Thayer Watkins
Silicon Valley
& Tornado Alley

The Expropriation of
the Petroleum Industry
of Mexico in 1938

The events leading up to the expropriation of most of the petroleum companies of Mexico were sufficiently complex and complicated that they deserve a separate treatment. First, it must be noted that the workers in the petroleum industry were by far the highest paid workers in Mexico at the time. For some statistical comparison see here. Also the Petroleum Workers Union was one of the most powerful.

In the summer of 1936 the leaders of the Petroleum Workers Union gathered for a conference at which all outsiders were excluded. This conference lasted for months. In November each general manager of the petroleum companies operating in Mexico received by mail a 165-page draft of a proposed labor contract to replace existing contracts. The companies were given ten days to agree to the contract without alternations or the union would declare a general strike.

This was not a contract that the companies could possibily accept. The purpose was to give the semblance of a labor-management dispute at which time the government could take control of the petroleum properties in the name of avoiding a general strike. The previous contracts had not run their term and thus there was no basis for opening contract negotiations. And what sort of negotiation is delivering an ultimatum to sign a 165-page contract in ten days or face a general strike?

The Petroleum Workers' Union's action was part of concerted effort on the part of Lázaro Cárdenas acting in conjunction with the labor union leaders of Mexico to take control of foreign-owned property. Cádenas had already taken control of railroads. He had also confiscated foreign-owned cotton farms in north central Mexico and distributed them to the farm workers under the ejido program. He had nationalized the sisal industry of the Yucatan. Near the end of 1935 he said in a speech

We expect the capitalist class to pay labor to the limit of its economic capacity.

The petroleum company management gained a two-week extension of the period for consideration of the union ultimatum. Management had some hopes of legal redress. The Supreme Court of Mexico in numerous decisions had health that private property could not be confiscated and that the oil rights to land purchased before May 1, 1917 were private property. Management also had some hopes that the government of Mexico would be more rational than the union leaders about interfering in industry. When the sisal industry of the Yucatan was nationalized the level of production fell fifty percent. Likewise the production of cotton fell when the cotton land was redistributed under the ejido program. The petroleum company management had confidence that Lázaro Cárdenas would hesitate to disrupt an industry as important as the petroleum industry was to Mexico. It appeared that this confidence might have been justified when just before the strike deadline Cá called for a conference of labor, management and government representatives to establish within six months a new contract. This, in effect, was to be binding arbitration on the part of the negotiating conference.

The conference, however, provided no respite for management. The union relinguished not one of its demands and added more. At the end of the six month negotiating period, the petroleum company managers requested a ten-day recess for them to formulate their terms for a contract.

The proposed contract submitted by the petroleum company management included these terms:

The terms demanded by the union which the companies were not willing to grant were:

The union leaders did not accept the contract proposed by the petroleum companies and called for a general strike. This strike threatened to severely damage the economy of Mexico. Mexican law provided for a Federal Board of Mediation and Arbitration to pass judgment on the legality of any strike if either party to the strike requests its intervention. The management of the petroleum companies did not seek this agency's intervention because in upwards of 95 percent of its actions it agreed with the unions. Normally this agency could not intervene on its own, but its charter provided for its unilateral intervention under the special circumstances that a strike involved

Causes of an economic order which cannot by their special nature be determined in an ordinary manner.

The special provision was put into the law to allow a struck company to demonstrate to the government that a strike would bring about its financial collapse. This usually involved the company presenting its accounting records to the Federal Board of Mediation and Arbitration.

Although this provision was created to protect companies the union and government saw it as a means to publicize the financial records of the petroleum companies. A week after the general strike against the petroleum companies had begun the union request the intervation of the Board on the basis of special economic circumstances. When Board agreed to intervene it suspended the strike during the period of its investigation. Thus the union called a strike and then requested the Board to intervene and suspend that strike.

At various points Cárdenas posed as the guardian of the public interest, and perhaps he was less radical in his plans than Vicente Lombardo Toledano, the head of organized labor for Mexico. But culturally and politically Cá could not appear to be more faint-hearted than Toledano. So once the process of holding up the petroleum industry was initiated the inevitable outcome had to be the confiscation of petroleum industry properties.

The Commission of Experts for
the Federal Board of Mediation and Arbitration

The Board appointed a commission of three men to conduct the inquiry. The head of the commission was Jesus Silva Herzon, a university professor, avowed Marxist and the workhorse of the commission. The union and the petroleum companies selected representative to serve as experts for presenting information to the Commission.

Herzog and the union representatives were intent upon limiting the economic data to the years 1934 through 1936, which included the effect of the opening up of a new oil field at Poza Rica by the Mexican Eagle oil company, a British-owned firm. The wells at Poza Rica raised the annual production levels of petroleum in Mexico by about 14 million barrels per year. But such a spike in production is a short term phenomenon. After the initial high level of production in the first years of production production drops back. If new discoveries are not being developed will trend inexorably downward.

Looking only at the winners in any type of risky venture is of course misleading. It would be like looking only at the winners in Los Vegas, which would give a completely wrong impression of gambling. Gamblers collectively leave more in Los Vegas than the winners take away. Any surviving petroleum company is a winner. The Mexican government's focus on the period right after the development of the Poza Rica field was like looking at the winnings of the winning gamblers only after one of them had hit a big jackpot.

The commission's investigation also gave a good deal of attention to a comparison of wage levels in the U.S. petroleum industry with those in Mexico, saying in effect, "Forget the fact that wages in the Mexican petroleum industry are several times higher than wages in other industries in Mexico, look at what American workers get." This reflects the medieval delusion that prices should not be set by supply and demand but should be set administratively by authorities applying some principle of the just price.

After weeks of uninformed rhetoric, Herzog closed the hearings. After thirty days he presented the report of the commission. It was about three thousand pages long, indicating a rather remarkable average output of one hundred pages per day. Professor Herzog must have written rather frenetically. With a ten hour work day working seven days a week he would have had to have turned out a page of text about every six minutes. One marvels at this feat of Professor Herzog.

Of course the alternate explanation is that the report had been largely written years before as part of long planned program for the confiscation of the petroleum industry property. Professor Herzog asserted that the petroleum companies had capital reserves as of the end of 1936 of 77 million pesos. The companies' auditors put the figure at 26 million pesos. The commission's estimate of reserves were based not upon any accounting information but on revenue figures derived from multiplying production figures times trade journal offer prices. On the cost side the commission left out taxes and overhead costs. On the basis of the dubious revenue and cost estimates the commission asseted that the profits of the petroleum companies (the ones which did not go broke) were about 43 million pesos per year higher than what the petroleum companies acknowleged as their aggregate annual profits, which was about 20 to 30 million pesos per year. Professor Herzog's commission report then asserted that the rate of return on capital for the petroleum companies for the years 1934-1936 was 16.8 percent. The expert witnesses for the petroleum industry asserted that the figure for that period was 7.5 percent and that the rate for the period 1927-1936 was 4.25 percent.

Clearly there was a disputed difference concerning the profitability of an investment in the petroleum industry. Consider the fate of the petroleum company which the Mexican government set up to compete with private industry. This company had free rein to drill in all land that had not been transferred to private companies before May 1, 1917. Despite this opportunity this government-sponsored company made no new discoveries on its own. Instead it relied almost solely on drilling offset wells adjacent to the field discovered by private industry. Even at that the government-sponsored petroleum company did not prosper and was abandoned. If there had been even a modicum of financial success for the government-sponsored petroleum company it would have continued and competed with private industry. There was not.

Professor Herzog's report concluded that the private petroleum companies had an aggregate capacity to pay 26 million pesos per year more than they were paying. Since the companies had made an offer to pay 13 million pesos per year more there is a strong suggestion that Professor Herzog simply doubled the companies figure. The cost of the social benefits was in addition to the direct wage payments. After Professor Herzog's submission of the commission report the petroleum industry representatives were given 72 hours to respond. Perhaps Professor Herzog felt that since he could write, seemingly, one hundred pages of report per day that petroleum company representatives could also work at this pace.

The Group Seven Subcommittee Hearings

With the conclusion of the investigation of the commission the Federal Board of Mediation and Arbitration created an operating subcommittee of three people which was called Group Seven. The three-man Group Seven consisted of representatives for the companies, the union and government. Almost always the government representative voted with the union representative. The committee was merely a facade to simulate fair procedure. The companies were merely given a totally powerless token representative. Its actions were never in doubt. The creation of such a subcommittee of the Board was a deviation from its normal procedure. Perhaps this was because the Board members wanted to save themselves the tedium of long hearing whose results would be a forgone conclusion.

The Group Seven hearing dragged on for two months. At one point it prohibited the companies from introducing accounting information on their profitabilities. Later it reversed itself on this matter, which was the heart of the issue of how much the companies could pay. In October of 1937 the Group Seven hearings were concluded. The Group Seven subcommittee was acting in the name of the full Board. The law specifies that the Board will render its decision within 72 hours after the ligitants have filed there final briefs. That 72 hours passed and there was no decision. Seven weeks passed. The Petroleum Workers' Union called in protest a 24 hour strike. The Board announced that its decision would be made on December 18, 1937.

On that day a 1000-page report was presented to the Group Seven. Only the government representative was aware of its contents. The report was read aloud over the course of ten hours. After a section was read the Group voted, always the government and union representative approving and the companies representive dissenting. The conclusions of the report was that a contract proposal differing only insignificantly from that proposed by Professor Herzog. There is a strong suspicion that Professor Herzog may have been the author of the thousand-page report.

The report did add to the social benefits the companies were to provide. In addition to providing free medical care for the extended families of employees, the companies were to build new hospitals wherever a national medical commission specified. In addition to free schools for the children of employees the companies were to be required to provide free night schools for adults. Furthermore a specified number of employees or their sons were to given technical training in Mexico or outside of Mexico if necessary. As in the original union proposal any employee could at any time request and receive three days leave with pay. The companies were to pay for transportation involved in these leaves as well as for vacations. Employees with less than ten years service were to receive 21 working days of vacation. Those with ten years or more of service were to get 31 working days of vacation.

The Group's report required the companies to replace all foreign technical employees with Mexican workers within three years. If any three union members complained about an executive, that executive was to be fired.

On the crucial matter of wage levels the Group report made moderate modifications but concluded that the companies should pay 26 million pesos more in wages, the same aggregate figure as in Professor Herzog's report.

The Labor Court of the Supreme Court

The companies appealed the Board's decision to the Supreme court of Mexico. Before 1934 the judical branch of the Mexican government was independent of the executive branch. But when Lázaro Cárdenas became president he sponsored an amendment to the constitution to limit the Supreme Court justices to the same six-year term as the president. Furthermore the president under this legislation had the power to replace the justices at any time. Cárdenas immediately used this power to pack the Supreme Court with justices loyal to him. At about the same time in the U.S. Franklin Roosevelt attempted to pack the Supreme Court but failed.

The Supreme Court took the appeal of the petroleum companies and delegated it to a subcommittee of five of its justices called the Labor Court.

The Labor Court deliberated for two months over the evidence. Meanwhile the union was producing public demonstrations to sway public opinion and intimidate any Labor Court justices who might have any qualms about proceedings. The companies on their part tried to negotiate some agreement with Cárdenas. The companies told Cárdenas that they would except the 26 million pesos increase if he would guarantee that was the limit. Furthermore they wanted the clauses having to do with management staff removed from the contract. Cárdenas turned down the companies' request and this may be the basis for the story that the expropriation came from the companies demanding that Cárdenas put into writing an agreement that they had gotten his verbal approval on thus impuning his integrity to honor his word.

At this time economic conditions were worsening. It was the time of the worldwide Great Depression. In the U.S. economy there had been some upturn in economic conditions but in 1937 and 1938 there had been a change of policy that resulted in a recession in the recovery from the Depression. This recession may have spilled over into the Mexican economy. But Mexico was in addition experiencing a flight of capital as a result of the nationalization and impending expropriation of the petroleum industry. This in itself could have produced hard times. The unions leaders of Mexico, particularly Vicente Lombardo Toledano, charged that the petroleum companies were behind the economic downturn of Mexico.

On March 1, 1938 the Labor Court of the Supreme Court of Mexico rendered its verdict on the appeal of the petroleum companies on the judgment of the Group Seven of the Federal Board of Mediation and Arbitration. It found on a vote of four to nothing that there was no constitutional provisions violated by the Board's judgment. One member of the Labor Court excused himself on the basis of his involvement in political activity concerning the case.

The Act of Expropriation

The petroleum companies made a last ditch effort. They applied for and received a temporary suspension of the application of the terms of the Board's contract terms. But on March 12, 1938 the suspension expired. Still the companies held that they could not comply. The union appealed to the Board that the petroleum companies were in default. The legal term for this situation in Spanish is rebeldía. Although this word looks like the Spanish word for rebellion, rebelion, it is not the same. On March 18, 1938 the Board declared that the petroleum companies were in rebeldía; i.e., in default. Within hours of this Board finding President Lázaro Cárdenas issued a decree that the petroleum companies were in rebellion against the government of Mexico and under the powers granted him under the Expropriation Act passed by the Congress of Mexico in late 1936 expropriated them. The next morning, March 19, 1938 union personnel took conrol of the properties.

It must be noted here that not all petroleum companies were expropriated at that time. Only those involved in the dispute with the Petroleum Workers union were effected. This was most but not all of the oil companies. The workers in some companies had not joined a union and thus those companies were unaffected.

The most powerful union leader in Mexico, Vicente Lombardo Toledano, made an interesting remark after the expropriation. Speaking to a radical audience in New York City he commented on the last ditch negotiation of the petroleum companies with Cárdenas in which the companies offered to raise wages 26 million pesos.

This offer Cárdenas refused. If we had accepted, it would have been a victory of labor over capital within the Mexican petroleum industry; but by refusing the offer, we won a greater victory for the Mexican people against foreign imperialism.

The expropriation of the petroleum industry had been in the pipeline for years; it was just implemented in 1937-38.

The Matter of Compensation

The U.S. government at the time of the expropriation of the petroleum industry was buying silver from Mexico at a fixed price that was significantly above what the market price of silver would have been without such purchases. The export tax on silver was a significant source of revenue for the Mexican government. A little more than a week after the expropriation the U.S. government ended those silver purchases. The Mexican peso fell in value.

Cá had labeled the siezure of the petroleum companies' property as expropriation rather than confiscation without compensation. The governments of the U.S., Britain and the Netherlands filed complaints on behalf its citizens. There had been numerous expropriations in the past for which no compensation was forthcoming. There were claims dating back to the period of the Mexican Revolution of 1910-1917 that had not been settled.

It was not surprising that no compensation had been paid on past expropriations in as much as the Mexican government had not made payments on its national debt, external and internal, for many years. Cárdenas replied to the diplomatic notes with typical bombastic but empty rhetoric,

You may be sure, Mr. Ambassador, that Mexico will know how to honor its obligations of today and its obligations of yesterday.

He then engaged in a bit of splendidly effective public relations. He said that the United States wanted Mexico to bleed and therefore he was requesting loans from the Mexican people to pay compensation for the petroleum properties. There were public rallies and marches in which people donated money and jewelery to this cause. The middle class responded but there were no real loans from the wealthy because the wealthy knew that a loan to the Mexican government at that stage was, in reality, a gift. The wealthy in general were transfering their wealth out of Mexico as quickly as possible to places where it would be safe from confiscation. Cárdenas' request for loans brought him much political capital but only a tiny, tiny fraction of the amount needed to make compensation for the expropriations.

The Real Costs of the Expropriation to the Mexican People

The desperate attempts of workers to migrate from Mexico and Central America to the United States is, in essence, an attempt to get from capital poor regions to a capital rich region. And why are Mexico and Central American countries capital poor? It is because the governments of those countries chose to make them unsafe places for investment. The governments were able to confiscate capital for a short period only; thereafter capital kept a safely out of reach of the confiscators. And who paid for the capital shortage that developed and continued to prevail? It was no other than the labor in those countries. Consider the case of Singapore. It is a small island devoid of natural resources. But the workers of Singapore are vastly more prosperous than workers in Latin American countries; they are even more prosperous than workers in many industrialized European countries. What is the secret of Singapore's success? It is that the political leader of Singapore, Lee Kwan Yew, made Singapore safe for capital investment. The absence of restrictions on the flow of capital out of Singapore and low tax rates enticed capital into Singapore. The investment of foreign capital in technology resulted in Singaporeans working in high tech, high paying jobs. Lee Kwan Yew, as a politician, was not perfect. He had his failings, but despite his background as a socialist he was smart enough to know what works economically and what does not. In this matter he was vastly smarter than Lázaro Cárdenas.

But has not the national petroleum company of Mexico, PEMEX, been profitable for the Mexican government? The profits of PEMEX for the past several decades have been from petroleum properties that could have been developed without the 1938 confiscations. The government of Mexico had ownership of petroleum under all land that was not sold before May 1, 1917. All it took to develop it was a sensible policy that did not involve politicians and bureaucrats making technical, economic decisions. This came in 1950 when PEMEX began letting private industry do the drilling under contract. Likewise petroleum refineries could have been built by private industry under contract.

What Mexico got with Cárdenas' confiscation in 1938 was oil wells that produces for only a few years and physical plant that wore out after some years. The two decades of capital shortage lasted longer than the oil wells and the physical plant. The workers of Mexico suffered greatly from that shortage of sources of capital. With confiscation came union control and and the consequent overstaffing and inefficiencies.

(To be continued.)


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