Inflation In Underdeveloped Countries; R. Ferrero

INFLA TION IN UNDERDEVELOPED COUNTRIES MANY people today, in industrially developed countries such as the United Kingdom and the United States, are concerned-and rightly so-with an inflationary situation marked by a 3 or 4 per cent annual increase in the level of prices. But so modest a rate of inflation would seem like stability in many underdeveloped countries. In Peru, for instance-though we've fared better than most of Latin America-inflation over the past 20 years, as measured by the cost of living index, has been at the an nual rate of 11 per cent, compounded. The cost of living in Peru is 8 times as high as it was 20 years ago. There is a widespread belief that free economies have a capacity to take "open" or "unsuppressed" inflation in stride without much harm. But the "open" inflation of the past 20 years has caused a great deal of harm in Peru, as in most underdeveloped countries. The following are Dr. Ferrero is a distinguished Peruvian economist, agricultural engineer, author, teacher, and adviser to the Chamber of Commerce and private business concerns. He also has served as Minister of Agriculture and Minister of Finance and Commerce and represented his country in several international meetings.

172 INFLATION IN UNDERDEVELOPED COUNTRIES 173 some of the bad consequences I have seen in an official capacity of trying to cope with inflation: 1. Inflation kills the market for all kinds of long-term bonds, making it exceedingly difficult, if not impossible, to obtain sound financing for major projects essential to economic development. If public works cannot be financed through the sale of government bonds to pri vate investors, then the government resorts to "borrow ing" from the Central Bank, which means outright print ing of paper money-inflation. The housing problem, one of the most serious in underdeveloped countries, cannot be solved unless there is a market for mortgages. But there is no possibility of developing such a market under conditions of rapid inflation. Though authorities in Peru have increased the yield on mortgage bonds to a present rate of 9 per cent of face value, and granted tax exemp tion, it is difficult to find investors who will pay as much as 80 per cent of face value for such bonds.

2. Inflation not only curbs the supply of capital avail able for economic development, but it also upsets the la bor market and makes for bad employer-employee relationships. Underdeveloped countries are seldom backward in ex periments with "welfare programs." Peru, for instance, boasts such "social benefits" for workers as service in demnity or severance pay, paid vacations or holidays, life insurance, sickness insurance, old-age and survivors in surance, profit sharing, health and welfare benefits, bo nuses for employees with long service, workmen's com pensation, and .Christmas bonuses.

174 ROMULO A. FERRERO The cost of all these "benefits" is considerable, averag ing approximately 50 per cent as much as the basic wage or salary. This added cost of labor means that basic wages are much lower than they otherwise could and should be, that workers are getting "social benefits" often deferred-instead of more adequate food, shelter, clothing, and other necessities of the moment. Conse quently, workers press for higher wages, which harassed employers find difficult to pay on top of the heavy tax burden of the Welfare State. Social legislation has been one of the most powerful engines for inflation in many countries that can ill-afford such luxuries. Finally, inflation creates a problem with respect to pen sion funds and service indemnity reserves. There are no sound securities in which to invest such funds; inflation eats away the real value of the reserves; governments use the reserves of official funds to meet current expenditures.

So these reserves add nothing to real capital or produc tivity or national income nor in any way help to re lieve the burden of social benefits. Meanwhile, the poorly conceived benefits create friction between employees and employers. Pensions, based on length of service and on the employee'S most recent wage level, tempt employers to discharge workers who are about to qualify and to hold .wage levels down arbitrarily for older workers. Such problems multiply in time to break forth in open conflict. 3. Rates or service charges for public utilities never keep up with inflation and increasing costs.' Political pres sure prevents rate readjustment, with the result that INFLATION IN UNDE~DEVELOPED COUNTRIES 175 services deteriorate and the utilities face physical break down. Nevertheless, public opinion strongly, and wrong ly, opposes increased rates. 4. Tax authority allowances for depreciation of fixed assets, on the basis of original cost, fail to recognize the declining purchasing power of the monetary unit. This represents, in effect, a drastic increase in the rate of in come taxes. The "excess profits" tax becomes, in reality, a confiscation of capital; and the replacement of worn-out tools and equipment ,becomes a major problem for businessmen.

5. Rapid inflation encourages speculation and mis direction of investments. There is a marked preference for deluxe apartment or office buildings or other real estate as a hedge against inflation. Foreign exchange is purchased, which means correspondingly less investment in the domestic economy. Investors turn to the accumu lation of inventories to benefit from price rises instead of starting businesses of their own or helping to finance further industrial development. 6. Sooner or later, rapid inflation leads to all kinds of governmental regulation: price control, rent control, wage control, import control, exchange control. "Open" inflation thus becomes "suppressed" inflation. Exports are particularly discouraged because internal costs rise while exchange control unduly depresses selling prices. To add insult to injury, the exporters are blamed for the "shortage" of foreign exchange and the devaluation which inevitably must come. The loudest cries against exporters come from the very ones who had pressed hard176 ROMVLO A. FERRERO est for the monetary policies .and other governmental interventions that caused the inflation.

The inevitable result of all these controls is reduced production of the things most needed, these being the favorite targets of control: housing, food, public utilities, exports. Shortages develop. The international balance of payments is unbalanced. Exports decline. More and more foodstuffs have to be imported. Saving is discouraged. In vestment is misdirected. Economic development is retarded.