mentioned in this connection; they exported into India modern methods of fighting contagious diseases. The result was a tremendous increase in the Indian population and a corresponding increase in the country's troubles. Facing such a worsening situation, India turned to expropriation as a means of dealing with its problems. But it was not always direct expropriation; the government harassed foreign capitalists, hampering them in their investments in such a way that these foreign investors were forced to sell out.
India could, of course, accumulate capital by another method: the domestic accumulation of capital. However, India is as hostile to the domestic accumulation of capital as it is to foreign capitalists. The Indian government says it wants to industrialize India, but what it really has in mind is to have socialist enterprises.
A few years ago the famous statesman Jawaharlal Nehru published a collection of his speeches. The book was published with the intention of making foreign investment in India more attractive. The Indian government is not opposed to foreign investment before it is invested. The hostility begins only when it is already invested. In this book — I am quoting literally from the book — Mr. Nehru said, "Of course, we want to socialize. But we are not opposed to private enterprise. We want to encourage in every way private enterprise. We want to promise the entrepreneurs who invest in our country, that we will not expropriate them nor socialize them for ten years, perhaps even for a longer time." And he thought this was an invitation to come to India!
The problem — as you know — is domestic capital accumulation. In all countries today there are very heavy taxes on corporations. In fact, there is double taxation on corporations. First, the profits of corporations are taxed very heavily, and the dividends which corporations pay to their shareholders are taxed again. And this is done in a progressive way.
Progressive taxation of income and profits means that precisely those parts of the income which people would have saved and invested are taxed away. Take the example of the United States. A few years ago, there was an "excess profit" tax, which meant that out of one dollar earned, a corporation retained only 18 cents. When these 18 cents were paid out to the shareholders, those who had a great number of shares had to pay another sixty or eighty or even greater percent of it in taxes. Out of the dollar of profit they retained about 7 cents, and 93 cents went to the government. Of this 93 percent, the greater part would have been saved and invested. Instead, the government used it for current expenditure. This is the policy of the United States.
I think I have made it clear that the policy of the United States is not an example to be imitated by other countries. This policy of the United States is worse than bad — it is insane. The only thing I would add is that a rich country can afford more bad policies than a poor country. In the United States, in spite of all these methods of taxation, there is still some additional accumulation of capital and investment every year, and therefore there is still a trend toward an improvement of the standard of living.
But in many other countries the problem is very critical. There is no — or not sufficient — domestic saving, and capital investment from abroad is seriously reduced by the fact that these countries are openly hostile to foreign investment. How can they talk about industrialization, about the necessity to develop new plants, to improve conditions, to raise the standard of living, to have higher wage rates, better means of transportation, if they are doing things that will have precisely the opposite effect? What their policies actually accomplish is to prevent or to slow down the accumulation of domestic capital and to put obstacles in the way of foreign capital.
The end result is certainly very bad. Such a situation must bring about a loss of confidence, and there is now more and more distrust of foreign investment in the world. Even if the countries concerned were to change their policies immediately and were to make all possible promises, it is very doubtful that they could once more inspire foreign capitalists to invest.
There are, of course, some methods to avoid this consequence. One could establish some international statutes, not only agreements, that would withdraw the foreign investments from national jurisdiction. This is something the United Nations could do. But the United Nations is simply a meeting place for useless discussions. Realizing the enormous importance of foreign investment, realizing that foreign investment alone can bring about an improvement in political and economical world conditions, one could try to do something from the point of view of international legislation.
This is a technical legal problem, which I only mention, because the situation is not hopeless. If the world really wanted to make it possible for the developing countries to raise their standard of living to the level of the American way of life, then it could be done. It is only necessary to realize how it could be done.
What is lacking in order to make the developing countries as prosperous as the United States is only one thing: capital — and, of course, the freedom to employ it under the discipline of the market and not the discipline of the government. These nations must accumulate domestic capital, and they must make it possible for foreign capital to come into their countries.
For the development of domestic saving it is necessary to mention again that domestic saving by the masses of the population presupposes a stable monetary unit. This implies the absence of any kind of inflation.
A great part of the capital at work in American enterprises is owned by the workers themselves and by other people with modest means. Billions and billions of saving deposits, of bonds, and of insurance policies are operating in these enterprises. On the American money market today it is no longer the banks, it is the insurance companies that are the greatest money lenders. And the money of the insurance company is — not legally, but economically — the property of the insured. And practically everybody in the United States is insured in one way or another.
The prerequisite for more economic equality in the world is industrialization. And this is possible only through increased capital investment, increased capital accumulation. You may be astonished that I have not mentioned a measure which is considered a prime method to industrialize a country. I mean protectionism. But tariffs and foreign exchange controls are exactly the means to prevent the importation of capital and industrialization into the country. The only way to increase industrialization is to have more capital. Protectionism can only divert investments from one branch of business to another branch.
Protectionism, in itself, does not add anything to the capital of a country. To start a new factory one needs capital. To improve an already existing factory one needs capital, and not a tariff.
I do not want to discuss the whole problem of free trade or protectionism. I hope that most of your textbooks on economics represent it in a proper way. Protection does not change the economic situation in a country for the better. And what certainly does not change it for the better is labor unionism. If conditions are unsatisfactory, if wages are low, if the wage earner in a country looks to the United States and reads about what is going on there, if he sees in the movies how the home of an average American is equipped with all modern comforts, he may be envious. He is perfectly right in saying, "We ought to have the same thing." But the only way to obtain it is through an increase in capital.
Labor unions use violence against entrepreneurs and against people they call strikebreakers. Despite their power and their violence, however, unions cannot raise wages continually for all wage earners. Equally ineffective are government decrees fixing minimum wage rates. What the unions do bring about (if they succeed in raising wage rates) is permanent, lasting unemployment.
But unions cannot industrialize the country, they cannot raise the standard of living of the workers. And this is the decisive point: One must realize that all the policies of a country that wants to improve its standard of living must be directed toward an increase in the capital invested per capital. This per capita investment of capital is still increasing in the United States, in spite of all of the bad policies there. And the same is true in Canada and in some of the West European countries. But it is unfortunately decreasing in countries like India.
We read every day in the newspapers that the population of the world is becoming greater, by perhaps 45 million people — or even more — per year. And how will this end? What will the results and the consequences be? Remember what I said about Great Britain. In 1750 the British people believed that six million constituted a tremendous overpopulation of the British Isles and that they were headed for famines and plagues. But on the eve of the last world war, in 1939, fifty million people were living in the British Isles, and the standard of living was incomparably higher than it had been in 1750. This was the effect of what is called industrialization — a rather inadequate term.
Britain's progress was brought about by increasing the per capita investment of capital. As I said before, there is only one way a nation can achieve prosperity: if you increase capital, you increase the marginal productivity of labor, and the effect will be that real wages will rise.
In a world without migration barriers, there would be a tendency all over the world toward an equalization of wage rates. If there were no migration barriers today, probably twenty million people would try to reach the United States every year, in order to get higher wages. The inflow would reduce wages in the United States, and raise them in other countries.
I do not have time to deal with this problem of migration barriers. But I do want to say that there is another method toward the equalization of wage rates all over the world. This other method, which operates in the absence of the freedom to migrate, is the migration of capital. Capitalists have the tendency to move towards those countries in which there is plenty of labor available and in which labor is reasonable. And by the fact that they bring capital into these countries, they bring about a trend toward higher wage rates. This has worked in the past, and it will work in the future, in the same way.
When British capital was first invested in, let us say, Austria or Bolivia, wage rates there were much, much lower than they were in Great Britain. But this additional investment brought about a trend toward higher wage rates in those countries. And such a tendency prevailed all over the world. It is a very well-known fact that as soon as, for instance, the United Fruit Company moved into Guatemala, the result was a general tendency toward higher wage rates, beginning with the wages which United Fruit Company paid, which then made it necessary for other employers to pay higher wages also. Therefore, there is no reason at all to be pessimistic in regard to the future of "undeveloped" countries.
I fully agree with the Communists and the labor unions, when they say, "What is needed is to raise the standard of living." A short time ago, in a book published in the United States, a professor said, "We now have enough of everything, why should people in the world still work so hard? We have everything already." I do not doubt that this professor has everything. But there are other people in other countries, also many people in the United States, who want and should have a better standard of living.
Outside of the United States — in Latin America, and still more in Asia and Africa — everyone wishes to see conditions improved in his own country. A higher standard of living also brings about a higher standard of culture and civilization.
So I fully agree with the ultimate goal of raising the standard of living everywhere. But I disagree about the measures to be adopted in attaining this goal. What measures will attain this end? Not protection, not government interference, not socialism, and certainly not the violence of the labor unions (euphemistically called collective bargaining, which, in fact, is bargaining at the point of a gun).
To attain the end, as I see it, there is only one way! It is a slow method. Some people may say, it is too slow. But there are no short cuts to an earthly paradise. It takes time, and one has to work. But it does not take as much time as people believe, and finally an equalization will come.
Around 1840, in the western part of Germany — in Swabia and Würtemberg, which was one of the most industrialized areas in the world — it was said, "We can never attain the level of the British. The English have a head start and they will forever be ahead of us." Thirty years later the British said, "This German competition, we cannot stand it; we have to do something against it." At that time, of course, the German standard was rapidly rising and was, even then, approaching the British standard. And today the German income per capita is not behind that of Great Britain at all.
In the center of Europe, there is a small country, Switzerland, which nature has endowed very poorly. It has no coal mines, no minerals, and no natural resources. But its people, over the centuries, have continually pursued a capitalistic policy. They have developed the highest standard of living in continental Europe, and their country ranks as one of the world's great centers of civilization. I do not see why a country such as Argentina — which is much larger than Switzerland both in population and in size — should not attain the same high standard of living after some years of good policies. But — as I pointed out — the policies must be good.