Jude Wanniski
August 28, 2004


Memo To: SSU Summer Students
From: Jude Wanniski
Re: Economic Origins of the Vietnam War

This last lesson of the summer session coincides with a revived discussion about the Vietnam War in the presidential campaign. It originally ran July 23, 1999, in that year's summer session and is worth a revival today.

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As far as I know, nobody else has examined this topic, as I did in 1977 in the course of research for "The Way the World Works". If any of you out there in cyberspace know of such research, please let me know. There is a whole book to be written about it. As with so many other stupendous errors made by our Political Establishment, this is one it chooses to completely ignore. We cannot blame the Establishment for turning its back on its blunders, as it cost the lives of 55,000 American soldiers to clean up the mess that was made. In this lesson, you will get only the outlines of the errors made. Someone should really dig in and write an entire book about this side of that most unpopular war.

The official version is that the Communists caused the war and that was that. My version suggests there might not have been a war if President John F. Kennedy's economic advisors had given sound advice to the Saigon government on how to improve their economy. At home, Kennedy was a supply-sider, backing a hard currency and the gold standard and recommending sharply lower income-tax rates to restore incentives to production. Unhappily, the economists he sent to Saigon in 1961 gave the same poisonous advice the IMF continues to dispense to this day.

Here are the pages I devoted to the Vietnamese economic situation in my book. Note the NYTimes news story quoted in early 1962, written by Max Frankel, who went on to become executive editor of the newspaper and, I think, one of its best in my lifetime. When I ran an earlier account of this summer lesson on July 23, 1999, Max responded with a note expressing "amazement" at the idea that "fiscal policy alone could have rescued Vietnam." I append along my response. Take your time with this and you will realize why history has to take a deeper look at Vietnam.

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The Way The World Works: Excerpt, Chapter 11, "The Third World on the Laffer Curve"

To the people of the Third World, the whipsawing of "infrastructure" loans, foreign debt, currency devaluations and taxation is more or less what is behind the phrase "economic imperialism." The demand for debt moratoriums and a new international economic order -- a clean slate -- is a direct answer (which the creditor nations and banks will of course resist). The indirect answer is internal change in tax structures and development policies that can free intellectual resources and enable foreign debt to be rapid our of expanded output. For this to happen, the quality of economic advice being exported by the West to the Third World must sharply improve.

There are no doubt thousands of discrete theories on why the United States "lost" South Vietnam, and we would not dispute any of them. But events in Vietnam at least do not cut against the ideas expressed in this chapter, and in many ways fit the political and economic model in ways that have not heretofore been expressed.

The rupture of French colonial rule in Indochina, in July, 1954, was distinctly a function of economic exploitation by France finally outweighing French contributions to Indochina in language, commerce, law, education, and medicine. Time and again in the 1930s the Vietnamese peasants had rebelled against the French taxes levied both to finance projects the French thought good for Indochina and to redeem French loans to the region. After World War II, as Britain and the Netherlands made explicit plans to dismantle their colonial empires, France sought to reassert its hold on Indochina and encountered resistance in war by the Vietnamese nationalists, the Viet Minh. In nine years, the French spent 1.6 trillion francs in military and economic support of the war -- twice the amount it received in Marshall Plan aid from the United States. The forces of history doomed France in any case, but the first distinct signal in our model that the end was in sight came on May 11, 1953, when France unilaterally devalued the piaster from seventeen to ten francs, thereby withdrawing its chief source of support to the domestic economy of Vietnam.

As Joseph Buttinger wrote in his book, "Vietnam: A Dragon Embattled": "It was a psychological shock, because it seemed to imply that France was no longer either able or willing to carry the heavy costs of the Indochina War. Furthermore, since the devaluation of the piaster 'took place after French financial and commercial interests had completed the transfer of their capital and activities to other parts of the world,' Vietnamese nationalists concluded that the French in Indochinese business, and in particular the Bank of Indochina, no longer believed in a military solution of the conflict."

There is no illusion in the electorate. With the devaluation of the piaster and the 50 percent rise in domestic prices that occurred literally in a matter of weeks, the Vietnamese had to immediately calculate upon the departure of France.

From 1954, when the Geneva Agreements divided Vietnam in two at the 17th parallel, communism and capitalism had this social laboratory for a test of strength. It was Ho Chi Minh and communism in the north and Ngo Dinh Diem and capitalism in the south. From 1954 through 1961, Diem was clearly in the lead. In 1955-56, indeed, there were times when it appeared Ho would lose the support of the people who had worshiped him in 1954.

Ho rushed to industrialize, and the Soviet Union and communist China aided this effort not only with material but with technicians to run the factories and train the North Vietnamese. At the same time he rushed to implement a land-reform program, in the process liquidating between 10,000 and 15,000 "rich" peasants -- those who held claim to two or four acres of land instead of the prescribed one acre; between 50,000 and 100,000 were imprisoned or deported. Open rebellion took place in November, 1956 in reaction to these cruelties, and while the communists crushed the rebellion, killing perhaps a thousand peasants and imprisoning several thousand more, Ho was smart enough to know he had pushed too hard and was losing popular support. He publicly apologized for the "errors" of the land-reform program and halted the blood-letting in his own ranks.

Oddly enough, the conventional theory of why Diem began losing popular support after 1957 is that he was not bold enough in pressing land reform in the south. That is, he should have been more aggressive to expropriating the holdings of the landlords and distributing land free to the peasantry. But this is a static argument, which rests on the assumption that the contest between north and south was over which could be more egalitarian. U.S. critics of Diem, then and now, equate democracy with income redistribution, and assert that Diem could have won the minds and hearts of the people by taxing the haves in favor or the have-nots.

Diem gave in to American pressure on land reform. Landlords were given 10 percent cash and 90 percent twelve-year bonds (which proved worthless) for holdings that were distributed at low cost to tenants. But as this solution did not seem to win Diem much affection, the Americans argued that Diem was not expropriating fast enough. In January, 1962, The New York Times -- the loudest voice for "social reform" of South Vietnam in the United States -- editorialized:

Large land holdings have been divided and redistributed to small proprietors. Rural standards of living have been substantially increased and are much higher than in Communist North Vietnam.

Curiously, however, these considerable accomplishments have not greatly enhanced esteem for the identification with the Government among the peasantry. The new farmer proprietors no longer remember that they got their land at a knocked-down price under Government auspices. They only recall that they now have to pay annual installments on its cost to the Government, even though these installments are low. Peasant attitudes are attributable, in part, to effective Communist propaganda and the perversities of human nature. But they are also due to governmental inefficiencies, in some cases to unpopular local officials, to poor Government propaganda and information programs, and to the general aloofness of the regime and its failure to establish sufficient rapport with the people.

Diem's problem with the communists was in the countryside, but the solution was in the cities, the central marketplaces. For the peasants, who trade their crops for the goods and services of the cities, land rents loom as a greater burden when the price of city goods and services rises. They diminish as a burden when the price of city goods and services falls. The price of city goods and services thus had to fall to solve the countryside problem, and this of course required economic growth and commercial expansion in the metropoles.

Unhappily, Diem had left in place the nominally high tax rates imposed by the French during the colonial days. The tax code was festooned with steeply progressive personal income taxes -- rising to 70 percent at $20,000, with an additional 24 percent surcharge on dividend income -- plus business and consumption taxes of all manner and variety. These yielded very low revenues, but because the government did insist upon collecting them when they became visible, they stood as a barrier to commerce. Their worst aspect was that they invited corruption. Government workers had to pay the taxes, being the most visible to the government. The best positioned government officials were then able to recompense themselves and their aides by extorting bribes from businessmen and entrepreneurs, who had to avoid confiscatory tax rates in order to remain in business.

When hostilities ended in 1954, the economy of South Vietnam expanded fairly rapidly despite the tax system. This was because major efficiencies were possible simply because hostilities had ended. Minor road or bridge repairs alone could bring increases in productivity. Crops came to market instead of being burned by war. But after these one-time efficiencies were absorbed by the economy, it became clear there was something wrong with the structure of the economy. It was not growing fast enough. In 1960, a team of economists from Michigan State University went to Saigon to survey the economy, with the perfectly correct starting assumption that "for the long-run, accelerated economic growth may be the crucial factor contributing to a solution of the security problem."

The economists found that a significant portion of the profits being generated by the South Vietnamese economy were not being reinvested in the economy, but were instead being placed in foreign accounts simply to earn interest. The U.S. economists, though, did not see that it was the high tax rates that were discouraging commerce and investment in the metropoles. [As one economist put it at the time in a Saigon lecture]:

The prime requisite for a satisfactory rate of growth in Vietnam is an increase in the share of investment in the national output. The first step in this direction is to limit consumption so that resources may be released from the production of consumer goods and devoted to capital formation. I believe it is possible to do so. Current living standards in Viet Nam, while not generous, compare favorably to those of other economically underdeveloped countries of Asia. There appears to be some room to reduce consumption. The only effective way to limit consumption, short of complete direct controls, is by vigorously enforcing an effective tax system. This is not the place for a comprehensive analysis of Viet Nam's tax system. But it is apparent that Viet Nam's tax system, which relies heavily on import duties, cannot effectively control domestic consumption. Moreover, taxation as an instrument of control, is inhibited by ineffective and capricious enforcement procedures. It is imperative that the tax system and the tax administration be reorganized. There is no other way, in a free society, to control consumption in a reasonable and equitable fashion.

The Michigan group for the most part wanted expanded tax revenues to go into industrial expansion. But there were also U.S. advisers who wanted tax revenues to expand so that Diem could go directly after the minds and hearts of the people by giving them good things -- like land, schools, hospitals, and social services. The upshot was new taxes for both objectives, as reported in The New York Times of January 5, 1962:

11-Point Plan Seeks to Raise Living Levels
Vietnam to Alter Tax System


Washington, Jan. 4 -- The United States and South Vietnam announced today a "broad economic and social program" to raise living standards in South Vietnam.

The eleven-point plan, covering expanded efforts in public health, education and agriculture and industrial development, was the subject of a joint communiqué issued here and in Saigon.

The program was explained by State Department officials here as an effort to demonstrate Washington's faith in the future of a free South Vietnam, to complement substantial increases in military aid, and to enhance the popularity of President Ngo Dinh Diem.

United States sources said they could not yet estimate the cost of the development program, but they expressed confidence that non-military aid to South Vietnam would rise "appreciably" above last year's total of $136,000,000. The cost of military assistance is secret.

The development efforts are to be financed by the Vietnamese government with the help of new funds being raised through an austerity import duty and tax system....

By agreement between the two governments, priority is to be given to imports "required to meet the needs of the people" and to develop Vietnam's infant industries. Luxury goods will be the most severely taxed....

As a condition of pouring more military equipment and manpower into South Vietnam, Washington has been demanding that President Ngo Dinh Diem adopt forthright measures that would persuade his peasant people that he, more than the Communists, could offer not only security but also substantial material benefits.

In addition, the United States has wanted the President to adopt administrative reforms permitting younger officials a greater voice in Vietnamese affairs and giving local army commanders a freer hand in the conduct of war against guerillas....

The development program is an outgrowth of a study made last summer by a joint committee under the leadership of Prof. Vu Quoc Thuc of South Vietnam and Dr. Eugene A. Staley, a Stanford Research Institute economist.

The Staley mission did not envision specific projects as much as it sought ways of helping South Vietnam develop a financial plan to make them possible.

After further consultations through the fall, financial changes were finally worked out and announced in Saigon last weekend. Their purpose is to adjust the flow of imports toward the most needed goods and to raise additional revenues for development and national defense.

The official exchange rate will be held to thirty-five piasters to the dollar.

The Saigon Government announced a new basic import levy, to be called the "economic development and national defense surtax" at roughly twenty-five piasters to a dollar of value. A further import duty is to be placed against all goods except those defined as necessities and still another duty, called an austerity tax, will be imposed on goods defined as luxuries. The South Vietnam government also will establish a special budget for economic development and budget receipts, which now run at about 15,000,000,000 piasters.

The new revenues thus raised from taxes, increased United States aid, and Government borrowing will be channeled into the eleven areas specified in today's communique.

Up to this point, Diem had been holding his own. The economy had not been booming, but it had not been contracting either. Now, it went into contraction. The 71 percent tax on "luxury" goods, which covered most consumer goods, and the tax on foreign-exchange -- an indirect tariff on literally all imports, sent prices up in the cities, which meant a decline in the purchasing power of country goods. The military situation began eroding almost immediately.

One of the conditions of U.S. aid to Saigon was that all funds be spent on American goods. This diminished the value of the aid to Saigon, which was thus forced to buy the most expensive goods and pay the longest shipping charges. As the economy contracted in the spring of 1962, Diem pleaded for relief from the "Buy American" rule. A small story on page 6 of The New York Times of June 20, 1962 speaks volumes:

SAIGON, Vietnam, June 19 -- South Vietnam's plea for relief from the "Buy American" policy was caused by Government concern over business stagnation and the first budget deficit in the regime's history.

South Vietnam complains that some United States goods are too expensive, notably industrial machinery and fertilizer, and that shipping costs are excessive.

Saigon wants to buy industrial machines and fertilizer from Japan and other goods from Hong Kong. But both Japan and Hong Kong are among the nineteen countries barred as sources of imports to countries using United States aid dollars.

Vietnamese economists expect the deficit to approach 4,900,000,000 piasters ($68,000,000). American observers regard this estimate as too high but concede that a deficit of 2,000,000,000 or 3,000,000,000 piasters is likely at the end of the calendar year. American observers say the economic stagnation is due not only to the high prices of imports but also to a deteriorating military situation, which prevents the flow of goods to rural consumers, and to a new Government tax on foreign exchange transactions.

On August 19, 1962, the last nail was driven into the domestic economy of South Vietnam:

SAIGON, Vietnam. Aug. 19 -- South Vietnam is ready to embark on a large-scale program of deficit financing to help pay for the increasingly costly struggle against Communist insurgency.

This was disclosed today by high United States officials here. They hailed the development as a heartening policy change that would shift the economy of the Southeast Asian country from peacetime to wartime footing.

The new policy is expected to inflate prices....

It was explained that the Government of South Vietnam for its part had undertaken new measures to increase its tax revenues to support its budget. But United States sources said that deficit financing would be necessary for at least two years.

Americans here observed that economists generally agreed that a certain degree of inflation, if kept under control, was desirable for an underdeveloped country. It was termed a stimulant to business.

The sharp economic contraction of 1962 led Diem to increase his authoritarian attempts to regain control, seeing no other solution and by now understandably wary of the advice of his American counselors. But the accumulating social tensions of an economy in sharp contraction grew to explosive force and could not be contained in authoritarian hands without massive blood-letting, and this was no option at all.

On June 11, 1963, an elderly monk, Thich Quang Duc, protested against Catholic "persecution" of Buddhists by burning himself to death in a public square. The persecution was not really religious, but a reflection of the economic contraction. Racial, religious, and ethnic differences are always magnified during a sharp contraction, when a smaller "pie" must be redistributed. Diem, a Catholic, had given Catholics a marginally superior position to defend themselves against redistribution by having them disproportionately weighted in the bureaucracy. The Buddhist crisis of 1963 brought an end to Diem's political support in the Kennedy Administration -- which itself had begun the chain reaction in January, 1962, by threatening to withhold military aid unless Diem accepted its tax spending ideas.

President Kennedy explicitly withdrew support from Diem, which meant to the Saigon military that American aid would be ended unless Diem were removed. The generals paid this price by assassinating Diem on November 1, 1963. On November 22, President Kennedy was assassinated. For another decade, Presidents Johnson and Nixon tried by brute force to salvage Vietnam, and a succession of South Vietnam generals installed as presidents of the country followed their advice by enacting more and more social reforms. But nobody ever suggested pulling the internal tax rates down from the top of the Laffer Curve. Instead, inflation pushed them higher and higher, until by the end of the war the 70 percent bracket was encountered at less than $5,000.