SOME POLITICAL AND ECONOMIC PROBLEMS ARISING FROM STATE ENTERPRISE IN LATIN AMERICA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP79T00472A000400010014-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 22
• Document Creation Date: December 22, 2016
• Document Release Date: July 30, 2012
• Sequence Number: 14
• Publication Date: January 15, 1965
• Content Type: MEMO

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15 January 1965
OCI No. 0748/65
Copy No.
0.9
INTELLIGENCE MEMORANDUM
SOME POLITICAL AND ECONOMIC PROBLEMS ARISING
FROM STATE ENTERPRISE IN LATIN AMERICA
DIRECTORATE OF INTELLIGENCE
Office of Current Intelligence
GROUP 1
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W CONFIDENTIAL IF
OCI No. 0748/65
CENTRAL INTELLIGENCE AGENCY
Office of Current Intelligence
15 January 1965
Some Political and Economic Problems Arising
From State Enterprise in Latin America
1. The economic and political problems arising
from Latin America's experience with state enterprises
bear closely on US concerns about the effectiveness of
foreign assistance policies. Assistant Secretary of
State Thomas C. Mann has pin-pointed the deficits of
Latin American state enterprises as a major cause of
"chronic, galloping inflation" and as a drain on do-
mestic savings urgently needed for development purposes.
2. In all the larger Latin American countries, as
well as some of the smaller ones, the state has assumed
a major role in economic sectors that were largely op-
erated by private enterprise 30'yeara ago. The
state, for example, now dominates most forms of public
transporation. Practically all the common carrier rail-
roads are nationalized, with the exception of a few
short lines in Central America and one segment of the
rail system in Peru. The state is the principal owner-
operator of commercial airlines and maritime fleets and
has a substantial stake in coastal and river shipping
in some countries.
3. Governments also dominate in the fields of
fuels and power, operating national petroleum monopolies
(or virtual monopolies) and generating most of the elec-
tricity. In addition, the state is a large investor in
mining enterprises (especially coal, iron ore, tin, and
copper) and has a monopoly or major position in tele-
communications facilities in several countries. Other
sectors in which the state plays an important role in-
clude steel production, commercial and investment bank-
ing, insurance,? natural gas distribution, shipbuila,;
ing, and consumer monopolies such as salt, beer, tobacco,
and alcohol.
4. Both political and economic considerations
contributed to the origins and expansion of state
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WCONFI DENTI AL W
enterprises. National pride has been a factor in
the establishment of certain state economic agencies
and has virtually made "sacred cows" of such enter-
prises as oil and mining complexes, rail systems,
merchant marines, and steel mills. In addition,
there is widespread acceptance in Latin America of
the philosophy that the government should have a
monopoly of certain "social" services and provide
these to users without consideration of production
costs. In many countries, the absence of a dynamic
entrepreneurial class has left an investment void
for the state. In some cases, private capital has
recognized that it could not survive under govern-
ment policy and regulation and has sought a nego-
tiated sale of its assets to the state.
5. The chronic deficits accumulated over the
years by most state economic agencies support the
allegation that they have a built-in trend toward
bankruptcy. Public subsidies provide a seemingly
inexhaustible means of financing public inefficiency
in spheres where private mismanagement or mistakes
would have led to liquidation. In the exceptional
cases where state enterprises are well managed,
they have often had to incur heavy deficits because
of government policy preventing them from charging
prices that keep pace with rising costs.
6. Programs to improve the efficiency of state
enterprises in Latin America have usually been post-
poned because of political risks or undermined by
administrative and labor elements with vested interests
in the status quo. Uninformed about the economic
costs of wasteful state enterprises, the general
public places considerable value on their status as
symbols of sovereignty and tends to be vehement in
their defense.*
cause of the diversity of the area and the
complexities of the topic, generalizations in this
paper must of course be qualified or refined to fit
particular countries. It should also be noted that
there are many gaps and inconsistencies in the avail-
able statistical data on the performance of state
enterprises.
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ORIGINS AND RATIONALE OF STATE ECONOMIC ACTIVITY
7. Prior to achieving independence, Spanish
America was subjected to three centuries of colonial
rule characterized by strict government economic
control and regulation. During the first century
of independence, the state continued to exercise a
generally strong influence over economic affairs,
despite the growing prestige of liberal economic
thought stressing laissez faire, especially in con-
nection with the import of foreign capital from
Western Europe and the United States.
8. The rise of nationalism in the early
decades of the twentieth century brought a renewed
emphasis on state participation in economic life.
State interventions since 1900 have often been de-
signed to eliminate or reduce the predominant
position of foreign capital, which in many countries
pioneered the development of basic sectors of the
economies. These included rail and other forms of
public transportation, electric power generation
and distribution, petroleum resources, mining and
smelting, telecommunications, and investment and
commercial banking. Many state enterprises were
founded to carry on the functions of private com-
panies which were nationalized.
9. The dissemination of Marxist theory and
the establishment of Communist and socialist parties
in the hemisphere after 1920 tended to popularize
statist ideas. These political groups provided in
most of the countries a nucleus of articulate sup-
porters for nationalization of private investments
and for increasing state involvement in economic
activity. Mexico's state economic programs during
the peaceful phases of the Mexican Revolution and
its generally successful record in growth and
diversification have probably had a measure of
influence on the rest of the hemisphere as an
example of economic promotion by the state.
10. Further stimulus for state enterprise
sprang from the disruption of Latin America's trade
during World War II, especially the interdiction of
the normal flow of manufactured imports and the li-
quidation or seizure of European investments. As
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a consequence governments were encouraged to launch
industrialization programs and to promote self-
sufficiency.
11. More recently, government price policies
and other regulations, as well as nationalization,
have led to further liquidation of private invest-
ment, particularly in public transportation and
electric utilities. In still other spheres, the
state as a matter of policy or in order to satisfy
popular aspirations has established monopolies--
for example, the oil industry in Mexico, Chile,
and Brazil. The state has also stepped in to re-
place or substitute for private capital in sectors
which cannot attract private funds. On the other
hand, Latin American governments have generally
had access to sizable foreign and domestic credits
and other assistance to finance the programs of
state enterprise, except perhaps in oil exploration.
12. In any event, a major role for the state
in economic activity is widely accepted in Latin
America--as in other developing areas of the world--
and endorsed by influential leaders. Some of the
principal reasoning is synthesized by Raul Prebisch,
former executive secretary of the UN Economic
Commission for Latin America, whose ideas have had
a pronounced influence on government economic
policies in the past decade and a half. He asserts
that, even if private enterprise in Latin America
could be transformed into a dynamic force,
there would be weighty reasons for state
action in our countries. Some of these
reasons have to do with economic develop-
ment. There are cases in which the state
has had to undertake activities in these
strategic areas of the economic system,
or make investments which have not proved
attractive to private enterprise. In
other cases, state action has had the virtue
of building up a technical capacity that
would have been difficult to achieve other-
wise.
Apart from these development consid-
erations, there are other considerations
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that in Latin America's experience are
generally important: the avoidance of
an excessive concentration of economic
power in private hands, with the conse-
quent political danger; and the taking
over by the state of enterprises that
by their nature are monopolistic or ac-
tivities that can operate in other ways
through international arrangements that
restrict competition.
POLITICAL BACKING FOR STATE ENTERPRISE
13. State enterprise draws upon a number of
sources for its strong political support. Prob-
ably the majority of the influential economists in
government subscribe to a large or expanding role
for the state in economic activity as the best
means for accelerating economic growth. The
faculties of the schools of economy in Latin Amer-
ican universities in recent years have been almost
completely dominated by professors of Communist or
Marxist orientation and their students often adopt
a similar philosophy.
14. Most political parties and pressure groups
of the center and left-of-center subscribe to a
large state-operated sector of the economy, includ-
ing the Christian Democratic parties and their labor
and student affiliates. For example, President
Frei of Chile advocates "Chileanization" of the
foreign-owned segment of the copper industry, which
apparently means extensive control over prices and
marketing as well as government ownership of a
partial equity interest in the operating companies.
Communists and pro-Communists, often joined by ex-
treme nationalists of both the right and the left,
support state enterprises and nationalization of
private foreign investments.
15. Political support for state enterprise
is reinforced by the inadequacies of the private
sector. Business is usually oriented toward limited
risk of capital, low volume production, and high
profit margins. The private sector is composed in
large part of family enterprises and closed corpo-
rations, which are in perennial pursuit of govern-
mental favor and protection--usually in the form
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of administrative, tariff, and tax privileges--and
various administrative devices to quell or restrict
more efficient competition, foreign and domestic.
SOME ECONOMIC COSTS OF STATE ENTERPRISE
16. Reliable data are often not available to
measure precisely the operating costs of state enter-
prises. Financial statements of these enterprises
often do not include adequate allowances for depre-
ciation and depletion; interest charges on debt; a
realistic allowance for a return on the public capital
invested; and the ever-mounting financial burdens of
pension and other employee benefits.
17. However, the financial statements do re-
flect the heavy expenditures for labor. To a large
degree, a number of state economic enterprises serve
as public works projects in an area where underem-
ployment and unemployment rates have been high in
recent years. Both management and work force are
generally in surplus on a minimum average of 30% to
35%. For example, the National Motor Company of
Brazil in 1962 produced 1,178 vehicles with a work
force of 3,800 persons. The affiliate of the Ford
Motor Company produced 14,000 vehicles of comparable
make with about the same number of employees. State
oil entities provide a further illustration of this
pattern. From 1959 to 1964, employment in the
Brazilian state oil enterprise Petrobras trebled
while production rose only about 50. Mexico's oil
agency PEMEX, which employs more workers than the total
of several private oil companies in Venezuela--each
of which has its separate administration and opera-
tions force--has production equal to about 12% of
Venezuela. Featherbedding is rampant in such
agencies as the Argentine, Brazilian, and Bolivian
railways and the Bolivian state mining enterprise
COMIBOL. Government policy and regulations, how-
ever, largely prevent the discharge of surplus
workers by management.
18. Apart from costs which appear or should
appear in profit and loss statements, there are
many indirect costs to the economy, such as the in-
flationary impact. The Brazilian Minister of Planning
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reported last July that the operating losses of
Brazilian state companies were equal to 80% of
the central government deficit. The subsidies
granted to four of these entities last year--the
railroads, ports, airlines, and merchant marine--
alone totaled about 57% of the deficit. Losses
of state enterprises have run to about 30% of Chile's
central deficits in recent years. The $300 million
deficit of the Argentina state railroads for the
fiscal year ending October 1964--and estimated 70%
of the net of operational losses of all state enter-
prises--amounted to about 25% of the total govern-
ment deficit. The US Embassy in La Paz stated in
1962 that the deficits of the state mining entity
alone averaged between one-half and two-thirds of
the value of the US aid program. An important cause
of Mexican budget deficits in recent years has been
subsidization of state enterprises which price their
goods and services below cost. Operational deficits
of state enterprises are also a major factor in
central deficits in Uruguay, where subsidies to the
state railroads and airlines alone will amount to
more than one-third of the total in 1964. In all
these countries but Mexico, large government deficits
have contributed to steep inflationary spirals.
19. Another indirect cost of state enterprise
in Latin America has been the adverse impact on
private investment, domestic and foreign. Policy
statements of leaders as well as national develop-
ment plans formulated under the Alliance for Progress
have recognized the need for a high level of private
investment to complement the resources of the public
sector. Nevertheless, governments have inhibited
or reduced private investment in a number of coun-
tries through restrictive regulations, administra-
tive practice, legislation, and price controls.
These policies and measures have the effect of plac-
ing an increasing strain on limited public develop-
ment funds. In some cases nationalization or the
threat of its has aggravated balance-of-payments
problems by frightening away potential foreign in-
vestment and by driving private domestic capital
into safer havens abroad. Vagueness of official
policy toward the private oil industry in Argentina,
Venezuela, and Peru, the foreign-owned copper
industry in Chile, the private mining sector in
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Mexico, and the electric power industry in Mexico
and Brazil in recent years are cases in point of
serious deterrents to new investment in Latin America.
20. Another closely related indirect cost of
state enterprise has been the loss of substantial
revenues in the form of corporate income taxes, fees,
import duties and royalties from private investments
which might have entered or expanded in various
spheres of activity. As one US businessman with
extensive experience in Latin America testified in
1964:
Inevitably rstate economic interventions7
retard or prevent the formulation of new
job-creating facilities in the private sec-
tor, due to the threat or the reality of
competition from government enterprises
not playing the same game of profits and
taxpaying and to the fear of outright con-
fiscation.
21. One of the heaviest drains of state enter-
prises has been the extensive use of public invest-
ment funds to expand or sustain operations which
are essentially uneconomic. For example, in recent
years, large sums of money have been invested in
the maintenance of state rail lines in several
countries which can no longer compete with parallel
road transportation.
A comprehensive transportation study con in
Argentina under the direction of the IBRD in 1961
recommended that over half of the state rail system
be eliminated and that additional substantial
trackage be studied for possible abandonment.
22. To the extent that losses of state entities
have contributed to the need for Latin American
stabilization loans, balance-of-payments assistance,
and budget support, they have directly diverted such
funds from more productive expenditures. The present
depressed condition of agriculture in a region which
continues to be heavily dependent on this sector
for exchange earnings and employment can be traced
in part to government emphasis on national prestige
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projects, such as steel mills, coal mines, smelters,
merchant marines, hotel chains, auto factories and
the maintenance of other operations which are not
economically viable by ordinary business standards.
PRINCIPAL SECTORS OF EXPERIENCE WITH STATE ENTERPRISE
23. Most of the larger countries in the area,
including Brazil, Argentina, Mexico, Chile, and
Venezuela, have had extensive experience with state
enterprises, and two of the smaller ones--Bolivia
and Uruguay--are virtually socialist in orientation.
The governments of Colombia, Peru, and Paraguay are
less deeply involved, but have also suffered finan-
cial drains from subsidizing state entities. In all
of these areas the state is a major investor in, or
director of, "mixed" corporations and has generally
made available large credits for their operations.
State and mixed agencies in each of these nations
are among the largest business enterprises, from the
standpoint of capitalization and total production.
24. In contrast, the governments of Central
America and Panama have participated to a much lesser
extent in their economies. Nationalization of pri-
vate companies and state enterprise programs have
not been important political issues. Costa Rica has
been the most inclined among the six toward promotion
of state enterprise, but its program too has been on
a modest scale.
25. Although the Mexican government has long
been involved in economic activity through a variety
of state enterprises, an aggressive private business
sector is becoming increasingly a brake on further
governmental inroads into its sphere. The govern-
ment itself is showing an awareness of the need
for greater efficiency from state enterprise and
is tending to select managers on the basis of techni-
cal and professional competence, rather than to meet
the demands for political patronage. Some Mexican
state agencies are well managed, such as the national
steel mill, and others, like the oil agency PEMEX,
have demonstrated improving performance in recent
years. Moreover, the state's investment banking ac-
tivities have often assisted and stimulated the private
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sector. The comparative vigor of the Mexican
economy attests to the dangers of generalization
on Latin America about the economic impact of state
enterprises.
26. Where private foreign-owned companies
still operate in Latin American utility, oil, com-
munications, transportation and mining fields, the
threat of nationalization is ever present in some
degree. This is the case of the copper mining
industry in Chile and the oil industry in Peru.
Some government regulatory policies suggest that
private capital is to be frozen in the status quo
or eliminated by a gradual process leading ulti-
mately to a negotiated sellout. The latter has oc-
curred in Mexico in recent years in such diverse
fields as electric power and motion picture exhibi-
tion, and the private mining industry there has
long faced adverse regulation which points in the
direction of greater government control. During
the past two decades, Latin American government
regulatory policies have been least restrictive
toward private foreign investment in the manufac-
turing sector.
27. The principal contributors to state
enterprise operating deficits have long been the
national rail systems. This is true of Argentina,
Mexico, Brazil, Chile, and Uruguay. State rail
losses are also relatively heavy in Bolivia,
Paraguay, Ecuador, Peru, and Colombia. During
1964, the combined operating losses of the Argen-
tine and Brazilian state railways were estimated
to be about $500 million, or 25% of the projected
annual new investment from external sources under
the Alliance for Progress. The financial records
of other state transport entities have also been
adverse, with few exceptions, but the size of the
loss has generally been smaller.
28. State oil agencies, with the exception
of the one in Chile, have been another drain on
government funds. The history of PEMEX is highly
controversial; its record is probably permanently
buried under biased accounts both for and against
this complex. PEMEX, which took charge of a modern
and prosperous oil industry in 1938 with a capacity
considerably above domestic requirements, had by
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1958 incurred a substantial cumulative deficit. Ac-
cording to a study PEMEX was
heavily in arrears on tax payments to the Mexican
government and outstanding debt was seven times its
net worth. Moreover, Mexico may be approaching a
deficit in its trade balance in petroleum products,
in contrast to sizable exports in 1938.
29. Enterprises supplying electric power to
the public in Latin America, both government and
private, have been severely handicapped by govern-
ment rate policies and depreciation allowances which
impede their ability to accumulate internal funds
for maintenance and expansion. Low returns have
also prevented them from competing in the open mar-
ket to raise capital. Low rates combined with in-
flationary conditions have in effect forced the
liquidation of private companies. For example,
American and Foreign Power (AMFORP) has negotiated
the sale of its subsidiaries in recent years to
erpr
electric en
government
r.,i nmhi a _ Mexico_ and Brazil.
'The future of the remaining
private sector in the electric power industry in
many of the major countries appears precarious.
30. Private enterprise in domestic telecom-
munications (excepting commercial radio and tele-
vision broadcasting) has met a similar fate. The
enclaves holding out in various countries may be
facing ultimate absorption by the state. For
example, in Mexico, the government has purchased
a major interest in the largest telephone company
and may be considering eventual nationalization.
31. In mining and smelting, Bolivia's state
mining enterprise COMIBOL is -the prime example of
deficit performance by state entities. State coal
mines in Argentina, Venezuela, and Brazil have also
placed heavy demands on public funds to cover
operating deficits and capital requirements.
32. To carry out industrialization policies,
governments have entered diverse manufacturing
fields in recent years--iron and steel, chemicals
and petrochemicals, fertilizer, rail car manufacture,
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automobile production and assembly, aircraft, ce-
ment, and others. Steel industries, which have
become prominent prestige symbols, have probably
required the greatest amount of investment in this
sector. Government experience is difficult to
evaluate, in part because many manufacturing
operations are conducted by so-called mixed
corporations. However, few of these entities ap-
pear to be managed competently and to have become
self-supporting.
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GOVERNMENT CAPABILITIES FOR CARRYING OUT REFORMS
33. Many Latin American leaders acknowledge the
need for reforms in the operation of state enterprises.
However, governments have been largely preoccupied with
other economic issues, such as adverse terms of trade
throughout much of the period since the mid-1950's,
trade barriers imposed by some of Latin America's prin-
cipal customers, and the inability to attract larger
amounts of foreign public and private investment funds--
the so-called external bottlenecks to development. They
usually consider these difficulties to be the fundamen-
tal causes of their economic ills.
34. State enterprise is an extremely sensitive
political issue throughout Latin America, largely be-
cause it is inseparably tied to national sovereignty
and pride. Unstable governments in Latin America,
concerned primarily with political survival, usually
prefer to avoid the hazards of decision in this field.
This hesitancy about taking action is reinforced by the
fact that government economic enterprises in many
cases have attained autonomous power which presents a
latent challenge to the authority of the central gov-
ernment. Some have become empires within an empire
successfully defying efforts to reform them. The state
railroads of Argentina and the state mining corporation
of Bolivia fall into this category. In Uruguay, the
President of the National Council of Government recently
advised the US Ambassador that state agencies were
"little republics with independent disregard of the
general welfare and governmental policy." No Mexican
politician would question PEMEX's monopoly position or
criticize publicly its administrative or financial
record. Petrobras in Brazil is similarly sacrosanct,
particularly since its management by tradition belongs
to the military. The autonomous Brazilian transporta-
tion agencies--rails, merchant marine, and others--are
almost outside of the control of their nominal coordi-
nating body, the Ministry of Transport and Public Works.
35. There thus seems little likelihood of any
extensive liquidation of state entities, although pros-
pects are better in some countries for an elimination
of certain uneconomic operations of these corporations.
The chances also seem somewhat more favorable for a
modicum of restraint in the further expansion of state
economic activity, provided governments face up to a
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sober appraisal. of their past experience. Some gov-
ernments, such as those in Peru, Ecuador, and Costa
Rica, have in recent years considered divesting
themselves of a few deficit state monopolies. Under
present conditions, however, there is little reason
to believe that private capital can again be attracted
to share the burden of development in certain sectors--
particularly in electric power, telecommunications,
transportation, oil, and in some cases, mining and
smelting.
36. The political chances are fair for a meas-
ure of progress in the election of management on the
basis of professional and technical qualification
rather than political affiliation, as is usually the
case. Under these circumstances, management tenure
would become tied to performance and less subject to
frequent political shifts with the concomitant dis-
ruption of sound planning and investment programs.
Recognizing this need, both Venezuela and Bolivia
have contracted with skilled management to assist in
obtaining better results in the operations of certain
state agencies. However, the most skilled management
is effective only to the extent that it has power to
carry out wise operating and investment decisions.
State enterprise directors and planners require the
support of the government, political and labor groups,
and public information media to implement politically
difficult measures.
37. Central governments also appear to have
within their power the enforcement of stricter con-
trols over investments, budgeting, and accounting
of state enterprises--a prerequisite for more economic
operations.
38. The continuing adjustment of prices charged
for goods and services of state enterprises to meet
costs of production under inflationary conditions and
to generate internally at least a portion of the funds
for maintenance and modernization is still another
essential to reducing deficits. This action along
with a substantial reduction in employment are-prob-
ably the sine qua non if state entities are to approach
a break-even point-in- their operations. Such reforms
are known to be politically dangerous, but often not
to the degree asserted by incumbent governments in
the area.
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39. Any successful program to improve the
efficiency of state enterprise over current levels
would be more effective if accompanied by a more
favorable government policy toward private capital.
Such a policy would recognize the need to attract
investment funds from a wide range of sources in
an effort to obtain the maximum cooperation with
the public sector in accelerated economic develop-
men-t. A changed attitude toward private invest-
ment by implication requires some abandonment of a
doctrinaire approach to state enterprise and a
clear definition by the state of those spheres in
which investment can operate with a reasonable
degree of security over the long run.
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State and Mixed Enterprise in Selected Countries and Sectors*
Telecommuni- Electric Invest Other
Country Public Transportation cations Power Oil Mining Banking Steel Industry
Scheduled Merchant
Rail Airline Marine
Argentina M VM D M VM VM D D D H
Brazil M H D H D VM D D D H
Chile M VM D D D VM H D H H
Mexico M D D H M M H D H H
Colombia M S D M D H H D D H
Venezuela M D D M D S S D D H
Peru H S D H H H S H D H
Bolivia VM M - D H H D D - S
Uruguay M M H M M VM - D - H
Paraguay M M D M M - - D - H
I
00
H
*Symbols reflect a general relationship to the private sector in each country. They do not
reflect monetary values of investments.
Key: M = Monopoly
VM = Virtual Monopoly -- i.e., some private enterprise continues on a small scale
D = Dominant position -- the state has the largest single investment and accounts
for a minimum 35% of the production of goods or services for direct investment
H = Heavy investment
S = Small investment
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CONFIDENTIAL
Declassified in Part - Sanitized Copy Approved for Release 2012/08/22 : CIA-RDP79T00472A000400010014-2