Debt Disaster?: Banks, Government and Multilaterals Confront the Crisis 9780814784907

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GEONOMICS INSTITUTE FOR INTERNATIONAL ECONOMIC ADVANCEMENT SERIES Michael P. Claudon, Series Editor

Debt Disaster? Banks, Governments, and Multilateral Confront the Crisis edited by John F. Weeks

DEBT DISASTER?

Banks, Governments, and Multilateral Confron t th e Crisis

Edited by JOHN F. WEEKS

NEW YORK UNIVERSITY PRESS New Yoik and London

© 1989 by New York University All rightsreserved Manufactured in the United States of America

Library of Congress Cataloging-in-Publication Data Debt disaster? : banks , governments, and multilaterals confront the crisis / edited by John F. Weeks, p. cm . Bibliography: p . Includes Index. ISBN 0-8147-9233-2 1. Debts , External—Developing countries. 2 . Deb t relief—Developing countries. 3 . Developin g countries—Economic policy. I. Weeks , John. HJ8899.D434 198 9 336.3,435,09172409048—dc20 89-920 7 c i o 9 8 7 6 5 4 3 2 CI

New York University Press books are printed on acid-free paper, and their binding materials are chosen for strength and durability.

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CONTENTS

List o f Figure s i

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List o f Table s x

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Acknowledgments xii —John F. Weeks

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Foreword x —Michael P. Claudon

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Introduction xi —John F. Weeks

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PART I DEBT

CRISIS IN THE THIRD WORLD 1

Chapter 1 The Outloo k fo r Developmen t —Barry Herman 3 Chapter 2 External Shocks , Adjustment , an d Incom e Distribution —Rolph van der Hoeven 2

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Chapter 3 Losers Pa y Reparations , O r Ho w th e Thir d World Los t th e Lendin g Wa r —John F. Weeks 4

PART II THE DEBT CRISIS AND COMMERCIAL BANKS 6 Chapter 4 Background t o th e Deb t Crisis : Structura l Adjustment i n th e Financia l Market s —Karin Lissakers 6

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Chapter 5 Safe Passag e Throug h Dir e Straits : Managin g an Orderl y Exi t fro m th e Deb t Crisi s —Paul M. Sacks and Chris Canavan 7

PART III STRUCTURAL ADJUSTMENT: SOLUTION OR PART OF THE PROBLEM? 8

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Chapter 6 World Bank-Supporte d Adjustmen t Program s —Robert Liebenthal and Peter Nicholas 9

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Chapter 7 Assessing Structura l Adjustmen t Programs : A Summar y o f Countr y Experienc e —Robin A. King and Michael D. Robinson 10

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Chapter 8 Undervaluation, Adjustment , an d Growt h —Richard D. Fletcher 12

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Chapter 9 Old Win e i n Ne w Bottles : Policy-Base d Lending i n th e 1980 s —Jose D. Epstein 13

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CONTENTS vi

PART IV STRUCTURAL ADJUSTMENT: IMPACT IN THE THIRD WORLD 14

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Chapter 1 0 Social Cost s o f Adjustmen t i n Lati n Americ a —William L. Canak and Danilo Levi 14

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Chapter 1 1 Political Chang e an d Economi c Polic y i n Latin Americ a an d th e Caribbea n i n 198 8 —Louellen Stedman and Peter Hakim 16

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Chapter 1 2 The Demis e o f th e Labo r Aristocrac y i n Africa : Structural Adjustmen t i n Tanzani a —ValiJamal 17

PART V SEEKING

A SOLUTION 19

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Chapter 1 3 Facing th e Realitie s o f th e Deb t Crisi s —Rep. Bruce Morrison 19

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Chapter 1 4 From Adjustmen t wit h Recessio n t o Adjustment wit h Growt h —Rudiger Dornbusch 20

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Chapter 1 5 From Adjustmen t an d Restructurin g t o Development —Osvaldo Sunkel 22

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Chapter 1 6 Is t o Forgiv e th e Deb t Divine ? —William Darity, Jr. 23

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Chapter 1 7 Foreign Lendin g a t th e Brin k —Michael P. Claudon 24

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Bibliography 25

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Index 27

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About th e Contributor s 28

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About th e Edito r 28

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LIST O F FIGURE S

1-1 Outpu t Per Capita 8 1-2 Ne t Resource Transfers and Investment in Middle Income and African Country Groups 1

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LIST O F TABLE S

1-1 Th 1 -2 Ne

e Growth of Per Capita Output 1 t Transfer of Resources of Capital-Importing Developing Countries 1 2-1 Nonfuel-Exportin g Developin g Countries: External Shocks, 1978-1987 2 2-2 Cumulativ e Change in Real Industrial Wages and Open Unemployment Rates in Selected Countries, 1981-1985 2 2-3 Inde x of Nonagricultural Real Wages, Employment and Labor Force 3 2-4 Centra l Government Fiscal Balances 3 7-1 Economi c Variable Comparisons, 1974-1984 11 7-2 Economi c Variable Comparisons, 1974-1984 11 7-3 Economi c Variable Comparisons 11 14 Three-Yea r Percent Changes in Economic Variables Following a Rescheduling Episode 11 7-5 Simulation s of the Impact of a Rescheduling Episode 11 7-6 Probabilit y of Debt Service Difficulty 11 7-A1 Vecto r Autoregression of Macroeconomic Variables 121-12 7-B1 Countrie s in Data Base and Reschedulings 12 12-1 Wage s in Current and Real (1969) Terms, 1957-1983 17 12-2 Indice s of Crop Prices and Minimum Wage in Current Terms, 1963-1988 18 12-3 Povert y Line for an Urban Family, December 1985 18 17-1 Exposur e of U.S. Banks to Six Troubled Developing Countries, 1984 24 17-2 Financia l Resource Balance 24 XI

1 3 2 6 1 3 1 1 3 3 5 7 2 3 9 4 7 8 9

ACKNOWLEDGMENTS

If th e succes s o f a conferenc e ca n b e measure d b y th e enthusias m o f it s participants and the quality of its papers, then the seminar sponsored by the Geonomics Institute over the weekend April 27-29, 1988, was an unqualifie d success. Particula r thanks go to Michael P. Claudon, President and Managing Director of Geonomics, who not only provided the inspiration for the meeting, but also found time to contribute to this volume. As in al l suc h endeavors, many people mad e for it s success . Foremos t among them was Colleen Duncan, Senior Editor and Conference Coordinator, whose contributions went far beyond the administrative, for she gave invaluable counsel in the process of selecting participants and editing and enriching the final manuscript. Elizabet h Leeds, Editorial Assistant, earned the debt of conference participant s fo r he r organizationa l assistance . Th e amiable and collegial ambiance of the conference session s and informal gathering s owed much to their site, Middlebury College's Bread Loaf Mountain Campus, and College officials provided generous support. Finally, I wis h t o than k thos e member s o f th e facult y wh o too k thei r valuable tim e t o chai r session s o f th e conference , Elizabet h Dore , Davi d Rosenberg, and Alicia Andreu. An d I would be remiss were I not to thank the undergraduates fromthe College who attended sessions and contributed insightful comments. On e hopes their enthusiasm and seriousness is indicative of the awareness and concern of their generation for the problems of the Third World. John F . Week s Xlll

FOREWORD

The surge of unprecedented private, commercial credit from Northern financial centers to the developing countries of the South, which originated about 1973, erupted in 198 2 into a global debt crisis, a crisis that today is still very much with us. Economists ar e fon d o f assumin g "othe r thing s equal, " bu t th e mos t important "other things" are very different in 1988 than they were fifteen year s ago. Th e post-Worl d Wa r I I economi c boo m ha s finall y ru n it s course . Growth in the 1990 s is unlikely to match, or possibly even come close to, that of the last two decades. Th e OPEC surpluses of the 1970s disappeared as real oil prices fell, and were subsequently replaced by Japanese and West German trade surpluses. Norther n commercial banks, their credibility and profitability severely, and potentially mortally , wounded by their exposure to debt service moratoria, reschedulings, and outright Latin American debt repudiation, have turned their collective bac k o n th e South . Th e large , multinationa l bankin g community turned away from the LDCs and toward industrial country markets. Globalization o f financia l market s continued , bu t wa s an d i s increasingl y limited to the developed economies in the North. Most of the orthodox strategies that have been adopted produced little more than momentary breathing room before the crisis resurfaced. Heavil y indebted developing economie s ar e now face d wit h a n impossibl e equation : Th e $3 0

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billion to $50 billion annual financial resource transfer to the North, averaging more than 5 percent of their GDPs, is exhausting desperately needed investment among debtor nations. Withou t substantial additiona l productive investment , growth i s impossible . Withou t a resumption o f economi c growth , continued debt servicing promises accelerating real wages losses, growing human misery, and increasing domestic instability within developing debtor nations. Now i s the time to design a facility aime d at dramatically decreasin g debt service, thereb y hastenin g recover y o f privat e banks ' and debto r countries ' financial healt h a s soo n a s possible . T o b e successful , suc h a pla n mus t facilitate, even provide an impetus to, debtor growth by somehow transforming interest payment s destine d fo r th e Nort h int o productiv e investmen t i n th e South. Option s t o b e considere d includ e paymen t o f interes t i n loca l cur rencies, legislate d decrease s i n th e interes t rat e pai d b y debtors , an d establishment of debt-investment rather than debt-equity swap options, as well as ne w multilatera l financia l intermediarie s betwee n debto r an d credito r countries. I t is hope d tha t thi s volum e wil l stimulat e suc h consideratio n t o begin i n earnest. Continue d financial an d economic healt h in the North, and resumption of true economic development in the South are securely tethered to resolving the global debt crisis. Growing ou t o f th e Geonomic s Institut e fo r Internationa l Economi c Advancement's 198 8 North-Sout h conference , Th e Worl d Deb t Crisis : Transnational Policy Alternative s on Trial, organized by Middlebur y Colleg e Professor of International Politics and Economics John F. Weeks, and held at Middlebury College's Brea d Loaf Mountain Campus, this volume focuses o n the origin s o f th e globa l deb t crisis , ensuin g developments , an d th e current situation. I t offer s a fres h perspectiv e o n th e crisis , propose s ne w an d unorthodox strategies , an d provide s a n intriguin g mi x o f normativ e an d positive analysis. That th e papers i n thi s volum e d o no t all spea k i n on e voic e allow s th e compilation t o contribut e t o ou r understandin g o f th e rang e o f possibl e outcomes. A s such, the volume will assist policymakers formulating possible legislation, busines s leader s assessin g th e potentia l fo r investin g i n Lati n America an d Africa , an d student s o f North-Sout h relation s tryin g t o gai n a fuller understanding of the debt crisis and what it portends. The Geonomic s Institut e seek s t o promot e a clearer an d mor e complet e understanding of international economic issues within and among the business, academic, and government communities. Th e Geonomics Institute is dedicated to sponsorin g an d publishin g policy-oriente d researc h an d seminars , an d providing advic e an d consultatio n t o policymaker s o n domesti c an d inter national economic policy. Annua l conference series fdr North-South and East-

FOREWORD

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West projects provid e sustaine d forum s fo r divers e group s o f academi c an d business researchers and government representatives t o examine, debate, and illuminate specific set s of issues. Geonomic s is privately funded, nonpartisan, and not for profit. We welcome ideas and opinions for better achieving our goals. Michael P . Claudo n

INTRODUCTION

From the end of World War II until the late 1970s , the field o f developmen t economics focuse d o n th e structura l problem s o f underdevelopmen t i n th e context o f growth : th e population explosion , th e desirable balanc e betwee n agriculture an d industry , and , particularl y i n th e 1970s , th e equitabl e distribution o f th e gain s fro m growth . A fundamenta l characteristi c o f th e development literatur e wa s th e presumptio n tha t th e growt h o f pe r capit a income i n th e Thir d World wa s th e rule, almos t a given, an d the issu e wa s growth—growth at what rate, its composition, and for whom. Th e debt crisis changed all that. I t is no longer the case that growth of per capita income be presumed the natural course. Th e 1980 s have brought stagnation and decline throughout th e Third World, catastrophicall y s o i n Sub-Sahara n Africa , les s virulently but across-the-board in Latin America, and with enough frequency in Asia t o generat e substantiall y increase d poverty. 1 Indeed , th e growt h performances of most Third World countries have been so depressing that it has become common to refer to the 1980s as the "Lost Development Decade," and has provoke d som e writer s t o abando n th e ter m developing countrie s a s a misnomer. At th e en d o f Apri l 1988 , th e Geonomic s Institut e fo r Internationa l Economic Advancemen t brought together a group of distinguishe d experts in the developmen t field a t th e Brea d Loa f Mountai n Campu s o f Middlebur y College to discuss, debate, and propose solutions for the current malaise in the 1. Th e relativel y goo d performanc e o f Asia n countrie s take n a s a whole i s th e resul t o f th e growth performances of India and China, which together total over half the population of the Third World. I t is true, however, that the debt burden is least in the Asian countries. XIX

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Third World . Whil e participant s cam e fro m varie d background s an d institutions—the privat e financial sector , multilatera l organizations , an d academia—and entered into what proved a heated debate, all were motivated by a concern tha t th e Lost Developmen t Decad e migh t stretc h t o th e en d o f th e century (indeed , millenium ) an d beyond . I n 1985 , Middlebur y Colleg e sponsored a conferenc e o n Thir d Worl d deb t (wit h som e o f th e sam e participants), and the 1988 gathering was inaugurated with the sober realization that three years later the debt crisis was not only aliv e and well, but by mos t indicators worse than before.2 That the dismal economic performances of indebted countries is the result of the debt burden itself i s hardly controversial , though the emphasis of author s varies. On e can go furthe r an d say tha t there is a growing consensu s o f th e existence o f a clear and present trade-of f betwee n growt h an d debt service . Shafiqul Isla m of the Council on Foreign Relations has put it starkly: . . . [T]h e primar y reaso n hal f a decad e o f har d wor k t o resolv e th e deb t problem has resulted in failure an d fatigue, an d not in success an d relief, i s tha t the internationa l deb t managers hav e spen t more tim e an d energy o n ensurin g interest i s collecte d i n ful l an d o n tim e [fo r th e privat e banks] , an d les s working ou t a viable long-ter m solution. 3

This emerging consensus that matters could no longer "muddle through" did not com e easily . I n Augus t 1982 , th e governmen t o f Mexic o formall y initiated th e crisis by announcin g it s inabilit y t o meet payments o n its hug e foreign debt . Fro m tha t tim e unti l Augus t 1985 , th e internationa l financia l community—creditor governments , the two Bretton Woods multilaterals (the International Monetar y Fun d and th e World Bank) , and private commercia l banks—pursued a strategy with regard to the debtor countries that came to be called "muddling through," a policy basically involving stop-gap rescheduling of debts (stretching out payments over time) and policy packages foisted upon debtor governments, usually designed by the IMF. B y 1985 , it was clear to all that while a general default on debt (or default by one or several of th e major debtors) ha d been avoided , i t had been achieve d b y th e stifling o f economi c growth. Indeed , a larg e numbe r o f countrie s i n Lati n Americ a an d Afric a suffered economic decline. The formal recognitio n tha t "muddlin g through" could not continue i n its orginal for m came in a proposal by James A. Baker III, U.S. Secretar y of the

2. Thi s point is documented in Chapter 14 by Dornbusch. 3. Isla m (1988: 7-8).

INTRODUCTION x x

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Treasury, in a speech before the annual meeting of the Bretton Woods "twins."4 There was little new in the proposal, but it had two major consequences. First , in th e vie w o f many , i t successfull y prevente d th e emergenc e o f a Lati n American debtors 1 cartel , whic h woul d hav e altere d th e balanc e o f powe r between th e financial communit y an d the governments o f th e Third World. 5 Second, it rendered formal the mediating roles of the IMF and the World Bank in the debt crisis. Th e vehicle for such mediation would be multilateral lending to Third World countries coupled with strong policy conditionally, wit h these policy-contingent package s referre d t o genericall y a s "structura l adjustmen t programs." Th e essenc e o f thes e program s wa s an d i s th e conservativ e economic philosoph y tha t call s fo r deregulatio n o f markets , "suppl y side " actions suc h a s ta x change s an d eliminatio n o f labo r regulations , "liberalization" of external trade and finance, and moves to encourage greater foreign investment It is this policy package the April 1988 conference addressed. I n particular, debate and discussion centered on whether these policies could be the vehicle by which the end would be brought to the Lost Development Decade. Th e issue of the appropriateness of these policies presents itself on several levels. A t the most fundamental , ther e i s th e questio n o f whethe r i t i s appropriat e fo r multilateral agencies , whos e official s ar e beholden t o no constituency i n the Third World, to play such a dominant role in the affairs o f nations, involving themselves i n matter s tha t ar e a s politica l a s the y ar e economic . Th e re solution of this first question probably makes little difference i n practice, but it leads naturally to a second: I f the debtor countries accept the legitimacy of the multilateral's policy conditionality, can they expect to reap the alleged benefits? The most important of these benefits in the short term is increased private bank financing, promise d bu t no t forthcomin g unde r th e Bake r Plan. Structura l adjustment program s frequentl y hav e a hig h domesti c politica l cos t i n th e adjusting country, and their main attraction fo r the debtor government i s th e new finance the y would bring. I n other words, without new finance, there is no reason a government should not design its own program without pressure from the multilaterals. Th e World Bank has always been quite clear that it sees new commercia l ban k financ e a s centra l t o th e succes s o f th e structura l adjustment strategy. 4. Christin e Bogdanowicz-Bindert, Senior Vice President of Shearson Lehman Hutton, wrote in 1986, "The Baker declaration was significant as it had taken three years of muddling through crises for the Reagan Administration to recognize the debt crisis for what it is: a long-term economic and political barrier to development that is slowly stranglin g world economic growth" (BogdanowiczBindert 1986). 5. "M y own assessment of the Baker Plan is that its major impact was to defuse any discussion of a debtor cartel in Latin America" (Bogdanowicz-Bindert 1986).

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T DISASTER? . . . [B]anks must show . . . that they intend to play a full part in supporting essential adjustmen t and investment programs. Withou t adequate financing, these program s wil l continu e t o giv e result s discouragin g t o debtor s an d creditors alike.6

The issue of whethe r acceptin g conditionality bring s "fres h money " to a debtor governmen t i s perhap s th e singl e mos t importan t politica l issue , because it raises the spectre of unilateral debt default. I f the benefits are not positive, then perhaps default is not such a costly strategy on the part of debtor governments. Bu t even more fundamental, i t may be that new finance is not part of the solution, but part of the problem. The fundamental proble m with [th e structural adjustment strategy] is tha t it requires the debtors to raise their already intolerably heavy debt burden to even higher levels and transfer massive amounts of scarce resources year after year to service loans that are not generating new income.7

The other propose d sourc e o f benefits from structural adjustmen t i s the alleged efficienc y gain s from a more optimal allocatio n o f resources. Th e authors i n thi s volum e ar e quit e divide d o n thi s issue . Bu t ou t o f th e disagreement emerges a sense of humility about the ability of economists to prescribe optima l remedies , which represent s a significan t ste p forwar d i n moving from debat e to consensus. Closel y related to the putative efficienc y gains i s th e issu e o f wh o carrie s th e burde n o f adjustmen t i n th e debto r countries, whic h i s a n issu e wit h wide-rangin g implications , includin g th e support for th e multilaterals by taxpayer s in th e developed countries . Fe w people in the creditor countries would support policies that systematically had the effec t o f transferrin g incom e fro m th e poor i n th e Thir d Worl d t o th e commercial banks in the First World.8 The foregoing issue s are treated in the essays that follow. Th e reader will find as he or she proceeds a sense of urgency and even passion underlying the contributions. Th e conference participants agreed on one issue: Th e deterioration of living standards in the Third World has gone on too long, and action to foster development out of the ashes of debt and decline is tragically overdue. John F . Week s

6. Worl d Bank (1987-1988: xvi). 7. Isla m (1988: 11) . 8. Thi s issue is treated in Chapter 13 by Representative Bruce Morrison.

I

DEBT CRISI S I N TH E THIRD WORL D

In August 1982 , just as the International Monetary Fund was about to convene its annua l meetin g i n Toronto , th e governmen t o f Mexic o stunne d th e international financia l communit y b y announcin g it s inabilit y t o servic e it s debt. Mos t date the "debt crisis" from that time, and it is still very much with us. Th e subsequen t approac h of th e international financia l community , both private and official, t o the debt crisis has been to foster (impose , some would say) a package of policy measures in developing countries ostensibly designed to facilitate repaymen t o f debt . Th e thre e essay s i n thi s firs t sectio n o f th e volume deal with the context in which those policies have been applied. In Chapte r 1 , Barr y Herma n consider s a ke y unknow n i n th e structura l adjustment/debt equation—th e globa l prospect s fo r growt h fo r developin g countries a s a whole. Thi s i s clearly a crucial issue , fo r if th e prospects fo r growth in the aggregate are not propitious, then the likelihood of success with "muddling through " the debt crisis i s no t great . Closel y complementar y t o Herman's analysis is the survey of the impact of changes in the world economy on developin g countrie s by Rolph va n de r Hoeven i n Chapte r 2. Hi s essa y indicates that "external shocks" to the economies of developing countries have been severe indeed; further , the author demonstrates that it has been the poorest countries, and perhaps th e poorest withi n thos e countries, tha t have suffere d most. In Chapte r 3 , Joh n F . Week s launche s a fronta l attac k agains t th e conventional wisdo m of th e financial community, arguing that the debt crisis

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can be likened t o a war that the developin g countrie s lost , and that the debt service i s equivalen t t o reparation s pai d b y th e defeate d nations . I n thi s interpretation, structural adjustment programs do not represent policy reform or growth strategies, but the international equivalent of blood-letting. Each o f thes e essay s raise s issue s tha t ar e pursue d i n mor e detai l i n subsequent chapters, and each provides the reader with a context (if a sometimes controversial one) in which to evaluate the analyses and proposals that follow.

1 TH I FO

E OUTLOOK R DEVELOPMEN T

Barry Herman

We wish to say something about the outlook for development in the rest of the century. I n essence, that is the same as wanting to say something about the experience of development in the 1980s. Whethe r done through estimated models or informal projections , futurology i s based on the relationships w e see today. Th e objective o f thi s paper is to try t o look t o the future b y saying some things about the present and by observing some things about economic attributes share d by most developing countries, though interestingl y enoug h not by all. WHICH COUNTRIES ? In a field lik e economic development, some definitional issue s must first b e settled to establish a common groundwork. On e is to identify th e countries that are included i n the analysis and at least ask about th e defining charac teristics of th e group. Lo w average income is not the key criterion, unles s Kuwait and the United Arab Emirates are to be excluded, as they are two of the four countries with the highest per capita incomes in the world (the other two being Switzerlan d an d the United States) . Similarly , Irelan d an d Spai n are The views expressed in this paper are those of the author and do not necessarily represent those oi the United Nations.

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usually no t though t o f a s developin g countries , althoug h Hon g Kong , Singapore, and Trinidad and Tobago, which are, have higher income per head.1 The structure of trade also does not define development status: Australia and New Zealan d ar e thought of a s developed countries , yet the share of manu factures in their exports are 15 and 21 percent respectively, whereas the share for Bangladesh i s 66 percent. 2 No r is a relatively recent colonial past the key indicator: th e Argentin e Republic wa s declared i n 1810 , Colombia ha s been independent since 1819 , and Turkey was the seat of the Ottoman Empire and a cradle of wester n civilization. Th e structure of production, skills of the labor force, healt h indicators , energ y consumption , numbe r o f telephones , an d statistically complicated combinations of these and many other indicators have offered possibilitie s fo r defining developmen t status. 3 But , in fact, there is no analytically clea n solutio n t o thi s definitional dilemm a and, not surprisingly , different authors draw different boundaries around the countries to be included. Making definitio n i s a particula r difficult y fo r th e officia l internationa l institutions where government representatives express definite preferences fo r how they wis h t o be classified . Th e institutions mee t the problem in various ways. Th e International Monetary Fund makes perhaps the largest grouping of developing countries, classifying al l but twenty-one industrialized countries as developing (th e Sovie t Union , shoul d i t joi n th e IMF , woul d presumabl y become the twenty-second developed country). Thus , the socialist countries of Eastern Europe , a s wel l a s Greece , Israel , Portugal , an d Sout h Africa , ar e included among the developing as far as IMF data—and statistical aggregates— are concerned. A smaller group is used by the United Nations Secretariat, as in its World Economic Survey an d severa l othe r reports o f th e Departmen t o f International Economi c an d Social Affairs . I t excludes al l th e countries just listed excep t Israe l an d Yugoslavia. Self-definitio n i s a major aspect o f th e grouping—for example , throug h membership in th e Group of 77 , or being a major recipient of official developmen t assistance. In on e sense , an y definitio n wil l do a s lon g a s i t i s explicit . Bu t i n assessing the economic performance and financial situatio n of "th e developing countries," i t matter s a grea t dea l t o th e fina l statistic s whic h countrie s ar e included o r not , o r a t leas t whic h big countrie s ar e include d o r not , a s th e example of China will make clear below.

1. A s measured for cross-country comparisons as of 198 5 in World Bank (1987a). 2. Thi s is due largely to jute products and, increasingly, garments. Dat a are for 1985; see United Nations (1987a: table 4.1). 3. See , for example, McGranaham et al. (1985).

THE OUTLOOK FOR DEVELOPMENT

5

DEVELOPMENT O F WHAT ? Economic developmen t ha s alway s mean t growin g pe r capit a outpu t an d income. I t has entailed growing employment opportunities and risingproductivity o f labor . I n th e United States , at leas t sinc e th e day s o f Alexande r Hamilton, i t als o mean t a diversifie d econom y wit h a manufacturin g base . Later, Frank Knight made economists think about nurturing the ability to bear uncertainty, a s wel l a s tak e risks, whil e Joseph Schumpete r sensitize d th e profession to entrepreneurship, Veblen to culture, Hobson to empire, and Lenin to the state. Th e list may seem somewhat arbitrary, depending on where the reader went to school, but, in any event, things changed. By the early 1960s , the physics metaphor was ascendant in economics and development became economic engineering. Nationa l planning was the rage for low-income countries. Largel y private, technologically backward, and incompletely integrate d economie s wer e suppose d t o b e guide d int o efficien t production structures by price incentives (taxes and subsidies) derived from a central analysis of relative scarcities, and by direct state investment in selected areas of production, indicated by programming model s for project selection . Algebra was everything. Eve n Schumpeter's "wind s of creative destruction" became McClelland's "n-achievement" or Leibenstein's "x-efficiency." I n 1965, the United Nations set up a Committee for Development Planning, composed of internationall y prominen t economist s an d heade d b y Jan Tinbergen , and charged i t wit h elaboratin g plannin g technique s t o shar e wit h developin g countries. Twenty-three years later, the United Nations committee still exists and still comprises prominent economists from around the world, but it never discusses planning a s such . Perhap s comin g ful l circle , a workin g grou p o f th e committee has recently produced a report that takes as its starting point the following quote from Amartya Sen: "The process of economic development can be seen as a process of expanding the capabilities of people." 4 B y the same token, the received engineering-style wisdom that donor governments, the IMF, and the World Bank insist upon in programs of balance of payments adjustment has no w bee n critique d b y anothe r formulation—albei t no t ye t full y articulated—called "adjustment with a human face" (Comia et al. 1987). The picture just sketched is admittedly something of an exaggeration, made to emphasize a point. Twent y to thirty years ago one could push aside protests largely from sociologists and historians and talk about the growth of economic output, and do so using the more inclusive term "development" O f course, it 4. Take n from Sen (1983: 755), quoted in United Nations (1988a: 1).

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was understood that there was more to development than the growth of output. But, surely , i t wa s believed , th e correlation s wer e stron g amon g economi c growth, rising standards of living of the poor, emergence of an entrepreneurial class, an d politica l developmen t (th e latte r generall y defined , a t leas t i n academic circle s i n the United States , as evolution o f politica l institution s t o increasingly resemble those of the industrial democracies). Unfortunately , it did not quit e wor k ou t tha t way , an d "growt h withou t development " becam e a watchword in the development profession in the 1970s. Somebody discovere d that , "Despit e unprecedente d rate s o f aggregat e economic growt h i n muc h o f th e 1950 s an d 1960 s an d impressive gain s i n health and literacy, mor e people i n developing countrie s wer e living i n deep poverty at the end of th e 1960 s than a decade earlier" (Martin 1985 : 49). Th e result was to introduce broader considerations into policy planning exercises for developing countries, most notably through the country missions of the World Employment Programme of th e International Labour Office, followe d b y the call of the president of the World Bank, Robert McNamara, to address poverty alleviation in the design of World Bank lending programs. A t least there were efforts t o measur e an d analyz e incom e distributio n an d povert y i n poo r countries. The critique of development practice was important to donor country governments. Whateve r the realpolitik i n disbursing official developmen t assistanc e (ODA), it is sol d to public opinio n in donor countries as aid to the poor. A s the wide public respons e to the last African famine demonstrated, people are deeply move d by acut e suffering , especiall y if it occurs far away. I f people believed that a larger aid appropriation did not reduce poverty, legislators would be hard-pressed t o support it, and the leverage o f government s i n disbursing ODA would suffer. I n the Third World, the anti-poverty critique of economic growth had a mixed reception. Representative s of developing country governments i n internationa l forum s wer e distrustful , a s i s no w agai n th e cas e i n response to the donor community's new enthusiasm for environmentally soun d development. Thes e ideas promised interference by outside meddlers, however well-intentioned, in domestic policy, politics, and the making of wealth. This is not to defend developing country elites, who are as surely part of the problem a s the y ar e likel y t o b e par t of th e solution. 5 Bu t th e developin g country delegations wer e on to something, namely, that social policy wa s not development policy. Lor d Peter Bauer was not King Lear, but there seems to 5. A n interesting analysis to this effect i s by one of the fathers of development economics and North-South negotiations , Raul Prebisch , i n a series o f lon g article s i n Englis h an d Spanish in CEPAL Review (Unite d Nation s Economi c Commissio n fo r Lati n Americ a an d the Caribbean, Santiago), from 197 6 to 1981, collected into Prebisch (1981).

THE OUTLOOK FOR DEVELOPMENT

7

be a kerne l o f trut h i n hi s writin g abou t "relie f o f povert y o r som e othe r purpose unrelated to development" (Bauer 1981 : 101). 6 O f course, this is put too strongly, but it seems that the social process that can be called economic development is consistent with a variety of policies toward poverty. Th e point can be asserted positively: "It is possible . .. fo r governments successfully t o pursue distributiv e equit y objective s a s wel l as growt h objectives " (Unite d Nations 1988a: 5). Equivalently , distributive equity does not seem a part of the definition o r measure of development. I t may be an important determinant— many things are—but it is not part of the thing itself; neither is the emergence of friendl y lookin g politica l institutions , no r consistentl y "good " macro economic management or efficient resource allocation. What does seem central to economic development is that there is a long run of rising per capita output and income, that a large share of income is continuously plowed back into the expansion, upgrading, and renewal of production capacity, tha t a n increasin g variet y o f commoditie s i s produce d an d a n increasing proportion designed locally, that people invest in themselves, and that a significant portion of the high- and low-income strata of the population is optimistic about the future. FORTY YEAR S O F DEVELOPMEN T POLICY : HOW MUC H GROWTH ? A further perspectiv e on the development prospect is gained from a review of some broad orders of magnitude at the global level. Worl d economic analysis by the United Nations Secretariat, for example, divides the nations of the globe into three broad classifications: developed market economies (DMEs), centrally planned economies (CPEs), and the developing countries. Abou t 75 percent of the people of the world live in the developing countries (define d t o include China), 8 percen t i n th e CPEs , an d 1 7 percen t i n th e DMEs . Averag e productivity difference s amon g th e groups—eve n afte r man y decade s o f development efforts—ar e simpl y enormous , as is illustrate d i n Figure l-l. 7 This is not to deny that there has been progress. Befor e 1990 , output per capita in the developing countries as a whole is expected to reach twice that of 1960. 6. Take n from Baue r (1981), quoted by Michae l Lipto n (1984a : 44-50) i n his Commen t o n Bauer that is highly recommended. 7. Th e leve l o f outpu t o f th e CPE s (th e Sovie t Unio n an d Easter n Europe , excludin g Yugoslavia) is somewhat understated compared to that of the other groups of countries because the data that the CPE governments repor t to the United Nations ar e net material product rather than gross domestic product, which includes more service activities.

8 DEB

T CRISIS IN THE THIRD WORLD

Figure 1-1 . Outpu t Pe r Capit a (Thousand 1980 Dollars)

Source: United Nations (1986c).

THE OUTLOOK FOR DEVELOPMENT

9

However, excluding China , it will tak e almost unti l th e yea r 2000 t o doubl e the 1960 per capita output level. The growth rate of per capita output over the forty years from 196 0 to 2000 is estimate d on th e basis o f curren t projections t o be almost th e same in th e developing a s in the developed world , averaging 2. 4 percen t annually i n the DMEs and 2.5 percent in the developing countries. However , excluding China, the developing countries' average rate of growth per capita drops significantl y lower, to 2 percent per year. Certainly , the long-run rate of growth of outpu t itself ha s bee n highe r i n th e developin g countrie s (4.7 percen t annuall y o n average) than in the DMEs (3.2 percent), but the difference is eaten away by the higher rate of growt h of populatio n i n th e former. 8 Suc h numbers are ofte n used t o buttres s th e argumen t fo r activ e populatio n policie s i n developin g countries, as indeed are warranted. But for purposes of the present discussion, attention shoul d focu s o n th e per capita growth trend s per se, as over such a long perio d thes e ma y b e take n a s roug h indicator s o f relativ e trend s i n productivity growth. At suc h a gros s leve l o f aggregatio n an d suc h a n approximat e leve l o f analysis, the development enterprise does not seem t o have been a success at all. Th e story i s somewha t different a t the regional level , wher e growth has been greatest over the long run in the developing countries of Asia. 9 Pe r capita output almos t double d fro m 196 0 t o 198 0 an d i s forecas t t o almos t doubl e again by the year 2000 (se e the second panel of Figure 1-1) . Considerin g the low leve l o f Asia n pe r capit a incom e i n 1960—$25 4 a t 198 0 price s an d exchange rates—this development was desperately needed. At the other extreme, per capita output in Africa is lower now than it was in 1980, and it is not expected to regain even that level by the end of the century. Despite the vast oil wealth of th e continent and considerable other resources, developing Afric a (define d t o exclud e Sout h Africa ) wil l hav e becom e th e poorest region in the world by 1990 . Th e Latin America and Caribbean region has exhibited another form of tragedy. Th e economic structure of the region is generally mor e comple x her e tha n elsewhere , indicate d b y th e fac t tha t per capita outpu t i n 198 0 wa s abou t thre e time s tha t of th e Asia n an d Africa n average. I t was said at the beginning o f th e international deb t crisis in 198 2 that Latin America might lose a decade of development. Measure d by per capita output, that forecast seem s t o be coming true , and the 1990 s do not yet hold out the promise of a greatly improved situation. 8. Populatio n growth wa s 2. 1 percen t in al l developing countries , but 2.3 percen t excludin g China, versus 0.8 in the DMEs. 9. Asi a i s define d her e t o rang e fro m Turke y i n th e west , throug h th e Middl e Easter n oi l exporters, to the Pacific island countries in the east.

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T CRISIS IN THE THIRD WORLD

Figure 1- 1 ca n b e use d t o sho w tha t th e ga p betwee n th e developin g countries a s a whole (an d each of th e main regions) an d the other groups o f countries ha s bee n growin g an d i s projecte d b y th e Secretaria t t o continu e growing. However , the widening of the gap between developed and developing countries a t th e aggregat e leve l wa s almos t inevitable . Give n th e 196 0 difference in income per capita levels, the developing countries would have had to grow by unrealistically rapid rates just to keep the absolute size of th e gap from widening. 10 Indeed , even wit h the more rapid growth i n the CPEs, the gap between the m an d th e DME s als o grew , whic h ca n b e see n a s wel l i n Figure 1-1 . The arithmeti c i s suc h tha t th e onl y wa y th e developing countrie s coul d narrow th e gap wit h th e industrialized countrie s i s i f th e latter slowe d thei r growth appreciably, which has already happened to a degree. A slowdown did take place in the 1980s , and only a partial recovery i s forecast fo r the 1990s , but a slowdown also took place in the growth of the developing countries, and, again, only a partial recover y i s projecte d fo r th e 1990 s (Tabl e 1-1) . Th e slowdown occurred in each of the three main regions, but in Africa and Latin America i t too k th e form o f a n actual declin e i n outpu t per capita. I n Latin America, a certain developmental momentum was broken. Fo r the 1970 s as a whole, eigh t countrie s o f th e regio n (Brazil , Colombia , Cost a Rica , th e Dominican Republic, Ecuador, Guatemala, Mexico , and Paraguay) sa w their GDP gro w b y mor e tha n 5 percen t pe r yea r o n average . I n th e 1980s , no country has seen that kind of growth year in and year out. I n Africa, aside from certain majo r exporter s o f oil , Cot e d'lvoire , Kenya , Morocco , an d Tunisi a averaged over 5 percent GDP growth per year in the 1970s. Nevertheless , with population growin g a t abou t 3 percen t pe r yea r an d th e outpu t o f othe r countries growing more slowly, growth of per capita output for the region was virtually nonexistent. Fo r the 1980s as a whole, a drop of 1. 4 percent per year on average is estimated. Now, the usual analysis is that the developing countries need a rapid rate of growth i n the DMEs s o that the latter expand their imports of th e exports o f the developing countries and raise international commodity prices. Whethe r or not th e industrialize d worl d ha s bee n a generalize d engin e o f growt h fo r 10. A constan t ga p requires tha t the absolut e chang e in per capita outpu t in the developin g countries b e th e sam e a s tha t i n th e develope d countries . I f x i s th e outpu t pe r capit a o f th e developing countries and y is the same for the DMEs, then the criterion of a constant gap requires that xx' = yy', where x' and y' are rates of growth . Thus , a constant gap requires x' = (y/x)y \ I n 1960, x = $411, y = $5445 (both in 198 0 dollars), and for the forty-year period, y' = 2.4 percent a year on average. T o have maintained a fixed gap, the average annual rate of growth per capita would thus have had to be 32 percent per year over forty years.

11

THE OUTLOOK FOR DEVELOPMENT Table 1-1 . Th e Growth of Pe r Capita Outpu t (Average Annual Percentage Change) 1960s 1970 Developed Market Economies Centrally Planned Economies Developing Countries Asia China Other Asia Africa Latin America

3.8 5.6 3.2 2.8 0.0 3.6 3.4 3.3

s 1980 2.3 4.2 2.9 4.0 5.3 3.5 0.2 2.3

s 1990 1.6 2.4 1.3 3.2 6.9 1.8 -1.4 -0.4

s 2.0 3.2 2.6 3.8 5.5 3.1 0.5 1.1

Source: United Nations Department of International Economic and Social Affairs (dat a 19601985, estimates 1986-1987 , forecasts base d on Project LINK to 1990 , long-ran projections t o 2000).

development, there are reasons to wonder if the post-war period of rapid growth has not already ended.11 Th e fact that Europe has been so politically tolerant of slow growt h an d hig h rate s o f unemployment , especiall y unemploymen t o f youth, gives one pause. Nevertheless , authors have seen the "stationary state" on the horizon at least since the English classica l economist s an d so far have been wrong. One ca n envisio n a mor e attractiv e scenari o fo r globa l growt h tha n a stagnating cente r and a dependent periphery. Th e developing countries—i n particular, th e middl e incom e countries—shoul d becom e th e world' s ne w growth pole, pulling up global demand, generating new products and production processes, and so on. T o a very limited degree, it has begun, for example, with Hong Kong designers showing at the pret a porter exhibitio n i n Paris, Indian engineering firms doin g contract work abroad, Brazil exporting smal l aircraf t (not t o mention weapons) , an d Korea n multinationa l firm s establishin g pro duction facilities in North America. Thi s kind of development, however, grows out o f a lon g perio d o f domesti c economi c dynamism , an d on e strikin g difference between the current decade and the 1970s is the far smaller number of countries that are experiencing sustained, rapid economic growth. Fo r example, out o f a sampl e o f eighty-thre e developin g economies , thirty-thre e ha d a n average rate of growt h of GD P of a t least 5 percent per annum i n the 1970s , 11. See , for example, Glyn et al. (1988).

12 DEB

T CRISIS IN THE THIRD WORLD

while only ten have had this much growth on average thus far in the 1980s.12 The countries that have undergone a significant growt h slowdow n are either major exporters of petroleum or countries whose foreign debt burden became impossible to bear. I t is very hard to say anything with much confidence about petroleum price s o r thei r outlook , bu t th e rol e o f th e deb t proble m a s a constraint on development is something else. DEBT AN D TH E NE T TRANSFE R OF FINANCIA L RESOURCE S Not all the developing countries have a debt problem, but the difficulties o f the highly indebted countries weigh so heavily that they have swung certain statistical aggregates of overall financial relationships . One , the net transfer o f financial resources, which is the flow o f financing ne t of the flow o f financial service payments, has been th e focus o f internationa l attention . Fo r direct investments, this means the net increment t o the stock o f direc t investmen t minus the net payment of dividends. Fo r credit flows, it means the change in the net stock of foreign deb t outstanding (aside from th e valuation effects o f exchange rate or price changes) minus the net payment of interest income. A s the net stock of debt is the gross debt minus the foreign asset s of developing country residents, the net credit flow include s outflows fro m th e developing countries a s wel l a s foreig n lendin g t o thos e countries. 13 Finally , officia l transfers—mainly OD A an d militar y assistanc e i n gran t form—ar e als o included. What is noteworthy about the aggregate net transfer i s that it was significantly positiv e i n th e 1970s , but sinc e th e onse t o f th e deb t crisi s i t ha s become significantly negative . Th e results for th e past ten year s for a large sample of countries that have been net users of foreign capital over the past few decades are shown in Table 1-2 . I n the first four year s of the period shown, from $3 7 billion to $42 billion wa s added t o developing-country purchasin g ability beyond what had been generated domestically. Sinc e 1985, in contrast, 12. Th e 1980 s lis t comprises Burma , Cameroon, Hong Kong , the Republic o f Korea , Oman, Pakistan, Singapore, Thailand, Turkey, and Uganda. (Uganda qualifies only in the purely statistical sense, as it is recovering from a disastrous decade in which GDP fell o n average by 1.7 percent per year.) 13. Th e convention followed b y the United Nations Secretariat, the United Nations Economi c Commission fo r Latin America an d the Caribbean, and others, is to exclude addition s t o officia l reserve asset s fro m th e credi t outflo w o f residents . Th e Secretaria t explicitl y treat s reserv e accumulation a s a particular form o f domesti c inventor y investment , namel y accumulatio n o f foreign currency assets. Fo r further details, see United Nations (1986a: 163-164).

0 198

1 198

5 7 -8. 0 -2.

2 198

8 -8. 6 -0.

3 198

1 -7. 6 -1.

4 198

0 -8. 3 -1.

5 198

5 13. 7 11. 3 11. 0 28. 4 29. 5 27. 2 -7. 1 -8. 8 -10. 2 35. 0 32. 0 29. 3 41. 7 11. 8 -0.

6 12. 5 14. 8 25. 0 14. 3 -11. 8 -13. 2 25. 7 15. 6 -9. 5 -22.

4 14. 4 15. 2 15. 0 13. 5 -16. 2 -17. 2 13. 1 11. 7 -20. 1 -22.

8 7 1 2

5 0

0

6 1987

0 35. 8 24. 2 12. 2 8. 8 2. 0 1. 6 -1. 0 5 -29. 0 -42. 4 -38. 9 -41. 4 -39. 3 -33. 6 -31. 3 6 6. 9 -18. 2 -26. 7 -32. 5 -37. 2 -32. 0 -32. 3

2 7. 9 6. 6 6. 2 7. 5 5. 7 7. 9 -10. 3 -10. 0 -9. 5 -0. 1 -2. 1 -3.

9 198

a

Source: United Nations Department of International Economic and Social Affairs, based on IMF data, national official, and other sources an d estimates.

a. Preliminary .

Direct Investment Transfe r Net Investment Flow 4. 6 7. 2 6. 4 10. Net Investment Income -7.0 -8. 6 -10. NetTransfer -2. 4 -1. 4 -4. Private Credit Transfer Net Credit Flow 33. 8 33. 6 34. 7 -18. Net Interest Paid -11. 8 -17. NetTransfer 22. 0 15. 9 15. Official Flows Transfe r Grants 7. 3 12. 3 13. Net Credit Flow 14. 1 15. 4 22. Net Interest Paid -4. 4 -5. 1 -6. NetTransfer 16. 9 22. 6 29. Total Net Transfer 36. 5 37. 1 40.

1978 197

Table 1-2. Ne t Transfer of Resources of Capital-Importing Developing Countrie s (Billions of Dollars, 98 Countries)

THE OUTLOOK FOR DEVELOPMEN T 1 3

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T CRISIS IN THE THIRD WORLD

at leas t $2 0 billio n o f domesticall y generate d purchasin g powe r ha d t o b e transferred abroad instead of being used at home. Tha t swing of roughly $6 0 billion is the heart of the debt problem and why it is so intractable. The culpri t i s clearl y visibl e i n th e table . I t is no t direc t investment , al though it has exhibited a negative financial transfer in every year. Th e amount of tha t transfe r ha s bee n smal l overal l an d relatively smalle r stil l i n recen t years. Officia l financia l flows have come down quite sharply from their high in 1981, but they have remained positive (although the net transfer on account of official credi t flows per se have been negative since 1986) . Privat e credit, on the othe r hand , ha s bee n absorbin g i n exces s o f $3 0 billio n a yea r i n ne t transfers, whereas in the pre-crash years it had provided transfers of $15 billion or more a year.14 A fe w year s ago , several author s emphasized tha t the swing i n net credit transfers was not solely th e fault of the private banks that had lost enthusiasm for extending new credits to debtor countries when the old loans could no longer be serviced. Th e problem, they said, was also and very much one of "capita l flight." A numbe r of observation s ar e in order on tha t phenomenon. First , some of th e banks that complained loudly about capital fligh t ha d themselves competed to attract such resources into accounts in their own banks, so if there is sin here, the banks are not innocent of it Second , while the concept itself is elusive, estimate s indicat e tha t the outflo w peake d i n 1979-1982. 15 Durin g those years , th e overal l ne t transfe r o f financia l resource s wa s a t it s mos t positive. I n short, the negative net transfer problem is very much the result of the negative cash flow vis-a-vis the foreign private creditors. The effect o f th e shif t i n ne t overall resourc e transfer s ca n be see n mos t clearly i f th e grouping o f countrie s i s narrowe d somewhat . Figur e 1-2 , fo r example, show s th e ne t transfer an d investment a s a share o f GD P fo r tw o groups of heavily indebted countries, one largely middle income and the other relatively poor. I t may be seen that in the first group of countries—which are the fifteen countrie s usually associate d with the proposal of th e United States Secretary of the Treasury16—the net transfer of financialresources dropped from 2 percent of GDP at the beginning to -4 percent in the mid-decade years. The 14. Th e role of private credit flows i n the fluctuation in overal l net transfers ca n be put a bit more systematically. Th e variability of the overall net transfer measured as the standard deviation relative to the absolute value of the mean from 197 8 to 198 7 was 2.8. Fo r direct investment it was 0.6, for official flow s it was 0.3, but for private credit it was 1.9 . 15. Fo r an analysis and review of estimates, see Deppler and Williamson (1987: 39-58) . 16. Se e the statement by Treasury Secretary James A. Bake r m i n IMF (1985a: 50-58). Th e countries, which wer e not an explicit par t of th e proposal, ar e Argentina, Bolivia , Brazil , Chile, Colombia, Cot e dTvoire , Ecuador , Mexico , Morocco , Nigeria , Peru , Philippines , Uruguay , Venezuela, and Yugoslavia.

THE OUTLOOK FOR DEVELOPMENT

Figure 1-2 . Net Resource Transfers an d Investment i n Middle Income and African Countr y Groups (Percent of GDP)

a. Preliminary . b. Sub-Sahara n Africa excludes Nigeria. Source: United Nations (1988c: 54).

15

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T CRISIS IN THE THIRD WORLD

investment share of GDP moved almost in parallel. Developmen t requires that it return to previous levels. A similar pattern appears for the countries of Sub-Saharan Africa, which in the second panel of Figure 1-2 excludes Nigeria (which would otherwise swamp the data for th e smaller countries of th e region). Th e region ha s enjoyed a positive resource transfer throughou t the period, but the swing in the size of that transfe r ha s been almos t a s grea t as i n th e cas e of th e middle-incom e countries, fro m aroun d 8 percent o f GD P in th e earl y 1980s , to aroun d 3 percent at mid-decade. Relativ e to the trough in 1984, the resource transfer and investment shar e have improved somewha t more for thi s group of countries than for the former, but the level remains below what was already an inadequate investment share in the early 1980s. The swing in the net transfer of financial resources does not explain all the economic difficultie s o f th e middl e incom e countrie s o r o f th e Africa n countries. Ther e have also been other international factors, with the weakness of international commodity prices in the 1980s having been a special burden. In Sub-Saharan Africa (again excluding Nigeria), it has been estimated that the net deterioratio n i n th e externa l financia l positio n betwee n 1979-198 1 and 1985-1987 was almost equally split between terms of trade losses and losses through changes in the net transfer of resources.17 But, undoubtedly, there is still something more. Representative s of developed country governments and multilateral financial institution s have argued strongly in many forums that the developing countries have created their own difficulties throug h bad policy. No t that the developed countries have been so well managed themselves, but developing country representatives do acknowledge that they have made policy mistakes. Give n present circumstances, that is an easy admission to make. Wha t is not so simple is to provide an answer to the question of what to do next, an answer that takes into account political conditions in the developing countries and international economic prospects. WHAT D O W E LEAR N FRO M THE "SUCCESS " STORIES ? It has been noted above that while all the developing regions experienced a slowdown in growth in the 1980s, the Asian economies as a whole have been less seriously disrupte d (again , se e Table 1-1) . Indeed , th e United Nation s 17. Th e total deterioration between the two periods expressed as an annual flow was estimated at $6.5 billion, of which $2.9 billion was terms of trade losses. Se e United Nations (1988b: 14).

THE OUTLOOK FOR DEVELOPMENT

17

Secretariat undertook a study of fourteen developing economies, all but two of which (Cameroon and Congo) were Asian, that were relatively fast growing in the firs t hal f o f th e 1980s . I n comparin g thos e economie s t o th e othe r developing countries, certain patterns emerged.18 First, agricultural production grew faster in the faster-growing countries (for example, 4 percen t for faster-growin g energ y importer s versu s 2 percent fo r other energy importers), continuing a difference i n agricultural output trends of the 1970s . Th e 1980 s difference i n agricultural growt h was attributed t o the greater importance attache d t o agricultur e i n th e developmen t polic y o f th e faster growers . Thi s wa s give n effec t throug h a n emphasi s o n th e us e o f modern inputs and investment in infrastructure, especially irrigation, but it also included agricultural policies that provided effective incentives to farmers. I t is significant a s wel l i n thi s contex t tha t foo d productio n wa s emphasize d i n countries that had been satisfying some of their food needs with imports. I n an adverse internationa l economi c environment , tha t for m o f impor t substitution—especially fo r countries on the scale of China and India—had an inescapable logic. It is a well-worn poin t in international discussion s o f developmen t polic y that a higher degree of expor t orientation raises economic growth . Thi s was also foun d t o b e th e cas e i n th e U N sampl e o f countries , bu t eve n mor e important was the composition of exports. Tw o types of exports did especially well i n th e firs t hal f o f th e 1980s , namel y manufacture s an d oi l fro m smal l producers tha t wer e no t boun d b y th e ceiling s o n productio n agree d t o b y members of OPEC. Development specialists have argued for decades about what poor countries should produce and export, very often invokin g stati c efficiency (comparativ e advantage) arguments. Th e experience of th e 1980 s suggest s temperin g such considerations wit h thre e others. First , the ability t o export a wide rang e of products seem s essentia l i n a volatile worl d economy , an d som e significan t portion o f thes e shoul d probabl y b e manufacture s (a s th e cas e o f Malaysi a attests, where highly diversified exports of primary commodities did not provide protection fro m externa l strain s whe n virtuall y al l commodit y price s sank) . Second, somethin g i s wron g if developmen t financin g agencie s promot e th e same commodit y i n a strin g o f countries . Th e implici t "small-country " assumption that the international market will not be affected b y the increment to supply does not hold for many countries added together. Third , a reallocation 18. Th e Asia n economie s include d i n th e stud y wer e Burma , China, Hon g Kong , India, the Republic of Korea, Malaysia, Oman, Pakistan, Singapore, Sri Lanka, Thailand, and Turkey. Se e United Nations (1987b: 155-167).

18 DEB

T CRISIS IN THE THIRD WORLD

of resources toward tradeable goods is the wrong metaphor for what is involved. More accurate is intensive investment in the tradeable goods sectors. A final domesti c factor that distinguished the faster-growing countries was that the y ha d substantiall y lowe r rate s o f inflation . Thei r rat e o f inflatio n averaged 1 1 percent during 198 1 t o 198 5 amon g the energy importer s in the sample, compared to 35 percent in the same period for other energy importers, with a comparable difference among the energy exporters. Couple d with faster growth o f output , a relatively mor e stable economic environmen t mus t have helped to raise th e savings rates, which wer e on average higher than in other developing countries . Whil e maintaining a high investment rate, these countries had a smaller "savings gap," and thus needed to rely less heavily than other countries on external resources. The faster-growing countrie s seemed, all in all, to partake more heavily o f the factors tha t were claime d abov e t o be centra l t o economic development , including a long-run rise in per capita output and income, a high savings and investment rate, and a policy environmen t tha t encourages productio n o f an increasing variet y o f commodities . Bu t whether othe r countries can fit suc h results int o thei r ow n politica l an d economic environmen t i s no t a questio n easily answered , an d neithe r i s whethe r th e conduciv e condition s i n th e countries actually developing will persist indefinitely. So fa r only on e countr y ha s graduate d from being a trouble d high-deb t country to a more rapidly growing country with access to private international finance—Turkey. Thi s i s no t t o sa y tha t Turke y ha s solve d al l it s macro economic problems, as it still registers high inflation an d high unemployment. After havin g undergon e a serie s o f deb t rescheduling s an d macroeconomi c adjustment programs starting in the latter years of the 1970s , Turkey was able to return to the private credit markets in 1985 . Severa l things happened along the way , includin g a larg e growt h i n exports , bot h t o th e Middl e Eas t an d Europe. Significantly , th e composition of exports also changed: manufactures rose fro m 3 6 percent o f export s i n 198 0 t o 7 5 percen t i n 1985 . Outpu t has grown substantially, averaging 5 percent per year thus far in the decade, which has undoubtedl y ease d th e burde n o f exchang e rat e devaluation s an d othe r adjustment measures. Investmen t has also been strong, led in 1980—an d this is important—b y a recovery o f publi c secto r investmen t supporte d by large scale net financial transfers from abroad in the form of official assistance. 19

19. Th e net financial transfer ros e from 1. 2 percen t o f GN P in 1978-197 9 t o 4.9 percen t i n 1980, which also considerably helped ease the burden of a 23 percent real effective exchang e rate devaluation, not to mention an 18 percent terms-of-trade loss largely from the increase in oil prices (United Nations 1987c : 90-91). Th e IMF and the World Bank alone have provided Turkey with

THE OUTLOOK FOR DEVELOPMENT

19

Aid on a comparable scale for all the heavily indebted developing countries is not now on the horizon. A continuing negative net resource transfer is. An d should the world's central banks of the Group of Seven industrialized countries tire o f supportin g th e dolla r a s muc h a s the y hav e bee n doin g recently, 20 interest rates in the United States would have to rise. I f that in turn led to the onset o f th e nex t recession—an d recession s hav e no t bee n outlawed — developing countrie s coul d fin d themselve s i n anothe r financia l squeez e o f rising interest charges and falling commodity expor t prices. Th e shadow that this scenario casts on the outlook for development is a long one.

about $4.5 billion in eight World Bank adjustment loans and three IMF standby arrangements since 1980. Se e World Bank (1988). 20. Althoug h estimate s o f th e ne t amoun t o f officia l financin g o f th e $16 1 billio n curren t account deficit of the United States in 1987 are necessarily imprecise, it seems to have accounted for two-thirds of the total. Se e United Nations (1988c: 72-73).

2

EXTERNAL SHOCKS , ADJUSTMENT, AN D INCOME DISTRIBUTIO N Rolph van der Hoeven

For more than a decade developing countrie s hav e undergone a numbe r of external shocks . Dependin g o n their intensit y an d the characteristics o f th e economic structure in place, these shocks had direct consequences on developing countries' capacit y t o pursu e domesti c economi c an d socia l policies ; employment and income levels in many countries have been negatively affecte d in man y countries . Th e variou s externa l shock s di d no t tak e plac e simultaneously, but rather overlapped (Table 2-1). Afte r the commodity price boom in 1977, the terms of trade for developing countries deteriorated for five consecutive years, improving slightly in 1983 and 1984, and declining again in 1985 and 1986 . Som e years o f continuous improvemen t wil l be needed t o wipe out losses accrued during 1978 to 1982. Th e growth rate in industrialized countries began to decline seriously in 1980, resulting in decreased demand for developing country exports. Until 1980 , foreig n rea l interes t rate s (measure d i n term s o f nonfue l developing country export prices) were low or even negative. Man y developing countries mad e ample use of th e availability o f commercial ban k capita l to finance th e losse s cause d b y change s i n term s o f trad e an d th e shrinkin g markets, and thus try to preserve consumption and investment patterns of the The views expressed in this paper are those of the author and do not necessarily reflect those of UNICEF. Part s of this paper draw upon van der Hoeven (1987and 1988 ) and van der Hoeven and Vandemoortele (1987).

21

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Table 2 - 1 . Nonfuel-Exportin g Developin g Countries : External Shocks , 1978-1987 a (Percent)

78 7 Change in Terms ofTrade -3.

9 -1.

98

08

18

28

38

48

58

68

7

2 -5.

8 -4.-

0 -2.

0 0.

6 2.

6 -2.

3 -2.

9 0.

6

Real GNP Growth of Industrial Countries 4. 2 3.

3 1.

3 1.

5 -0.

3 2.

7 4.

9 3.

2 2.

7 3.

1

Foreign Real Interest Ratesb 2.

7 -6.

8 -2.

0 16.

1 19.

4 16.

0 10.

5 13.

6 6.

8 n.a

4 26.

0 59.

2 57.

3 31.

3 19.

2 14.

7 16.

4 5.

2 4.

9

8 27.

1 33.

0 51.

3 25.

8 5.

8 2.

3 -1.

5 -4.

6 -1.

8

2 4.

0 1.

9 0.

3 1.

4 -2.

0 -1.

9 -0.

9 -1.

3

2 -16.

5 -20.

1 -17.

2 -10.

9 -6.

5 -6.

1 -1.

8 1.

0

.

Capital Flow s ($000mil) c 28. Latin America* 1 25.

Sub-Saharan Africa 1. 6 0. Current Account Deficit -11.

9 -14.

a. Th e following developin g countries are fuel exporters : Algeria, Bahrain, Congo, Ecuador, Gabon, Indonesia, Islamic Republic of Iran, Iraq, Kuwait, Libyan Arab Jamahiriya, Mexico, Nigeria, Oman, Qatar, Saudi Arabia, Syrian Arab Republic, Trinidad and Tobago, Tunisia, United Arab Emirates, and Venezuela. b. Long-ter m rates of seven major OECD countries, adjusted for percentage changes in export prices of nonfuelexporting developing countries. c. Ne t external borrowing excluding borrowing fromofficial creditors and reserve-related liabilities. d. Dat a for Latin America include Ecuador, Mexico, Venezuela, and Trinidad and Tobago. e. A s percentage of exports and goods and services. Source: IMF (1988, and earler issues).

1970s. However , deflationar y policie s i n industrialized countrie s pushe d interest rates to all-time levels after 1980, making it difficult for many indebted countries, alread y strugglin g wit h low prices an d low volume of exports, to service their debts. Th e debt service problem, especially the dramatic Mexican crisis, an d the need t o finance th e increasing curren t accoun t defici t o f the United States led to a sizable reduction in capital flows to developing countries after 1982, 1 makin g it difficult fo r countries to finance their current account deficits throug h additiona l borrowing , especiall y becaus e fuel-exportin g countries have ceased to produce current account surpluses. As a consequence, most developing countries were forced in a rather short time t o reduce their current account deficits quickly and drastically either as part of a n agreed stabilizatio n an d adjustment packag e o r through emergenc y 1. Se e Chapte r 4 by Lissaker s an d Chapte r 5 b y Sack s an d Canava n o n factor s influencin g commercial bank lending to developing countries.

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 2

3

measures. Curren t account deficit s expresse d a s a percentage o f export s o f goods and services returned in 1983 to the pre-1978 level, declined even further in 1984 , 1985 , and 1986 , an d turned into a surplus in 1987 . Becaus e thes e deficits are expressed as a percentage of exports of goods and services, which hardly increased, a lower percentage implies a considerable reduction in imports. This is especially true for Africa and Latin America, where imports dropped 19 percent and 36 percent respectively over the brief period from 1981 to 1983. In this limited sense developing countries were able to adjust to the effect s of thes e shocks . Bu t thre e qualification s ar e i n order . First , althoug h a s a group developing countries have managed to adjust their balance of payments deficits, suc h an adjustment is not the most appropriate response on a global level. Th e contractio n inevitabl y ha d second-roun d negativ e effect s o n th e industrialized countries. I t has been estimated, for example, that the economic recession in the Third World cost the United States alone more than $60 billion in export s an d 1. 7 millio n job s fro m 198 0 t o 198 6 (Sewel l e t al . 1988) . Second, as we have seen, capital inflows decreased and the terms of borrowing worsened, whic h narrow s th e margi n fo r a viabl e balanc e o f payment s considerably.2 This , of course, struck at the roots of growth and employment creation. A less abrupt change and more room to maneuver would have reduced costs of adjustment. Third , as stabilization an d adjustment were forced upon developing countries primarily by external events, it seemed difficult fo r many to adjus t i n a n orderl y manner . Adjustmen t t o change d internationa l circumstances coul d not and cannot be brought about overnight. Adjustmen t involves a restructuring of man y aspects of th e economic framewor k throug h policies such as changing incom e distribution, asset distribution, and prices of products an d factors , perhap s throug h direc t interventio n i n som e markets . Such policies generall y nee d time t o be fully effective . Furthermore , abrupt changes i n governmen t policie s ma y mee t wit h s o muc h resistanc e tha t implementing the m become s extremel y difficult , resultin g i n popular unrest that prompts abandonment or reversal of policy changes. Although the macro figures, especially the balance of payments gap, show a favorable trend , this should not be a reason for optimism. O n the contrary, it is mor e importan t t o se e ho w an d under wha t circumstance s countrie s hav e adjusted. Afte r considerin g this , one should investigate the consequences fo r employment level s an d poverty , an d th e futur e prospect s fo r growt h an d alleviating poverty. Fro m the ensuing discussion it will become clear that all 2. Th e concept of a viable balance of payments typically means, especially for many developing countries, a current account deficit that can be financed on a sustainable basis by net capital inflows on terms that are compatible with the development and growth prospects of the economy (Guitian 1980).

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adjustment policies and measures have direct and indirect consequences for the distribution of income among various groups in the society. Neglectin g these distributional aspect s wil l no t onl y upse t an y socia l balance , bu t wil l als o affect the potential welfare of various groups in the long run. I examine the effects o f the shocks and consequent policies by focusing on two country groups, Latin American and Sub-Saharan Africa (followed specifi cally by Kenya). Bot h regions have suffered a drop in per capita income since 1980; in Latin America the 1985 per capita income was about 9 percent lower than in 1980, while the per capita income in Africa was 10 percent lower. ADJUSTMENT POLICIE S I N LATI N AMERIC A Many Latin American countries have known a long tradition of inflation and associated adjustmen t programs . Persisten t inflationar y pressur e i s ofte n explained by prevailing socia l an d economic conflicts o n the distribution of surplus (Hirschman 1981, especially chapter 8). Mor e recently, excess liquidity of the international capital market allowed many Latin American countries to finance curren t accoun t deficit s throug h externa l borrowing . Thi s wa s especially relevant from the late 1970s to the early 1980s, when Latin America to a large extent played the role of absorber of the current account surpluses of the oil-exportin g countries . Externa l borrowin g wa s use d t o financ e bot h government deficits a s well as investment in private and public enterprises. Investment deman d an d th e financin g o f th e public-secto r defici t ha d a n expansionary impac t o n th e econom y becaus e domesti c saving s wer e no t crowded out. Wit h high import coefficients fo r intermediate and capital goods, imports ros e mor e quickl y tha n export s an d curren t accoun t deficit s wer e financed with yet new inflow of loans and capital. However, after contractionary policies in the industrialized countries (beginning in 1980), real costs of capital skyrocketed. Mos t loans were provided on floating rates, so room had to be made to finance increasing amounts of debt service payments, a situation aggravated by a sizable capital flight, especially significant i n Venezuela, Argentina, and Mexico.3 Man y countries embarked on a set of adjustment an d stabilization measures, which became increasingly necessary after 1982 , when capital flows to Latin America virtually dried up. Policies regarding the external balance succeeded. Lati n American current account deficits were reduced from $42,400 million in 1982 to $2,600 million 3. Fo r these countries capita l fligh t a s a percentage o f gros s capita l inflows ove r the period 1979-1982 was respectively 13 7 percent, 65 percent, and 48 percent, compared to only 8 percent in Brazil (IBRD 1985).

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 2

5

in 1984, and $4,700 in 1985 , while the balance in trade account reached a surplus o f $37,60 0 millio n i n 198 4 an d $32,70 0 millio n i n 198 5 (IM F 1987) . But stabilization and adjustment policies were not without costs. Lati n American exports did not grow, terms of trade remained unfavorable, and interest rates stayed high. Adjustmen t was reached through a large contraction of imports, which by 1985 were 43 percent below 198 0 levels (Geller and Tokman 1986). Because of the structure of industry in most Latin American economies such a fal l i n import s primaril y resulte d fro m a contractionary policy . Rea l pe r capita GN P fel l b y 9 percen t betwee n 198 0 an d 1985 . Suc h interna l contraction resulted in increases in unemployment: ope n unemployment in the region increased from 7 to 1 1 percent from 198 0 to 1984 . Th e later figure i s still an underestimation, for participation rates were falling an d hours worked decreased. A comparable figure would be in the order of 1 3 percent (Geller and Tokman 1986) . Unemploymen t increase d particularl y i n Chile , Colombia , Peru, and Venezuela. I n addition t o unemployment rising, real wages fel l i n most cases. Tabl e 2-2 indicates severe decreases in Mexico and Peru of 35 and 22 percent respectively, and sizable decreases in Chile and Venezuela. Because most Latin American economies have low share s of agriculture in their GDP, almost all adjustment and stabilization policies carried out relate to urban formal-secto r activities . Th e mor e importan t adjustmen t policie s involved reduction of government deficits, devaluation, liberalization, and wage restraint. Reductio n o f th e governmen t defici t ha s contractionar y effects . While devaluation is supposed to have initial contractionary effects, its longerterm impact is allegedly expansionary. Effect s of liberalization are both shortand long-term , wit h th e principa l ai m t o stimulat e a smoothe r transfe r o f resources fro m on e secto r t o another , a s wel l a s t o attrac t foreig n finance . Decreases i n rea l wage s ar e aime d a t increasin g employmen t opportunitie s (assuming a high elasticit y o f substitution) , regaining internationa l competi tiveness, and diminishing production cost and consequently inflation . Bu t as I will argue , many of the assumptions di d not hold and the outcome wa s ofte n radically different As note d elsewhere , hardl y an y ne w foreig n financ e i s availabl e t o mos t Latin American countries, so the public-sector deficit can no longer be financed through externa l loans. 4 Ye t th e government budget has come unde r severe pressure at the same time. Budge t deficits were partly the result of decreasing revenues (impor t an d export taxes) , increase d transfe r payment s becaus e o f recession, and increased interest payments on public debt (and private debt that

4. Se e the discussion in Chapter 14 by Dornbusch.

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Table 2-2. Cumulativ e Change in Real Industrial Wages (W) and Open Unemployment Rates (E) in Selected Countries, 1981-1985 Country Argentina Brazil Chile Colombia Mexico Peru Venezuela

W E W E W E W E W E W E W E

1981

1982

1983

1984

-10.7 4.7 65 7.9 11.7 9.0 0.4 8.2 3.1 4.2 -1.9 10.4 -3.0 6.8

-21.2 53

8.1 4.6 3.8 6.7 -2.4 19.0 7.9 11.8 -23.4 6.7 -22.2 13.9 -3.1 10.5

28.9 4.6

13.9 6.3 8.8 20.0 4.3 9.3 1.7 4.2 -1.0 10.6 0.0 7.8

-2.9 7.1 -3.1 18.5 16.8 13.4 -35.5 6.0 -22.2 16.4 -10.0 14.3

1985

63 5.3 17.0 14.1 4.8 17.6 14.3

Source for wages: ILO (1986). Source for unemployment: ILO/PREALC (1986).

has been taken over by the central government). 5 A s a consequence, recourse had been sought , muc h mor e than in th e past, t o monetary financin g o f th e public-sector deficit, whic h contributed to inflation. Still , sizable efforts wer e made t o cu t expenditure , primaril y throug h reduce d capita l expenditure . Investment in social infrastructure suffered most (IDB 1985:63) . To boost production of tradeables, devaluation of the currency has often been used. Unfortunately , th e internationa l situation , a s wel l a s th e structur e o f industry i n Lati n America , ha s mad e devaluatio n les s tha n effective . Th e international recession, mounting protectionism, and application of devaluation by virtually all Latin American countries reduced expected benefits. Moreover , a sizabl e portio n o f Lati n America' s expor t product s stil l consist s o f ra w materials and minerals that have a low price elasticity. Perhap s more important is that imports mainly consist of intermediate products and capital goods and relatively fe w fina l consume r goods. Th e first tw o categories ar e much les s sensitive to price changes than the third. Th e major consequence of devaluation is th e increas e i n productio n costs , whic h i s compensate d fo r eithe r b y 5. Week s discusses the socialization of private debt in Chapter 3.

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 2

7

increasing prices of final products or by decreasing wages.6 T o deal with these phenomena firms must either increase productivity or shift production to more profitable activities . Th e latter , however , require s muc h mor e tim e tha n i s conventionally allowe d in stabilization policies. Rea l wages are often th e cost category par excellence t o be reduced to compensate for other cost increases. Because the short-term structure of production is fixed, decreases in wages do not immediately lead to increased employment. I t has been observed that after implementation of stabilization policies the wage share in national income has decreased (Pasto r 1985) . Becaus e cost s hav e bee n reduced , o r rathe r no t increased, international competitiveness coul d increase. But , again, time lags involved could be too long for any program (or the government implementin g the program) to survive. A n immediate effect of decreased real wages is a drop in demand by wage earners, which adds to the contractionary climate. Although countr y experience s vary , mos t adjustmen t program s includ e elements of liberalization and deregulation. Th e latter is often applied through dismantling public-secto r enterprise s an d reducin g governmen t directio n o f investable funds. Th e former usually means reducing state intervention on the domestic capita l marke t (mobility o f foreig n capital ) an d in th e trade sphere (removal o f restriction s an d taxe s o r subsidie s o n import s an d exports) . However, because the public sector has played an historically important role in establishing enterprise s i n Lati n America , i t i s difficul t t o refor m thi s rol e away. I t is indeed questionable whether the private sector in most countries is able and willing i n the present economic climat e t o take over the role of th e public sector (PREALC 1985). Liberalizing facto r an d product market s i n neoclassica l theor y wil l hav e positive results. Unfortunately , th e theory starts from a hypothetical situatio n of equilibrium in which distortions are introduced, and then shown to decrease welfare (Addison and Demery 1986) . However , the more relevant situation to start from (a highly distorted economy ou t of equilibrium i n which distortions are dismantled one by one) is much more difficult t o analyze, as the experience of liberalizatio n attempt s i n th e Souther n Con e o f Lati n Americ a indicates . Problems encountere d aros e fro m tw o mai n sources : th e openin g u p o f economies durin g worl d recessio n an d th e metho d o f implementin g th e liberalization strategy , whic h wen t to o fast , lacke d adequat e coordinatio n between liberalizatio n i n each market , and was not supported by appropriat e macroeconomic policy (Corbo 1985). The exampl e give n a t presen t o f th e countr y havin g mos t successfull y undergone structural transformation and able to reduce current account deficits in 6. Se e Solimano (1986) for the example of Chile.

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a rathe r shor t tim e i s tha t o f Brazil . Structura l adjustmen t i n Brazi l wa s achieved through very heterodox policies relying on massive public investment and control of variou s markets rather than on more conventional o r orthodox policy instruments . Althoug h not all projects have borne fruit (some projects in Brazil can be quoted as perfect examples of white elephants), the heterodox policies allowed Brazil to undergo a process of structural change that enables it now t o react better t o externa l shocks . Ha d Brazil applie d mor e restrictiv e policies, a s Chil e did , i t woul d no t b e i n a s goo d a positio n t o respon d positively to the external environment (Cortazar 1986). Recent experienc e i n Lati n America n countrie s ha s show n tha t quic k turnarounds in balance of payments deficits ca n be arrived at in a rather short period o f time . Bu t suc h a turnaroun d i s ofte n a t th e risk o f undul y larg e contraction, whic h severel y affect s vulnerabl e group s o f th e population . Fundamental structural changes are needed for countries to better weather the shocks i n th e future . Wha t shoul d b e th e characteristic s o f adjustmen t programs accompanying suc h structural changes? Thi s obviously depends on the long-term objective s o f development policies an d the effectiveness o f the instruments used. Developmen t objectives should form the major guidance for any adjustmen t program . I f th e objective s ar e no t clearl y spelle d ou t an d translated int o effectiv e instruments , an y adjustmen t progra m wil l fai l t o contribute t o meaningfu l development . I t shoul d g o withou t sayin g tha t setting objectives and choosing the development path is a national prerogative depending o n th e specific situatio n i n eac h country . However , a number of general observations can certainly be made. Two conclusion s emerg e fro m studyin g th e problem s Latin Americ a ha s encountered: (1) producing foreign exchange in an interdependent world has to remain (or become) an important priority, and (2) protection has led in the past to decreased incentive s an d sometimes t o prestige project s wit h littl e futur e earning capacities. O n the other hand, across-the-board measures like devaluation and sudden liberalization of markets have not led to desired and expected results because of the characteristics of the economic and production system in Latin America. Thus , selectivity i n instruments and the recognition tha t nonmarket instruments are important should be explicitly built into any adjustment package, which would allow the adjustment program to be more target-oriented and t o tak e int o accoun t concern s fo r employmen t an d povert y (PREAL C 1985). An importan t elemen t i n thi s woul d b e th e selectiv e us e o f trad e polic y instruments. Activitie s that create more employment and cater to production of essential service s coul d b e subjecte d t o highe r impor t tariffs . However , t o avoid a situation in which too little attention is given to exports, certain export

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 2

9

activities, thos e i n whic h th e prospect s ar e mor e buoyant , shoul d receiv e subsidies t o be paid ou t of proceed s fro m increase d impor t tariffs . A mor e selective applicatio n o f trad e tarif f policie s should , however , no t lea d t o a neglect of exchange rate policies, which keep the rate at a stable and adjusting level to avoid large fluctuations.7 The public secto r in Latin Americ a ha s often acte d to protect interests o f poorer groups, throug h low-cost housin g an d infrastructure construction , fo r example. I t should certainly continu e to fulfill thi s important role, as well a s regulating a considerable share of investment in productive sectors. A furthe r element of an adjustment package should be a coordinated set of incomes and price policie s acceptabl e t o al l parties . Som e countrie s hav e establishe d complicated indexation systems that tend to perpetuate inflation. I f these are to be given up, workers can justifiably expec t a period of price control, or at least intervention t o secur e pric e moderatio n fo r basi c goods . Furthermore , t o achieve more equitable burden-sharing, reduction should not only be restricted to wage income but also to income from other sources, such as profit and rental income. Equit y i n thi s regar d coul d b e achieve d throug h direc t taxe s an d selective consumption taxes on luxury goods. B y dealing with wages, profits, conspicuous consumption, and prices simultaneously, organized labor's fear of bearing most of the adjustment burden may be removed. The socia l climat e ca n improv e even furthe r if wag e policie s tha t reduce wages o f poore r worker s les s tha n thos e o f mor e highl y pai d worker s (o r perhaps no t a t all ) ar e adopted . Furthermore , fo r som e group s o f worker s profit-sharing coul d be an acceptable trade-of f fo r wage restraint in times of austerity. Temporar y increases in social security benefits represent still another equity option. Wag e restraint could in some instances be accompanied by noneconomic benefit s suc h a s a mor e complet e respec t fo r trad e unio n rights , collective bargaining, participation i n certain types of enterprise management, or in the preparation of certain government measures affecting workers and their organizations (Zoeteweij 1985). The mai n conclusio n i s tha t to o muc h emphasi s ha s bee n place d o n th e effectiveness o f a restricted number of policy instruments in restoring a viable balance o f payment s situatio n i n Latin America. Th e exercise o f adjustmen t needs to be placed in a broader developmental framework . T o this we should add tha t slo w growt h i n th e OEC D countries ha d been a major (bu t not th e only) reaso n fo r disappointing Lati n American expor t performance. Interes t payment an d amortizatio n o f Lati n America n deb t ha s take n o n suc h proportions tha t increase s i n export s wil l no t lea d t o increase d imports , 7. I n Chapter 8, Fletcher discusses exchange rate policy with emphasis on manufactured exports.

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portending problems especially for the U.S. economy. Th e drop in demand for U.S. exports has affected manufacturin g industrie s and agricultural exporters, sectors i n whic h unemploymen t i s on th e rise in th e United States , and in which rea l income s hav e bee n declinin g fo r a numbe r o f years . Fro m a political economy' s poin t o f view , i t i s no t surprisin g tha t proposal s ar e emerging from these affected groups to grant Latin American countries debt and interest relief to make room for increased imports from the United States (Joint Economic Committee 1986). The cost s o f suc h relie f proposal s ar e a t th e expens e o f th e bankin g community, whic h ha s resiste d suc h suggestions . However , th e bankin g community di d reac t enthusiasticall y t o anothe r proposal , th e Bake r Plan , which sought to restore some of the capital flow to developing countries and especially Latin America, and attempted to stimulate economic growth to allow for full repayments at a late date. Th e speed with which banks are writing off their loan s t o Lati n Americ a indicates , however , tha t mos t hav e mad e an implicit choice on practical grounds. I f the countries in Latin America could also profit from these changes by seeing the value of their debt reduced, benefits and costs would be more equitably distributed. ADJUSTMENT POLICIE S I N SUB-SAHARAN AFRIC A Economic decline in Africa has forced many countries to undertake stabilization and adjustment policies . I n 1987 , no less than twenty African countrie s had concluded standby arrangements wif£i the International Monetary Fund. Balanc e of payments deficits have been reduced, but the turnaround in economic activity has ye t t o come . Rea l wages—i n moder n nonagricultura l activities , fo r example—have dropped considerably (Table 2-3). Furthermore , the growth of modern nonagricultural employmen t is lower, often muc h lower, than that of the labo r force , indicatin g a n increas e i n eithe r ope n unemploymen t o r underemployment (Table 2-3; se e also van der Hoeven, forthcoming). Why has the situation i n Africa no t improved? Wh y were objectives of adjustment policie s s o difficul t t o obtain , le t alon e abl e t o brin g abou t a reversal o f th e declinin g tren d i n rea l wage s an d i n employmen t growt h opportunities? Althoug h situation s diffe r i n man y countries , a commo n denominator i s that the structure of African economie s renders conventional policies less effective than elsewhere, and in certain cases countereffective. Th e main elements of adjustment and stabilization policies in Africa are common,

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 3

1

Table 2-3. Inde x o f Nonagricultural Rea l Wages, Employment an d Labor Forc e (1980 = 100)

Country Kenya Zambia Tanzania Malawi Mauritius Swaziland Zimbabwe

Year Latest Figure Available

Nonag. Wages

1985 1984 1983 1984 1985 1983 1984

78 67 60 76 90 95 89

Nonag. Year Latest Figure Employment Available Modern Sector 1983 1983 1984 1983 1984 1983 1983

111 95 123 103 102 119 113

Nonag. Labor Force 120 114 124 136 118 117 116

Source: Unpublished ILO data.

one of the most important of which is a reduction in the public deficit, usually achieved by decreasing public activities. However , public-sector deficits hav e often increase d because of externa l causes. Lowe r imports and exports mean less ta x revenue . Taxe s o n internationa l trad e a s a percentag e o f tota l government revenue dropped in Zaire during 197 2 to 198 2 from 5 8 percent to 25 percent , in Tanzania from 5 1 t o 22 percent, in Madagascar fro m 4 2 t o 35 percent, in Kenya from 38 to 24 percent, and in Zambia from 48 to 14 percent. At th e sam e time , becaus e o f th e recessio n increase d claim s ar e put on th e government to cushion effects through price subsidies and alternative provision of employment . Cuttin g expenditur e i s mad e more difficult b y pressure fo r recurrent costs of development projects financed wit h bilateral o r multilateral aid. Because mos t Africa n countrie s hav e lo w credi t rating s i n internationa l capital markets , borrowin g t o finance budge t deficit s i s primaril y domestic . Moreover, in the absence of sizabl e domestic capital markets , resort is mostly sought directly from the banking system, which generates a direct inflationar y impact. However , a s import s ar e usuall y ratione d o r otherwise limited , th e inflationary impac t does not translate itself directly into increased imports, but into excess liquidity in the domestic market Thi s excess liquidity finds its way into urba n an d rura l informa l activitie s an d int o blac k market s fo r foreig n exchange, wher e rates are pushed u p by great pressure t o transfe r wealth , at almost any cost, out of the country.

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No country would admit that an excessive budget deficit is a healthy cause, and various attempts have already been made to trim down budgets. Centra l government fiscal imbalances in Sub-Saharan Africa hav e been considerabl y reduced since 1982 . I n 1985, governments of Sub-Saharan countries had lower fiscal imbalance s than in the United States and other large industrial countries (Table 2-4). Rathe r than desperately cutting down fiscal deficit in a very short period, it is more appropriate t o remove th e underlying cause s of th e budget deficit, on both income and expenditure, and to spread out fiscal reforms over a longer period of time . Thi s would avoid the frustration fo r many countries of not regularly meetin g targets of lowerin g public deficits. I t is worthwhil e to note that African countrie s wit h a poor administrativ e structur e are asked to trim budgets a t a pace tha t none o f th e industrial countrie s ha s been able t o reach despite official commitmen t to such a course of action. Spreadin g deficit reduction over time would allow for planning and discussion of future directions of public spending. Plannin g could include contingency programs to safeguard essential basi c services , a point discusse d later . Trimmin g expenditur e to o drastically can easily have negative consequences for investment, precisely the category of final demand that needs to expand.8 Finally, the effects o f reducing government expenditure do not have a large direct effect o n imports . Th e balanc e o f payment s effec t o f reduce d publi c deficits ha s to come from general deflation which , because of indirect effects , may require rather large expenditure cuts to be effective. Because o f faste r inflatio n a s compare d t o thei r tradin g partners , man y African countries have seen their effective exchang e rates increase, indicating overvaluation. However , most African countries are price-takers at the world market, an d a devaluation o f th e currency wil l no t result i n an expansion o f their expor t share . An y positiv e effec t ha s t o com e fro m a n expansio n o f supply, which is supposed to take place after devaluation through an increase in incomes i n domesti c currenc y t o those sector s o f th e economy tha t produce exportables. Import s ar e suppose d t o fal l a s the y becom e mor e expensive , though the immediate effect o f this is to add to inflation. Th e major effect o f devaluation is thus a change in income distribution. Income s of producers of exportables ar e increased while others will se e their real income s diminishe d because o f increase d prices . T o suppor t this change i n incom e distribution , additional increases in producer prices for agricultural crops are often proposed, both for exportables and domestic food crops. A s the devaluation will make the cost o f importe d foo d product s mor e expensive, price s fo r locall y produce d 8. Helleine r (1985) argue s that reactions to the second oi l shoc k had more drastic effects o n investment than the reactions to the first oil shock.

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 3

3

Table 2-4 . Centra l Governmen t Fisca l Balance s 1981 198

2 198

3 198

4 198

5 198

6

Sub-Saharan Africa

-6.6

-5.8

-4.8

-5.0

-5.5

United States

-2.4

-4.1

-5.6

A.9

-5.1

-5.0

Six Largest Industrialized Countries Excluding U.S. a

-4.5

-5.0

-5.3

-5.1

-4.7

-4.3

-6.9

a. Canada , Japan, France, the Federal Republic of Germany, Italy, and the United Kingdom. Source: IMF (1987).

crops are often set at a slightly higher level to boost domestic production. The problem in many primary product countries is that such measures will, for a variety of reasons, not immediately provide the desired effect. Firs t of all, some exportable crops, such as coffee, tea , and rubber, have a long gestatio n lag from planting to harvesting. Second , because of th e continued recession, existing infrastructure to support increases in exports has often deteriorated, to a large extent constraining quic k increases in export production. Moreover , in such a situatio n increase d expor t proceed s from devaluatio n and/o r pric e increases may merely inflate monetary demand for goods that are unavailable because o f th e pitiful stat e of th e production o f domesti c product s o r import restrictions. Thi s result s i n inflationar y pushes , backward-bendin g supply curve reactions, or illicit trading of agricultural goods for consumer goods with neighboring countries.9 It is consequentl y questionabl e whethe r th e reactions o f producer s o n th e export side will be as expected by theory. Equall y important is what happens in the urban environment. Povert y in Africa is becoming an increasingly urban phenomenon, as the gap between rural and urban incomes has narrowed (Jamal and Weeks, forthcoming a; Ghai 1987) . Althoug h this may mark a reversal of earlier and unwanted trends, some aspects are a cause for concern. First , the decrease in the rural-urban earnings gap has come less from a sizable increase in rural incomes than from large cuts in real wages. I n Tanzania and Zambia, for example, real wage s hav e halved in a time span as short as five t o six years. Second, real wages have decreased largely because of sizable increases in the price of basi c staples , either because subsidie s wer e abolished o r through the 9. I n Chapter 12, Jamal discusses these "perverse" reactions in some detail in his analysis of Tanzania under structural adjustment.

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combined effect s o f adjustin g produce r price s t o border prices a t a tim e o f currency devaluation . Th e pric e o f foo d traditionall y play s a n importan t psychological role in African societies, and although price increases may have been warranted, their extent has often met with strong reactions. The measures indicated above aim at a shift of factors of production toward producing exportables. Bu t the question is whether such a shift can take place quickly to relieve the pressure on the balance of payments and whether such a shift i s alway s i n th e long-ter m interes t o f th e country involved . Fo r mos t primary producin g countrie s th e shif t wil l mea n fo r som e tim e t o com e a process of deindustrialization. On e may wonder whether measures to adjust and stabilize wil l no t overshoo t thei r objectiv e b y divertin g th e long-ter m development paths of primary product producing countries. Stabilizatio n and adjustment measures , if the y wer e better abl e t o serv e th e ai m o f increase d growth and employment, should take into account the economic structur e and the long-term development goals of the country. Thi s will mean that programs should be more country-specific an d take into account the particular problems African countries are facing (Loxley 1986a). One o f th e mos t seriou s problem s mos t Africa n countrie s fac e i s tha t o f import strangulation. Import s have been reduced to the bare necessities. Pe r capita import volume in Sub-Saharan Africa in 198 4 was 82 percent of that in 1981, the level fo r the latter year being 25 percent lower than in 1970 . Thi s decline resulted in increases in excess capacity (ILO 1988) and caused a slowdown i n economi c growth . Adjustmen t program s aimed at reviving growt h will no t succee d unles s a sufficient amoun t of import s can enter the country right from the beginning of the program in the form of intermediate products or consumption goods , whic h woul d impl y allocatin g fund s a t th e beginnin g rather than during the program.10 Because of the structure of many African countries, policies need to be more selective rather than rely on across-the-board effects o f changes in prices. No t all Africa's export products will be able to rapidly expand; selective incentives will nee d t o b e give n t o thos e product s tha t sho w mor e prospects . Furthermore, import s shoul d b e (o r continu e t o be ) allocate d t o th e mos t dynamic sectors in the economy, and imports of basic consumer goods may be 10. Suc h "front-loading" of import s would , of course , reduce the amount of contro l financia l agencies hav e b y mean s o f checkin g agains t performanc e indicator s durin g th e cours e o f th e program. However , as most countries are on an almost permanent basis engaged in activities with the IMF and the World Bank , th e questio n o f contro l becomes les s urgent . Performance s an d assessment of program s can be made from one program to the other, allowing fo r a greater time period of the program to materialize. Moreover , regular discussion on performance can still be held because the threat of discontinuin g financin g o f a program has often bee n more theoretical than practical.

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5

required at the same time. Import s shoul d thu s form par t of a preconceived investment an d spendin g pla n i n whic h mor e fund s ar e t o b e allocate d t o intermediate products and to maintenance in order to arrive at a rapid increase in output. A s a sizabl e portio n o f import s enter s i n th e for m o f good s an d products of projects financed with foreign aid, coordination of donor activities should for m a n integra l par t o f selectiv e impor t an d expor t measures. 11 Regarding th e agricultura l sector , emphasi s i n adjustmen t program s i s overwhelmingly o n export crops (although far m and consumer prices of foo d crops are usually taken into account). Give n the poor state of food production in Africa, more emphasis ought to be given to domestic food production. Her e a fresh look could be given to the various institutions involved in transporting and marketing foodstuffs, cuttin g waste and overheads, and transferring som e activities to the private sector (Green 1986). Adjustment policies often chang e the distribution o f incom e considerably ; special consideratio n shoul d b e give n t o th e socia l effect s o f incom e distribution. Larg e decreases in real wages and reduction of essential services, including education and health, will have not only social effects, but effects on labor productivity, especially fo r low-income workers. I f wages drop quickly and reach extremely lo w levels, worker morale suffers, productivity falls , and second-job activities increas e to complement fallin g incomes , a scenario that sets into motion a downward spiral of lower wages and lower productivity. I n cases wher e a decrease i n real wage s i n som e industrie s an d public service s appears unavoidable, alternatives to cushion the effects o f falling wages should be introduced from the outset of the program. Thes e could include traditional measures suc h a s increase d socia l securit y an d workers ' participation i n th e capital o f th e industr y i n exchang e fo r cos t o f livin g adjustment , bu t als o allocation of plots of land to grow one's own foodstuffs an d set times of the day or week t o cultivate these plots to avoid high and random absenteeism. Lo w and fallin g wage s als o ad d t o a reductio n i n fina l demand , wit h advers e consequences for economic growth, as the production can often not be geared to exports. I n man y Africa n countries , domesticall y manufacture d consume r products shoul d b e regarde d a s quasi-nontradeables . Th e reaso n fo r thi s i s twofold: the product specification i s often not suited for industrialized markets, and the possibilities for exports to neighboring countries are usually limited. Equally important are the consequences of macroeconomic measures for the welfare of poverty groups, which must be scrutinized closely i n the design of any adjustmen t program . Instea d o f simpl y advocatin g a n increas e i n ta x 11. Se e Morss (1984), where demands of donor s on local administration capacity is show n to hamper domestic institution-building and, as a consequence, economic growth.

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revenue, the type of tax to be raised could be made more specific to exclude the incomes o f poore r group s o r th e product s the y consum e (Stewar t 1987) . Similarly, rather than apply credit restrictions in general, exemptions could be given to small-scale enterprises and farmers.12 A s to the essential services for education and health, the financial stringenc y that is often unavoidable should be seen as an impetus to developing cost-saving measures and better targeting expenditure t o those groups most in nee d by focusing o n specia l program s (Cornia et al. 1987) . Fo r most countries this often mean s a departure fro m existing practice; suc h changes in policies could be discussed and supported in donor coordination activities referred to earlier. ADJUSTMENT AN D STABILIZATIO N I N KENY A The general points made in the previous section can be applied to the Kenya situation. Durin g 1979 to 1985, Kenya stabilized its economy and reduced its current account deficit, but did not succeed in increasing nonagricultural exports or in restructuring th e economy i n response to changed external conditions. Growth suffere d an d employmen t creatio n slowed . Stabilizatio n measure s included the restriction of imports, a fall in real minimum wages, an increase in real interest rates, control of government expenditure, and devaluation. Th e latter resulte d i n a shif t i n incom e distributio n t o producer s o f tradeable s (agricultural exporters ) fro m nontradeables , bu t th e suppl y respons e wa s limited. Similarly , increases in the real rate of interest in 1983 and 1984 came after, rather than before, the large increases in savings that occurred in 1981 and 1982. Thus , the rise in the interest rate benefited thos e who had been able to accumulate assets in the past Becaus e in all sectors real wage costs increased less than sectoral GDP and employment lagged behind in most cases, income distribution changed in favor of nonwage earners. Due to the fall in urban real wages, rural-urban differences decreased , but overall incom e inequality ha s probably increased . First , i n urba n areas the position of wage earners has deteriorated in relation to that of nonwage earners. Second, i n th e agricultura l secto r exporter s o f tradeable s profite d fro m devaluation and price increases in 1983 and 1984. Export crops are now grown by large farms and by a minority of prosperous farmers (less than 20 percent) who hav e larg e plot s o f land . Increase d attentio n t o expor t crop s woul d probably increas e inequality withi n th e rural areas. Plantations , which had 12. I n Zambia, fo r example , i t i s argue d tha t more credi t t o farmer s i n 198 0 woul d hav e increased food production and saved the country foreign exchange going into food imports (van der Hoeven 1982).

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 3

7

difficulty hirin g labo r in 198 0 an d thus recruited foreig n workers , appear to have had no difficulty i n hiring since 1984 . Also , the lower real urban wages tend to lower supply price of rural labor. Durin g 197 9 to 1984, funds available for investmen t sho t up, initially becaus e o f increase d foreig n borrowin g and later because impor t restrictions limite d domestic output . I n 198 3 and 1984 , investment rates returned to "normal" Kenyan values of around 25 percent. I t remains puzzlin g wh y Keny a i s unabl e t o gro w faste r an d t o creat e mor e employment with such a high investment rate. In 1985 and 1986, the economy benefited greatly from the increase in coffee prices. Becaus e o f th e increase, th e International Coffe e Organizatio n lifte d quotas, and Kenya was able, on top of normal exports, to sell off coffe e stoc k from 1985 , resulting in a doubling of proceeds from coffee in 198 6 compared to 1985. I n contrast to the coffee boom of 1976-197 7 and the tea boom of 1984 , the government does not intend to pass on all price increases to coffee exporters in 1986, but rather plans to use part of the increased revenue to pay off external public debts. However , because exporters form an important political group, it is too early to say how much of the windfall gain will in fact be used to reduce external publi c debt . Curren t projection s o f coffe e an d te a price s ar e no t encouraging. Kenya n authorities have begun to make the case for an increased quota, arguing that when present trends in production continue Kenya will be able at the end of the decade to sell only 50 percent of its production through its quota on the world market Another serious proble m i s tha t th e volum e o f Kenya' s export s o f agricultural product s ha s kep t u p better tha n th e volum e o f nonagricultura l exports, thoug h th e latte r hav e bette r price prospects . Althoug h lowe r rea l wages coul d be a comparative advantag e fo r Kenya, thi s ha s not manifeste d itself a s yet , primaril y becaus e o f restriction s i n surroundin g countrie s an d difficulties confrontin g Kenya n product s i n competin g i n industria l countr y markets. Thi s suggest s that , excludin g som e positiv e shocks , suc h a s ba d harvests in other parts of the world, its trade prospects are not favorable. The important policy question is whether stimulus of export crops (tea and coffee) can be achieved without detriment to food production. Evidenc e on this is mixed . Thi s questio n i s compounde d b y th e fac t tha t Keny a i s quickl y reaching it s limi t of arabl e land, and increased production ha s to come fro m intensification, which means inputs and improved technologies. I n the medium term increased output could also be promoted by land redistribution, because small farmer s hav e higher yields tha n large-scale farmers . Th e World Bank estimates tha t a 1 0 percen t reductio n i n th e holdin g siz e raise s outpu t pe r hectare by 7 percent and employment by over 8 percent. A recent government

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paper, "Economic Management for Renewed Growth," is much less outspoken and puts the emphasis on intensification. The formulatio n o f a strategy o r se t o f scenario s fo r futur e developmen t should take into account the basic characteristic s o f th e economy: namely it s large an d dynami c small-scal e agricultura l sector , hig h saving s rates , hig h population growth , an d th e lan d shortage , al l o f whic h sugges t increase d attention t o small-scal e agriculture . Suc h attentio n shoul d g o beyon d th e present emphasis on domestic an d foreign pricin g policies t o include a much larger transfer of nationa l saving s to the agricultural secto r as a whole. Thi s transfer should be accompanied by policies fo r land redistribution t o increase output and provide income opportunities to the fast-growing population. Thes e policies would be facilitated by an increased inflow o f foreign aid and capital, but initiative s ar e no t blocke d b y lac k o f funds . Increase d investmen t i n agriculture can be stimulated by offering specia l benefits o r be financed fro m increased taxe s o n nonwag e income , whic h ha s increase d i n severa l urba n sectors, a s indicate d earlier . Thi s taxatio n woul d mea n a lowerin g o f th e investment rate in urban areas, which would not necessarily decrease growth, as ICORs hav e bee n rathe r hig h an d could b e lowere d throug h bette r capacit y utilization and improved efficiency. In the modern sector, lack of investable capital is less relevant than lack of foreign exchange , resulting in low-capacity utilizatio n ratios. Anothe r reason for low-capacit y utilizatio n i s th e stand-stil l i n rea l consume r deman d b y workers who have seen their incomes reduced by up to 20 percent from 197 9 to 1984. Increasin g privat e consume r deman d shoul d b e stimulated , no t necessarily by wage regulation but rather by changes in the fiscal regime, where the wag e ta x o n lowe r incom e group s coul d b e reduce d an d tha t o n highe r income group s an d accumulated wealt h an d assets increased . Another , no t necessarily opposed , variant would be to stimulate public consumption rather than private consumptio n (noninflationar y i f financed b y fisca l reforms ) t o maintain provision of basic services, such as education and health, at present or slightly higher levels. Althoug h the direct productivity effects of the provision of such services are difficult to measure, indirect effects in the form of increased social mobility have been noted by several authors. The policies discusse d abov e woul d o f cours e hav e implication s fo r th e balance of payments. A n expansion of final demand to reduce excess capacity may caus e import s t o increas e abov e sustainabl e levels , becaus e acces s t o foreign exchang e remain s constrained . However , i n suc h case s impor t restrictions o r prohibitiv e tarif f structure s coul d b e imposed , couple d wit h policies t o expand suppl y b y allowin g a greater role for th e informal sector , which has already shown signs of increased dynamism during the stabilization

EXTERNAL SHOCKS, ADJUSTMENT, AND INCOME DISTRIBUTION 3

9

period an d i s meetin g th e demand s o f man y low-incom e consumers . Th e import problem would be less if public consumption (noninflationary-financed ) is increase d rathe r than private consumption , bu t a combination o f th e tw o seems likely to be most acceptable socially.

CONCLUSION I have described briefly ho w several external shocks have affected developin g countries rathe r drastically , especiall y primar y commodit y exporter s an d exporters o f mor e traditional manufactures . Althoug h respons e t o the crisis was different , a large number of countrie s ende d u p in th e early 1980 s wit h large an d unsustainabl e deficit s o n thei r curren t account . Throug h forma l adjustment and stabilization programs , or through more haphazard activities, most countries managed in the middle of the decade to reduce considerably their current account deficits. However , socia l cost s wer e high . I n the two case s examined in detail in this chapter, Latin America and Sub-Saharan Africa, real wages in modern-sector undertakings dropped substantially and unemployment increased, leading to increased urban poverty. These negative effects occurre d because in most adjustment programs any form of buffer mechanism or protection of the poor was absent. Policie s were usually defined as to their effect on macroeconomic indicators , such as size of government expenditur e an d credi t expansion , wit h n o explici t concer n fo r income distribution and poverty effects. Specia l schemes to deal with the poor were for budgetary reasons often not even considered. Furthermore , adjustment and stabilization policies were of a deflationary nature (at least in the short run), and most poor people suffered already through sheer element of contraction. Alternative adjustment strategies are necessary. I n general, policies shoul d be carried out over a much longer period and be part of a long-term growth and development policy . Th e latte r woul d cal l fo r mor e selectiv e economi c instruments rather than rely solely on broad macroeconomic indicators . Fo r a development strategy to become successful, an y adjustment policy should also set th e basis fo r equity-oriente d growt h t o satisf y th e basi c need s o f th e population. Althoug h thi s would require country-specific analysis , a general set of policies needs to be developed. I t is necessary to reassess macroeconomic instruments for their growth potential as well as for their direct effect on poorer groups. Rathe r than relying o n across-the-boar d ta x increases , fo r example , taxes can be targeted with respect to specific groups. T o redistribute productive assets, such as land and education, as well as to increase the productivity of the

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poor, various interventions aimed at increasing the satisfaction o f basic needs, as well as at structural changes in the sociopolitical setting, are required. Because adjustment policies ofte n involv e difficult polic y choice s suc h as how t o distribut e th e burde n o f adjustin g t o advers e externa l shocks , an y meaningful progra m shoul d b e base d o n socia l consensu s i f i t i s t o b e successfully implemented . Thi s woul d impl y designin g program s togethe r with al l affecte d socia l groups . Thi s coul d lead , fo r example , t o th e formulation o f incomes and price policies that affect wage s and include other incomes such as profit and rental. A s part of a broader developmental policy , social consensu s coul d b e sough t t o exemp t th e poore r wag e group s fro m declines in their incomes in times of contraction by setting a floor to minimum wages and guaranteeing acces s t o essential service s t o safeguard a minimum level of living.

3

LOSERS PA Y REPARATIONS , OR HOW THE THIRD WORL D LOST TH E LENDIN G WA R John F. Weeks

In the late 1970s , the economies o f Latin America and Africa entered into an economic depression worse than that of the 1930s, plunging the populations of these countries to levels of poverty and unemployment of a decade before. A disturbing aspect of this profound economic and social crisis is that most of the concern of the international community has focused on what in human terms is a mino r sid e effec t o f thi s catastrophi c depression—th e inabilit y o f governments to service their foreign debts. I n any rational world, the financial side of the crisis would be the least of our worries, a problem easily dealt with through a moratorium o n payments , "forgiving " par t of th e debt , o r general default, as in Latin America in the 1930s. 1 Bu t on the contrary, the solution to the narrow financia l issue , whose resolution directly affects relativel y fe w people and to an extent merely involves manipulation of accounting categories in a world of ledger entries and reserve ratios, has become the prior condition 1. "Thos e who tremble at the prospect of widespread fault will find their fears reinforced by the World Bank. Th e biggest and most lasting casualty of a conflictual breakdown of loan agreements would be the confidenc e indispensabl e t o future economi c an d financial relation s an d the broad perception of a shared common interest in making the international economy work. A t stake may be no t onl y futur e financial flow s t o developin g countries , but the preservation of the whole international framework"(World Bank 1987b: x). Emphasi s added. On the Richter scale of apocalypti c polemics, the last phrase must register quite high, and one can perhaps speculate on the discretion involved in invoking such visions of doom.

41

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for amelioratio n o f starvation , deprivation , an d th e genera l degradatio n o f human existence that accompanies a sudden descent into abject poverty.2 We are indeed in a world turned upside down, a world in which those who stress the urgency of material problems such as poverty and unemployment are considered hopeless romantics, and those who restrict themselves to the rarefied world of high finance are hard-headed realists. Ther e is good reason for this inversion of reality. A t one level, we live in a world in which financedoes in fact tak e priority ove r material life. Th e representatives of the international financial syste m speak with a certain truth when they say that default on debt, particularly by the Latin American governments , could destabilize the world monetary system, though the long-term cost of this for the peasants and wage earners of the Third World might be less than that of orderly debt servicing.3 While at one level we can grasp the irrationality o f a world gone mad in which finance counts for all and the human condition for little, we necessarily must enter into that world lest we ourselves be judged as unbalanced, and our suggestions discarded as the ravings of deranged romantics. I t is the purpose of this paper first to review the process by which Third World countries accumulated large external debts over the last fifteen years . Second , I consider why the accumulation o f deb t has resulted i n a protracted crisis . Finally , I critique structural adjustment programs in light of the preceding discussion. THIRD WORL D DEB T AN D RESERV E CURRENCIE S It is obvious that the great impetus to developing country debt was the dramatic increase i n petroleu m price s durin g 1973-1979 , which redistribute d worl d income fro m oi l importer s t o oi l producers . Bu t befor e considerin g wh y governments of underdeveloped countries reached a point of over-indebtedness, one must ask a prior question: Wh y is it underdeveloped countries that are in this situation and not developed ones? A quite plausible argument can be made that a numbe r o f advance d industria l countrie s wer e mor e sensitiv e t o th e increase i n oi l prices tha n wer e underdevelope d countries. 4 Japa n and the Federal Republic of Germany, the second and third industrial powers in the 2. O n human suffering, se e Jolly and Comia (1984). 3. Commentin g on default as a policy alternative to full debt service, Robert Devlin writes: "I t is not at all obvious that the debtor countries [i n Latin America] would have been worse off wit h full or partial conciliatory defaults and acceptance of the risk of costly sanctions ..." (Devli n 1987: 93). I n an insufficiently note d paper, Carlos Diaz-Alejandro demonstrates that debt default in the 1930s had a net positive effect on Latin American economic development (Diaz-Alejandro 1985). 4. Certainl y th e declin e i n oi l price s i n recen t year s ha s benefite d industria l countrie s mor e (World Bank 1987b: xi).

HOW THE THIRD WORLD LOST THE LENDING WAR 4

3

western world, produce no oil, and because their economies are so industrialized they are much more dependent upon oil than even Brazil and Korea. Ye t Brazil and Korea have huge absolute and per capita foreign debts, while the FRG and Japan do not Clearl y something more than a rise in oil prices was involved. First an d most important , th e monie s o f th e wester n industria l countrie s serve as de facto reserve currencies, th e currencies i n which othe r countries, namely underdeveloped countries, must conduct their trade (even among themselves) and hold in hoards to clear trade imbalances. Thi s has a profound effec t on the balance of payments of the western industrial countries. I f Brazil runs a persistent defici t i n it s internationa l payments , i t mus t soone r o r late r see k private ban k financin g o r go t o th e IMF in hope s of strikin g a bargain o n a standby agreement. Further , when borrowing from private banks the government i s partl y financin g it s defici t vi a th e deficit s ru n by reserv e currenc y countries. Th e "hard currencies" that banks lend to Brazil do not accumulate in those banks by magic. This interactive relationship, in which th e currencies of wester n countrie s are sustained in part by the borrowing of governments of underdeveloped countries, wa s quit e obviou s durin g th e boo m i n petroleu m prices . Durin g th e 1970s, the major oil-producing countries ran enormous surpluses on their trade accounts. Thes e wer e matche d b y deficit s suffere d b y oi l importers , bot h developed an d underdeveloped . Th e so-calle d "recycling " o f petrodollar s involved i n par t th e financing o f wester n econom y deficit s b y Thir d World governments' borrowing. 5 Fa r from facin g a situation i n which the y ha d to borrow to finance their trade deficits, the governments of the western countries found themselves in the enviable position that their financial systems were net lenders. Thei r currencies returned to them as hoards held by oil exporters and, to a lesser extent, direct investments in physical assets. Rathe r than creating a financial squeez e in the western economies, the worldwide trade deficits of nonoil producing countries stimulated a financialboom. For thos e romantic s wh o migh t questio n a monetary syste m i n whic h a major shock (oil prices, for example) hits underdeveloped and developed countries alike, but stimulates potential crisis in the former and a boom (financial at least) i n th e latter , a n apologeti c answe r i s a t hand . Wer e i t no t fo r stabl e reserve currencies (of individua l countrie s or in the form of Specia l Drawin g Rights from th e IMF), world trade would be chaotic, w e are told. Whil e th e arrangement ma y no t b e precisel y t o th e likin g o f th e governmen t o f eac h country, i t i s hardl y realisti c t o thin k tha t internationa l payment s coul d b e 5. Se e Chapte r 1 3 b y Representative Bruc e Morriso n fo r a discussion o f th e publi c polic y implications of the recycling of petrodollars.

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cleared with currencies as unstable and legally restricted as those of, say , Latin American countries. This, however, i s a transparently fallaciou s argument . T o the extent that the dollar, mark, pound, et cetera, are more stable than the currencies of Latin American countries, this is in part because they have a reserve status, not viceversa. I f in Bretton Woods at the end of World War II the criterion for reserve status ha d been stability , no rational perso n woul d hav e selecte d th e pound sterling a s a mediu m o f internationa l payments . No t onl y wa s i t severel y devalued afte r th e war , i t wa s sharpl y restricte d a s t o th e condition s fo r it s convertibility (thoug h mos t o f thes e restriction s wer e late r dropped) . Th e pound wa s selecte d fo r geopolitica l reasons , no t th e leas t o f whic h wa s th e existence of Britain's colonial empire, in which the pound played a central role. The rol e o f th e dolla r i n clearin g trad e account s i n Lati n Americ a ha s a n analogous origin. Specificall y wit h respect to the U.S. dollar, little claim can be mad e fo r it s stabilit y i n recen t years . Indeed , a significan t par t o f th e instability o f Latin American currencies can be traced directly or indirectly to the instability o f th e dollar , a point I consider belo w whe n treatin g interes t rates. Thus, we can conclude that a major reason the oil price boom manifeste d itself in developing countries in the form of heavy debt burdens, but did not do so in the western economies, is because of the organization for the international monetary system . I t should come as no surprise that from 197 6 to 1982 , 10 8 of the 114 standby agreements reached with the IMF involved governments of underdeveloped countries (Killick 1984a). 6 Bu t there is a further reason that the western industrial economies fared better with regard to the oil price increases, namely the flexibility o f these economies. After th e firs t ris e i n oi l prices , man y commentator s predicte d tha t th e debilitating effects would be overcome by conservation measures in response to relative pric e changes , bot h throug h lowe r us e o f petroleu m du e t o incom e effects an d th e substitutio n o f alternativ e fuel s fo r oil . I n th e industria l countries these predictions have largely been fulfilled, bu t not in the countries of th e Thir d World . Whil e ther e ar e notabl e example s o f developmen t o f alternative fuels , suc h a s th e productio n o f combustibl e fuel s fro m sugar , "conservation" in the Third World was primarily achieved by lowering the level of economic activity, or not at all. Ther e is a good reason for this: the development of alternativ e energ y source s require s investment . Foreig n investmen t flows to developing countries declined substantially over the last ten years, and 6. Fo r an analysis of the 1947-197 9 period, when borrowing by developed countries was more important relatively, see Officer (1982).

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government investment has been constrained by the same balance of payments pressure that was th e impetus fo r conservation . Th e possibility tha t existing plant and equipment could be used for alternative energy sources was virtually nil. Further, in the industrial countries reduction in use of petroleum cam e not only in use of fuel but also in use of petroleum-based inputs, as natural fibers and nonmetallic minerals became relatively cheaper. Suc h substitution requires a develope d productio n structure , whic h mos t developin g economie s d o no t have. Fo r example, Nicaragua was an exporter of raw cotton; the increase in petroleum prices made cotton a cheaper input for clothing than synthetic fibers, yet there was not a single plant in Nicaragua in the 1970 s to render raw cotton into threa d (Week s 1985a : chapte r 7) . Adjustmen t t o th e rise i n petroleu m prices require d ne w investment s a t every leve l o f productio n i n developin g countries, new investment which for the most part was not forthcoming. The answer to the question of wh y underdeveloped countries in particular accumulated large debts: It was the necessary consequence of their relationship to th e international monetar y syste m an d the underdeveloped natur e of thei r economies. Give n this, is i t nonetheless th e case tha t governments borrowe d beyond their means and banks lent beyond the point of financial responsibility ? One ca n only pos e tha t questio n b y ignorin g th e event s tha t followe d th e increase in oil prices , or by treating those events as predictable. I f ther e has been any even t sinc e th e end of WWI I tha t can be described as a transitory, "once-and-for-all" change , i t wa s th e increas e i n oi l prices . Give n th e tremendous price increases in 197 3 and 1974, it was only reasonable to assume that at some point in the not too distant future an oil glut would result. Man y observers predicted this and, notwithstanding the sharp price rise in 1979, these predictions proved correct, perhaps beyond the dreams of those who had made them. I n the mi d 1970s , it wa s reasonabl e tha t both governments o f under developed countries and private bankers would view the large trade deficits of Latin America n countrie s a s transitory, which wit h respect t o oil price s the y were. Further , many developing countries of the region had experienced rapid growth just prior to the price increases, and there seemed no reason t o think that such woul d no t be th e cas e onc e th e effect o f th e oil shoc k ha d run its course. Three other factors indicated reason for optimism. First , the prices of many nonoil primary product prices experienced a moderate boom, so even the shortrun repayment situation seemed favorable. Second , increased oil prices had a depressing effec t o n th e rat e of growt h o f th e wester n industria l economie s (particularly in the United States) , and a reasonable prediction wa s that once adjustment had occurred, their rate of expansion would be rapid. Thi s in turn

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would presumably increas e th e demand for primary products , facilitating th e repayment of th e debts that were being contracted. An d third, the debts were negotiated i n a period of inflationar y pressur e at real interes t rates that were quite low. 7 Fe w expert s seriously believe d tha t international inflatio n woul d fall dramatically within the space of a decade, particularly if the recovery of the western industria l countrie s occurre d a s anticipated . Therefore , th e futur e interest burden appeared manageable. I n light of these reasonable expectations, a Third World government would have been foolish not to borrow, for not to do so would have implied as an alternative a program of domesti c deflatio n tha t prevailing expectations predicted to be unnecessary. Afte r all, one of the major functions of credit, for individuals, firms, and governments, is to "smooth out" short-period fluctuationsalong a long-term trend. Some o f thes e expectation s wer e fulfilled , namel y a dramatic shif t t o a petroleum marke t characterize d b y exces s supply . However , th e othe r expectations—buoyant primary product prices, continued inflationary pressures, and economic growth of developing countries with a strong export record—all derived fro m th e anticipatio n o f economi c growt h i n th e wester n industria l countries. Instea d of growin g as projected, the U.S. economy entere d into its worst depressio n i n hal f a century , wit h it s performanc e i n 198 1 t o 198 3 nothing shor t of disastrous in terms of unemploymen t and falling real wages. Instead o f rising , primar y produc t price s fell , an d petroleum-importin g developing countries began to run deficits even on their nonoil imports. Wors e still, whil e th e shar p declin e o f th e U.S . econom y ha d th e effec t tha t an y Keynesian woul d predict—lowering th e rate of domesti c inflation—nomina l interest rates rose to historically unprecedented levels. 8 Wh y real interest rates rose I consider below. Were these problems not enough, the glut on the petroleum market proved a mixed blessing indee d to the developing countries , if i t was a blessing a t all. While high oil prices had generated trade deficits, they had also generated the liquidity b y whic h thos e deficit s coul d b e finance d i n th e shor t run—th e "recycling" of petrodollars discussed above. Bu t the new trade deficits, created by th e depression i n th e U.S. economy , ha d no suc h benevolen t sid e effect . Once oil-producin g countrie s n o longe r enjoye d larg e trad e surpluses , th e supply o f worl d liquidity contracte d dramatically . I n retrospect, the years of high petroleum prices made for an environment considerably more favorable for 7. Fo r example, Devlin calculate s that interest rates deflated b y changes in the world price of Latin America's exports averaged -4.8 percent for 1973 to 1979 (Devlin 1987 : 91). 8. Devli n calculate s a n average real interest rate for Latin American debtor countries o f 17. 4 percent fo r 198 1 t o 198 6 (Devli n 1987 : 91). Th e Worl d Ban k calculatio n fo r al l developin g countries for the same period is about 15 percent (World Bank 1987b: xii).

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the growth of developin g economie s tha n do present circumstances. Fo r oilproducing countries, it was obviously a time of boom. Fo r nonoil producers, the higher cost of petroleum wa s partly offset b y easy access t o liquidity and the concessionary oil sales by Mexico, Venezuela, and the Gulf States. Less tangibly, but of great importance, during the 1970s the relationship of developing country government s t o the world financial community wa s quite different from wha t i t ha d been befor e o r i s likel y t o b e i n th e foreseeabl e future. Fro m the end of WWII until the oil boom, short-term balance of payments suppor t was usuall y obtaine d onl y from the IMF or bilaterally. Bot h sources involved governments entering into economic and/or political commitments that they might otherwise not have chosen. Wit h liquidity i n effect n o longer scarc e durin g the years after 1973 , private banks wit h mone y t o lend lacked the market power to impose conditions on the borrowing governments, due to the competition among banks. By contrast , the developing countr y governments found themselves i n the worst o f possibl e world s i n th e 1980s—lo w expor t prices , tigh t liquidity , unprecedented real interest rates, and a staggering debt burden carried forward from the previous decade . An d th e situatio n ha s proved wors e still . I n th e past, th e recover y o f th e U.S . econom y ha s bee n associate d wit h a n improvement in primary product prices. I n 1983 , the United States economy began t o revive , growin g rapidl y i n 198 4 an d earl y 198 5 (vi a enormou s depression-induced idl e capacit y an d excess deman d stimulate d b y massiv e budget deficits, a s any Keynesian woul d predict). However , th e response of primary produc t prices ha s been sluggis h a t best, suggestin g suppor t for th e famous Prebisch-Singe r hypothesi s tha t primar y produc t price s ten d t o fal l relative to prices of manufactures in the long run. The recovery o f th e U.S. econom y ha s brought no relief fo r hard-presse d Third World governments. Th e export demand was sluggish for Latin American countries , whos e economie s wer e particularl y dependen t o n th e U.S . markets.9 Give n th e contras t betwee n th e medium-ter m expectation s b y governments an d banker s i n th e 1970 s an d subsequen t economi c events , attributing an unmanageable debt burden to the irresponsibility of the contracting parties is absurd. I n effect, i t seeks to cast blame and divert attention from the institutional and economic context in which the debts were contracted and the market interventions by creditor governments and multilateral agencies to force payment. 9. Mexic o and Brazil increased their exports to the United States by about US$5 billion on an annual average, 1982-198 5 compare d to 1980-1981 . However , for the rest of the hemisphere the increase was barely US$1.5 billion. I n the case of Central America, half the increased exports to the United States represented trade diversion (Weeks 1988).

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One o f th e mos t debilitating aspect s o f th e economic environmen t o f th e 1980s fo r debtor governments ha s been th e extraordinarily hig h real interes t rates, which , i t i s generall y agreed , ar e th e resul t o f th e policie s o f th e government o f th e United States . I n the last four years , developing countr y governments have faced interest rates in relation to export prices (the relevant comparison) that were multiples of what was experienced from 195 0 to 1980. The usual explanation of these high interest rates is the astounding size of the operating deficit of the federal government budget in the United States—more federal debt accumulated in the first four Reagan budgets than in the 200 years since th e America n Revolution . Ther e i s a certain bitte r iron y abou t thes e deficits, whic h n o doub t i s no t los t o n Lati n America n politician s an d policymakers. A s w e shal l se e i n a subsequent section , th e policy package s being pressed upon Latin American governments by the multilateral agencie s with th e enthusiastic encouragemen t o f th e current U.S. administratio n plac e heavy emphasis on "fiscal responsibility," reducing state expenditures to cut the gap between those expenditures and state revenues. Wer e the IMF to impose the same discipline on the most profligate governmen t in the world, one might take the commitment to fiscal austerity a bit more seriously. However, th e hypothesis tha t interest rates are high because of th e size of the federal defici t ("crowding-out" ) i s based on dubious application of close d economy monetary theory. I t obscures a much more fundamental difficulty o f the U.S. economy that will not be eliminated by cutting the deficits. Ove r the last tw o decades , th e U.S . econom y ha s becom e increasingl y import-using , with the share of imports in GNP more than doubling since the 1950s and early 1960s. O n the other hand, export performance has been quite poor, resulting in enormous annua l trad e deficits . I n mos t developin g countries , a s loca l policymakers know to their chagrin, the result of a huge trade deficit would be to force a program of severe austerity on the population. I n contrast, the U.S. economy enjoyed a recovery beginning in 1983, though trade deficits continued to grow. Thi s was possible because of high interest rates, which drew in shortterm capital from abroad to finance the excess demand for imports. Thus , far from bein g a factor restrainin g economi c expansio n i n th e United States , as some argue , the high interes t rates are the necessary conditio n fo r economi c expansion. Lowe r interes t rates woul d mak e the trade deficit unmanageabl e (even though the dollar is a reserve currency), forcing deflationary policies on the current administration to reduce the import bill. In other words, the growth of the United States economy i n the 1980 s was based o n attractin g short-ter m capital , whic h intensifie d th e internationa l liquidity shortag e for Third World governments. I t was largely circumstantial that the capital inflow serve d to finance a government deficit Wer e the United

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States fiscal deficit to be substantially reduced, high interest rates would still be necessary t o finance the large import bill, whose basic caus e i s the lack of competitiveness o f domestic production compare d t o production i n Western Europe and Japan. T o the extent that there is a "crowding-out" phenomenon, it is borrowers in Latin America and other parts of the underdeveloped world that are being "crowded," not the private sector in the United States. BANK MARKE T POWE R AN D THIR D WORL D DEB T During the 1970s and early 1980s , developing countries accumulated external debts to a previously unprecedented level. However , this accumulation need not have resulted in a prolonged crisis of debt management. Give n the economic environment, a payments crisis was inevitable for governments of developing countries, but properly functioning financialmarkets provide a variety of means to resolve even the most severe payments difficulties. Th e accumulation of unmanageable debt in the private sector is hardly uncommon, and the response in financialmarkets is bankruptcy or some form of devaluation of debt paper. The purpose of this section is to consider why world financialmarkets did not respond quickly and smoothly to eliminate the payments crisis. It i s usefu l t o begi n wit h a though t experimen t tha t demonstrate s th e efficient respons e of financial market s to a payments crisis. Followin g common practice, let it be assumed that private banks in the 1970s carried out their lending on the basis of rational calculations of costs and benefits. Further , as is the current vogue, let it be assumed that economic agents made their predictions o f th e futur e o n th e basi s o f rationa l expectations . Tha t is , the y formulated their lending policy on the basis of a correct and complete model of the worl d economy , suc h tha t thos e prediction s corresponde d t o th e mean outcome o f a se t of alternative s eac h characterize d b y rando m shocks . I n formulating policy , banks presumably se t the lending rate to incorporate th e probability of varying degrees of default and rescheduling. O n the reasonable assumption tha t bank s treate d th e worl d econom y a s characterize d b y uncertainty and risk, the lending rate and terms of loans were set above what would have prevailed in a world of perfect foresight. I t should be added that market power on the part of banks, an issue that looms large below, would not affect the evaluation of probable outcomes. I f capital markets are efficient, then at a minimu m th e averag e term s o f loan s incorporate d th e possibilit y o f outcomes unfavorable to creditors even had expectations not been rational. T o assume otherwise require s on e to justify systematicall y irrationa l behavior ,

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which among other things would imply a general lack of faith in the efficienc y of market outcomes.10 The implicatio n o f thi s though t experimen t i s tha t whil e th e economi c environment of th e 1980 s was radically differen t fro m tha t of th e 1970s , the new conditions were ones that rational agents would have anticipated and that efficient market s would accommodate. Onc e the payments crisis began, one would expec t tha t competitiv e financia l market s woul d produc e secondar y trading i n Thir d World deb t paper , wit h bon d value s fallin g t o a leve l tha t would adjust the actual debt service toward the long-term equilibrium level. I f private trading was efficient ther e would be no reason to expect the competitive market outcom e t o be disruptiv e t o th e internationa l financia l system . Thi s unfortunate occurrence (from the point of view of banks) would be read as but one o f man y possibl e outcomes , t o b e balance d agains t pas t an d futur e outcomes when banks benefited from favorable random shocks. T o assume that banks an d th e internationa l communit y woul d b e throw n int o shoc k b y th e commonplace and mundane vehicles of secondary trading in debt paper and loan default i s t o attribut e a n irrationalit y t o economi c agent s i n thi s cas e tha t economic theory refuses to entertain in any other line of inquiry. Economic theor y tell s on e tha t secondary tradin g i n debt paper would be stabilizing. Whil e th e devaluatio n o f loan s migh t resul t i n bankruptc y o f lenders, there is nothing in the theory of the firm that suggests that bankruptcy is anythin g mor e than an aspect of th e efficient workin g of markets . O n the debtor side of the ledger, default and discount sales of debt would reduce debt service t o a manageable level , whic h a s a sid e effec t woul d strengthe n th e balance sheet s o f remainin g internationa l banks. 11 Onc e deb t ha d bee n discounted an d defaulte d t o a manageabl e level , debtor s woul d agai n b e creditworthy an d competition amon g lender s would bring fort h ne w loan s i f such were required. I f one is skeptical about this sanguine scenario, then one is in effect rejecting the general conclusion of mainstream economics that markets produce efficient outcomes, with the implication that policy should be based on political and power considerations rather than criteria of economic efficiency . In ligh t o f wha t theor y suggest s a s th e obviou s marke t solutio n t o th e payments crisis , thi s questio n necessaril y arises : Wh y di d no t efficien t secondary market s i n Thir d World deb t paper develop? Th e answe r t o th e question i s tha t th e monopol y powe r o f th e prime r internationa l bank s prevented the emergence of such a solution. A brief comparison to the 1930s is 10. I n Chapter 16, Darity argues that banks in fact may not have incorporated a risk premium. 11. Durin g the lending boo m it wa s common practice for borrowing government s t o contract not to repurchase their debt on a secondary market. Suc h a pledge could easily be circumvented.

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relevant here. I n the 1930s, the governments of Latin America escaped from an unmanageable debt burden through default and secondary market discounts of their debts. Th e decentralized characte r of debt-holdin g mean t that creditors could neithe r combine t o distort th e operation o f th e market mechanism no r combine an d conspir e t o enforc e punitiv e sanction s agains t debto r governments.12 Th e experience of th e 1930s , along with economic theory , suggests that the fea r tha t "th e whole internationa l economi c framework" (to us e th e World Bank phrase) migh t crumble in response t o the efficient operatio n o f financial market s is not inherent in default and discounting, but the result of the monopoly power of internationa l banks. Tha t the market distortions preventing the spread of secondary trading in debt are the result of a cartel of banking interests is generally recognized, and World Bank authority can be cited: . . . [M]an y bank s remai n concerne d tha t a n expanding secondar y marke t i n developing countr y deb t wil l cal l int o questio n th e valuation of l o a n s . . . .U. S banks, i n particular, hav e bee n reluctant t o trad e i n th e secondar y marke t fo r this reason, an d have thus restrained its growth. 13

It i s hardl y surprisin g tha t bank s woul d b e reluctan t t o encourag e th e development of secondary markets, because their efficient operatio n would be precisely t o discoun t deb t ("cal l int o questio n th e valuatio n o f loans") . I t remains the case that action by banks to prevent the emergence of such trading represents perhaps the most serious market distortion associated with the debt crisis. On e can identify severa l inefficient consequence s of this market distortion. First , it has prolonged the payments crisis, which might well hav e been several year s behin d u s ha d secondar y market s operate d efficiently. A s a consequence, inefficiencies i n the banking systems of the developed countries have been perpetuated, the growth of worl d income has slowed, and there has been a substantial increas e i n the tension between government s o f develope d and developin g countries. 14 Second , th e exercis e o f monopol y powe r ha s effected a n arbitrary redistribution o f incom e fro m debtor s t o creditors. Th e redistribution i s arbitrar y i n tha t i t bear s n o stric t relationshi p t o efficien t market outcomes. A s argue d at the outset of thi s section , either th e lending policy o f bank s reflected a rational expectation s predictio n o f probabl e out comes o r borrowin g cost s incorporate d th e ris k o f defaul t an d discounte d 12. Fo r a brief bu t illuminating discussio n o f th e 1930s , se e Devli n (1987 : 92-93); and als o Diaz-Alejandro (1985). 13. Worl d Bank (1987b: xxxiii). 14. On e might also speculate about the Third World governments that have faUen, the increase in the incidence of malnutrition, the children that have gone uneducated, and the public investment in social infrastructure that has been cancelled.

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refunding of debt I n either case, the distorted management of financialmarkets to achieve full repaymen t under original conditions represents an attempt by banks to recover not only the normal rate of return, but also a monopoly rent This can be demonstrated by way of a hypothetical example. Assum e over n time periods competition among lenders sets normal loan conditions. I n some time periods the lenders will do abnormally well (for example, full repayment at a real interes t rate above what wa s predicted); in othe r tim e periods th e lenders will do abnormally poorly (high default rates or real interest rates well below predicted levels) . However , i f shock s ar e random an d expectation s rational, the mean outcome will correspond to the normal rate of return under conditions of long-run equilibrium. Whe n lenders seek to avoid losses during the unfavorable periods they are in effect violating the operation of competitive markets and unilaterally altering the rules of the game. The foregoin g analysi s suggest s a majo r ite m fo r th e agend a o f publi c policymakers in developed countries and multilateral agencies: I f one adheres to the principle that market outcomes are efficient, then the distorting effect of the bankers1 cartel should be eliminated;15 an d at the very least responsible agencies and governments should not aid and abet the distortions. Th e issue can be put another way: Secondar y trading in debt paper might not have solved the payments crisis, but it is a solution offered b y the market mechanism. Give n that representatives of creditor governments and multilateral agencies have professed great fait h i n th e magic o f th e market, why wa s thi s possible solutio n no t seriously pursued? THE ALLIANC E O F TH E INTERNATIONA L BANK S AND TH E "BRETTO N WOOD S TWINS " Anyone who has followed World Bank publications in recent years will know that the Bank has come to place increasing stress upon the importance of the private sector in the process of growth and development in the Third World, to the extent of recommending privatization of state property. Th e IMF can of course be commended for its consistency on this issue throughout its existence. One ca n presum e tha t suc h emphasi s reflect s a theoretica l an d empirica l judgment that market outcomes are generally efficient. Therefore , it is rather puzzling that with regard to Third World debt both of these institutions have discouraged policies that would allow market processes to operate effectively. 15. Combinatio n and conspiracy to restrict the size of the secondary market is not inconsistent with disarray among the banks on other issues, as described by Sacks and Canavan in Chapter 5.

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Creditors have used monopoly power to insulate themselves against market discipline i n a number of importan t ways, none of whic h th e Bretton Woods multilaterals hav e show n dispositio n t o criticize. Indeed , cooperation o f th e multilateral wa s probabl y a key elemen t i n th e succes s o f monopol y inter vention i n th e financia l market . Firs t an d perhap s mos t important , th e international banks have been impressively successful in maintaining discipline in their own ranks against the pressure of market forces while preventing any symmetric solidarit y amon g debto r governments. I n a strategy an y genera l would envy for an armed conflict, the banks have managed to concentrate their forces i n a protracte d serie s o f cas e b y cas e battle s agains t scattere d an d disorganized debtors. Mor e than incidental to this strategy of avoiding a pitched battle agains t th e combine d oppositio n ha s bee n th e role o f th e IM F a s a n advance force to define the scope of conflict. Th e combination of the case by case revie w o f debto r governmen t financia l need s an d servin g t o confir m creditworthy status has made the IMF central to the exercise of bank monopoly power. Thi s role of th e IMF as the broker for the bank cartel began on an ad hoc basis, an d its impressiv e succes s i n preventing officia l defaul t le d t o it s emergence a s official Fun d policy i n mi d 1982 , when Managin g Directo r J. deLarosiere announce d tha t th e multilatera l woul d serv e a s a catalys t fo r organizing debt rescheduling on a case by case basis.16 Second, the multilaterals have been instrumental (or at least acquiescent) in bank pressur e t o forc e debto r countr y marke t interventio n t o nationaliz e (socialize) privat e sector debt, a policy mos t important in Latin America. A substantial proportion of the money owed by the most indebted countries was contracted by private economic agents . On e can presume that this portion of the debt was agreed upon with rational calculations of profit and loss by both sides of the exchange under the rules of governance of market trading. There fore, it is a quite brazen exercise of monopoly power by international banks to demand debtor government intervention to "guarantee" private debt "Guarantee" i n thi s cas e i s a misnomer , fo r wha t i s involve d i s stat e intervention to protect private agents from th e judgment of marke t outcomes. Clearly there can be extenuating circumstances. I f a private debtor operates in a country with severe exchange controls such that hard currency is available only through an administrative process, then the state has de facto socialized private debt and should do so officially. However , the most celebrated case of cartel pressure to force socialization of foreign debt, that of Chile, involved no such 16. I t is difficult to find neutral observers with regardto the payments crisis, but a quite balanced discussion of the role of the IMF is contained in ECLAC (1985). A n excellent analytical treatment is found in Darity and Horn (1988: chapter 9).

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extenuating circumstances. Whe n the government of Chile announced that the private sectors foreign deb t was the responsibility o f those who contracted it, capital control s wer e sufficientl y lenien t t o leav e littl e complain t abou t th e convertibility o f th e nationa l currency. 17 Ye t th e governmen t o f Chil e immediately cam e under tremendous pressure from th e international financia l community, including threats of sanctions. Bot h the IMF and the World Bank were at that time counseling governments throughout the Third World to limit the scop e o f governmen t interventio n an d rely mor e o n privat e initiativ e i n resource allocation. Therefore , it is surprising that these two multilateral did not use their great influence t o support this privatization move by the Chilean government. Wha t seems to be involved here is a double standard. I n as far as privatization an d deregulatio n facilitat e privat e profitability , government s should limit thei r intervention i n markets. However , when marke t outcomes dictate private losses, government intervention is not only tolerated but forced upon debto r countries. Thi s asymmetri c position—fo r example , enthusias m for privatizatio n o f virtuall y an y stat e activit y bu t pressure t o socializ e th e foreign debt—casts doubt upon the allocative efficiency argument s offered by the World Bank and the IMF.18 Market s achieve their allocative magic through penalizing loser s wit h losse s a s wel l a s rewardin g winner s wit h profits . Deregulating t o stimulate the latter while socializing t o discourage the former generates majo r marke t distortions . Th e "practical " argument on e hear s t o justify socializin g developin g countr y foreign deb t is that not to do so would result i n a serious los s o f confidenc e o n th e part of th e internationa l banks . This may well be so. I f it is, it implies that market processes are destabilizing and not t o be truste d fo r resourc e allocation . T o continu e wit h th e presen t example, if the Chilean private sector cannot be trusted with the responsibility of it s externa l debt , shoul d i t b e entruste d wit h th e ove r 50 0 firm s denationalized since 1973? There is a further market distortion create d by socializatio n of th e foreign debt. A s argue d above, presumably th e lending condition s of th e contracted debt incorporate d a risk element t o compensat e bank s fo r th e possibility o f default Onc e all governments are forced to socialize the debt and repay in full, the risk element has been eliminated. Par t of the debt service then represents a 17. Fo r a discussion of control s o n capital flows in Chile in the mid 1980s , see Arellano and Ramos (1987). 18. Interestingl y enough, when discussing how privatization increases the return on investment in developing countries , Chile is noted as a positive example . "Severa l countries, notably Chile, have begun to return government-controlled companie s t o the private secto r in order to improve competitive conditions and reduce budgetary outflows" (World Bank 1987b : xii). I t is a surprising oversight that the passage does not refer to the government's forced nationalization of approximately 2 percent of GDP (the relative size of private debt servicing).

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pure monopoly ren t and a misallocation o f national resources to unrequited foreign transfers . On e look s in vain i n the reports of the multilateral s for reference to this major market distortion. A third source of market distortion regarding the payments crisis should be mentioned: capital flight. Ther e seems to be a consensus that the international banks, aided by creditor government policies, have actively sought to attract private deposits from wealthholder s in Third World countries.19 Rodrigue z characterizes this process as "criminal": . . . [FJoreig n bank s an d government s hav e create d variou s incentive s t o stimulate capita l flight , an d thus tax evasion fro m Latin American countrie s A behavio r considere d crimina l . . . i n th e advance d countrie s i s activel y prompted by the members of the . .. OECD, especially th e United States. 20

Perhaps th e most surprisin g aspec t o f thi s inconsisten t polic y b y the multilaterals is the heavy stress placed on the disruptive effect of nonpayment. The emphasis given to apocalyptic consequences of default and debt discounting is a relatively recent phenomenon, one which contrasts sharply with previous views. Fo r example, in the influential Pearso n Commissio n Report , one i s told "deb t relief shoul d be recognized as a legitimate for m o f aid," and the contemporary Rockefelle r Repor t too k a similar vie w (Pearso n 1969 : 18; Rockefeller 1969). 21 On e should entertain the possibility that the predictions of catastrophe emanate more fromthe boardrooms of the international bank cartel than fromthe inherent workings of the international financial system. STRUCTURAL ADJUSTMENT : TH E LENDING WAR ON TH E DOMESTIC FRON T Since it s creation, th e International Monetar y Fun d ha s functioned a s an institution concerned wit h short- and medium-term monetar y an d balance of payments adjustment. A s such, its role has not been t o promote economic development, though its defenders migh t argue that the policies of the Fund have a favorable effect o n development. Th e task of promoting development was assigned to the International Bank for Reconstruction an d Development (World Bank), and the Inter-American Development Bank was established to 19. "[M]an y foreign private banks and financial institutions were accomplices of capital flight ai competitive pressures induce d them to actively solici t deposit s fro m privat e economic agent s in [Latin America]" (Devlin 1987:90) . Th e word "competitive" should be interpreted in the context of oligopolistic competition . 20. Rodrigue z F. (1987: 139) . 21. A detailed treatment for debt refundingin this century is found in Bitterman (1973).

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play the same role on a regional level. Unti l recently, the approach to lending by the Fund on one hand and the World Bank and the IDB on the other reflected the two different roles. Th e Fund provided balance of payments support, and in doing s o fel t justified i n th e dubiou s practic e o f imposin g condition s o n it s loans that involved policy decisions we normally take to be the responsibility of governments.22 This rol e o f th e IMF—layin g dow n macroeconomi c conditionality—ha s always been controversial, and is generally avoided by the World Bank and the IDB. Restrictin g themselves primarily to program and project lending, these two institution s di d no t i n th e pas t ten d t o se t macroeconomi c conditions , though continued lending to a government was always conditional upon "creditworthiness." Creditworthines s basically referred to the likelihood of a government's bein g abl e t o repa y a loan , bu t th e criterio n wa s applie d wit h considerable flexibility , consisten t wit h it s vagueness . Countr y report s b y these tw o institution s include d macroeconomi c polic y suggestions , bu t a n official o f a Latin American country wh o went t o Washington t o negotiate a loan with the World Bank or the IDB would not anticipate being presented with a shopping list of policy changes that would be the precondition for financing of a highway, rural development project, or social developmen t scheme. Th e technicians of the World Bank and the IDB were primarily concerned for it to be demonstrated that the money would be used for the stated purpose and reach the proposed beneficiaries. Suc h an approach was particularly th e case wit h the IDB, whos e executiv e officer s too k th e vie w tha t their institutio n ha d been created b y th e government s o f th e hemisphere , afte r all , an d i t woul d b e inappropriate to dictate policy to the organization's ultimate constituency. Given this orientation of th e World Bank and the IDB, it is not surprising that the two organizations took a considerably more eclectic view than the IMF of th e possibl e economi c polic y regime s tha t migh t b e consisten t wit h successful economi c development . Withi n th e halls of thes e institutions on e found a response to the shifts in current thinking about the nature and goals of development that was notably absent in the IMF. Fo r example, a considerable amount of theoretical and empirical work was done in the World Bank on what came to be called the "basic needs approach" to economic development (though official Worl d Bank policy never endorsed such an approach). Th e eclecticism of thes e institutions gav e a degree of freedo m t o borrowing governments that they woul d no t hav e enjoye d a fe w hundre d yard s awa y a t th e IMF . I n 22. B y custom, governments are considered to some degree to representtheir populations, so it is appropriate that they alone should take the momentous decisions that affect th e welfare of their populations and be held responsiblefor taking them.

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particular, the fact that a government might be unwilling to agree to conditions set down by the IMF for a standby loan did not necessarily prejudice its chances of obtaining project or program funding from the World Bank and the IDB. This situation has undergone rapid change in the last five years , to a point that soon th e division o f labo r between th e Fund and the Bank may be more apparent than real. Th e vehicle for this shift in World Bank basic policy is the structural adjustmen t loa n (Wrigh t 1980 ; Landell-Mills 1981). 23 Structura l adjustment loans are very close cousins of th e IMF standby lending, with the same type of conditionally. Th e shift i n emphasis from project and program lending to lending based on macroeconomic conditionall y woul d seem t o be the wave of th e future in the World Bank. Th e similarity i n outlook betwee n the IMF and the World Bank, wit h the IDB movin g i n the same direction, is even more clearly demonstrated in the unprecedentedly close cooperation among the thre e institution s i n recen t years . Thi s i s show n i n tw o developments . More overtly, emergenc y loa n packages hav e been put together among thes e institutions for several countries, a notable case being the Costa Rican crisis of 1981-1982. I t might be thought that cooperation can only be a good thing in these matters so that efforts are coordinated. Thi s would certainly be the case in a perfect world in which the borrowing government and the lending institutions shared the same goals and assessment of current economic difficulties. Bu t as shown in the previous section, this cooperation has become an integral part of monopoly intervention to block market outcomes. This i s particularl y th e cas e wit h th e IM F servin g a s th e internationa l financial system' s gatekeeper and watchdog. I n case after case in Africa, Latin America, and Asia, reaching a standby agreement with the IMF served as the necessary conditio n fo r obtaining World Bank structura l adjustmen t loan s as well a s progress i n renegotiatin g outstandin g deb t wit h privat e banks . Th e international financial community has indeed responded forceably t o the Latin American debt crisis. I t has closed ranks, established a common hard line, and developed a policy package that all governments mus t accept or face th e real prospect of international financial boycott24 Needless to say, the Reagan administration was extremely enthusiastic about this approac h t o th e deb t crisis , fo r th e polic y measure s incorporate d i n structural adjustmen t program s ar e ver y clos e t o th e heart s o f conservativ e politicians. However , ther e i s a more fundamenta l reaso n fo r th e return t o importance of the pre-Keynesian theoretica l and analytical framework. Give n 23. Se e Chapter 9 by Epstein for the history of policy-based lending by the World Bank. 24. I t should be stresse d agai n that the cost o f noncooperation wit h the Fund may be exag gerated. A s Lissakers and Sacks and Canavan argue in chapters 4 and 5, no new lending would be forthcoming in any case.

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the severit y o f th e deb t crisis , ther e i s little , i f any , possibilit y o f Lati n American countrie s achievin g histori c growt h rate s and repaying th e debt. 25 Because the financial community in the 1980s ruled out any significant reform that would reduce the debt burden in the foreseeable future, policies for growth must yiel d t o policies t o facilitat e repayment . This , however , i s a difficul t argument for the multilateral agencie s t o make explicitly—that th e economic welfare of millions must be sacrificed (at least any significant improvement) to satisfy the welfare of the workfs major private banks. The conservativ e structura l adjustmen t program s offe r a way ou t o f thi s difficult ideologica l situation. Th e central message of the structural adjustment programs is that the present difficulties o f th e Third World economies ar e the result of bad policy, and if correct policies are followed growth will result with no chang e i n th e presen t internationa l economi c environment . Thi s i s a powerful ideologica l message , a n apparen t exceptio n t o th e genera l rul e i n economics that there is no such thing as a "free lunch." Th e argument is that if "distortions" are eliminated—economies opene d to the international environ ment and "governmen t taken of f th e backs of people"—export s wil l expand , investment wil l b e forthcoming , an d growt h wil l follow . Thoug h som e developing country policymakers may have been under the impression that their economic difficulties aros e in part from th e instability of th e world economy, the fact of th e matter, we are told, is tha t the difficulties aros e because their economies wer e insufficientl y integrate d int o th e worl d economy. I t is thi s powerful ideologica l message , tha t throwing one' s economy int o the arms of the unregulated marke t will b e th e salvatio n o f th e Third World, that I now briefly consider. While th e wor d "structure " i s vagu e whe n use d i n th e ter m "structura l adjustment," it suggests changes that involve basic alterations in an economy. "Changing the structure of production, " for example, suggests more than just policies; i t suggests also investments, technical innovations, and retraining of the workforce . However , i n th e contemporar y context , th e ter m mean s something quite different an d much more limited—deregulation, denationali zation, and reducing the size of th e government sector. Th e basic change it suggests i s primaril y a n ideologica l one—fo r Thir d World policymaker s t o abandon th e path o f economi c nationalis m an d adopt the doctrine o f laisse z faire. Thi s i s offere d a s i f it s benefits ar e so obviou s tha t only th e ignorant would challeng e them , despit e th e fac t tha t no presently develope d countr y developed b y followin g laisse z fair e policies , wit h th e exceptio n o f Grea t Britain. 25. Chapte r 15 by Sunkel addresses this issue.

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Let us consider the argument at face value. Th e basic structural adjustment package include s som e or all o f th e following polic y measures . Th e allege d benefits are given after each policy measure.26 1. Devaluatio n of the exchange rate: to reduce imports and increase exports. 2. Restrictio n o f th e growt h o f mone y wage s (and , implicitly , lowe r rea l wages): to increase the rate of growth of employment, dampen inflationar y pressures, and increase international competitiveness. 3. Cu t government spending : t o reduce th e growth o f th e mone y suppl y (i f there is a fiscal deficit ) an d "free " resources fo r private-secto r initiative ; domestic demand will fall, further releasing resources for export production. 4. Directl y reduce the growth of the money supply by central bank action: to reduce inflationary pressures. 5. Deregulat e markets , eliminating pric e controls , interes t rate ceilings , and subsidies on commodities and services: to achieve a more efficient allocation of resources. These policy measure s reflect certai n assertion s o f causalit y tha t have an almost religiou s status : " a fal l i n rea l wage s wil l increas e employment, " "inflation result s fro m excessiv e expansio n o f th e mone y supply, " an d " a devaluation of the exchange rate will stimulate exports and discourage imports." These are only a representative sample. I t should be noted that none of thes e are factual statements , nor are they theoretical inference s abou t which there is general agreement. O n the contrary, even at the most theoretical an d abstract level eac h o f thes e apparentl y simpl e statement s i s a victim o f intens e controversy. I f one survey s the literature on macroeconomic theor y over the last twenty years, one discovers that none of these statements holds true except under very restrictive theoretical conditions. Thi s cannot be stressed too much. Contrary t o wha t som e ma y argue , thes e statement s do no t reflec t basi c economic laws. The y are nothing more than abstract conclusions derived from a highly controversial theoretical model whose internal, logical inconsistencie s are well documented. I shall take each of these statements in turn and demonstrate the theoretical controversy surrounding each. I n the case of the first, the means (lower wages) achieves th e end (mor e employment) o n th e argument that lower wages wil l induce capitalists to change from thei r current technique of production to one that i s mor e "labor-intensive. " Thi s analysi s o f technique-switchin g i s 26. Th e discussio n tha t follow s migh t b e compare d t o th e presentatio n i n Chapte r 6 b y Iiebenthal and Nicholas on the World Bank approach to adjustment policies.

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theoretically valid only if the economy produces a single product. Thus , even in theory (to say nothing of the real world) it holds in conditions so restrictive as t o b e absurd. 27 The difficult y wit h th e secon d statemen t (mone y supply/inflation) i s tha t it cannot b e establishe d tha t ther e exist s somethin g called "th e mone y supply " tha t i s unde r th e direc t contro l o f governmen t authority (throug h the central bank) or indirect contro l (throug h governmen t expenditure an d taxation), except agai n unde r very restrictive assumptions. 28 With regar d t o devaluation , ther e ar e at least si x separat e approache s t o it s impact on imports and exports, the majority of which conclude that its result is a priori indeterminate . Th e monetarist approach tells us that devaluation has no permanent effect at all except in so far as it reduces the "real money supply." 29 All of this suggests that experts do not agree, to say the least. Ten year s ag o thi s highl y restrictiv e mode l o f economi c behavio r upo n which th e structura l adjustmen t medicin e i s base d wa s i n disfavo r i n th e economics profession. I n recent years, with the rise of right-wing politics in the Unite d State s an d Grea t Britai n i t ha s com e bac k int o vogue . Bu t it s resurgence i s no t th e consequenc e o f findin g solution s t o it s fundamenta l theoretical difficulties, but rather the result of a change in political climate that has made its ideological implications more functional. Ther e is no compelling theoretical o r intellectual reaso n t o adop t th e polic y package . No r i s ther e much reaso n o n empirica l grounds . Th e experienc e o f "market-oriented, " "outward-looking" macroeconomic regimes in recent years has been mixed.30 The theoretical and empirical judgment on the conservative policy package is negative ; ther e is littl e reason t o thin k tha t these policies woul d generat e growth any better than protectionist, nationalist-oriented policies. Why , then, is the policy package the new orthodoxy among the multilateral agencies? Th e answer i s quit e simple : Thi s i s no t a growth package ; rather , i t i s a polic y package designed t o minimize th e possibility o f loa n default. Wit h regard to debt repayment, it s strength and appeal lie precisely i n it not being a growth package. 27. Th e debat e ove r whethe r lowe r wage s induc e mor e employmen t i s par t o f th e "capita l controversy" in economic theory, and is treated in the context of short-ru n macroeconomic models in Weeks (forthcoming) . 28. Th e hypothesi s tha t th e availabilit y o f mone y adjust s automaticall y t o it s deman d ha s theoretical credential s a t leas t equa l t o th e hypothesis tha t ther e i s a money suppl y determine d independently of the demand for money. 29. Th e "monetaris t approac h t o the balanc e o f payments " denie s that devaluatio n ca n alte r domestic relative prices (Ghani 1984:7-12). 30. Se e the analyse s o f Chile , Argentina , an d Urugua y i n Foxle y (1982) ; se e also Fishlo w (1985: 133-142) . Th e Fishlow article provides a thorough and balanced critique of the free marke t orthodoxy prevalent in the IMF.

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The structura l adjustment/liberalizatio n packag e i s essentiall y a n outputreducing policy . I f ther e i s on e economi c relationshi p fo r whic h ther e i s general agreement among economists and considerable empirical support, it is that if an economy i s depressed sufficiently, ther e will come a point at which exports excee d imports . Thi s remedy , whic h som e critic s hav e calle d "leeching" after the nineteenth century medical practice of applying leeches to the sick t o extract "unhealth y blood," does no t always work ; and sometime s when it does work it requires a catastrophic decline in production to achieve its desired effect However , it does work with great regularity, making it a leastrisk choice for the financial community . Th e goal is to ensure that debts are repaid in full. I f a balance of payments surplu s (th e necessary conditio n fo r debt repayment) is more likely to be achieved through depression or stagnation of economie s tha n throug h growt h (whic h i s probabl y correc t unde r present world market conditions), then depression or stagnation it must be. The stabilizatio n packag e i s directl y deflationar y throug h it s stres s upo n cutting government expenditure . Argument s about the inflationary impac t of fiscal deficits are purely window dressing. Fo r example, the IMF set for Costa Rica a government deficit targe t of les s tha n 2 percent of GD P as conditionality a t a tim e whe n th e actua l Cost a Rica n defici t wa s alread y on e o f th e lowest in the hemisphere relative to national product 31 Wag e restraint has the same effect. Eve n more deflationary is the demand that economies be "opened." The consequenc e o f thi s i s t o driv e ou t o f operatio n impor t substitutio n industries, thu s reducin g th e deman d fo r importe d inputs . A t thi s point , devaluation becomes functional. Withou t devaluation, the collapse of domestic industry might result in a flood o f import s to replace commodities previousl y produced locally. Devaluatio n generate s inflation i n the prices of imports , as well as a regressive redistribution of income, which lowers aggregate demand. It migh t als o b e note d tha t liberalizatio n policie s hav e th e side-effec t o f undermining regional economi c integration , such as the Andean Pact and the Central American Commo n Market, a result consistent with preventing Latin American cooperation on debt issues. The hypothesis tha t throwing oneself a t the tender mercy of worl d market forces will result in debt repayment and prosperity is hardly convincing. Wer e it s o simple , th e government s o f developin g countrie s woul d hav e followe d such a policy cours e lon g ago. Th e IMF has been singin g th e praises of th e free market-liberalization strategy for forty years, and a mid 1980s policy paper reports that not only does this medicine work relatively painlessly, it also has

31. Fo r a discussion of the Costa Rican case, see Weeks (1985b).

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equitable distributiona l effect s (IM F 1985b). 32 I f this is true , one is left t o wonder wh y fe w government s eve r apply i t except unde r duress. Eithe r the patients ar e exceedingly stupi d o r the medicine i s no t the wonde r drug i t i s advertised t o be . Perhap s policymaker s i n Lati n Americ a hav e note d tha t governments hav e returned to the IMF for the same treatment up to nineteen times sinc e th e end of WWI I with n o obvious improvemen t i n th e health o f their economies (Weave r and Wachtel 1984) . Finally , on e must be skeptica l about a policy package that proposes deregulation with regard to one part of the economy (productio n and distribution), and massive government interventio n with regard to another part (private external debt).

CONCLUSION It has not been uncommon in world history for the victors in wars to demand reparations o f th e defeated, tw o notable examples bein g th e Franco-Prussian War and World War I. Thes e reparations represented unrequited transfers forced upon the vanquished, enforced by the threat of punitive sanctions. A t the risk of entering into polemics similar to those invoked by the supporters of current international polic y (wit h thei r vision s o f financial apocalypse) , th e current payments crisis can be likened to war reparations. Onc e the world economic environment turned dramatically unfavorable to creditors and borrowers around 1980, the issue became how losses would be apportioned. Becaus e borrowers and lenders had contracted jointly, a joint sharing of losses would not have been inappropriate; indeed, theory suggests that a competitive market solution would have produce d suc h a n outcome . I n plac e o f this , th e internationa l bank s embarked upo n a conflict strateg y designe d t o shif t a s muc h o f th e los s t o debtors as would be possible. Wha t then ensued was a financial war in which the debtors lost , ofte n ignominiously , an d were forced t o declare somethin g close to unconditional surrender . I f the war analogy seems too farfetched, one might refer t o variou s calculation s o f th e debt service burde n of developin g countries compared to the reparations paid by France in the 1870s and Germany in the 1920s (Devlin 1987 : 81-82; Fishlow 1985 : 142). Fo r African countries, one ca n not e tha t th e ne t flo w o f IM F fund s ha s bee n a negativ e US$2.2 5 billion fro m 198 5 t o 198 7 (Unite d Nation s 1986 b an d 1988b : 12) . Th e 32. Recentl y the IMF seems to have in part accepted the argument of its critics that its programs harm the poor. I t was reported in the Wall Street Journal on June 1 , 1988, (p. 7), "A report from the International Monetary Fund acknowledges that poor people have been hurt by policies it has pressed o n Third World countrie s wit h the suppor t o f th e U.S. " I t was not possible t o obtain a copy of this report before this volume went to press.

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decision befor e th e internationa l communit y i n th e lat e 1980 s i s whethe r t o continue to enforce reparations or to declare an end to conflict an d pursue an enlightened and magnanimous policy toward the vanquished. Ke y to ending the conflict woul d b e fo r th e multilatera l t o pla y a neutra l role , rathe r tha n facilitating the monopoly intervention of international banks.

11 TH E DEB T CRISI S 11 AN D COMMERCIA L BANKS

Among th e mos t stimulatin g an d thought-provoking session s o f th e semina r that produced this book were those dealing with the debt crisis and structural adjustment programs fro m th e perspective o f th e private commercia l banks . Both essays in this section demonstrate why this was the case. In a paper that should be read by all who hope for a renewal of bank lending to developin g countries , Kari n Lissaker s i n Chapte r 4 carefull y trace s th e institutional and attitudinal changes in the private financial secto r over the last decade. He r analysis i s bot h fascinatin g an d profoundly depressing , fo r i t convincingly demonstrates that even before the debt crisis began, private banks were shiftin g thei r prioritie s awa y fro m lendin g t o developin g countries — indeed, away from traditional lending as such. A clear conclusion can be drawn from he r chapter : "Fresh " lendin g t o developin g countrie s wil l no t b e forthcoming withou t strong policy interventio n by governments of develope d countries (and perhaps not even then). This view , tha t banks ar e inexorabl y divestin g themselve s o f "sovereig n debt," is pursued further by Paul M. Sacks and Chris Canavan in Chapter 5. I n their analysis , a s i n tha t o f Lissakers , i t i s no t a questio n o f whethe r th e commercial bank s wil l abando n th e Thir d Worl d t o it s fate , bu t whe n an d whether it will be an "orderly" process. Chapter s 4 and 5 set the stage for the proposals in Part IV; particular y relevant is the proposal by Osvaldo Sunkel, outlined in Chapter 15, to convert debt service to development expenditure. 65

4

BACKGROUND T O TH E DEBT CRISIS : STRUCTURA L ADJUSTMENT I N TH E FINANCIAL MARKET S Karin Lissakers

Post-1982 analyses of the debt crisis and the search for a solution have focused on the economic successes and failures of debtor countries. Fa r less attention has been given to major structural changes in international financialmarkets in this decade, changes that have come about coincidentally with the debt crisis but not necessarily because of it, changes that will have a direct and profound impact on its resolution. Beginning in 1979-1980, there was a series of events—of which the Mexican moratorium is only one—that created a set of conditions in world financial markets fundamentally differen t from the conditions that prevailed in the 1970s. I argue that structural changes in the markets are one of the factors tha t triggered the debt crisis, and that failure to recognize the long-term implications of these changes has led to the adoption of a debt strategy that was doomed to fail. THE CRISI S International economic conditions turned against developing countries in the early 1980 s and hit Latin Americ a particularly hard : (1) dollar interest rates went through the roof, (2) the industrial economies suffered recession , and (3) 67

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oil prices weakened . Th e first developmen t increased the cost of servicin g outstanding commercia l debt , whil e th e secon d an d thir d condition s mad e earning foreign exchang e through exports much more difficult. Wors t of all, banks tha t i n the late 1970 s had been willin g t o finance an ever-increasin g proportion of the major borrowers' debt servicing costs stopped lending. The simple explanation for the banks' sudden disenchantment with sovereign lending is that a large number of sovereign borrowers have gone bust or very nearly don e so . However , on e ca n tur n thi s statemen t o n it s head : Thes e countries are in financialstraits in part because commercial bank funds are no longer flowing . Foreig n ban k credi t ha s drie d u p because th e underlyin g macroeconomic, institutional, and regulatory conditions that drove the banks heavily into cross-border lending in the 1970s are no longer present. The increasing reluctance of financial markets to extend credit was apparent even before August 1982. Th e Falkland (Malvinas) War is often sai d to have been the shock that triggered the loss of bank confidence i n Latin American borrowers, but Argentina was in fact on the brink of seeking a rescheduling a la Poland when it launched the invasion. Forme r Brazilian Finance Minister Luiz Carlos Bresser-Pereira reports that in late 1980 and early 1981 , Brazil had extreme difficulty raisin g Euromarket loans and seriously considered going to the International Monetary Fund. Ironically , Citibank, as well as other larger creditors, talked Brazil out of doing so, arguing that going to the Fund would further damage Brazil's credit standing (Moreira 1986 : 31). An d the syndication of a $250 million Eurodollar loan for Mexico in spring 198 2 was successful onl y because Mexican banks in the U.S. picked up part of that loan (Kraf t 1984 : 37). Overall , international financialmarkets during this period were expressing their doubts by steadily shortening maturities on large sovereign borrowers. Since 1982 , OECD-based bank lending outside the region, even to nonrescheduling countries , ha s decline d dramatically . Foreig n asset s ar e a shrinking part of U.S. banks' total loan portfolio: loan s outstanding to Latin America have fallen 1 0 percent since their 1984 peak, loans to OPEC are down 39 percent from their peak in 1983, and loans to Asia have fallen by 45 percent since 198 3 (Merrill Lynch 1988) . Th e reasons for th e decline are far mor e complex than just the economic woes of some major debtor countries. CHANGES I N FINANCIA L MARKET S Sovereign lending ebbs and flows with the tide of world finance. Tha t tide now flows in a different directio n and through different channel s than it did in the 1970s. OPEC , whose financial surpluses fueled the surge in international bank

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lending i n th e 1970s , no w ha s to o muc h oi l an d to o littl e cash . Japa n ha s become th e world's largest capital exporter, the United States has become the largest capital importer, and the industrial countries as a group are net takers of funds rather than net suppliers to the rest of the world. Japanese investors have investment preferences fa r different from those of the oil sheiks. Th e oil states placed a substantial part of their savings as shortterm deposits with U.S. and European banks, which converted them into longterm claim s o n othe r developin g countries . Th e Japanes e surplu s i s bein g channeled mainl y throug h securitie s market s int o long-term claim s o n other industrial countries. Seventy-fiv e percen t of th e long-term capita l flo w fro m Japan fro m 198 1 t o 198 7 wa s i n securities , primaril y bonds , an d direc t investments. Th e overwhelming amoun t flowe d t o th e United State s and to Europe—and stayed there. Th e United States alone accounted for 50 percent of the foreign bonds purchased by Japanese investors. Th e U.S., with large twin budget and trade deficits, canno t afford t o intermediate thes e fund s t o Latin America (except to the extent our Japanese loans help pay for our imports from Latin America and other debtor countries with whom we have a trade deficit).1 Japanese banks have played an important intermediation role, not as lenders of Japanese savings to the rest of the world, but as net borrowers o f short-term funds abroad which are relent at home. Suc h loans enable Japanese investors to hedge th e currency ris k o n thei r long-ter m foreig n investments , particularl y dollar investments , b y takin g o n short-ter m foreig n currenc y liabilities . Recently Japan' s capita l export s hav e actuall y exceede d it s curren t accoun t deficit, which means that Japan is in effect recyclin g surplu s savings from the rest of the world to the United States. Bu t recycling in the 1980s largely leaves the troubled debtor countries out of the circle, and to an extent shuts out the big multinational banks as well. There ar e othe r force s turnin g financia l flow s awa y fro m developin g countries. Worl d financial market s have undergone rapid and dramatic change since 1979 . "Globa l Bang " is wha t the Financial Times call s th e sweepin g away of geographic, institutional, and regulatory boundaries withi n the financial service s industr y tha t is takin g place i n every majo r money cente r from London (where deregulation of the stock exchange in October 1986 was dubbed "Big Bang") to Tokyo, New York, and Amsterdam. Th e technology of finan cial service s ha s undergone an electronic revolution , and governments are for reasons of necessity scrapping , rewriting, or ignoring the rules that controlled the industry since the Depression, regulations which delineated national markets 1. Japanes e investment from Bank of Japan as reported in Salomon Brothers (1985) and AMEX Bank Review (1988).

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and distinguished th e providers o f on e typ e of servic e from another, insurers from stockbrokers , lender s from underwriters, foreig n bank s fro m domesti c banks. Ever y existing or aspiring player is having to reorganize, restaff, and rethink it s position i n th e marke t in response t o thes e recent and impendin g changes. Global deregulation means that banks will increasingly be allowed to do the kind of business at home and in the domestic markets of other industrial countries that was previously permitted only in the special context of cross-borde r lending, if a t all. Th e regulatory line s o f demarcatio n tha t distinguished th e "international" Eurocurrency markets from national, "domestic" financial markets are becoming blurred or erased altogether and the "regulatory differential" favoring the international credit markets over domestic markets is disappearing. Among the attractions of overseas markets for American banks in the 1960s and 1970 s wer e th e right s t o ope n multipl e branche s (wit h th e Fed' s permission) an d engage in certain investment banking activities prohibited at home, plus th e absence o f reserv e requirements an d interest rate ceilings o n Eurodollar deposits. Bu t in the 1980s, domestic regional interstate banking has become a reality, and national interstate banking is waiting in the wings. Th e Glass-Steagall Act, which separates commercial from investment and merchant banking i n th e United States , i s unde r assault. Eve n a s Congres s consider s scrapping the 1930 s reform act, the law is being circumvented with increasing frequency an d apparent impunity. I n 1980 , Congress passed th e Depositor y Institutions Deregulation and Monetary Control Act, which drastically lowered reserve requirements and phased out "Reg Q" interest rate ceilings on domestic deposits. Th e hom e marke t suddenl y look s a lot mor e attractiv e t o th e bi g American banks , an d tha t i s reflecte d i n thei r spat e o f ne w activitie s an d acquisitions, fro m Banker s Trus t winnin g cour t approva l t o underwrit e commercial paper to Chemical Bank buying Texas Commerce Bank (and all its troubles), which would not have been possible five years ago. Liberalization is not limited to the United States. Germany , Japan, Britain, Canada, Australia, the Scandinavian countries , and others, began dismantlin g post-war capital controls in 197 9 so that their citizens may more freely borrow and lend outside thei r borders. Sinc e 1980 , Australia, Norway, Sweden , and Portugal have decided to let in foreign banks; Canada has raised the ceiling on domestic bank assets that can be held by foreign banks; and Britain, Germany, and Japan have announced measures that will substantially increase the range of domestic banking activities in which foreign banks may engage and broaden the international role of th e mark and the yen. Foreig n banks are now allowed to own seats on the Tokyo stock exchange. Foreig n banks are for the first time able t o dea l i n Japanes e governmen t securities , lea d manage bon d issues i n

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Japan an d th e Euroyen market , d o trus t banking , an d offe r Euroye n CDs , among other things. 2 Similarly , Germany now permits foreign banks to lead manage mark denominated bonds and allows new mark instruments such as floating rate and zero coupon bonds (Tagliabue 1985). I n early 1985 , Bank of America became the first foreign ban k to manage a public sterling securities issue for sale to British investors, while Citicorp became the first foreign bank to take control of one of the Bank of England's nine money market agents and the first to function a s a clearing bank in Britain (Winkler 1985). Th e Bank of England has opened th e way for foreig n bank s to acquire building and loan societies, whil e a t th e sam e tim e expandin g th e powers o f suc h mortgag e finance companies . An d U.K. and foreign bank s have brought up London's largest stockbrokerage s t o take advantage o f liberalizatio n o f th e securitie s market there. The net effec t o f al l thes e changes , according t o Wall Stree t economis t Henry Kaufman, late of Salomon Brothers: The tren d o f commercia l banks , therefore , i s takin g a strang e turn . Th e regulations prevailing durin g the sixties an d seventies contribute d towar d an outward searc h fo r growth , th e massive increas e i n debt of les s develope d countries, an d th e overextensio n o f internationa l credit . I n contrast , th e deregulation of financia l institution s is now turning bank lending inwar d and limiting th e availabilit y o f fund s internationally , wher e th e need fo r credi t remains urgent.3

"Globalization" i s a misnomer. S o far, international financia l integratio n has been limited to markets in the industrial countries. Tha t is the turf banks and other financial intermediaries are now marshaling their force fight over. LDCs meanwhile are put on the back burner except when some flare-up of the debt issue forces them out front. FINANCIAL MARKET S AN D DEVELOPIN G COUNTRIES While market liberalization is making banking in the industrial countries more attractive, a simultaneous tightenin g o f certain regulations is making crossborder lending to developing countries decidedly less so. Thes e changes include 2. Se e statement of Donald T. Regan, Secretary of the Treasury, before the Committee on Banking, Housing and Urban Affairs, United States Senate, September 26,1984. 3. H . Kaufman (1986:101).

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new capital requirements, more public disclosure of foreign loan exposure, and changes in tax laws. U.S. regulations put firm minimum capital requirements on large banks for the first tim e in 1983 . Man y banks ha d to raise equity o r long-term deb t to slow the accumulation of assets (loans) and to meet the new capital/asset ratio. Then in 1987 , U.S., British, Japanese, and other industrial country regulators, presented a joint agreement to impose uniform "risk weighted" capital adequacy requirements tha t not only tighte n th e definitio n o f capita l bu t als o includ e many off-balance shee t items in the denominator. Th e new requirements will be phased i n until 1992 . Keefe , Bruyette , an d Woods, bank stoc k analysts , estimate tha t twenty-six larg e U.S. banks would have to dispose o f asset s or issue new common stock if these standards were effective immediatel y (Sha w 1988). Britis h and Japanese banks, among others, will probably als o have to add capital relative to assets in order to meet the new requirements. Th e capital situation is further complicated by last year's large addition to general loan loss reserves against Third World debt Som e of these reserves came out of equity, but under the old rules were still considered primary capital for capital adequacy purposes. No w th e central bank s have decided tha t after a transition perio d general provisions will no longer count as core primary capital. The price o f ne w ban k capita l ma y be quit e hig h a s rating agencie s an d investors have become increasingly skeptical about the viability of Third World loans. Amon g American money center banks, only Morgan is currently rated AAA, an d a t leas t on e larg e ban k ha s slippe d s o fa r i n th e rank s tha t i t i s having t o pay mor e tha n Mexic o fo r long-term funds . Th e smal l secondar y market for Third World loans that developed as an escape valve for the banking system came back to bite the big banks by setting a price on this paper that all could see , thereb y puttin g a valu e o n th e banks' loan portfolios withou t th e banks formally "markin g to market." Bi g bank stocks trailed the run-up in the bull market and have lagged the S&P 500 recovery since the October 19 crash. Worse, stocks of regional banks, which pose increasingly seriou s competition for the money centers in the era of deregulation and are not as burdened with Third World exposure, have been selling at a far higher price/earnings ratio than the money centers. Recent changes in tax and accounting rules also affect the banks' cost/benefit analysis of carryin g LDC loans. Th e alternative minimum corporat e tax imposed by th e 198 6 Tax Reform Ac t and the interruption i n interest payments from countries like Brazil may make it difficult fo r banks to fully realiz e the tax benefits of LDC loans. A t the same time, revised accounting standards are limiting the ability of banks to report anticipated tax benefits o n their income statements before tax losses are actually realized. Becaus e the IRS only grants

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tax deductions fo r losse s actuall y take n (loa n write-offs) , th e large loa n los s reserves taken by U.S. banks last year now yield no tax benefits at all, in either real o r accounting terms. 4 U.S . banks are at this point asking themselves: If loan loss reserves will not count as primary capital, will not reassure investors, and will not yield any tax benefits, what is the point of having them? These changes affect different banks differently, depending on relative loan exposure, capital base, and mix of domestic and international earnings. Thes e differing effect s ma y in turn explain th e growing divisivenes s i n the banking community ove r how t o proceed in managing the international deb t problem. Taken togethe r th e regulatory , tax , an d accountin g change s probabl y mak e holding th e LD C asset s t o maturit y les s attractiv e fo r man y bank s tha n securitization or even write-offs. And, significantl y i n the context o f th e current debate over debt strategy, these change s als o di m th e prospect s fo r an y resumptio n o f large-scal e "voluntary" lending by the banks to Third World countries. Thus , the original debt strateg y an d th e Bake r modification , whic h presume d jus t suc h a resumption of lending once debtor countries had "adjusted," is based on a false premise. Th e current debt strategy, which is supposedly "market based," is not that a t all. I t i n fac t run s directl y contrar y t o current , stron g trend s i n th e financial markets : agains t balanc e o f payment s flows , agains t capital constraints o n the banks, against the negative investo r attitude toward banks with large Third World loan exposures, and against the new opportunities and competitive pressures for banks at home. A ver y differen t approac h wil l b e neede d t o solv e th e debt problem—a n approach tha t take s thes e "structura l adjustments " i n financial market s int o consideration. Lookin g beyond the debt issue, a very different approac h wil l have t o b e take n b y developin g countrie s t o regai n acces s t o internationa l capital. A restoration of the status quo ante is not in the cards.

4. Befor e the accounting rule changes (which the banks are fighting), banks could boost reported post-tax earnings in a given year by "anticipating" future tax loan loss deductions on their income statements, even thoug h the actua l loss—and th e actual tax deduction—migh t not be taken until several years later.

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SAFE PASSAG E THROUG H DIRE STRAITS : MANAGIN G AN ORDERL Y EXI T FRO M THE DEB T CRISI S Paul M. Sacks and Chris Canavan

In the last year, a growing number of experts and participants have concluded that the debt crisis is worsening. The y cite militance of debtor countries, some of whic h hav e halte d interes t payments , a n even t tha t shoo k th e world' s financial syste m when threatened by Mexico in 1982 . Bank s have displayed equal drama : Citibank , America' s larges t bank, too k record losse s i n 1987 , claiming that Brazil's moratorium had forced its hand. I n the minds of many, these event s conjur e u p image s o f a process unravellin g beyon d anyone' s control. Despite thi s apparen t anarchy , th e debt crisi s ha s a distinct logic . Th e market that interlocks commercial banks and Third World debtor countries has changed markedly, but it has become no more unruly. I n our opinion, the rules have simply changed, and the new rules must be understood if the debt crisis is to be managed properly. Thos e who fear a chaotic deterioration may be vindicated in the end, but only if the players in this drama continue to behave as if the market has not changed. W e can understand these new rules if we compare them t o the earlier phases of th e debt crisis, which includ e the competitiv e entry phase that began in the early 1970s and the freeze phase brought about by the Mexican crisis of 1982. 75

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THE FIRS T PHAS E The first distinctive phase, which we call the competitive entry phase, began in the early 1970s , sparked by an economic shock with which we are all familiar. The first oil price shock drastically shifted the profile of international liquidity, creating huge current account deficits in poorer regions of the world and cash gluts in the banking systems of the richer nations. Al l at once, the demand for international credi t ros e i n th e Sout h an d th e suppl y ros e i n th e North. A process we called "petrodollar recycling" began to roll, gathering steam over the course of the decade. Nonoi l developing countries increased their borrowings (total bonds and credits) from $8.8 billion i n 197 3 to $18.9 billion i n 1976. International earnings of the top thirteen U.S. banks grew at an annual compound rat e o f 36. 4 percen t betwee n 197 0 an d 1975 , while thei r domesti c earnings only grew by .7 percent (Subcommittee on Foreign Economic Policy 1977). The boom i n lendin g altere d th e structur e of th e sovereign loa n market . What had been an oligopolistic market, controlled by a handful of large banks, was now much more competitive. Bank s that had little or no previous experience in the market quickly developed large portfolios of sovereign loans. The y found the market much easier to enter. W e are taught in introductory economics that a market becomes more competitive when lower barriers to entry allow smal l an d novic e firm s t o cu t awa y a t th e marke t shar e o f larger , established firms. Thi s is not quite what occurred in the sovereign loan market. Barriers to entry did fall, but in a manner controlled entirely by the large banks. What were the barriers to entry? Smal l banks stayed out of the sovereign loan market for two reasons. First , when countries requested credit, they asked for sum s far large r tha n wha t smal l banks could provide . Second , puttin g together such a loan taxed even the most sophisticated international banks and was beyon d th e capabilitie s o f a smal l ban k familia r onl y wit h domesti c markets. Th e syndicated loan eliminated these thresholds. Smal l banks were able to take on a piece of a loan commensurate with their size and could rely on the large banks to arrange and manage the loan. Competition in this market grew more fierce toward the end of the decade, which too k a tol l o n th e risk-pricin g mechanis m withi n th e banks . Th e difference betwee n th e interes t spread s charge d t o high-ris k an d low-ris k countries thinned as banks vied for the business of arranging loans to LDCs. In 1973, the average contractual fees on medium-term loans were .25 percent to 1 percent for develope d countries , compared t o 2 percent to 2.5 percent fo r developing countries. B y 1975, the spread for developed countries had risen to 1.5 percent, while for developing countries it had fallen from 1. 5 percent to 2.5

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percent (Subcommittee on Foreign Economic Policy 1977) . Fallin g spreads on developing loans were clues that banks were underestimating the risk to which they were exposed. In hindsight, i t should come a s no surprise that banks underestimated th e risk they faced. Whe n analysts and line officers calculate d the risk premium of a loan, they were in effect tryin g to measure the probability of events that had not occurred in recent memory. I n the previous two decades, there had been no large-scale defaults . Thos e banker s wh o remembere d th e deb t crisi s immediately following Worl d War II had long since passed away. Banker s in the mi d 1970 s wer e afflicte d wit h "disaste r myopia. " Furthermore , ris k analysts a t banks wer e unde r pressure t o minimiz e pessimisti c assessments , because this went against the sentiment of line officers whos e primary purpose was to book loans. Withi n the banks, the politics of sovereign lending favored those who blessed what was quite a profitable business. Ther e was still a third reason fo r underestimatin g ris k an d shavin g basi s point s of f interes t rat e spreads: large banks were earning revenue not only from interest payments but from fees paid for arranging and managing the loans, fees paid long before the loan's maturity . Ther e was les s incentiv e t o calculate th e interest rate accurately because management and commitment fees could make up the difference. Average commitment fees grew from .2 5 percent to .75 percent between 197 3 and 1975 , an d managemen t fee s gre w fro m ni l t o . 5 percen t ove r th e sam e period (Subcommittee on Foreign Economic Policy 1977 ) These were the rules of th e first phase of th e debt crisis, but they changed abruptly b y Augus t 1982 . A secon d oi l pric e hik e i n 197 9 create d furthe r demand for credit, but stretched the ability of borrowing countrie s t o service debt they had already contracted. Th e unprecedented rise in interest rates strained their liquidity. Th e crisis in Poland signaled t o some banks that a debt crisis was not so farfetched. Whe n Mexico announced it could no longer service its external debt without outside help, the petrodollar recycling process came to a crashing halt, and the second phase of the debt crisis commenced.

THE SECON D PHAS E The Mexica n crisi s o f summe r 198 2 wa s a cas e stud y i n financia l marke t failure. Presiden t Lopez Portillo reminded the world that financial markets are sensitive to that very mercurial commodity known as confidence. On e hint that this confidenc e migh t be misplaced , an d a marke t can freeze . Onc e bank s doubted that sovereign borrowers had sufficient liquidity , they stopped providing that liquidity, creating a self-fulfilling prophec y o f enormou s magnitude .

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With the freeze came an abrupt change in the rules of the market A s soon as banks realized that they were locked into bad exposure, it became apparent that sovereign lending was far from an ideal competitive market. Whil e there may have been somethin g aki n t o free entry durin g th e competitive entr y phase , there wa s littl e genuin e fre e exit . Onc e a bank mad e a five-yea r loa n t o a country, i t ha d little choic e bu t to hold on to thi s exposur e fo r the full ter m because there was no secondary market in which the asset could be liquidated. In th e first phas e thi s mad e littl e difference ; i n th e secon d phas e thi s wa s critically important. Trapped betwee n illiqui d LD C borrower s o n on e side an d a n illiqui d secondary marke t on the other, banks had little choice but to cooperate wit h each othe r t o maintai n a modicu m o f stability . A perio d o f unprecedente d collusion bega n betwee n larg e an d smal l banks , U.S . an d non-U.S . banks , banks and governments, and banks and multilateral organizations . Collusio n took place despite important differences in regulation and accounting standards which place d banks i n relatively differen t position s vis-a-vi s debto r nations. Several factor s motivate d thi s collusion. On e was the distinct perception on the part of bank s tha t short-ter m sacrifice s woul d revive th e sovereig n loa n market and restore it to its original condition. Ther e was also the newly found religion tha t said tha t macroeconomic disciplin e woul d pu t countries o n the right track. Banks unwillin g t o collude face d stee p costs. Eve n thoug h th e free-ride r issue wa s discusse d avidl y i n th e early year s of th e debt crisis, i t was no t a serious problem . Mos t banks genuinel y believe d tha t i f thei r intransigenc y undermined a debt agreement, a country's inability t o make interest payments could cause unparalleled damage to the bank's capital base. Bank s not persuaded by this argument came under fire from thei r respective centra l banks and the large banks in their domicile. Mos t of the time this pressure sufficed t o secure agreements. For five years, banks and governments behaved according to the rules of the freeze phase . Thes e rule s wer e ver y effectiv e i n achievin g thei r firs t goal , averting financial disaster , but they were less capable of securing their second objective, t o bring th e crisis t o an end. A proposition o n whic h thes e rule s were based was faulty. Thes e rules said, in effect, that through a high degree of collusion, governments and banks could reverse the tide of markets. Nowher e was thi s propositio n mor e explicitl y lai d ou t tha n i n th e Bake r Initiativ e o f 1985, i n whic h U.S . Treasur y Secretar y Jame s A . Bake r II I asked bank s t o increase their exposure to the fifteen most indebted developing countries while governmental institution s woul d d o th e same . Bu t th e paltr y result s tha t followed th e Initiative suggeste d that, in fact, government s an d banks would

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not be able to reverse the market. Thi s was the first indication that the rules of the game were changing, and that we were on the eve of a new phase in the debt crisis. Various unrelated factors concurred to change the banks* perception of the debt crisis. On e was the secular move by commercial banks, especially i n the United States , away fro m ter m lendin g altogether . LDC s wer e no t the onl y borrowers havin g troubl e meeting thei r obligations: U.S. farmers , real estat e moguls, an d oil rigger s als o struggled . A t th e sam e time , th e Euromarket s were throwin g u p a cornucopi a o f ne w financial instrument s tha t allowe d borrowers to bypass commercial banks and tap directly into the capital markets. If bank s wer e goin g t o kee p u p wit h th e times , the y woul d hav e t o adop t merchant banking strategies and compete squarely against investment banks, at least to the extent that the Glass-Steagall regulations allowed.1 Thes e were the days when Bankers Trust publicly considered giving up its commercial banking charter an d enterin g wholeheartedl y int o investmen t banking . Regulator y changes encouraged this. B y forcing banks to improve their capital adequacy, bank regulators increased th e cost of adding new asset s t o a bank's portfolio, because more capital would have to be allocated against these assets. Instead , banks sough t ways t o earn fee-income rathe r than interest income, muc h th e same way an investment bank operates. Traditiona l commercial bank lending was no longer as attractive. Powerful ne w constituencie s emerge d insid e bank s aroun d th e merchan t banking operations. The y wer e a new breed of commercia l banker, typically younger and often hire d from investmen t banks or law firms . Fo r them, the LDC deb t crisi s wa s nothin g mor e tha n a prison lockin g u p precious ban k capital tha t could be better allocated elsewhere. A s these constituencies grew stronger, so did their arguments for freeing up capital whatever the cost. Onl y with increasing difficult y coul d th e old guard stand up for a more moderated approach to the debt crisis. I f merchant banking changed the relative strength of camp s withi n commercia l banks , th e balance o f powe r among bank s wa s jolted by the fall in the value of the dollar. Th e second Baker "initiative," the managed depreciatio n o f th e dollar, left U.S . bank s holdin g th e bag a s nonAmerican institutions found their dollar-denominated assets shrinking in terms of bot h ris k an d return. Foreig n bank s became les s concerne d wit h dollar denominated sovereig n deb t problem s an d mor e concerne d with takin g competitive advantage of weakened American banks. Dollar-base d banks saw

1. Th e Glass-Steagall Ac t of the 1930 s established a set of regulations limiting the activities in which commercial banks could engage.

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with some alarm their competitive positions eroding as foreign bank s began moving in fromtheir enhanced financialpositions. These centrifugal forces—merchan t bankin g an d th e fall i n th e dollar— guaranteed the failure of the Baker Initiative. The y were the backdrop against which entreaties from the United States for increased bank lending fell on deaf ears. The y dealt a decisive blow to the proposition tha t governments could reverse th e movement of markets . I t was another proposition o f th e Baker Initiative that survived. Secretar y Baker argued that the best way forward was to keep lending. Th e banks agreed, but for a different reason . H e was hoping that greate r lending would revive the sovereig n loa n market , but th e banks believed tha t their only chanc e of exiting the market was to keep countries afloat lon g enoug h t o pul l out . Bake r aske d fo r renewe d loyalt y t o th e sovereign loa n market . Bank s were trying to keep the exit door open long enough to get out The rules of the game had changed subtly by the beginning of 1987, capped by Brazil's declaration of a moratorium. B y halting interest payments, Brazil ushered in what we refer t o as the competitive exit phase, with a new set of rules that govern the market today. An y viable plan to relieve the pressures of the debt crisis must be tailored to the new rules. RULES O F TH E GAM E I N TH E COMPETITIVE EXI T PHAS E The emergence of modest liquidity is the characteristic that distinguishes the exit phase from its two predecessors. Th e presence of a secondary market in LDC debt and a growing number of innovative transactions that make use of this market raise the possibility that banks might exit from th e sovereign debt market. Debt-for-deb t swaps allow banks to recompose their portfolios to their liking. Debt-for-equit y conversion s provide direct investors with a vehicle for cheap financing. Debtor countries can modestly reduce their debt obligations as well. Investmen t bankers have begun proposing methods to securitize debt— converting it into tradeable securities—which would inject additional liquidity into the market. But thi s liquidit y ha s cause d a s muc h worr y a s hope . Whil e th e press reports have nothing but good to say about the secondary market—the latest evidence that freemarkets can solve this debt situation—large banks, especially in the United States, have resisted participating in it. Liquidit y means that it would b e harde r t o kee p th e smalle r bank s i n th e game . A massiv e recomposition of portfolios is just another way of saying that those banks that

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can exit will do so, and those banks that cannot will be left holding more of the problem debt. Keepin g the smaller and non-U.S. banks in the game has taken on new urgency in the private dialogue among U.S. money center banks. In this increasingly complex environment, banks as well as debtor countries are given to unilateral actions. I n May 1987 , Citibank set aside $3 billion in loan loss reserves , presumably t o cushion th e bank against poor LDC loans. Bank of Boston publicly admitted to writing down Latin American exposure in December. Thes e actions, coupled with the Brazilian and Ecuadorean interest payments moratoria, legitimized moves that previously were considered out of bounds. Th e critical mass needed to restructure debt the old-fashioned way was crumbling. Underlying the exit phase is a new and more complicated matrix of motivations. Al l bank s woul d lik e t o ri d themselve s o f proble m loans , bu t the y approach this goal from increasingly divergent directions. Th e ease with which they can exit the market depends on a variety of factors, the most important of which ar e capital strength , leve l o f reserves , th e relativ e siz e o f thei r LDC portfolio, and the regulatory and accounting regimes in which they operate. Capital strengt h i s critical . A t th e onse t o f th e deb t crisis , U.S . ban k regulators wer e shocke d b y th e amount o f capita l jeopardized by th e larges t LDC borrowers. I n mid 1982 , credits to Mexico represented 50 percent of the capital o f th e nin e larges t U.S . banks . Credit s t o Mexico , Argentina , an d Brazil combine d totale d 11 5 percen t o f th e capita l o f thes e bank s (Morga n Guaranty 1983) . Le d by th e Federal Reserve Bank , U.S. regulators began a campaign t o rais e th e ratio of primar y capita l t o assets . Betwee n 198 2 and 1986, U.S. money center banks increased their primary capital from 4.8 percent to 7.1 percent of total assets. Th e respective ratio for regional banks grew from 5.5 percent to 7 percent. Perhaps more critical was the market's perception of this capital. A t the end of 1982 , the median share of a money center bank was trading at 70 percent of its book value . B y th e end of 1986 , it had only improve d to 9 0 percent . A median share of a regional bank traded at 72 percent of book value at the end of 1982, bu t b y Decembe r 198 6 th e shar e ha d rise n t o 13 1 percen t (Morga n Guaranty 1983) . Regiona l banks have gained a more healthy reputation, which improves their prospects for raising new capital if they so choose. Exitin g the sovereign loa n marke t i s a mor e plausibl e optio n becaus e th e los s ca n b e absorbed more easily. Greater reserves also enable banks to contemplate exit more readily. Thi s is one o f th e importan t difference s betwee n U.S . bank s an d banks fro m othe r countries, in particular Germany and Japan. U.S . banks tend to hold relatively low levels of reserves because of the great costs to holding these funds idle. I n

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Germany and Japan, banks may also have modest levels o f explici t reserves, but they hol d so-called "hidde n reserves," unrealized gains in their securities portfolios that can be used to absorb losses without causing serious distress to the balance sheet. Another facto r distinguishin g bank s from eac h other is th e importance o f LDC loans i n their portfolio. Obviously , bank s with a greater proportion o f LDC loans cannot contemplate exit as readily as others because the off-ramp i s simply not wide enough to let all thes e assets out of th e market. Bank s also have strategic questions to resolve. Eve n if the sovereign loan business is dead, larger international banks still see markets in countries like Brazil and Mexico. Citibank, fo r example, i s inten t o n building a large branch syste m i n Brazil. To remain in good standing with the Brazilians, Citibank must tread carefully in negotiations over sovereign debt. Finally, banks operate in different regulatory and accounting regimes, some of whic h are more hostile to innovations tha t might relieve the debt problem. In the United States, it is costly for a bank to defer interest payments, so costly that U.S. banks would prefer to extend new loans to guarantee these payments. In Europe, regulators and auditors (and shareholders) are more willing to let a bank capitalize interest (converting the missed interest payment into principal). This i s on e o f th e ke y difference s tha t mad e i t harde r fo r U.S . bank s t o experiment with innovative options. Durin g the freeze phase, the rules of debt management wer e tailored, in the main, to the U.S. regime. Non-U.S . banks are requesting that these rules be changed so that they may take advantage of the benefits o f what is permitted within their regulatory environment. Regulator y rules ca n represent barriers t o exit fo r any give n bank . Thos e tha t face th e highest barrier s ar e U.S. mone y cente r banks . I n almost ever y categor y i n which the y are at a relative disadvantage , U.S. regional bank s are somewhat better off. Germa n and Japanese banks are in a much stronger position, because of the weaker dollar and more forgiving regulatory and accounting systems. As bank s diverg e becaus e o f thei r differen t characteristics , s o d o thei r strategies. U.S . mone y cente r bank s canno t totall y exi t th e marke t an d therefore seek to minimize the liquidity and discounts on the secondary market. Smaller discount s represen t smalle r losse s whe n bank s us e th e secondar y market. Larg e discounts can "contaminate" portfolios, either because regulators and accountant s forc e bank s t o valu e asset s t o market , o r mor e subtl y i f shareholders discriminate against large portfolios o f heavily discounted assets. Large discounts also make it more difficult to negotiate with debtors. I t is hard to persuade shareholders that new commitments to a debtor country are worthy investments when, at the same time, the market treats the country as junk.

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Banks facing lower exit barriers take a somewhat different view. They , too, would lik e t o se e smal l discounts , but the y prefe r a secondar y marke t wit h maximum liquidity. Thi s would enable them to take advantage of the secondary market , and , becaus e the y ar e willin g t o tak e losse s tha t money cente r banks want to avoid, these banks hope that the secondary market could one day swallow their entire portfolios. Man y U.S. regional banks do not merely want to reduce their exposures, they want to eliminate them. But mone y cente r banks fea r liquidity . The y se e i n greater liquidity th e threat that they may be left holding the bulk of the exposure. I n this scenario, the task of meeting the foreign exchange needs of debtor countries would fall to a smal l numbe r of banks , and the costs of providin g thi s credit would grow . On some occasions, money center banks have had to contribute more than their pro rata share of ne w mone y package s t o make up for truant regional banks. U.S. regional banks are less and less sensitive to the entreaties and threats made by the U.S. government and the money center banks, and money center banks fear the possibility that this trend might accelerate. The motivation s o f debto r countrie s hav e change d somewha t a s well . During the freeze phase, they knew that to secure new loans and concessions they ha d t o showcas e thei r economie s i n glowin g terms . President s migh t bemoan the sorry economic state of their countries, but finance ministers were appending highl y optimisti c economi c forecast s t o th e ter m sheet s o f restructuring agreements . Th e rise of a secondary marke t had changed thei r strategic calculus . Larg e discount s ope n th e possibilit y o f deb t relief . A steeper discount encourages investors to redeem debt for conversion into equity. It might also allow debt to be swapped in a way that reduces total debt (as the recent Mexica n bon d issu e di d t o a limited extent) . I n th e extreme , a stee p discount migh t bring th e pric e o f deb t t o level s a t which th e countr y coul d afford to repurchase it In short , fro m a certai n perspectiv e a debto r country' s optima l strateg y might be to convince the market that its debt is utterly worthless. Bu t there are costs t o thi s strategy . B y issuin g pessimisti c economi c forecasts , a country jeopardizes it s access t o credit. Bank s woul d have more difficulty arrangin g new mone y packages . A discoun t coul d als o gro w s o larg e tha t i t woul d discourage relief. Onc e a bank has charged off th e bulk o f it s exposure t o a particular country , th e cost s o f holdin g o n t o th e deb t ar e relatively minor , though the country still owes the debt in full. Rathe r than selling the asset or swapping fo r equity , th e bank migh t calculat e tha t i t i s bette r t o gambl e o n future interest payments rather than liquidate the asset at a deep discount. Th e country woul d the n fin d tha t it s onl y rea l optio n wa s t o g o int o default , incurring a n onu s tha t mos t countrie s woul d rathe r avoid . Thus , i n th e

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competitive exit phase, countries face contradictory motivations. I t is virtually impossible t o discer n a strateg y tha t woul d maximiz e th e discoun t o n th e secondary market while avoiding the attendant costs. This new motivation matri x places banks trapped by high exit barriers in choppy waters . Othe r bank s ar e gettin g ou t o f th e market , o r a t leas t threatening to do so. Withi n their own institutions there are groups advocating exit at any cost. Countrie s are behaving according to ever more complicated motivations, and are therefore less predictable. I f the history of nonbanking sectors ha s an y pertinence , i t inform s u s tha t firm s trappe d i n declinin g industries engage in increasingly destructive competition. Bank s may follow suit by competing more fiercelyfor a competitive edge. Thi s might have been one of the motivations behind Citibank's addition to reserves. A s the largest bank in the U.S., it could afford t o set aside these reserves. Indeed , its stock prices increased afterwards, reversing the typical pattern. Othe r banks were forced t o follow bu t were in a much weaker position to do so. Anothe r such round of reserves accumulation could easily wipe out the net worth of one or two mone y cente r banks , makin g th e Continental Illinoi s debacl e pal e by comparison. I f such chaos broke out among banks, the political and financial stability of the large debtor countries would be threatened. Mos t of the major debtor countries still rely on commercial banks for credit from abroad, and to be deprived of it could mean a period of extreme austerity. MANAGING A N ORDERL Y EXI T While the competitive exit phase is operating accordin g t o a distinct se t of rules, it is poised to become chaotic. Fo r this reason there is a strong need to develop strategies to manage the exit phase in an orderly manner. W e submit that there is an important role to be played by public policymakers in the exit phase, though it is a moderated one . Policymaker s can make a contribution only i f the y conside r th e natur e o f th e exi t phase . First , w e offe r tw o propositions about the exit market that policymakers must keep in mind. Th e first is that the U.S. government, and OECD governments more generally, are at risk of having to shoulder an even greater share of development assistance given the exodus by banks from th e sovereign debt market. Th e public and private sectors have shared the burden of development financing to date, but as we look ahead to the 1990s , that burden could rest almost entirely on public shoulders. Give n the enormous pressure on OECD governments to reduce the size of the public sector, this burden can be ill-afforded. I n addition, capital flows from th e United States to LDCs are vital to supporting U.S. long-term

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commercial interest s in these countries. A n exodus by banks leaves the U.S. government a s lende r of firs t an d las t resort. I t is thu s i n th e U.S. nationa l interest to prevent a categorical an d panicked exit by commercial banks from the sovereign lending market. The second proposition is that policymakers can modify market behavior at the margin but cannot alter its direction . Thi s i s particularly th e case whe n financial intermediarie s ar e scattere d an d fragmented . Othe r tha n macro economic tool s suc h a s fisca l an d monetar y policy , policymaker s hav e tw o basic mechanisms : guarantees and regulation. Neithe r o f thes e can alte r the direction of markets, but they can exert an influence. To date , th e proposal s fro m policymaker s hav e no t heede d th e secon d proposition. Th e Baker Plan wa s a n explicit request that banks mov e i n th e opposite directio n fro m th e on e i n whic h the y wer e inclined . W e hav e mentioned th e reason wh y th e Baker Initiativ e failed . Bu t proposals fo r an International Deb t Managemen t Authorit y wer e equally flawe d becaus e the y asked banks to act collectively lon g after th e impetus to collude disappeared. These proposals may have succeeded at the high point of the second phase, but in th e presen t phas e the y ar e inappropriate . Instead , policymaker s shoul d realize tha t thei r greates t allie s i n th e exi t phas e ar e thos e bank s tha t fee l trapped, tha t is , th e larg e U.S . banks . Bot h OEC D government s an d thes e banks have similar interests, and could form a very influential strategi c alliance. In fact, large U.S. banks have already heeded the changes that have taken place i n the rules of th e game. Eve n thoug h the y woul d prefer no t to injec t liquidity int o the secondary market , they recognize reality. I f it is impossibl e to stop regional and non-U.S. banks from exiting, then the next best strategy is to structure this exit i n the least damaging way . Hence , money cente r banks have proposed a variety of ways that other banks might reduce their exposure, such a s the exit bonds in th e April 198 7 Argentin a rescheduling o r the bond issue devised b y Mexic o an d Morgan Guarant y i n Decembe r 1987 . Severa l other "alternative participation instruments " are being contemplated in private by the banks on the various steering committees. Policymaker s shoul d follo w the lead of trapped banks. The Mexican bond issu e was , i n man y ways , a model o f ho w publi c an d private actors could work together constructively durin g the exit phase. Th e program provided a mechanism fo r orderly exit by commercia l ban k players through the use of a government guarantee, but at no marginal cost to the taxpayer. I t also provided debt relief to our most important neighbor to the south, singling out Mexico for cushioning agains t a possible default. Also , the plan kept banks in the market because the collateral o n the bonds can be captured only afte r twent y years . Bu t there were also flaws i n the Mexico plan. Th e

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government guarantees were insufficient an d misplaced, because they should have applied to interest rather than principal. Anothe r flaw was that the players with th e larges t stake s an d highes t barrier s t o exi t wer e th e one s wh o leas t participated. Th e costs of exiting via the Mexican plan were still too high. The Mexico program was yet another example of the failure of policymakers to perceive clearly the broader consequences of the policy choices made in the context of th e exit market. I n particular, the SEC ruling providing that banks must adjus t thei r portfoli o t o th e bi d value, 2 eve n i f unsuccessful , wa s damaging an d short-sighted . Th e U.S . governmen t participate d i n a policy process that benefited ou r offshore neighbor s mor e than our own institutions, much the same way the weaker dollar has. How can policymakers shape the exit process in a way that will discourage the categorical abandonmen t of th e developing worl d by commercial banks ? They migh t d o s o b y tyin g th e stron g exi t curren t by bank s t o longer-rang e policy goals of the public sector. Rathe r than block the flow and cause disruption, the flow can be guided creatively and constructively. Th e initial step is to acknowledge tha t all players wan t to get out, and second, tha t recent rulings have made it harder for banks to exit and therefore have encouraged a disorderly exit process leading to mutually damaging behavior. Ta x changes and regulation that discourage loa n loss reserve s an d increase th e cost o f fund s hav e a deleterious effec t o n the banks involved i n the exit process. W e recommend that policies be fashioned in light of the new market realities. More appropriate regulation can provide safer passage out of the debt crisis to those banks that promise to maintain some presence in Latin America, such as givin g bank s a ta x advantag e i f the y increase d thei r trad e financ e i n a particular country. Thi s would allow a bank to exit from th e long-term deb t problem mor e easily, but the country in question would not lose access to the short-term trade credits that are desperately needed. B y granting a tax advantage here and a supportive ruling there , the U.S. governmen t ca n avoid havin g t o pump large sums of money into a debtor country when the banks have left for good. Bu t this is no t enough. Th e U.S. governmen t shoul d als o revive and assist the virtually moribund secondary market in LDC debt. Th e Mexico bond issue is a useful ste p in the right direction, but government policy crippled the plan wit h regulator y myopia . Simila r creativ e use s o f th e guarante e mechanism are steps in the right direction. We ar e witnessing th e twiligh t o f ban k lendin g t o developin g countries . This i s jus t on e par t o f th e overal l declin e i n commercia l banking . 2. Tha t is, value the loans at the price at which it offered them to the Mexican government for repurchase.

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Everywhere, banks are devising end-game strategie s tha t will ge t them out of dying businesse s withou t to o muc h cost . Governmen t official s ca n d o ver y little to reverse the trend, for the direction of the market is simply to o strong. The next best strategy, therefore, is to encourage an orderly exit. Otherwise , a war could break out in the banking system tha t could cause widespread harm. The U.S. financial syste m would be weakened and the U.S. government would be left assuming the cost of financing developing country growth. Rathe r than holding banks at bay, it is imperative that the government offe r saf e passag e from this crisis.

6

WORLD BANK-SUPPORTE D ADJUSTMENT PROGRAM S Robert Lieberthal and Peter Nicholas

ORIGINS O F ADJUSTMEN T An escalatin g economi c crisi s i n th e earl y 1980 s le d th e Worl d Ban k t o emphasize mor e strongl y tha n befor e th e introductio n o f economi c polic y reforms b y developing countries and to suppor t the reforms throug h adjust ment lending . Ther e ar e tw o aspect s t o thi s crisis , th e firs t o f whic h i s recession. Ove r the past nine years, there has been a major adverse change in the environment for almost all developing countries, caused by several events: the secon d oi l shock ; record-hig h rea l interes t rates ; th e commodit y pric e collapse; lowe r OEC D growt h couple d wit h risin g protectionism ; an d th e reversal of net lending flows. No t since the era of growth and development for LDCs got underway after Worl d War II, with that development for th e firs t time consciously fostered by international effort, hav e the circumstances been so unfavorable for global poverty alleviation. It i s therefor e remarkabl e tha t LDCs a s a whole have maintained som e growth, albeit inadequately, in the 1980s. Rea l GDP has grown by 3.4 percent in 198 0 to 1985 , two-thirds of the growth rate of 197 3 to 198 0 and only half as fast a s in 196 5 to 1973 . Bu t almost all this growth has been in Asia. I n

The views and interpretations in this paper are those of the authors and should not be attributed to the World Bank, to its affiliated organizations , or to any individual acting in their behalf.

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Sub-Saharan Africa, average per capita incomes have fallen to 1960s levels, and in Latin America, performance has been little better. Ne t investment, essential to increase productive capacity, has practically ceased in several countries. If thes e ar e th e broa d economi c dimension s o f th e presen t crisis , i t i s increasingly associate d wit h a socia l crisis , whic h i s les s eas y t o observ e because of inadequat e data, but abundantly clear on an impressionistic basis , and borne out by partial data, for the documentation of which a large debt is due to UNICEF (Cornia et al. 1987) . Example s include the 70 percent increase in open unemployment in Mexico in 198 1 to 198 4 (Pfeffermann 1986 : 11) ; a 40 percent reduction in real wages in Costa Rica in 197 9 to 198 2 (Pfeffermann : 17); and rising malnutrition amon g infant s an d children i n a broad range o f countries (Corni a et al.: 31-33). Recen t wor k conducte d a t the World Bank suggests tha t som e 10 0 t o 15 0 millio n peopl e i n Sub-Sahara n Afric a (4 0 percent of the population) are "food insecure." The second aspect of the crisis is the extension and intensification o f longstanding difficultie s i n severa l countries * developmen t strategies . I n Sub Saharan Africa , governments strugglin g t o mee t expectation s o f steadil y improving livin g standard s hav e ofte n promote d policie s that , instea d o f providing the basis for sustainable growth and poverty alleviation, have eroded the existing productive base. Contributin g t o this erosion has been a familiar litany o f policy problems : a bias against agriculture; 1 inefficien t stat e enterprises; unproductive government investment expenditures; a declining tax base as distorte d exchang e rate s driv e trad e underground; and , when face d wit h declining ta x revenues , a tendenc y t o maintai n o r expan d public-secto r employment level s a t th e cos t o f reduce d rehabilitatio n an d maintenanc e expenditures. Thes e problems have combined with high population growth and other structural problems to actually reduce living standards in an unfortunately large number of cases. Whil e most countries were able to ignore the need for changes in economic polic y i n the 1970 s when real interest rates were low or negative, externa l capital plentiful, an d real commodity price s favorable , the onslaught i n th e earl y 1980 s o f drought , highe r oi l prices , an d reduce d commodity prices made drastic change inescapable. A few countrie s had also borrowed heavily a t commercial interes t rates, and for them the sharp rise in real interest rates that began in 1979 only added to their problems. Up unti l 1983 , comparatively fe w countrie s too k step s t o deal wit h thes e problems. Man y mor e countries hav e no w starte d t o tak e action , suc h tha t some thirty African countries are, with IMF and World Bank support, trying to 1. Se e Chapte r 1 2 b y Jamal , wher e rural-urba n an d agricultural-nonagricultura l biase s i n Tanzania are investigated.

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cope with thi s crisis by introducin g wide-rangin g an d courageously imple mented programs of economic restructuring. A few, like Ghana, have already shown some successful results . I n much of the continent, however, attempts at reversing years of economic deterioration and loss of government control of the econom y hav e bee n compromise d b y powerfu l oppositio n an d som e understandable hesitancy on the part of governments. In Latin America, th e crisis of the 1980s was more sudden and unexpected. After a long period of sustained increase in per capita incomes and expanded government services, in part financedby huge external borrowing, the jump in interest rates and the subsequent cut-of f o f mone y fro m commercia l banks, compounded by reduced access to the markets of industrialized countries and sharply deterioratin g term s of trade , le d livin g standard s i n muc h o f Lati n America to decline precipitously. T o restore growth, these countries have been moving awa y fro m inward-oriente d growt h behin d hig h protectiv e barrier s toward a strategy that emphasizes expanding export volumes to finance more imports and negative net financial flows. Thi s strategy has met with varying success as countries have also faced increased protectionism and stagnant world trade. Excep t in 1984, external balance has been achieved much more through compression of imports than through expansion of exports. Thi s has not only hurt th e Lati n America n countrie s themselves , bu t als o ha s ha d seriou s repercussions for export industries in other countries, particularly th e United States. For development assistance agencies like the World Bank, these problems were manifested in deteriorating micro (project) performance, especially in SubSaharan Africa . Shortage s o f domesti c budgetar y resources , inappropriat e pricing policies, overextended public agencies, and restraints on trade were among the factors tha t reduced th e returns on investment, includin g donor financed projects . Prio r to the 1980s, development assistance had emphasized investment as th e primary instrumen t t o achieve growth , development, and poverty alleviation. Whil e investment lending by the World Bank had never neglected the policy environment, it was clear that the problems of the early 1980s in Sub-Saharan Africa and Latin America demanded instruments that put policy and institutional change at the forefront . ADJUSTMENT STRATEG Y Attempts at economic restructuring in the face of these problems have come to be characterized as "adjustment," and support for restructuring from th e multilateral agencies as "adjustment lending." Th e aim of all adjustment programs

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is to achieve an equilibrium, or sustainable macroeconomic balance (externally and internally) , i n respons e t o external shocks , whil e a t th e same tim e improving the prospects for growth and poverty alleviation.2 When ther e are major macroeconomi c imbalances , especially financing shortfalls, th e issue i s not whether t o adjust , bu t how. Th e choice for government is, at one extreme, a disorderly adjustment i n which import compression, inflation , an d depressed investmen t level s perpetuat e o r eve n exacerbate declines in living standards and, at the other, an organized adjustment in which a combination o f policy reform , investment , and external suppor t leads to eventual recovery. Th e experience suggests that postponing adjust ment is costly, especially for the poor, in both the short and the long runs. The main elements of World Bank-supported adjustment strategies are: 1. stabilization—th e elimination or reduction of macroeconomic imbalances— generally, though not necessarily, in association with IMF programs; 2. "switching"—shiftin g resource s toward the tradeable sectors and consumption away fromexportables; 3. efficienc y improvement , measure d by , for example , th e reduction of incremental capital output ratios (ICORs), through public expenditure and state-owned enterpris e rationalizatio n an d reductio n i n contro l and regulation; and 4. th e mobilization an d coordination o f internal an d external resource s to support these efforts. There are a number of common themes in adjustment programs, which can be conveniently grouped under four headings: trade, pricing, resource mobilization, and resource use. Trade Reform o f incentives for production of exports and import-competing goods has been a key featur e o f almost all adjustment programs . Excep t in those African countrie s whose currencies are tied to the French franc, a devaluation has generally been the starting point for trade reform. Eve n those countries that did not allow their currencies to appreciate in real terms during the 1970s now face less favorable terms of trade developments as well as low-productivity 2. Se e Chapter 9 by Epstein, which treats the history of policy-based lending and questions its effectiveness.

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export- an d import-competing sectors , which imply a need for exchange rate depreciation.3 I n addition, in many countries high rates of domestic inflatio n actually le d th e rea l rat e o f exchang e t o appreciate , benefitin g thos e wit h privileged acces s t o foreig n exchange , bu t inhibitin g expor t an d competin g import growth. Increasin g shortage s o f foreig n currenc y i n turn led t o payments of large rents for access to foreign currency and to a parallel market at a more market-based rate , thus depriving th e government o f ta x revenue. Fo r this reason, some countries have experimented with foreign exchange systems or floats, which not only depreciate the official exchang e rate, but reduce the incentive an d opportunit y fo r paralle l markets . Despit e th e cost s t o th e economy as a whole of an overvalued exchange rate, devaluation imposes heavy economic costs on certain groups, like urban wage earners or those in both the public an d private sectors , who ma y los e thei r rents from contro l o f foreig n exchange or will have to pay significantly highe r prices for imports, and who can therefore be expected to resist strongly. On the export side , emphasis ha s been placed o n two types of promotio n measures: (1 ) th e provisio n o f financia l incentive s throug h ta x rebates , subsidies on imported inputs to offset impor t controls, and preferential acces s to imports and credit, and (2) the reform of administrative procedures and the establishment of better institutional support for exporters. O n the import substitution side, protection has generally been reduced to encourage efficiency and better exploitation o f comparativ e advantage . Th e emphasi s o f mos t Bank supported programs has been on the removal of quantitative restrictions and the introduction of mor e uniform rates of protection. Contrar y to some accounts, Bank-supported programs have not generally favored rapid import liberalization, but phased programs in which the removal of restrictions was coordinated with an active exchange rate policy aimed at preventing a surge of imports and the destruction of potentially efficient import-competin g industries. The impact o f thes e reforms , however , ha s been frequentl y hampere d by failure t o maintai n a realistic exchang e rate . I n about hal f o f th e countrie s where adjustment programs have been supported by the World Bank, the effect of larg e nomina l devaluation s wa s quickl y erode d b y domesti c inflatio n (sometimes cause d i n par t by th e devaluatio n itself) . I n addition, fo r low income countries and those highly dependent on commodity exports, the shortrun impac t o f devaluatio n o n export s ha s bee n limited, becaus e capacit y constraints i n th e exportin g sector s wer e greate r tha n anticipated . Thes e conclusions, rather than reducing the need for exchange rate and trade reform,

3. Se e Chapter 8 by Fletcher, where devaluation is treated in detail.

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underline th e importanc e o f complementar y policie s t o contai n domesti c inflation and to develop export infrastructures. Pricing Changes in economically strategic prices—particularly those in agriculture and energy—have been a feature o f most adjustment program s supported by the World Bank . Pricin g reform s hav e almos t invariabl y focuse d o n raisin g producer prices closer to international market price equivalents, and on cutting input and consumer subsidies. Mos t of these reforms, especially those related to the energy sector, seem to have had significant and visible benefits. Ther e is evidence of increased agricultural production and improved rural incomes, and of increased conservation and efficient impor t substitution of energy resources. The main obstacle to raising agricultural prices is often the opposition of urban consumers wh o wil l fac e highe r foo d o r energ y prices . I n Zambia , fo r example, attempts to raise food prices in late 1986 had to be withdrawn in the face of urban riots. Furthermore , rationalizing prices is not generally enough on its own, and complementary improvements in infrastructure and services are also needed to produce a supply response. I t is often convenient and necessary to address both price and nonprice factors in a single, comprehensive program. Resource Mobilizatio n While the patterns of response to external shocks have varied considerably, the need t o reduce resource imbalance s implie s som e combination o f reduce d domestic investmen t o r highe r domesti c savings . A s th e deb t crisi s ha s intensified, larg e share s of domesti c saving s hav e been externalized b y the heavily indebted countries and have not been available to finance much-needed domestic investment. I n addition, there were many situations in which it was important to channel resources to the private sector, especially in agriculture or export manufacturing. Better resource mobilization has thus been an important objective of adjustment programs. T o this end, the Bank has supported efforts t o reduce publicsector dissaving. Man y developing countries had already achieved quite high tax ratios to GDP; in these cases, Bank-supported programs have emphasized expenditure control and tax reforms aimed at better resource allocation. I n other cases, programs have emphasized better revenue collection and sometimes the introduction of new taxes, like VAT. Expenditur e reduction has emphasized

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direct cuts in low-priority government expenditure and control of the deficits of state and parastatal enterprises. Financial-sector reform has also become an increasingly important feature of adjustment programs . Initially , adjustmen t program s emphasize d raisin g interest rates to levels that were positive in real terms. Mor e recently, adjustment programs have sought to reduce excessively hig h real interest rates by reducing public-sector recourse to domestic financingand by reducing financial intermediation costs . Th e mos t difficul t aspec t o f financia l marke t an d banking-sector reform s ha s been ensurin g a n orderly transitio n fo r bankin g systems saddle d wit h man y nonperformin g loans , sometime s o f publi c enterprises, and liberalizing previously controlled lending and deposit rates. Financial reform s hav e bee n especiall y complicate d i n case s wher e th e government has been using the financial system to promote exports and offset the bias of continued domestic protection. Here , close coordination of financial and trade reform is called for. Resource Us e Bank-supported programs have not only sough t to improve resource mobilization and reduce financialimbalances, but have also attempted to improve the efficiency wit h whic h resource s ar e used , especiall y i n th e publi c sector . Public investmen t an d expenditur e review s hav e been carrie d ou t i n man y countries, as a result of which governments have been able to identify low priority investment s an d limi t th e allocatio n o f resource s t o the m whil e emphasizing maintenance and recurrent costs. Thes e reviews have also helped governments in aid coordination by providing a frameworkfor external support and a means of identifying priorities. Th e role of government as an operator of public enterprises has also been carefully studied . I n a number of countries these studies have proposed the divestiture of public enterprises. Ove r twentyfive countries have announced plan s to divest public enterprises, but actual implementation ha s been slow , not only because of political constraints, but because of technical complexity. IMPLEMENTATION The Bank has supported adjustment programs in 55 countries with 15 0 loans totaling $20 billion. Thes e loans have disbursed rapidly—normally i n one to three years—as countries have implemented reforms agreed between the Bank

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and the government concerned. Unlik e the Bank's investment lending, which disburses for the imports needed for a particular investment project, adjustment lending typically disburses against general imports. Th e Bank has had two objectives in committing such large resources to adjustment lending: (1) to use the Bank's economic expertise and its relatively independent point of view to help countries develop their adjustment programs, and (2) to provide immediate financial suppor t to help countries cover their balance of payments gaps as adjustment policies work to provide a longer-term solutio n through increased exports and greater domestic efficiency. The Bank links its lending and disbursements to the implementation of an agreed program of specific actions. Abou t three-quarters of all adjustment loans are experiencin g delay s i n the release o f funds a s a result o f tardiness in completing the action envisaged. Th e majority of such delays concerns reforms of publi c an d parastatal institution s an d enterprises, typicall y th e most politically difficul t an d complex reforms bein g attempted unde r adjustmen t programs. I t seems clear that governments and the Bank frequently hav e been overly optimistic about the speed with which these reforms can be carried out. More attentio n i s now being pai d t o institutional factors , suc h a s fisca l management, the management of key sectors, public enterprises, and overall public-sector management IMPACT There are a number of obstacles in the way of reaching a reliable judgment on the impact of adjustment programs. First , the benefits of adjustment programs are not evident for several years, which makes it hard to judge their impact on the basis of short-term economi c performance . Second , exogenous shocks, both favorable and unfavorable, occur and their effects ar e difficult t o distinguish fro m thos e of adjustment. Third , the process of adjustment i s almost never orderly or continuous. Change s in the timing of policy actions weaken the link between a planned reform program and short-term economic performance. An d finally, differentiating between the effects of different policies which nevertheless form part of an integrated package is especially difficult. Thes e obstacles could be overcome if comprehensive economic models, and the data needed to use them, were available. Sinc e they are not, country experience is the only available guide to the results of adjustment programs.4 4. Se e Chapter 7 by King an d Robinson, whic h use s a model t o assess the impact of some major aspects of adjustment programs.

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A recent paper reviewed macroeconomic indicators for sixteen countries that have undertaken adjustment program s (World Bank 1988) . Whil e no certain causal connection s ca n b e mad e between trend s i n th e indicator s an d th e adjustment programs , some conclusions do emerge. Indicator s for GDP and exports sho w relativel y stron g growt h fo r abou t two-third s o f countrie s following th e introduction of adjustment programs. Fo r each country, growth rates for GDP and merchandise exports in the period following th e first Bank adjustment loan were compared with the equivalent figurefor a group of similar countries. O f the sixteen countries surveyed, eleven had higher GDP growth than thei r comparato r group , an d te n highe r expor t growth . Onl y tw o countries—Cote d'lvoire and the Philippines—have suffered negativ e growth following their first adjustment loan, and eight countries—Costa Rica, Ghana, Korea, Mauritius , Morocco , Pakistan , Thailand , an d Turkey—hav e s o fa r achieved growth in per capita GDP. Trend s in export volumes have varied widely. Jamaic a ha s suffere d a 2.5 percen t pe r yea r expor t declin e sinc e initiating adjustment, while Korea and Turkey have 12 and 22 percent growth rates respectively. Twelv e of the sixteen countries reduced their current account deficits, and nine their fiscal deficits, over their adjustment periods (although improvements in the current account may reflect shortages of foreign exchange rather than government policy). Hal f the countries had decreased both deficits, while only in Togo had both increased. These assessment s d o no t tak e int o accoun t variation s i n th e degre e t o which planned actions were actually carried out, and the impact of world conditions. Suc h factors can only be incorporated by focusing on individual country cases. Eve n here macroeconomic models are not yet sufficiently advance d to allow rigorous analysis of the effects of reform packages on performance. FUTURE DIRECTION S World Ban k suppor t fo r adjustmen t program s wa s initiall y viewe d a s a n exceptional activity, both in terms of the volume of lending and the approach to desig n an d implementatio n o f Ban k assistanc e programs . Adjustmen t lending now, however, accounts for about 25 percent of annual lending. Mor e importantly, perhaps, the need for adjustment i s influencing al l Bank lending and giving rise to new directions in assistance program design. Four broad hypotheses arise from th e eight or so years of experience with Bank-supported adjustment programs. Thes e relate to the global environment for adjustment and the need for adequate financialresources to resume investment and growth, the importance of addressing poverty concerns more directly

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in adjustmen t programs , th e importanc e o f institutiona l factors , an d som e evolution in adjustment program design. Adjustment Progra m Financin g The financing o f adjustmen t programs , broadly interprete d t o include debt restructuring and possibly some debt reduction, has become the critical issue for the heavily indebted countries, as well as for low-income Africa. Withou t adequate financing , ther e i s impor t strangulation , underinvestment , fisca l pressure, and a serious reduction i n the incentive for countries to undertake adjustment programs . No t that the alternatives are at all attractive: Peru and Zambia are examples of countries undergoing serious economic difficulties as a result of not undertaking adjustment programs, despite unilateral reductions in debt servicing. Failur e to mobilize adequate external resources of the right kind and on the right terms carries an increasingl y heav y cos t in term s of faile d adjustment. Th e Bank is therefore giving increasing attention to the mobilization of finance, to debt restructuring and the "menu" of debt options, and to aid coordination in low-income countries. Even if development financebecomes easier, however, the need for adjustment will remain. Th e basic parameters, like rapid population growth, weak commodity prices, and environmental and natural resource degradation, suggest continued emphasis on efficiency i n the use of resources and the maximization of benefits fro m internationa l trad e and the world economy. Countrie s that have undertaken serious adjustment programs now need to extend the effort into specific sectors , to deal in depth with important development problems, like public-enterprise refor m an d restructuring , financial-sector reform, public expenditure rationalization, and the creation of a supportive environment fo r private investment, enterprise development, and technology transfer. I n lowincome countries, especially Africa, the reform of food-sector policies, and the development of agricultural technology , infrastructure, an d human resources feature strongl y in development strategies. Som e of these activities can perhaps proceed without a macroeconomic adjustment program, but the continuation of large macroeconomic imbalances typically confounds such efforts. Adjustment an d Povert y The weak economic performance in developing countries in recent years has, as already noted, led to a serious deterioration i n social conditions. Thi s is in

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contrast to original expectations, which were not (as some have suggested) that the benefits o f adjustment woul d trickle down to the poor, but that growthoriented adjustment could succeed relatively quickly and set up an environment in which poverty programs could resume or expand. Th e longer-than-expected course of adjustment i n most countries has led to growing concern about the impact of adjustment on the poor. Transitiona l costs of adjustment, resulting from th e depression o f output, employment, and consumption, almost inevitably affect poo r groups adversely. I n addition, changes in prices, subsidies, and exposure to market forces as part of adjustment programs lead some groups to gain and some to lose. An d the process of shifting resources, especially in developing countries , is rarely smoot h an d frictionless . I n many countries, adjustment involves the scaling-back or closure of facilities in poorer regions, where they were established precisel y to create employment, but with weak economic justification. Some of thes e costs are inevitably associate d wit h adjustment . I n these areas, there is a straightforward trade-of f between adjustment and protection of the poor, as a result of which it may be necessary, if additional resources can be found, to slow down the adjustment process. I n others, it is possible to protect the poo r throug h th e redesig n o f socia l program s (targeting) , throug h th e redirection of social expenditures, and through specific compensatory programs. These efforts are increasingly finding a place in World Bank-supported adjust ment programs , a s i s th e us e o f foo d ai d t o suppor t povert y alleviatio n measures. Institutional Aspect s The crisis conditions in which adjustment programs have been introduced have exposed severa l institutiona l an d politica l weaknesse s i n man y developin g countries, especially i n Sub-Saharan Africa . Al l too often, apparentl y welldesigned adjustment programs have faltered because a limited number of key decisionmakers and technocrats must undertake a perpetual round of donor and creditor negotiations with negligible support from dono r or domestic bureaucracies. Mor e fundamentally, it is rare that an adjustment program can succeed on the basis of short-term "push-button" policies (devaluation, price changes) alone; sustaine d effort s t o redesig n policies , implemen t them , monito r performance, an d feed back results for furthe r analysi s are needed an d must become part of developing countries' economic management capacity. Adjust ment programs have therefore increasingl y emphasized improvements in the use of cor e economic policy instruments , especially public expenditure and

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investment, taxation, and external debt management; sectoral restructuring and policy reform; and public-sector management enhancement (pay, employment, and organization of public administration). Thes e issues are often addresse d through self-standin g technica l assistanc e loan s o r credits, in parallel wit h structural adjustment loans. Adjustment Progra m Desig n One of the effects o f the adjustment er a is to bring more closely together the various elements of economic and social policy in developing country governments, and in thei r externa l assistance . Thus , the need t o assign prioritie s more rationall y amon g competin g sector s force s close r integratio n an d discipline in public-expenditure management. Similarly , confronting generi c problems in public-enterprise management demands a cross-sectoral approach. To produce the needed supply response in a sector requires broad-based and coordinated programs that address directly, or establish a framework for , both trade an d pricing reforms , a s wel l a s th e longer-ter m need s fo r enterpris e restructuring, investment incentives, and technology development World Ban k program s ar e increasingl y acquirin g thes e characteristics . Adjustment suppor t i s continuing, but is merging increasingl y wit h a "new look" sector-investment approach, differentiated fro m project lending through its emphasis on a comprehensive sector-wide attack on a range of problems, and differentiated fro m adjustment lending by its attention to medium- to longterm problems (World Bank 1988).

7

ASSESSING STRUCTURA L ADJUSTMENT PROGRAMS : A SUMMAR Y O F COUNTR Y EXPERIENCE Robin A. King and Michael D. Robinson

This paper attempt s to answer tw o important questions about th e structura l adjustment policies implemented as a part of debt rescheduling: Wha t are the economic impacts of structural adjustment? And , do these policies improve a country's chances of meeting debt service obligations in the short term? Som e studies hav e attempte d t o captur e th e economi c effects, 1 bu t no study has addressed th e implication s o f thes e effect s o n th e futur e abilit y t o pay o f rescheduling countries. 2 Thus , there is a major ga p in our knowledge about international debt rescheduling. Thi s paper endeavors to fill this gap by determining the impact of rescheduling and adjustment on ability to pay. We consider standard rescheduling policies and criticism of them and proceed to briefly outline the theory of the macroeconomic impacts of adjustment fro m the point of view of the IMF and its critics. A discussion of rescheduling and adjustment succes s and failure follows. Severa l steps are taken to empirically evaluate th e economi c impact s o f adjustmen t o n abilit y t o pay: statistica l estimates of the economic impacts of rescheduling are obtained from a comparison o f reschedulin g an d nonreschedulin g countrie s an d fro m a vecto r 1. Se e Pastor (1987). 2. Fo r previous woik by the authors on this topic see King and Robinson (1988).

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autoregression model. W e continue the analysis by presenting evidence on the impacts of the policies on ability to pay. T o determine the consequences of the economic impact s o f reschedulin g o n abilit y t o pay, th e economi c effect s predicted as a result of adjustment ar e used in conjunction wit h our previous estimates o f a logi t mode l o f deb t servic e problem s t o predic t defaul t probabilities. B y comparing the predicted probability of debt service problems in simulation s wit h an d withou t reschedulin g episodes , th e impac t o f th e rescheduling on ability to pay can be estimated. Thes e experiments indicate that rescheduling an d adjustmen t policie s improv e balance of payment s by decreasing deb t service and imports, while concurrently reducin g growth in GNP, exports, and commercial disbursements. Thes e effects tend to offset one another, and we conclude that the net impact of the policies on ability to pay is negligible. B y examining the results more closely, policy suggestions for improving debt management can be made, and we provide a brief discussio n of these policy implications. STANDARD RESCHEDULIN G POLICIE S AND THEI R CRITIC S Three principles underli e standar d adjustmen t practices : imminen t default , conditionality, and burden-sharing. Th e situation must be quite serious for the restructuring process to begin. Defaul t must be imminent—arrears must have accumulated. Conditionalit y rest s o n th e principle that deb t relief wil l not solve debt problems, good economic management will; care must be taken to ensure that a recipient debtor nation quickly regains its ability t o service its debt. Th e premise of conditionality is that an outside agency, such as the IMF, can provid e economi c polic y insigh t tha t migh t b e lackin g withi n a government. Th e typical IMF adjustment pla n outlined i n a letter of inten t calls fo r limitatio n o f mone y suppl y growth , decreas e i n th e governmen t budget deficit , contro l o f credit , improve d exchang e rat e polic y (usuall y removal of an overvalued rate via a devaluation), lifting of price controls, and an improvement in the trade balance. Governmen t intervention in the economy should b e limited , an d th e marke t shoul d b e truste d t o allocat e resource s according to price signals. Fo r official deb t rescheduled vi a the Paris Club, repayments of principal due over a two to three year period are consolidated, with 80 percent of the consolidated amount given new terms at market rates of interest for two and a half to ten years. Th e commercial bank long-term debt is typically rescheduled over five to ten years, with grace periods of one to four years. Ne w mone y i s ofte n provide d i n a commercial ban k reschedulin g

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package. Burden-sharin g attempt s t o plac e th e cost s o f reschedulin g o n participants in a negotiation. A number of critic s o f th e standard reschedulin g policies argue that the policies are doomed to fail because of the assumptions under which the Paris Club, th e IMF , an d commercia l bank s operate . Critic s o f th e standar d rescheduling process can be found in all economic and political camps.3 Mos t criticism ha s focused o n th e deflationary adjustmen t program s of th e IMF, which are characterized as concentrating too much on deflating demand while not paying sufficien t attentio n t o returning th e debtor country t o a positive growth path . A n econom y tha t i s no t growin g wil l almos t certainl y hav e future deb t problems. Some critics (Paye r 1975 ; Pastor 1987 ) focus o n the regressive nature of IMF adjustment, wit h labor's share of income bearing a large portion of the cost of adjustment. Other s (Garcia 1985; Grinspun 1984; Ferrer 1984) argue that the burden of adjustment i s shared unequally between creditors and debtor countries, with debtor countries expected to incur all of the costs of resolving the problem. T o meet these costs, the populations in these debtor countrie s mus t lowe r thei r standard s o f livin g an d growt h i n th e economy will be reduced. Despite the different focuse s of the many critics, we find three main themes running throughout the critical literature: (1) the rescheduling and adjustment process does not encourage economic growth and development, (2) the costs of adjustment are borne largely by the debtor countries (more specifically b y the less fortunate in such countries), and (3) the outcome of the process does not leave debto r nation s bette r abl e t o mee t deb t servic e payment s afte r th e rescheduling and adjustment Th e remainder of this paper examines themes (1) and (3 ) i n mor e detail . Empirica l evidenc e i s presente d tha t suggest s th e criticisms may be justified. MACROECONOMIC IMPACT S O F STRUCTURAL ADJUSTMEN T Before th e onse t o f th e deb t crisis , IM F program s wer e referre d t o a s "stabilization programs" and were explicitly expected to be short-term. Wit h the advent of the debt crisis of the 1980s, "adjustment programs" have replaced the stabilization program s of th e past, with lower expectations for th e short run, and a longer timefram e allowe d fo r success . Th e basic outlin e of th e 3. O n the IMF, see Bird (1984a), Kfflick (1984b) , Feinberg and Kallab (1984); on the process in general, see Bradley (1986), Lever (1983), Kenen (1984), Rohatyn (1983), and Dombusch (1986).

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programs, however, has remained the same, with the IMF continuing to focus on stabilization , specificall y o n controllin g aggregat e demand . Long-ter m liberalization ha s bee n adde d t o th e basi c short-ru n stabilizatio n programs , resulting i n structura l adjustmen t programs . Typica l adjustmen t policie s recommended b y th e IMF include contro l o f mone y supply , credi t controls, control o f budge t deficit s throug h limitation s o n governmen t spendin g an d increased governmen t revenues , decreases i n real wages , domesti c currenc y devaluation, and liberalization of all markets. Th e last, liberalization, generally translates into the lifting o f price, interest rate, foreign exchange , and foreign trade controls. Throug h attemptin g t o contro l an d limit aggregat e demand , these policies are expected to return the economy to more appropriate levels of spending, investment , an d growth. Governmen t policy-induced "distortions " will be eliminated, allowing relative prices to reflect "tru e scarcities" of facto r endowments. Wit h "correct" relative prices, rational consumers and producers will mak e consumptio n an d production decision s tha t are sustainabl e i n th e long run. We ca n briefly sketc h the expected effect s o f eac h o f th e policies recommended b y th e IM F i n a typica l stabilizatio n program . Credi t an d mone y supply contro l wil l decreas e inflationar y pressure s b y discouragin g furthe r expansion o f aggregat e demand . Decrease d governmen t expenditure s an d increased taxes will also decrease inflationary pressures. Lowe r wages will lead to lower consumptio n o n th e demand side . O n the supply side , the y shoul d encourage expansio n o f employmen t wit h movemen t towar d th e relativel y more abundan t facto r endowmen t o f labor . I n th e lon g run , this proces s i s expected t o lead t o increased profits, whic h shoul d encourage private-secto r investment and economic growth. Devaluatio n of the domestic exchange rate will improv e th e trad e balance. Overvalue d exchang e rate s ma y encourag e excessive use of imported inputs and intermediate goods, among them foreign capital. Liberalizatio n of price controls is expected to lead to increased supplies of basic foodstuffs an d to improve the government's deficit problem as publicsector prices increase. Liberalizatio n i n money market s will increase interest rates, reflecting th e relative scarcit y of capital. Highe r interest rates can also lead t o highe r saving s retaine d i n th e financial syste m an d increased capita l inflows. Th e lifting o f foreign exchang e controls, combined with devaluation and lifting o f export taxes and import subsidies and licenses, should stimulate exports. If th e basic proble m underlyin g th e need fo r structura l adjustmen t i s no t excessive aggregate demand, then the above policies may be inappropriate. A rescheduling country forced to undergo an adjustment program, by definition, is neither healthy nor does not necessarily have a highly integrated industrial and

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financial sector . W e shoul d not be surprise d to see effects tha t are not predicted b y orthodo x monetar y approac h t o th e balanc e o f payments . I n a developing country , orthodo x adjustmen t policies ma y hav e unexpected an d negative results. Structuralis t critiques of IMF-type adjustment policies argue that the resulting effect s ar e most likely t o be contractionary withou t solvin g the problem of inflation o r establishing the necessary conditions for economic growth. Mor e radical critiques focus on the advantages given to capital at the expense of the workers. Wha t analysis lies beneath these criticisms? Let us begin by briefly sketchin g th e domestic an d international situatio n during an adjustment episode. A country is unable to generate sufficient for eign exchang e t o meet its international financia l obligations . I t agrees t o an IMF program as part of a rescheduling package, which should ease its foreign exchange burden , at least temporarily , b y pushin g curren t debt amortization payments into the future. Th e currency is devalued, markets are liberalized, and the government budget is slashed. On e must take into consideration the effects of devaluation on debt service payments for the LDC government. Th e foreign debt service burden in domestic currency will increase with every devaluation, thus providing a stimulus to a burgeoning government deficit. 4 A s a result, if the deficit i s t o be "unde r control," further cut s i n domesti c service s and/o r investment will be required. Whil e tax increases are another possible way of controlling th e government budget deficit, politica l realit y make s i t unlikely that progressive taxatio n wil l b e implemented . Regressiv e sale s taxes , th e only politically feasibl e taxes , will inflict greate r adjustment costs on those at the lower end of the income scale. Devaluation is expected to generate increased foreign exchange through the expansion o f export s an d th e reductio n o f imports . Thi s effect , however , assumes that the Marshall-Lerner conditions hold, with the devaluation leading to a positive effec t o n th e trad e balance. Thi s abstract s awa y fro m incom e elasticities an d timin g problem s an d focuse s solel y o n pric e elasticities . I n addition, it has not been proven conclusively tha t these conditions hold for all LDCs. Fo r exports to increase, they must have markets. Therefore , one can say that adjustment programs require, as a necessary conditio n fo r success , a relatively fre e internationa l tradin g syste m wit h acces s t o al l markets , particularly those of higher income countries with more free-spending consumers. Here the situation becomes more complicated: Th e observer needs to take into account th e simultaneit y o f adjustmen t program s i n man y countrie s o f th e world. Al l debtor countries are encouraged to increase exports and cut imports. 4. Th e increase d focu s o n thi s poin t ha s le d t o th e increasin g importanc e o f "operationa l deficits," but much attention continues to be directed to the traditional budget deficits as well.

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Logistical problems may result from this "maximize exports while minimizing imports" approach to adjustment (and, indeed, economic growth) if there is no country willing and able to purchase the net increase in exports from adjusting countries. With the liberalization of financialand foreign exchange markets, the interest rate required to retain capital domestically (merely reflecting expected future devaluations) is likely to be high. Whil e this will encourage capital inflows, it is likel y t o discourag e productiv e investmen t whil e encouragin g financia l investment wit h it s highe r short-ru n returns . However , du e t o th e eas y mobility of capital and excessive speculation, the economy is rendered subject to more serious fluctuations. Last, one must remember that the rescheduling process and IMF programs began with a short-run perspective . It was expected tha t significan t capita l inflows woul d soo n return t o productive use s in thes e countries . A s it has worked out , adjustmen t policie s hav e ofte n bee n implemente d withi n a n environment of international financialausterity, with net transfers of resources flowing away fro m th e LDCs, not towar d them , as would b e expecte d b y traditional theory and the assumptions of adjustment programs . I n short, one must tak e int o accoun t th e possibility tha t IM F policies ma y no t hav e th e expected effects and may lead to further problems instead of making the process smoother and more efficient. I t may be the case that it is not in a developing country's economic interest to follow these policies. RESCHEDULING AN D ADJUSTMEN T SUCCES S AND FAILUR E To fully evaluat e th e macroeconomi c effect s o f adjustmen t policies , some attention mus t b e give n t o th e impac t o f th e policie s an d thei r economi c outcomes on ability to pay. T o facilitate thi s analysis, we have developed a definition of rescheduling episode success and failure: A reschedulin g i s successful i f further reschedulings ar e not needed, tha t is, if a country's financial healt h has returned t o a point where i t can meet its financial obligations a s previously contracted. 5

5. Thi s definitio n i s no t inconsisten t wit h tha t give n b y Guitia n (1982 : 73-104), a senio r analyst a t the IMF : ". . . the Fun d shoul d adop t policies o n the use o f it s resource s tha t assis t members in overcoming thei r balance of paymen t problems . .. an d . .. t o ensure that the use of the resources by members is temporary."

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This rather pragmatic definition skirts the distributional issues raised above and should b e though t o f a s a firs t tes t o f adjustment . Adjustmen t shoul d a t a minimum improv e th e balanc e o f payment s an d abilit y t o pa y o f th e rescheduling nation. I f adjustment fails this test, then adjustment policies need to be reworked regardless of their distributional impacts. O n the other hand, if adjustment policies do improve the short-term financial situatio n of a country, then consideratio n o f th e distributiona l impact s shoul d b e undertake n t o determine if the costs of financial improvement are too high. Under the rescheduling procedures and policies of th e standard process, a hypothetical successfu l episod e o f deb t crisis resolution ca n be outlined. A debtor nation with serious debt service arrears that appears to be in imminent default appeals to the Paris Club and its commercial ban k creditors fo r help. After negotiatin g wit h th e IM F o n a se t o f economi c policie s designe d t o restore th e debtor nation's econom y t o health , th e terms o f th e reschedulin g will be negotiated. Durin g the grace period, the economic policies an d other aspects o f th e rescheduling packag e shoul d lea d t o improvin g financia l an d economic conditions , including decreased debt service obligations, decrease d imports, increased exports, an improved reserve situation, renewed economi c growth, and possibly renewed investo r confidence i n the ability t o pay of the debtor nation as contracted financial commitments are met. Several problems ma y arise that thwart the successful resolutio n of a debt crisis episode. A s mentioned above, the economic policies agreed upon by the IMF and the country may fail to produce the economic revitalization necessary to resume debt service payments (or perhaps the policies are not implemented), the amount of debt consolidated ma y not be sufficient t o allow th e country to regain economic health , the length of time that the rescheduled deb t has been postponed may be too short, or other unforeseen crises may occur (for example, natural disasters, unexpected export price fluctuations) that return the country to a position of requiring additional relief from debt service obligations. Other definitions o f rescheduling succes s are found in the literature and in the press, yielding the conclusion that rescheduling has been successful thus far in the debt crisis. Tha t definition o f succes s is held by the proponents of the "muddling through" strategy pursued to date, who argue that the international financial syste m has not yet fallen apart. Followin g this line of reasoning, the "success" of th e process unde r tremendous strai n has been resounding. Ou r definition, however, is more stringent. W e are looking at the economic effect s of rescheduling packages. Althoug h difficult t o find articulate d publicly, the entire standar d proces s i s base d o n a n implici t assumptio n tha t thes e deb t service problem s ar e merel y transitor y an d w e wil l retur n t o "normal " conditions after a brief period of adjustment. Th e logical consequences of such

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an assumption imply a definition of success similar to ours, where a successful rescheduling lessens the need for further assistance. MODELING TH E MACROECONOMI C IMPACT S OF ADJUSTMEN T In this sectio n th e results of tw o statistical analyse s of th e macroeconomi c impacts of adjustment are reported. Tw o approaches are taken. Th e first, similar to that used by Pastor (1987), Reichman and Stillson (1978), and Donovan (1982), compares the performance of countries recently involved in adjustment with countries not involved in adjustment programs . Th e second employs a "before" an d "after " compariso n fo r th e same country. I f Fund adjustmen t programs improve a country's balance of payments, decrease imports, increase exports, and improv e economic growth , the n comparison s o f th e economic performance unde r such a program befor e an d after implementatio n shoul d reveal program outcomes. I n addition, comparisons can be made between the change in variables of interest between program an d nonprogram countries. 6 The data for the entire analysis that follows were obtained from the World Debt Tables (1984), published by the World Bank, which cover the years 197 4 to 1984 and include seventy-two debtor nations. Appendi x B contains a complete country list, reschedulings used, and definitions of variables. W e have assumed that each rescheduling episode is identified with an adjustment program and that the adjustment programs are equivalent. Th e economic variables included were those use d i n th e Feder , Just , an d Ros s (1981 ) mode l o f deb t servicin g difficulties, an d includ e GNP , deb t service , imports , exports , reserves , commercial inflows, and noncommercial inflows. Tables 7-1,7-2, and 7-3 report the results of tests of difference i n means of growth in the economic variables. Tabl e 7-1 compares all countries that have rescheduled in the last five years to other countries that rescheduled between 1974 and 1984 ; Table 7-2 compares these same countries to all other debtor nations; and Table 7-3 compares the economic variables the two years before rescheduling t o th e tw o year s afte r rescheduling . Growt h i n import s wa s reduced by the program in each case, and in two cases the evidence indicates decreasing growt h o f deb t service . Thes e ar e th e desire d outcome s o f adjustment an d shoul d improv e balance o f payments. However , growth in nominal GNP is reduced in each case, export growth is reduced in one case, and inflows of new money decreased. Thes e results are not those predicted by the 6. Se e Appendix A for elaboration of the second model.

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Table 7-1 . Economi c Variabl e Comparisons , 1974-1984 a» b (Mean Growth Rates by Rescheduling Status)

Variable

Growth Rat e Countries Rescheduling Countrie s not Rescheduling in Last Five Years i n Last Five Years T-Statisticc

GNP Growth Export Growth Import Growth Debt Service Growth Reserves Growth Com. Inflows Growt h NonCom. Inflows Growt h

0.050 0.075 0.062 0.177 0.234 0.864 0.117

0.086 0.088 0.109 0.277 0.121 1.131 0.323

1.75d 0.47 1.77d 1.65d -1.53 0.33 2.45d

a. Sampl e size 338. b. Countrie s rescheduling at least once during the period. c. T-Test s are reported for either an equal variance or unequal variance test of means depending on the results of a test for equal variances. d. Significan t at the 90 percent level.

Table 7-2 . Economi c Variabl e Comparisons , 1974-1984 a>b (Mean Growth Rates by Rescheduling Status)

Variable

Growth Rat e Countries Rescheduling Countrie s not Rescheduling in the Last Five Years i n the Last Five Years T-Statistic

GNP Growth Export Growth Import Growth Debt Service Growth Reserves Growth Com. Inflows Growt h NonCom. Inflows Growt h

0.050 0.075 0.062 0.177 0.234 0.864 0.117

0.102 0.142 0.123 0.316 0.121 1.689 0.363

c

2.67d 1.99*1 2.53d 2.29d -1.53 1.23 3.40d

a. Sampl e size 681. b. Al l countries. c. T-Test s are reported for either an equal variance or unequal variance test of means depending on the results of a test for equal variances. d. Significan t at the 95 percent level.

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traditional monetaris t model of adjustmen t and may be indicative of potential problems. Th e results on imports and debt service are broadly consistent with the research o f Pasto r (1987) , Reichma n an d Stillso n (1978) , an d Donova n (1982). Analysis o f thi s typ e ca n b e subjecte d t o a numbe r o f criticisms. 7 Fo r example, suc h comparison s fai l t o distinguis h betwee n progra m effect s an d more genera l economi c processes . Also , whe n comparin g befor e an d afte r rescheduling, external economic shocks may affect the results. T o improve the analysis, a secon d econometri c approac h wa s undertake n tha t attempt s t o control for as many factors as possible. Th e details of thi s approach are presented in Appendix A . T o obtain estimates of th e impact of rescheduling o n the economy of the debtor nation a simple vector autoregression (VAR) model of the economies of debtor nations was employed similar to the model used by McFadden et al. (1985). Include d in the VAR process were dummy variables to measure the three-year impacts of the rescheduling and adjustment policies. The net three-year rescheduling impacts estimated with the VAR model are shown in Table 7-4. Th e 10 percent decrease in debt service and the 6 percent decrease i n imports are beneficial t o balance of payments and reflect desire d effects o f the rescheduling procedure. Decrease d growth in debt service payments shoul d fre e resource s t o be employe d withi n th e domesti c economy . Decreased growth in imports improves the current account and decreases outflow o f foreign exchange . I t also, however, could signify potentia l problem s for firm s tha t rel y o n import s i n th e productio n o f good s fo r domesti c consumption o r export. Reserve s ar e estimated t o improv e over 20 percent. The remaining effect s ar e more troubling . A reschedulin g episod e reduce s growth in GNP, exports, and inflows o f foreign funds . Th e decreased growth in GNP indicates the general recessionary effects of the standard approach and does not augur well fo r future repayment problems. A n economy tha t is not growing is likely to have future debt service problems, especially once principal amortization commences. 8 Th e lack of growth in exports is probably the most distressin g sig n fo r th e creditors , a s th e orthodo x strateg y relie s o n generation of a trade surplus. Th e devaluations that often accompan y implementation of the standard approach do not appear to have the desired effects o f stimulating exports. Th e decrease in the growth of foreign exchang e inflow s

7. Thi s criticism applies to the cited empirical woik as well as to our own research. 8. Thi s has not been lost on policymakers withi n the international financial organization s and the U.S. government. Th e growth-oriented Baker Plan announced by U.S. Treasury Secretary Baker at the IMF meeting in Seoul in September 198 5 is one example. Anothe r is seen in recent World Bank announcements about the need for renewed growth—"growing out of debt."

ASSESSING STRUCTURAL ADJUSTMENT PROGRAMS 1

13

Table 7-3 . Economi c Variabl e Comparisons a (Countries Rescheduling between 1976 and 1981)

Variable Befor GNP Growth Export Growth Import Growth Debt Service Growth Reserves Growth Com. Inflows Growth d NonCom. Inflows Growth d

Growth Rat e e Rescheduling Afte r Rescheduling T-Statistkr 4.00 c 2.50c 4.57 c 0.49 0.94 2.04c 0.21

-0.031 -0.056 -0.056 0.073 -0.169 -0.690 -59.66

0.050 0.059 0.104 0.031 -0.434 51.83 -77.60

a. Sampl e size 18. b. T-Test s are reported for an equal variance test of means. c. Significan t at the 95 percent level. d. Measure d as annual change, not as a percent.

Table 7-4. Three-Yea r Percen t Changes i n Economic Variable s Following a Rescheduling Episode (Estimates from the VAR Modelf Variable Debt Service Imports Exports Reserves GNP Commercial Inflows Noncommercial Inflow s

Percent Change

F(l,511) b

-10.84 -6.62 -2.38 26.08 -5.55 -48.47 -10.37

a. Derive d from the parameter estimates of the VAR model shown in Appendix A. b. F(l t511) tests whether the entire estimated effect is significantly different from 0. c. Significan t at the 90 percent level . d. Significan t at the 95 percent level.

1.068 3.382c 0.221 4.644c 3.673c 5.146d 0.646

5

114 STRUCTURA

L ADJUSTMENT: SOLUTION OR PART OF THE PROBLEM?

reflects th e increase d riskines s o f th e situatio n an d consequen t credito r hesitancy, particularly among commercial lenders, to commit new funds.9 A stylized picture of the economy of a rescheduling country i n the years immediately afte r th e agreement can be constructed from thes e results. Th e agreement lowers the debt service obligations of the country, and IMF-imposed economic policie s reduc e th e growt h i n import s t o th e economy . Thi s i s consistent with the results reported by Pastor (1987), Reichman and Stillson (1978), and Donovan (1982) . However , exports are not stimulated (i n fact , they are reduced as part of the general economic slump), GNP growth slows, and banks in industrial nations are not forthcoming wit h new loans. Th e net impact on reserves is positive despite the mixed effects. Clearly , this analysis, while supported by the estimates in Tables 7-1,7-2,7-3, and 7-4, can be made only as a hypothesis. However , the results of the estimation clearly support the arguments of some of the critics of standar d rescheduling practices who maintain tha t a scenari o o f thi s sor t i s th e mos t likel y outcom e o f a rescheduling episode. SIMULATIONS AN D ABILIT Y T O PA Y ANALYSI S The macroeconomic effects outline d above are only part of the story. I n our definition o f reschedulin g succes s an d failure , w e state d tha t o f particula r interest is the net impact of the rescheduling and adjustment on ability to pay. To provide an estimate of the impact of a rescheduling episode on a county's economy tha t take s all possible interaction s int o effect an d t o estimat e the impact of these effects o n ability to pay, simulations were made for severa l Latin America n countrie s usin g th e vecto r autoregressio n model. 10 Tw o forecasts of the period 198 4 to 1989 were completed for both countries. Th e first forecas t assume d n o rescheduling , whil e th e secon d assume d a 198 4 rescheduling episode. Thi s experiment is designed for comparative purposes rather tha n a s a n actua l forecas t fo r th e countries . Th e result s o f thes e simulations, whic h ar e quite similar t o the static predictions, ar e shown in Table 7-5. Deb t service and imports decline substantially by the fourth yea r after th e rescheduling fro m th e nonrescheduling forecast . GN P falls, as do commercial and noncommercial foreign exchange inflows.

9. Se e Chapte r 4 b y Lissaker s an d Chapter 5 b y Sack s an d Canavan fo r discussions o f th e impact of changes in bank regulation on the commitment of new funds in the 1980s. 10. Thes e countrie s wer e chose n becaus e o f th e authors ' particular interest i n Lati n America . Other simulations could be produced on request

ASSESSING STRUCTURAL ADJUSTMENT PROGRAMS 1

15

Table 7-5 . Simulation s o f the Impact of a Rescheduling Episode 3 Simulated Results for 1989/Reschedulin g in 198 5 (Millions of US. Dollars)

Variable Wit

h Rescheduling N

Debt Service Brazil Peru GNP Brazil Peru Exports Brazil Peru Imports Brazil Peru Reserves Brazil Peru Commercial Inflows Brazil Peru Noncommercial Inflow s Brazil Peru

o Rescheduling Percen

t Differenc e

7718 677

8283 727

-6.82 -6.87

221172 16609

232716 17475

-4.96 -4.95

49175 6022

50293 6159

-2.22 -2.22

38258 4684

43614 5339

-12.28 -12.26

10782 2136

8319 1648

29.60 29.61

2566 296

4046 467

-36.57 -36.61

218 35

244 39

-10.65 -10.25

a. Fro m simulations using the model described in Appendix A.

Tables 7-1 through 7-5 indicate the impact of the economic policies associated with rescheduling on the economies of the debtor nations. Th e impacts are mixed wit h regar d t o increasin g th e creditworthines s o f th e reschedulin g nations. Deb t service and imports are reduced. Thi s should increase reserves and the ability to pay of the country. However , GNP growth is reduced, which could negatively affec t abilit y to pay. Export s are not increased; rather, they seem to fall with the decline in economic activity . Finally , the inflow o f new reserves from external sources is severely curtailed after a rescheduling episode. The ne t effec t o n abilit y t o pa y o f th e countr y i s therefor e no t clear . A model of deb t service difficulty ca n be used to determine the net impact of a rescheduling o n th e financia l healt h o f th e debto r country. Severa l author s (King and Robinson forthcoming; McFadden et al. 1985 : 179-201; Feder, Just,

116 STRUCTURA

L ADJUSTMENT: SOLUTION OR PART OF THE PROBLEM?

and Ros s 1981 ) hav e use d quantitativ e model s t o forecas t deb t servicin g difficulty. Thes e models predict the ability of a country to meet debt service obligations based on the economic an d financial stat e of th e country. Feder , Just, an d Ros s (1981 ) foun d tha t th e followin g ratio s wer e significan t i n predicting debt problems: debt service to exports, real per capita GNP to U.S. per capita GNP, reserves t o imports , exports t o GNP, and (non)commercia l foreign exchang e inflow s t o debt service. B y modelin g th e ability t o pay of Brazil and Peru from the simulations described above, some measure of the net impact of the rescheduling can be reached. I f the rescheduling is a net success, the abilit y t o pa y o f th e countr y shoul d improv e a s th e impact s o f th e rescheduling and associated economic policies spread throughout the economy. If, o n the other hand, the effects o f the rescheduling decrease ability to pay or increase th e probability o f deb t service difficultie s i n the future, th e policies have failed. Usin g the King and Robinson estimates 11 o f the Feder, Just, and Ross mode l o f deb t servicin g difficulties , th e probabilitie s o f deb t servic e problems were estimated for Brazil and Peru under both the 1984 rescheduling scenario and the no rescheduling scenario. Thes e results, contained in Table 76, can be used to determine the net impact of the 1984 intervention. The results from Table 7- 6 sho w tha t the net impac t o f th e various eco nomic consequence s tha t have been discusse d throughou t thi s paper is onl y marginally favorable for improving the ability to pay of the debtor nation. I n both simulations the probability for debt service problems of the countries was reduced less than 6 percent in 1989. 12 Thes e results would seem to indicate that the standard rescheduling practices have not been successful in solving the debt crisis o r in improvin g th e abilit y t o pay o f countrie s facin g deb t problems.

11. Th e estimated coefficients fo r the Feder, Just, and Ross model as they appear in King and Robinson (forthcoming) are as follows: Variable Estimat Debt Service/Exports 5.5 Exports/GNP 0.7 Commercial Inflows/Debt Service -0.3 Noncommercial Inflows/Debt Service -0.1 Reserves/Imports -1.0 GNP Per Capita/U.S. GNP Per Capita -9.9 Intercept -1.6

e Std 1 1.3 3 0.5 9 0.2 6 0.1 8 0.7 4 2.8 7 0.5

. Error 2 1 0 0 4 0 3

The probability of reschedulin g is compute d with the above coefficients i n a logit probability form. Probabilit y = e b'X / (1+ e b'X). 12. I n simulations no t reported with Chile, the rescheduling simulatio n actually increased the probability of repayment difficulty.

ASSESSING STRUCTURA L ADJUSTMENT PROGRAMS 11

7

Table 7-6 . Probabilit y o f Deb t Servic e Difficulty 3* b Brazil and Peru, 1985-198 9 (Probability of Repayment Difficulties) 1984 198

5 198

6 198

7 198

8 198

9

Brazil Rescheduling in 1985 No Rescheduling Percent Differenc e

0.141 0.141 0.000

0.146 0.152 -3.940

0.125 0.130 -3.840

0.124 0.129 -3.870

0.143 0.143 0.000

0.146 0.150 -2.660

Peru Rescheduling in 1985 No Rescheduling Percent Difference

0.098 0.098 0.000

0.104 0.107 -2.800

0.105 0.109 -3.660

0.111 0.122 -9.010

0.123 0.130 -5.380

0.129 0.137 -5.830

a. Compute d fro m th e Robinson-Kin g estimate s o f th e Feder , Just, an d Ross mode l o f deb t service capacity. b. Fro m simulations using the model described in Appendix A.

In light of these results, it is interesting to consider why countries continue to participate in standard rescheduling practices, rather then seek other remedies. As members of the international economic an d trading community, they are reliant on other countries as markets for their exports, sources of imports, and sources of trade and balance of payments finance. Thes e important connections might lead to a reluctance to challenge the standard approach for fear of being further cu t off fro m acces s to international market s and credit. Still , given these results, deciding to break with the standard approach, as Peru did publicly in July 1985, does not seem such an irrational decision. Indeed , the more relevant question may be why more countries have not adopted a similar attitude. CONCLUSIONS AN D RECOMMENDATION S Considerable debate has been engaged as to whether the standard rescheduling practices of the IMF and conditionally ar e a viable means of solving the debt crisis facing th e world economy. Thi s paper evaluated thes e policies i n an econometric fashion . Th e economic impact s of rescheduling episode s fro m 1974 t o 198 4 ar e modele d b y treatin g the m a s innovation s t o a vecto r autoregressive process. Thes e estimates indicat e tha t substantia l economi c impacts do result from rescheduling and the adjustment policies enacted as part

118 STRUCTURA

L ADJUSTMENT: SOLUTION OR PART OF THE PROBLEM?

of the rescheduling process. I n the three years after a rescheduling occurs, debt service and imports are reduced to levels below what they worM have been in the absence of the rescheduling. A t the same time, reserves increase. Thes e are desired outcomes of the economic policies of standard rescheduling practice. However, les s positiv e change s occu r a s well : GNP , exports, an d foreig n exchange inflows ar e reduced to levels below those which the y would have attained without the rescheduling. Thes e changes would be detrimental to the ability to pay of the rescheduling nation. The net magnitudes of these effects wer e examined i n simulations of the economies o f Brazi l an d Peru wit h an d withou t reschedulin g innovations . These simulation s provid e conclusion s simila r t o thos e obtaine d fro m th e estimates of the vector autoregression model. I t appears as though rescheduling practices achieve only partial succes s in improving the health of debtor nation economies . T o determine th e net impact of th e offsetting effect s o f declining debt service and imports and declining GNP and export growth, a logit model of repayment problems first used by Feder, Just, and Ross (1981) and reestimated by King and Robinson (forthcoming) was used to predict the probability o f deb t servic e problem s fo r Brazi l an d Per u unde r th e tw o simulation scenarios . I n thi s experiment , neithe r Brazi l no r Per u woul d develop substantially lowe r probabilities of repayment problems if the y had rescheduled in 1985 than if they had not Despite the insights this analysis offers, on e must be aware of its limitations. Th e vector autoregression mode l used her e does not force structura l consistency o n th e economies . I n addition , an y analysi s don e unde r th e assumption all countries respond in the same manner should be viewed with caution. A s mor e an d bette r dat a becom e available , researc h wit h mor e complex model s woul d b e useful . An y update d mode l shoul d attemp t t o capture policy changes that may be in progress. Th e actors involved i n the rescheduling process have learned a great deal in recent years and have begun to modify their actions. Attemptin g to model these policy changes would provide useful insight s int o th e ongoing deb t reschedulin g process . Havin g issue d these word s o f warning , w e repea t tha t ou r result s sugges t tha t standar d rescheduling practices as implemented between 1974 and 1984 did not improve the prospects for debtor nations. Th e policies were successful in lowering debt service obligations and reducing imports. However , these gains were offset by the general slowdown in economic activity that follows a rescheduling and by a reluctance of creditor s t o provide ne w mone y t o trouble d countries . A rescheduling episode for a debtor nation, through its economic impacts, does not significantly decreas e the probability tha t further deb t service problems will emerge.

ASSESSING STRUCTURA L ADJUSTMENT PROGRAMS 11

9

In light of th e lack of succes s o f th e standard rescheduling approach , and given ou r results , tw o perspective s o n polic y becom e apparent . W e hav e shown that exports are not increased by standard adjustment policies. Th e roles of export s an d foreig n exchang e earning s clearl y ar e critica l i n allowin g a country t o servic e it s foreig n currenc y debt . Expor t earnings , however, ar e subject to bilateral and multilateral regulations limiting access to markets. I f a country i s expecte d t o servic e significan t amount s o f debt—i n dollars , fo r example—it wil l b e abl e t o d o thi s mos t easil y i f i t ha s acces s t o market s where it can directly earn dollars. Tyin g debt repayment to export earnings, as Peru's Garci a ha s attempte d t o do , i s no t a n impractica l strateg y i f i t i s accompanied b y continuin g negotiations . I n fact , i t migh t b e possibl e t o specifically ti e debt repayment to one country's banks to that country's import purchases fro m th e concerne d debto r country . Thi s woul d consis t o f U.S . banks, fo r example , receivin g som e portio n o f U.S . impor t purchase s o f a specific debtor' s exports. Thi s would serve to move at least part of the burden of stimulating exports from the debtor country to the commercial banks, which might be quite useful given the lack of export growth that our results indicate. A Garcia-typ e proposa l ha s severa l advantages . I t make s th e connectio n between financial debt payments and trade earnings explicit. I t would force the creditor banks—those wit h a direct stake in the repayment process—to assis t their customers, the debtor nations, in gaining access to markets. Som e of the political cost s of adjustment are thus transferred to the creditor banks. Whil e the mechanics may be difficult, on e must remember that the entire rescheduling process as it stands absorbs significant amounts of time and resources, and thus has substantial costs of its own. A secon d policy consideratio n i s th e apparent deterioration i n the capital account implied by the reduction in foreign exchange inflows following adjustment. Thi s result in part goes against current wisdom tha t an IMF agreement represents a seal of approval that should lead to increased bank lending. Ou r results suggest that rescheduling an d adjustment would be more successful if continued inflows of new credit were maintained.

120 STRUCTURA

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APPENDIX A : MODE L SPECIFICATION S To obtain estimate s o f th e impac t o f reschedulin g o n th e debto r nation , a simple vector autoregression mode l of the economies of debto r nations was employed similar to that used by McFadden et al. (1985). Thi s represents a straightforward firs t approach. A more completely developed macroeconomic model capturing structura l relationships shoul d be possible sometim e in the future a s more data become available. I n spite of the simplicity of the VAR technique, it has been used as a successful short-ter m forecasting tool by Webb (1984). Also , it has certain advantages over techniques employed by Pastor (1987) and used in other empirical work that do not control for the simultaneity of economic relationships. Th e state vector of the economy consist s of the natural log of seve n importan t economi c variables. First , difference s wer e employed to make the vector stationary. Th e equation that was estimated is shown below. log(X)t4og(X)t4= a + B1'(log(X)t-1-log(X)t-2)+B2'(log(X)t-2)-log(X)t-3) •+Cl(R)t-l+C2(R)t.2+C3(R)t.3+et Where X ^ is th e econom y stat e vecto r a t tim e t , R t i s a dumm y variabl e representing a rescheduling agreement in time t, and et is the error term in time t.

The model was estimated using data from seventy-two developing countries over the years 1974 to 1984. Appendi x B contains a complete country list, a list of reschedulings, and further variabl e definitions. Th e economic variables included were those variables used in the Feder, Just, and Ross model of debt servicing difficulties . The y include : GNP , debt service , imports, exports, reserves, commercial inflows, and noncommercial inflows. Th e source of the data was the World Bank's World Debt Tables (1983-1984,1984-1985). The use of pooled cross-section time series data poses some problems that must be acknowledged. W e estimate a fixed-effects model , using the standard pooled cross-section time series treatment. Dumm y variables are included to allow different intercept s across both time and region. Th e regions used are Latin America, East Asia and the Pacific, Sub-Saharan Africa, North Africa and Middle East, South Asia, and Europe and Mediterranean. Th e countries are placed in regions as defined by the World Bank. Th e error structure is assumed to be independent of both time and country, though the use of first difference s minimizes potential problems.

ASSESSING STRUCTURAL ADJUSTMENT PROGRAMS 12

1

A three-yea r first-degre e distribute d la g o f eac h countries ' reschedulin g history wa s added to the economy vecto r of th e autoregression t o model the impact of rescheduling episodes . Th e three-year lag seems most appropriate because the typical grace period allows three years for the economic reforms of the rescheduling package to be enacted. Othe r lag structures were employed with similar results and are available from the authors. Th e results of th e estimations are shown in Table 7-A1.

Table 7-A1. Vecto r Autoregression of Macroeconomic Variables 3 (Including Rescheduling Innovations) Dependent Variable s Lagged Variables

Debt Service

Imports

Exports

Reserves

GNP

Com. Inflows

NonCom. Inflows

DebtService(-l)

-0.271 (-6.05)b

0.002 (0.15)

0.014 (0.67)

-0.112 (-Z43)b

0.007 (0.61)

0.071 (0.62)

0.047 (0.87)

DebtService(-2)

-0.009 (-0-20)

0.022 (1.51)

0.018 (0.85)

-0.087 (-1.88)c

0.011 (0.95)

-0.164 (-1.45)

0.011 (0.20)

Imparts(-1)

0.026 (0.18)

-0.003 (-0.07)

0.275 (4.05)b

-0.080 (-0.54)

0.073 (1.93)c

0.882 (2.41)b

0.209 (1.18)

ImpQrts(-2)

-0.093 (-0.68)

-0.071 (-1.54)

0.033 (0.52)

-0.393 (-2.79)b

0.004 (0.13)

0.345 (1.00)

0.070 (0.42)

Exports(-l)

-0.040 (-0.43)

0.060 (1.76)c

-0.424 (-8.82)b

0.297 (2.82)b

0.043 (1.61)

-0.422 (-1.63)

-0.018 (-0.15)

Exports(2)

-0.080 (-0.91)

0.098 (3.02)b

0.112 (2.48)b

0.172 (1.73)c

0.037 (1.44)c

-0.458 (-1.87)c

-0.119 (-1.01)

Reserves(-1)

0.024 (0.05)

0.089 (6.04)b

0.075 (3.67)c

-0.172 (-3.84)b

0.038 (3.36)b

-0.046 (-042)

0.004 (0.08)

Reserves(-2)

0.024 (0.55)

0.094 (3.28)b

-0.000 (-0.01)

0.006 (0.14)

0.013 (1.17)

0.177 (158)

-0.053 (^0.99)

GNP(-1)

-0.048 (-0.26)

0.102 (1.65)c

0.120 (1.40)

-0.032 (-0.17)

0.159 (3.29)b

0.453 (0.98)

-0.245 (-1.10)

GNP(-2)

-0.143 (-0.80)

-0.187 (-3.09)b

-0.265 (-3.15)b

-0.082 (-0.44)

-0.231 (-4.89)b

-0.590 (-1.31)

-0.033 (-0.15)

Commercial Inflows(-l)

0.043 (2.43)b

-0.003 (-0.56)

-0.005 (-0.67)

-0.009 (-0.51)

0.002 (0.55)

-0.359 (-7.98)b

-0.011 (4.52)

Commercial Inflows(-2)

0.029 (1.65)c

-0.000 (-0.12)

0.001 (0.20)

0.026 (1.45)

0.001 (0.32)

-0.208 (-4.63)b

0.035 (1.62)

122 STRUCTURA

L ADJUSTMENT: SOLUTION OR PART OF THE PROBLEM?

Table 7A- 1 (continued)

Noncommercial Inflows(-l)

0.092 (2.63)b

0.003 (0.33)

-0.009 (-0.56)

0.024 (0.68)

0.002 (0.32)

0.076 (0.85)

-0.285 (-6.66)b

Noncommercial lnflows(-2)

0.044 (1.23)

0.007 (0.60)

-0.015 (-0.95)

0.013 (0.36)

0.005 (0.59)

-0.002 (-0.032)

-0.066 (-1.52)c

Afiica

0.002 (0.05)

-0.020 (-1.35)

-0.030 (-1.44)

-0.103 (-2.26)b

0.003 0.293

0.008 (0.07)

0.023 (0.435)

East Asia

0.084 (1.38)

0.031 (1.53)

0.044 (1.55)

0.011 (0.18)

0.028 (1.78)c

0.238 (1.54)

0.013 (0.18)

North Africa

0.095 (1.56)

0.017 (0.85)

0.027 (0.96)

0.001 (0.02)

0.046 (2.87)b

0.066 (0.42)

0.005 0.07)

South Asia

-0.058 (-0.73)

0.040 (1.53)

0.016 (0.45)

0.063 (0.77)

0.017 (0.84)

0.130 (0.65)

-0.016 (-0.16)

Europe

0.028 (0.39)

0.011 (-0.56)

0.041 (1.23)

-0.027 (-0.37)

-0.018 (-0.95)

0.320 (1.76)c

0.018 (0.21)

1978

0.107 (1.44)

-0.092 (-3.67)b

-0.206 (-5.86)b

-0.110 (-1.43)

-0.039 (-1.99)b

-0.008 (-0.04)

0.080 (0.88)

1979

0.032 (0.44)

-0.005 (-0.22)

-0.074 (-2.18)b

0.124 (1.66)c

0.000 (0.02)

-0.396 (2.16)b

0.087 (0.99)

1980

-0.046 (-0.63)

0.011 (P.45)

-0.010 (-0.31)

-0.186 (-Z45)b

-0.153 (-0.78)

-0.304 (-1.63)

0.065 (0.72)

1981

0.010 (0.13)

-0.163 (-6.36)b

-0.242 (-6.78)b

-0.419 (-5.37)b

-0.125 (-6.22)b

-0.656 (-3.42)b

-0.079 (-0.85)

1982

-0.117 (-1.59)

-0.215 (-8.64)b

-0.329 (-9.53)b

-0.412 (-5.45)b

-0.120 (-6.17)b

-0.517 (-Z78)b

-0.205 (-2.29)b

1983

-0.112 (-1.48)

-0.238 (-9.25)b

-0.328 (-9.19)b

-0.294 (-3.76)b

-0.133 (-6.60)b

-0.697 (-3.62)b

-0.202 (-Z18)b

1984

-0.143 (-1.73)c

-0.160 (-5.71)b

-0.173 (-4.48)b

-0.399 (-4.69)b

-0.117 (-5.37)b

-0.547 (-2.61)b

-0.066 (-0.65)

-0.112 (1.06)

-0.067 (3.38)c

-0.024 (0.22)

-0.551 (3.67)c

-0.622 (5.14)b

-0.106 (0.64)

Rescheduling Effects R-Squaied 0.13 M.S.E. 0.16

5 0.30 4 0.02

7 0.46 5 0.03

4 0.20 6 0.17

0.240 (4.64)b 5 0.42 3 0.01

8 0.19 1 1.04

5 0.13 8 0.24

0 4

a. T-Statistic s i n parentheses. Fo r the rescheduling effects , coefficient s represen t the sum o f the three-yea r lagged effects. F-Statistic s testing the null hypothesis that the sum is zero are reported in parentheses. b. Indicate s significance at the 95 percent level. c. Indicate s significance at the 90 percent level.

ASSESSING STRUCTURAL ADJUSTMENT PROGRAMS 12

APPENDIX B : DAT

3

A

Table 7-B1. Countrie s in Data Base an d Rescheduling s Country Reschedulin Algeria Argentina Bolivia Brazil Burma Cameroon Central African Republic Chile Colombia Congo Costa Rica Cyprus Dominican Republic Ecuador Egypt El Salvador Ethiopia Fiji Gabon Ghana Greece Guatemala Guyana Haiti Honduras India Indonesia Israel Ivory Coast Jamaica Jordan Kenya Korea Liberia Madagascar

g Years Countr None 84 80,81,83 83,84 None None 81,83 83,84 None None 83,84 None 83 83,84 None None None None 78 74 None None 82,83 None 82 None None None 84 78,79,81,84 None None None 80,81,82,83,84 None

y Reschedulin Malawi Malaysia Mali Mauritania Mauritius Mexico Morocco Nicaragua Nigeria Oman Pakistan Panama Paraguay Peru Philippines Rwanda Sierra Leone Singapore Somalia Sri Lanka Sudan Swaziland Syrian Arab Republic Thailand Togo Trinidad and Tobago Tunisia Turkey Uganda Uruguay Venezuela Yemen Yugoslavia Zaire Zambia

g Years None None None None None 83,84 83,84 80,81,82 83 None 74 84 None 78,80,83,84 84 None 77,80 None None None 79,81,82,83 None None None 80,81,83,84 None None 78,79,81,82 None 83,84 84 None 83,84 76,77,79,80,81 83,84

Sources: Economi c Variables : GNP , Deb t Service , Exports , Imports , Commercia l Disbursements , Non Commercial Disbursements and Reserves from the 1984-1985 World Debt Tables. Populatio n from International Financial Statistics Annual, 1986. Reschedulin g Episodes from Dillon et al. (1985).

8

UNDERVALUATION, ADJUSTMENT, AN D GROWTH Richard D. Fletcher

Devaluation—or "exchang e rate action," as it is euphemistically called—ha s become a standard feature of IMF conditionally in the 1980s. I n 1981-1983, for example, 80 percent of IMF-supported programs (excluding those involving members o f currenc y unions ) include d devaluatio n a s par t o f th e packag e (Johnson 1985) . Th e IMFs preference for devaluation is not generally shared by politician s i n th e LDCs . A s th e Finance Ministe r o f Guyan a recentl y remarked, "The IMF uses devaluation like a man with a hammer who believes that everything is a nail."1 Th e skepticism of politicians about the usefulnes s of devaluation is understandable. Afte r all , they can see from th e unpleasant experiences o f erstwhil e colleague s tha t bein g associate d wit h currenc y devaluation often cuts short an otherwise promising political career. Moreover , political fears are reinforced by doubts about whether devaluation will actually be effective i n correcting balance of payments disequilibria. Thi s aversion to devaluation is unfortunate because in economics, as in the practice of medicine, it is preferable that the patient as well as the physician have confidence that the prescription will work. The views and interpretations in this paper are those of the author and should not be attributed tc the Inter-American Development Bank. 1. Car l Greenidge, Guyanese Finance Minister, at the Caribbean Symposium on Exchange Rate Management, Trinidad and Tobago, January 1988.

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HOW EFFECTIV E I S DEVALUATION ? In theory, devaluation i s a very effective instrument : it will raise prices (in local currency) of exports and imports, leading to an expansion of exports and import substitutes, a decline in imports, and an improvement in the trade balance (Bird 1984b). I n practice, hbwever, there is a considerable delay before the improvement occurs. Thi s can be seen, for example, in the recent case of U.S. devaluation, where it has taken nearly two years for the trade deficit to improve following a steep devaluation of the U.S. dollar. I n LDCs, where infrastructure is lacking an d th e productive structur e i s less flexible tha n i n th e U.S., the response time is even greater—probably three years or more (Morawetz 1981). Thus, devaluation should not be considered as an instrument for dealing with short-term balanc e o f payment s problems , but rathe r a s a n instrumen t fo r correcting longer-term imbalance between exports and imports. I n this context, the relevant issue is not the effectiveness o f a single isolated devaluation, but the effectiveness o f a sustained strategy of keeping the exchange rate undervalued for a long period of time. Th e experiences of the LDCs in the 1970s and 1980 s are very instructive in this regard. Afte r th e oil shock of 1973 , it appeared that the most privileged LDCs were those fortunate enough to capture "rents" from the export of scarce primary commodities, such as oil and bauxite. Fifteen year s later, it is sobering to note that virtually al l the "rent earning" LDCs fell victim to "Dutch Disease." Thei r exchange rates became overvalued, and they lost the ability to compete in the export of products other than their rent commodity (Corden 1984) . I n contrast, the countries that performed best during the last fifteenyears were those that did not have the option of exporting natural resources and were forced to develop a comparative advantage in the export of labor-intensive manufactures. Thes e countries (for example, Singapore, the People's Republic of China, Hong Kong, and Korea) have maintained faster rate s o f growt h o f outpu t an d employmen t an d enjo y bette r incom e distributions than the more privileged LDCs that export primary commodities (United Nations 1987b; Fields 1984). Th e lesson is clear: LDCs that developed a wide range of manufactured exports achieved success in the 1970s and 1980s. In those LDCs, export competitiveness was achieved and maintained in part by a deliberate long-term strategy of undervaluation of the exchange rate. WHICH STRATEG Y WIL L WOR K I N TH E 1990s ? Evidence shows countries following a sustained policy of undervaluation had better results in the 1970 s and 1980 s than those that were overvalued. Wil l

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7

similar strategie s wor k i n th e 1990s ? Wil l i t b e counterproductiv e fo r al l LDCs to attempt to become exporters of light manufactures? Wil l this result in excessive competition, a loss i n th e gains from trade , and even provok e protectionism i n OECD markets? (Cline 1982 ; Ranis and Cline 1985) . Ther e is no categorical answer to these questions, but dangers appear to be small for two reasons. First , manufactured import s fro m LDC s are still a very small percentage o f tota l consumptio n i n OEC D markets . Onl y i n th e cas e of clothing do LDCs supply more than 15 percent of the OECD market. Second , there are vast possibilities i n South-Sout h trade , which ha s grown fro m 2 0 percent of LDC exports in 192 0 to 32 percent in 1986. I t thus appears there should be adequate markets for LDC-manufactured exports in the 1990s (Balassa et al . 1986) . Anothe r issu e i s whethe r LD C manufacture s wil l b e abl e t o compete in view of technological advances in the industrialized world. Again , there is n o definitiv e answer , but it i s likel y ne w technologie s wil l impac t primary commodities most adversely (Oversea s Development Council 1988), so that diversification int o manufactures make s sense if only as a defensiv e strategy. Ther e are also stron g indication s tha t LDCs that develop a broad capacity in manufactured export s have the flexibility t o roll with the punches and will be better able to adapt to new technology than exporters specializing in raw materials (Ranis 1984). POLITICAL OBSTACLE S T O UNDERVALUATIO N The economic rationale of the undervaluation strategy is very powerful, and has been around for a long time. A s early as 1950 , W. A. Lewis argued that the only viable strategy for industrialization of the (then) British West Indies was to achieve competitiveness i n labor-intensive manufacture d product s (Lewi s 1950). Ye t few LDCs have chosen to follow thi s approach—evident from th e small number that has become successful exporters of manufactured products— because political difficulties o f an undervaluation strateg y ar e immense. I n most LDCs, the political forces that benefit fro m undervaluatio n are weak, at least in the short run (Nelson 1986). Group s that favor overvaluation comprise a broad range of powerful interests : wage earners, consumers, importers, trade unions, civil servants , academics, and members of the security forces , all of whom would be adversely affected b y increases in import prices following a devaluation. Group s tha t woul d benefi t fro m undervaluatio n ar e exporter s (often foreig n firms) , peasants, and those who eventually will be employed in the expande d expor t sector . I n countrie s tha t d o no t hav e a traditio n o f

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exporting manufactures , thes e group s are poorly organize d an d wield littl e political influence. The pressur e fro m powerfu l group s i s usually sufficien t t o persuade a government to delay devaluation. Bu t unless the country is fortunate enough to benefit from a windfall (fo r example, an unexpected ris e in the price of its commodity exports), a disequilibrium caused by lack of export competitiveness will not be cured by procrastination. O n the contrary, the disequilibrium will worsen, the country will lose foreign exchang e reserves, and the government eventually wil l be forced t o implement a drastic devaluation combine d with recessionary demand management. I n this situation, the political costs will be even greater than those that would have been incurred by an early devaluation, and the economic benefits will take even longer to materialize. The lesson from th e above is that attempts to avoid the short-term political costs of devaluation inevitably lead to even greater political costs in the longer run. An d yet, in most competitive democratic systems the short-term concerns predominate. Th e result is that virtuall y n o open, competitive, democratic regimes hav e bee n abl e t o follow a sustained polic y o f export-promotin g undervaluation in the 1970s and 1980s. HOW T O DEVALU E SUCCESSFULL Y The politica l problem s cause d b y devaluation ar e so serious tha t n o LD C government will take this step with enthusiasm. Ye t it is clear that LDCs that get into balance of payments problems are obliged to take this step sooner or later. Th e question of how to devalue successfully i s therefore more relevant than the question of whether to devalue at all. The key to success i s timing. Earl y decisiv e actio n wil l permi t a less drastic devaluation. Moreover , it is better to correct overvaluation while there are still sufficient foreig n exchang e reserves to allow output and incomes to expand while the productive structure is adjusting.2 I n other words, early action will both reduce the immediate political costs and allow the economic benefits to be realized befor e th e electoral day of reckoning. T o take early action , policymakers need to have fair warning that the exchange rate is overvalued. The danger signal most frequently use d is the level of reserves, but this is a flawed indicato r because reserves may actually increase during the early stages of "Dutc h Disease." A much better indicator is the rate of growth of labor2. Conclusion s o f the Caribbea n Symposiu m o n Exchange Rat e Management, Trinida d an d Tobago, January 1988.

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9

intensive exports. I f these are growing rapidly, more than 15 percent per year, then thi s suggest s tha t export s ar e competitiv e an d th e exchang e rat e i s satisfactory. I f labor-intensive exports are stagnant or declining, then one has a sign of loss of competitiveness and overvaluation. A second issu e is the choice of th e "correct level " of the exchange rate. Economic theory prescribes that the rate be calculated using the price elasticities of imports and exports. However , this is of little practical value, because data on elasticities are usually unavailable. I n any event, the important issue is the country's ability to develop new exports rather than the expansion of traditional exports. Anothe r approach is to restore the real effective exchange rate to the value it had during a period in which the economy was in equilibrium. Bu t this is too general and does not specifically address the issue of competitiveness in the rate of labor-intensive exports. Th e most useful approach is to determine the exchange rate that will ensure profitability o f those products the country plans to develop in the relevant markets (Nashashibi 1980). The thir d issue , a s indicate d earlier , i s th e importanc e o f sustainin g a situation of undervaluation long enough for production to respond. Thi s is not easy because there will be pressures to revalue the effective rat e through increases in money wages. Thes e pressures must be fought with an appropriate combination o f incomes policy and prudent monetar y and fiscal policy. If , despite these measures, money wages continue to rise, then it will be necessary to have further devaluations . I n this regard, it is probably better to have small frequent adjustment s of the rate rather than large infrequent changes, because the latter will produce large variations in profitability and undermine the confidence of exporters. The fourth issue is how to reduce the lag in realizing the economic benefits from devaluation. Th e mos t importan t consideratio n i s t o giv e exporter s confidence that there is a long-term commitment to ensure the profitability of labor-intensive exports. Thi s means that in addition to keeping the exchange rate competitive, the government should support the export effort wit h a broad array of measures, including fiscal policies that favor exports, the provision of finance, the ready availabilit y o f importe d inputs , institutional support , and close collaboration between the public and private sectors in solving the myriad day to day problems of exporting (Rhee et al. 1984). FINAL COMMENT—TH E MORA L ISSU E There i s convincin g evidenc e i n th e las t fiftee n year s tha t thos e LDC s following a sustained strategy of undervaluation reaped substantial economic

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rewards in terms of rapid growth of exports, output, and employment. Thos e LDCs tha t overvalued thei r currencies ha d much less favorabl e results . Th e political difficultie s o f implementing a strategy of undervaluatio n ar e considerable, especially i n democratic system s with a competitive electoral process. These difficultie s ca n be minimized, however , i f actio n i s take n early and is supported b y othe r polic y measures . Apar t fro m politica l problems , th e strategy o f undervaluatio n raise s a n importan t mora l issue . Fo r LDCs , undervaluation essentiall y involve s exploitatio n o f labor . T o develop export competitiveness, the exchange rate must be devalued until costs of production are comparable t o price s availabl e i n internationa l markets . I n th e cas e o f labor-intensive manufactured products, the major item is the wage cost, so it is this which must be reduced. Moreover , for most LDCs other cost items such as profits , cos t o f capital , an d eve n manageria l cost s ar e no w pegge d a t international level s an d consequently ar e not subject t o control b y domesti c policies. Unfortunately , give n productivit y level s i n mos t LDCs , th e wag e rates that result from the need to establish export competitiveness are a fraction of the minimum wage in the developed economies. Thi s is unpalatable from a moral standpoint . I t i s unjus t tha t economi c succes s i n th e LDC s shoul d depend on their workers being obliged to work cheaply to produce goods that are enjoyed by relatively well-of f consumer s in the industrial countries. An d yet, the experience of th e last fifteen years suggests that other alternatives are no better, fo r eve n a t low wages , employmen t an d growth ar e preferable t o unemployment an d economic stagnation . Whic h lead s to the sad conclusion arrived at some twenty-five year s ago by Joan Robinson: "The misery of being exploited by capitalists is nothing compared with that of not being exploited at all" (Robinson 1964) .

9

OLD WIN E I N NE W BOTTLES: POLICY-BASE D LENDING I N TH E 1980 s Jose D.Epstein

NEW BOTTLE S On March 30 , 1988 , Secretary o f th e Treasury James A. Baker III testifie d before the Appropriations Committee of the Senate Subcommittee on Foreign Operations i n suppor t o f th e F Y 1989 budge t proposal s fo r multilatera l development banks, in particular the World Bank. H e made several references, in several contexts, to policy-based lending and its impact on the private sector: . . . policy-base d lendin g i s a n importan t elemen t o f Ban k private-secto r development efforts . Suc h lending ha s become a n important component of World Bank activity. Th e impact of such lending is broader than project loans, affecting th e borrower's macroeconomic policies rather than a specific activity . There is normally a requirement to meet preconditions before the loan will be submitted for board approval. Th e loans ar e tranched, and require additional action by the borrower before a second or third tranche will be disbursed.

With regard to the success of such programs, he added quite candidly: Currently abou t three-fourth s o f al l policy-base d loan s ar e experiencin g implementation delays . .. whic h are fairly unavoidable given the uncertainties in implementin g politically difficul t an d complex reform s i n suc h area s a s public and parastatal enterprises, which account for the bulk of the delays .... 131

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The policy reforms are only abandoned less than 10 percent of the time. Loan s have been cancelled altogether due to lack of agreement between the Bank and the country over economic policy.

Baker concluded this part of his testimony by speaking about the difficulties found with policy-based lending, despite the "quite good" label he accords the World Bank for the quality of its PBL, and by stating specifically: ".. . whil e we hav e bee n impresse d wit h suc h lendin g w e stil l hav e som e concerns , including th e impac t of PB L on the poor. Therefor e . . . w e hav e asked the Bank t o revie w policy-base d loans. " Throughou t thi s importan t testimon y there are two further mentions of PBL in other connections. First , when Baker gave a progress report on debt strategy, he referred to the debtor nations' need for financial resources and for " . .. sustained , market-oriented reform of their economic structur e . . . t o mak e thes e nation s mor e attractiv e fo r futur e investment." Th e othe r referenc e cam e whe n h e dre w attentio n t o th e showpiece countrie s i n deb t management , specificall y Colombia , Mexico , Uruguay, and the Philippines. H e stated specifically: "Th e World Bank has provided strong support... throug h both fast-disbursing, policy-based loans to support structura l reforms , an d projec t loan s t o enhanc e productio n an d development" The concentration on PBL, one of th e more important messages conveye d by th e U.S . administratio n t o Congres s i n suppor t o f budge t proposal s fo r International Financial Institutions (Ms) , i s all the more surprising when one takes into account that 75 percent of World Bank lending is devoted to its more traditional for m o f finance , namel y projec t loans . Perhap s eve n mor e surprising is to rediscover that virtually all U.S. administrations have frowned on IFIs' deviation from their project-based lending approach, which is embodied in their charters. Indeed , it was the borrowing LDCs that in the past insisted that structural adjustmen t (progra m loans ) wa s mor e importan t tha n project loans for development Thi s was particularly true for the newly industrialized countries (NICs), whose capacity for producing capital goods had been on the rise bu t wa s unmatche d b y thei r abilit y t o provide credi t t o thei r domesti c capital goods industry. Wha t happened to provoke this turnaround by the U.S. government is the subject of this chapter.

OLD WIN E I begin wit h a working definition o f policy-based loans , or structural adjustment lendin g (SAL ) i n th e ne w jargon : a quick-disbursing respons e t o th e

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balance of payments . .. intende d not only to provide more immediate funding than is usually the case with lending for specific projects, but also to influence a country's decisionmakers to adopt policies which the [lender] deems to be in the bes t interest s o f th e recipien t country " (Stevenso n 1988) . PBL s ar e associated wit h polic y refor m proposals , whic h i n tur n ar e relate d t o th e appearance of conditionalities tha t are attached to the particular loan contracts by the lenders and accepted by the borrowers. Th e central question is, as put bluntly in a recent study by the World Bank, "Does PBL work?" A t the risk of stealing m y ow n thunder , I woul d hav e t o repl y wit h typica l economists ' answers: either "i t depends," or "more research i s needed." Wha t does see m certain is that PBL often accomplishes policy reforms, or part thereof, that were stipulated a t contract signature . Ye t a considerable amoun t o f backslidin g occurs, and it is by no means certain that all the adjustments contemplated in the loan contract are necessary, desirable, or feasible for the recipient country. Policy-based lendin g is not new, although the World Bank gave it a status of majo r policy innovatio n whe n it began th e process i n 1980 . I t used to be called program financing when US AID made it part of its lending policy in the early 1960s . Th e utilizatio n o f th e loa n ha d relatively littl e t o d o wit h th e target sector, as is th e case now with the World Bank. Indeed , AID program lending wa s routinel y availabl e t o cover al l type s o f imports . Th e onl y restriction was that the domestic currenc y resulting from th e sale of finance d imports b e mad e availabl e fo r th e purpose s stipulate d i n th e loa n contract , usually budget and/or balance of payments support. I am uncertain when or for what reaso n AI D gav e u p th e practic e o f progra m lending , bu t I suspec t abandonment of PB L had to do with lower availability o f ai d funds an d also with the disappointment with policy adjustments as targets of lending. I n any case, PBL by AID involved the rare coincidence of the desires of the lender and borrower, particularly the Ministries of Finance in developing countries, which have bee n clamorin g fo r nonprojec t financin g fo r a lon g time . I n fact , recipients seem to prefer the program-financing instrumen t to discrete projects, for reasons I will try to explain later.

PROGRAM-LENDING B Y COMMERCIA L BANK S With the exception of strict trade-financing, most lending by commercial banks has been program-financing (tha t is, nonproject in character). Unrestricted-us e commercial ban k lendin g boome d wit h th e accumulatio n o f hug e offshor e deposits o n th e Eurodollar marke t after th e oi l shoc k o f 1973-1974 . Larg e

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resources o n deposi t wit h th e offshor e banks , owne d b y oi l exporter s wit h insufficient domesti c investmen t requirement s becaus e o f lo w populatio n pressure, were transferred by commercial banks serving as intermediaries, with a surcharge ("spread") over the London interbank rate (LIBOR, the base rate the banks agreed upon with depositors). Thi s arrangement between depositors (oilexporting governments) and banks resulted in variable (floating) rates of interest to borrowers. Th e borrowers, principally governments of developing countries, were of course at that time under great pressure to finance balance of payments deficits tha t resulted fro m highe r oi l prices . Balanc e o f payment s pressur e threatened t o interrupt o r slo w domesti c investmen t programs , especially i n social infrastructure . Commercia l lender s signale d thei r flexibilit y t o rescheduling the short maturities, and borrowing countries became habituated to "roll-overs" of their loans. B y 1980 , the debt crisis emerged in full force as the second oi l shoc k occurre d an d LDC s foun d themselve s sufferin g th e consequences of industrial countries' recessions. Until th e head y day s o f th e earl y 1970s , commercia l bank s ha d bee n accustomed to performing a country-risk analysis, which emphasized political and economic stability, "know-thy-borrower" being a lending tool with careful dispensing of new loans and cultivation of traditional clients. Th e incentive to "recycle" the petrodollars seemed to obviate the need for careful behavior, and banks followed a herd instinct by running after each other's clients, as well as trying to discover new ones. Thi s lending took place without any reference to projects, even token. Bank s had done this type of lending much earlier, but the amounts involved were minuscule when compared to the billion-dollar loans of the 1970s . Ove r the years of th e boom, commercia l ban k lending serve d t o finance budge t deficits , counterpar t requirement s o f projec t loan s b y IFIs , cofinance operation s wit h the World Bank and regional banks , and postpone adjustment measures, particularly those related to unpopular items such as tax increases, fiscal discipline , exchang e rate devaluation, an d control o f capita l flight. Why di d Ministrie s o f Financ e resor t t o commercia l ban k borrowin g a t variable interes t rates an d shor t maturities? Severa l reason s com e t o mind. First, th e resource s o f IFI s fo r projec t financ e ar e alway s i n shor t supply , because the y ar e granted at fixed rates, long maturities , and important grace periods. Second , commercia l borrowin g involve s n o lon g negotiation , n o counterpart requirements, no lengthy project preparation, and no complex loan analysis. Disbursement s are very fast; indeed, speed is desired by the lender, who does not begin earning interest until disbursements take place. Moreover , a psychological elemen t is also important: Th e length of a typical Minister of Finance's tenure is relatively short, and his term might be over before the loan

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matures. Whil e it is true that commercial bank lending has contributed heavily to the emergence of the debt crisis, the banks alone cannot be faulted. Before granting a loan to a foreign borrower, commercial banks traditionally would consider the degree of ability of a country to " . .. allo w its residents to repay external obligations on a timely basis . .." (Trifar i an d Villamil 1983: 102). Country-ris k analysis would include exchange rate risk, sectoral risks, 1 and othe r ris k components . A t present, a country-ris k tabl e (suc h a s tha t produced periodicall y b y th e Institutional Investor) refer s t o repaymen t experience rather than individual component elements of risk analysis. Thes e tables includ e indice s o f wha t banker s migh t conside r goo d economi c management, such as incentives rewarding risk-takersfor productive endeavors; a lega l structur e stimulatin g th e privat e sector ; correction s t o marke t distortions, includin g appropriat e fisca l policies ; an d simplicit y an d predictability of policies. Al l such requirements should be supported by highly competent officials a t central banks and Ministries of Finance; a cadre of midlevel officials with knowledge of economic management; an independent central bank; a minimum of red tape; and an economic team that communicates well with politicians. Moreover, country-risk analysis by commercial banks, when resulting in a favorable appraisal of lending recommendations, has included strategy considerations that took into account factor endowment s of the borrowing country, an open economy approach to realize the country's comparative advantage, and reasonable investment expenditures commensurate with domestic savings, with a low incremental capital-output ratio. Finally , the analysts look to short-term policies that result in a fiscal polic y that seeks to reduce the share of publicsector expenditur e a s a proportio n o f tota l GN P an d emphasiz e a non inflationary approach to monetary policy. PBL I N TH E 1980 s Do these country-risk prescriptions look familiar? Th e list is strikingly similar to the criteria and conditionalities of IMF and World Bank PBLs; the difference, of course, is that IFIs can impos e the criteria and conditionalities whil e the banks cannot. Componen t elements of adjustment policies affect a wide variety 1. Fo r example , Argentin a lowere d tarif f barrier s fro m 197 6 t o 1980 , whic h cause d man y bankruptcies. Brazi l i n th e mid 1960 s decide d t o import newsprint rathe r than allo w domesti c production to supply demand at higher prices, but impeded borrowers from paying their foreign creditors.

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of policies , principall y trade , fiscal , monetary , pric e and wage , an d foreig n exchange. Othe r conditionalities include public-sector investment priorities and institutional organization. Th e overall purposes are to promote export-oriented development. Present-da y emphasis on structural adjustment exhibits a strong bias toward outward-oriented development, in favor of export-led growth and private markets as principal vehicles of economic activity. No t so long ago, in the dark days of $30-per-barrel oil, adjustment normally meant upward revision of domestic oil and food prices. Thi s is in contrast to an earlier period when "structuralist" analysis, especially in Latin America, called for land reform and warned against over-dependence on the export sector and excessive emphasis on imported technology . I t seem s w e hav e com e a long wa y from that earlier epoch. We have been dwelling on adjustment options because PBLs and S ALs have incorporated them , particularly i n World Bank nonprojec t loan s sinc e 1980 . PBLs ar e conceived t o provid e foreig n exchang e fo r a number of purposes , including rehabilitation of industry and infrastructure, maintenanc e and counterpart requirement s o f ongoin g projects , and , abov e all , coverin g impor t requirements supposedly designed to expand export performance. S o Stevenson correctly states , ". . . . SAL programs focus o n opening u p the country to the world marke t throug h th e restructurin g o f incentives—prices , tariffs , taxes , subsidies, interest rates—with special emphasis on liberalizing the trade sector in orde r t o improv e th e competitivenes s o f exports , review o f public-secto r investment prioritie s . . . and high-priority sectora l adjustments " (Stevenso n 1988). The introduction of S ALs in the World Bank in 1980 (and shortly afterwards the equivalent experiment by the IDB with sectoral adjustment lending) was by no mean s withou t controversy . Th e lega l bas e i n IFI s fo r performin g non project lending has been thought by some of their attorneys to be questionable, if not downright in violation of the Bank's charter. Ye t the pressure to do nonproject lending came from both "donor" nations and borrowers, and the World Bank approve d a n experiment o f structura l adjustmen t lendin g fo r a limited period and a limited amount (not more than 10 percent of total annual lending). By mi d 1987 , th e Worl d Ban k ha d grante d forty-thre e SAL s t o thirty-on e countries for a total of $6.5 billion; in 1986 , almost one-half o f all lending to Latin America consisted of nonproject loans, and the trend seems here to stay. SALs were to be limited to no more than five operation s in as many years for any country, but only one country, Turkey, received all five. Mos t remaining countrie s receive d on e o r tw o SALs , an d fou r programs—i n Senegal , Bolivia, Guyana , an d Pakistan—had bee n discontinue d b y th e en d o f 198 6 because o f noncomplianc e wit h conditionalit y stipulations . Whil e SAL s a s

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7

such have been deemphasized and substituted by sectoral adjustment loans, the issue of adjustment requirements and conditionalities is virtually the same. Th e IDB ha d made tw o somewha t hesitan t experiment s wit h sectora l adjustmen t loans—in Guyana (rice production stimulation) and Peru (agricultural sector)— but the operations were not deemed successful. Sectora l adjustment loans have now take n over where structura l adjustment loans lef t off . Th e World Bank made over $10 billion worth of the former loans from 197 9 to 1987. It is quite possible that policy-based lending by Ms wa s greatly influenced by the growing reluctance o f borrowin g LDCs to continue contracting largescale infrastructure loans . Thei r heavy counterpar t requirements increasingl y impinge on domestic investment budgets because of larger import demands and the slowing down of commercial bank lending offers. Besides , a trend among NIC member s o f th e IFI community ha d been fo r a long tim e tha t program lending wa s preferabl e t o stric t projec t financing , wit h it s overtone s o f paternalism an d "th e lende r know s best " philosophy. A subtl e underlyin g factor for the acceptance of PBLs by LDCs has also been the long, drawn-out discussion abou t financing o f loca l (borrowin g countr y incurred ) cost s wit h foreign exchang e proceed s o f th e loan , a tediou s an d comple x issu e wit h overtones of economic development theory, which occupied the boards of M s during much of the 1960s and the early 1970s. PB L certainly obviated the need to demonstrat e impor t componen t o f inputs , calculat e foreig n exchang e multipliers an d margina l propensitie s t o import , an d justify th e transfe r o f dollars for payment of domestic costs. Structural adjustment loans are designed to be fast-disbursing, ideally within two years, broken down into several tranches, each subject to the measurable fulfillment o f a number of conditionalities, of which there may be as many as seventy i n a loan agreement I n most cases, SAL s ar e to be used for impor t financing, wit h a smal l lis t o f exclude d import s (weapons , conspicuou s consumption items) . Conditionalitie s focu s aroun d sector s o f th e econom y closely connecte d t o balanc e o f payment s problems , an d ofte n includ e conditions such as the passing of specific legislatio n or the abolition of custom tariffs conceived as too high, so as to oblige domestic industry to become more competitive. Th e last chapter of PBLs has not yet been written. I t is neither the solution to all debt and development problems, nor the villain of capitalist intervention in LDC economies as detractors have labeled it. It does see m certain , as th e analogy o f ol d win e i n ne w bottle s suggests , that we do not know whether SALs (and their cousins, the sectoral adjustment versions) accomplis h th e goa l o f promotin g structura l adjustment s i n th e sectors an d to th e degree foresee n i n th e loan documentation . Man y o f th e

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conditions contained in the contracts are either impossible to monitor or cannot be fulfilled withi n the very short disbursement period. Eve n assuming that the adjustment need s were jointly arrived at during the period preceding the loan between lender and borrower, SAL installments already have been disbursed, and the leverage, if any, of the lender has disappeared. Policy-base d lending is based on faith i n the free market model of neoclassica l theory , with it s efficienc y conditions of perfect knowledge, flexible prices, no market entry barriers, and all costs internalized into the price mechanism, all of which are rarely present in the real world. I t is ironic indeed that structural adjustment lending could be seen as responsive to the concerns of the early structuralists, who would bristle at being identified wit h neoclassicism. The y would, however, find solac e in discovering tha t th e conditionalitie s no w surroundin g SAL s ar e no t onl y impossible to enforce but are difficult eve n to monitor. Turkey' s first SAL in 1980 had eleven conditions in five areas; its fifthSAL in 1984 had seventy-five conditions at the sectoral and national policy levels. Formally , these should have been met within the normal two-and-a-half year disbursement period. Policy-based lending, while by no means new or innovative given the long AID (and now seven years of World Bank) experience, does seem an eminently suitable, albeit partial, mechanism to support debt management and to assuage the crushing cash-flow problems produced by debt service requirements. Thi s is also one of th e criticisms levele d o n PBL in th e sense that it is sometime s labeled a n instrument t o bail out commercial banks by providing th e debtor countries with foreign exchang e liquidity not specifically tie d to development investment. Th e other criticis m i s closely linked : On e of th e more serious consequences o f th e deb t crisi s ha s bee n th e postponemen t an d eve n abandonment o f infrastructure . PB L wil l certainl y no t hel p t o reactivat e development projects , excep t insofa r a s i t migh t creat e condition s fo r development by forcing recipient countries to implement policies more attractive to investors both domestic and foreign. LATIN AMERICA N EXPERIENC E WIT H PB L It is instructive at this point to look briefly at the experience of Latin American countries with PBL. Unde r policy regimes associated with World Bank and IMF programs , Brazil , Argentina , an d Mexic o strongl y compresse d thei r imports and increased their exports (by over 6 percent per annum between 1981 and 1984). A similar shift occurred throughout Latin America. Th e increase in exports partly accounted for a renascent protectionism trend in the industrialized countries, particularly i n th e United States . Th e overall swin g in the Latin

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American balance of trade with the rest of the world moved from a $10 billion deficit i n 198 1 t o a $35 billio n surplu s i n 1984 , almos t enoug h t o cover th e interest on the external debt A s can be seen, efforts towar d adjustment on the external front , whil e no t easy b y an y means , were successfu l i n a relatively short span. As for domestic adjustment, the performance has been disappointing due to a poor reactio n i n nationa l savings . Th e result s wer e sever e recession s an d accompanying inflation. 2 A s a result, public-sector savings were dramatically affected. Aggregat e investmen t ratio s fel l fro m 2 4 percen t o f GN P t o 1 8 percent in the two-year span from 198 3 to 1984 , and in more recent years did not show grea t improvements. Further , the social cos t of adjustmen t usually has been high . Improvement s i n current account of th e balance of payment s were achieved by sacrificing livin g standards, with the main burden falling on wage earners. Moreover , the continuity of investments in social infrastructur e was interrupted . Nonetheless , th e cos t o f adjustmen t policie s ca n ofte n b e lowered if goo d exchange rate policies prevail, maintaining a parity betwee n domestic an d internationa l prices . Thi s i s facilitate d b y a freel y floatin g exchange rate, and it is worth noting that the IMF has completely reversed its earlier (pre-1970s) resistance to deviations from fixed rates. Adjustment measures are normally constructed after the external debt-burden indicators are analyzed by the IFI. Thes e ratios include long-term debt burden (total debt/GNP); short-term debt burden or annual service payments; average maturity of deb t portfolio (tota l external debt/annual amortizatio n payments); and th e abilit y t o mee t interes t payment s (interes t payments/internationa l reserves). Thes e ratios have changed consistently over recent years. Th e World Bank used to consider a short-term debt burden of 1 0 to 12 percent reasonable, but presently a 25 percent ratio is considered tolerable. Nonetheless , this ratio exceeds 50 percent in many countries. The traditional opposition of the United States and other developed countries to policy-based loans evaporated in the wake of the Latin American debt crisis. In 1985 in Seoul, Korea, Secretary Baker stated: For the World Bank and the IDB capital increases . .. w e will assess how these institutions strengthe n thei r lendin g policies . Well-define d economi c an d country strategies to enhance economic reforms which encourage growth [will be taken into account]. Give n a firmcommitment by the IDB . . . i t should be permitted to introduce a major program of well-targeted nonproject lending.

2. Se e the discussion of inflation and debt service in Chapter 14 by Dombusch.

9

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The most volatile aspects of adjustment policies find expression in price and wage policies . Th e cos t o f adjustmen t i n Latin Americ a betwee n 198 2 and 1984, for example, resulted in accelerated inflation (even though most countries closely adhere d to IMF-prescribed measures), reduction in real wages, loss in real output, and a rise in unemployment. Thus , while success can be claimed for the balance of payments effect of PBL in Latin America, the domestic costs appear to have been quite high. Wit h this in mind, I return to the discussion of PBL to raise certain nagging questions. A number of things are not at all clear. I indicate these in a series of leading questions. First , if structura l reforms, including policies an d institutions, are so vital, why do not the affected LDCs proceed with such reforms on their own, without the incentive of policy-based loans? Doe s this not once again smack of paternalism, or "the lender knows best"? Second , what is a critical mass for a recipient country to proceed with policy reforms based on loans fromabroad? Is it possible to quantify minimu m amounts below which a country would not find i t worthwhil e t o implemen t polic y reforms ? Third , give n th e quick disbursing featur e o f th e loan s (eve n i n tranches) , wha t happen s t o polic y reforms no t implemente d afte r disbursement s hav e ceased and the presumed leverage of lenders to press for restructuring has ended? I s there enough of a commitment fro m th e borrowe r t o continu e th e reforms eve n whe n n o ne w disbursements are expected? Fourth , PBL, by its very nature, has not produced a direct stream of foreign exchange to generate repayments when they are due. What resources will th e borrower rely o n to make repayments if ther e are no resources directly or even indirectly attributable to the loans? Or , conversely, one o f th e mos t importan t feature s o f projec t lendin g ha s bee n thei r self liquidating character , that is, their ability t o generate resources to service th e loan. Wha t does a country hav e to sho w a s a consequence o f PBL , beyond policy reforms that may or may not have been successfully implemented ? I woul d submi t tha t thes e question s hav e no t a s ye t receive d adequat e responses. Therefore , countrie s woul d do wel l t o examin e closel y th e commitments they undertake when assuming PBLs. I n any event, a judicious mixture of PBLs with project loans seem s the better course to follow. PBL s are b y no mean s th e ultimate , muc h les s th e ideal , instrumen t t o provid e development financing in these troubled times for international lending.

| \ # STRUCTURA L I V ADJUSTMENT : IMPACT I N TH E THIRD WORLD

In the first part of th e book, Rolph van der Hoeven provided a survey o f th e impact o f externa l economi c shock s o n Thir d World countries. I n Part IV, three authors take that analysis t o a less aggregative level , with th e emphasis on th e tw o area s mos t affecte d b y structura l adjustmen t programs , Lati n America and Africa. In Chapter 10, William L. Canak and Danilo Levi provide an interpretation of th e role of th e multilateral agencie s i n the management o f th e debt crisis, then apply thi s analysis t o Latin America. Whil e data are somewhat limite d (partly due to the relative newness of the application of structural adjustment), they provide strong circumstantial evidence of high social and economic costs of World Bank and IMF policy packages. Thi s is a particularly useful paper, for it is a view o f th e multilaterals tha t is strongl y held by nationalists i n the Third World. Wit h social an d economic cost s hav e come political ones , and these are treated in Chapter 11 by Peter Hakim and Louellen Stedman. The book woul d not be complete without at least one in-dept h stud y o f a specific country , and this is admirably provided by Vali Jamal in Chapter 12. While on e mus t be hesitan t abou t generalizin g fro m a singl e case , Jamal' s analysis o f Tanzani a bring s t o ligh t a number o f trend s an d tendencie s tha t seem commo n t o much of Sub-Sahara n Africa . Particularl y importan t is hi s 141

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argument that the structural adjustment program implemented in Tanzania was largely redundant—he demonstrates that many of the changes it sought to bring about ha d occurred prio r to th e institutio n o f th e ne w polic y regime . Thi s chapter is especially valuable because it focuses on an African country , while most o f th e discussion o f th e debt problem places undu e emphasi s o n Latin America.

10

SOCIAL COST S O F ADJUSTMENT I N LATIN AMERIC A William L. Canak and Danilo Levi

The objective of this paper is two-fold: first, to develop a theoretical framework for understanding the relationship between constraints on international economic growth and the development of an interorganizational rationale for regime policies; and second, to consider the effects of structural adjustment policies in Latin America . I n th e followin g section s w e wil l discus s th e issues , th e institutions, th e policies , an d th e consequence s o f structura l adjustmen t policies.

THE ISSUE S The neoclassical mode l fo r economic growth , which ha s been th e foundatio n for most economic studies of development, is a world without transaction costs and institutions (Coas e 1960 ; North 1981) . Historically , nationa l wealth ha s been regarded as closely tied to trade, and the international division of labor has been viewed as the basis for productivity growth . Developmen t studie s have treated exchange processes as neutral or unimportant determinants of economic performance. However , transactio n cost s hav e alway s define d th e ke y constraints o n gain s fro m trade . Th e capacit y o f politica l an d economi c institutions t o defin e an d enforc e th e legitimate normativ e orde r i n a give n

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territory, no t transportatio n costs , ha s bee n th e ke y t o definin g transactio n costs (North and Thomas 1987; see also Weber 1968). Economic growth based on impersonal exchanges requires development of institutions that enable actors to engage in interdependent activities with other actors abou t whom the y hav e littl e informatio n an d no personal capacit y t o control or directly penalize for violation of an agreement. Government s and a normative order have allowed estimation of exchange costs and enforcement of property rights and contracts (North and Thomas 1987) . States , however, are not neutra l thir d partie s an d ten d t o us e thei r monopol y ove r legitimat e coercion t o th e advantag e o f specifi c group s an d at th e expens e o f others . Moreover, whil e politica l institution s ma y functio n t o enabl e marke t exchanges, their organizational interes t in ensuring access t o and controlling their resourc e bas e tend s t o lea d the m t o creat e policie s tha t undermin e economic efficiency an d guarantee support from powerful groups (North 1981 and 1984). The mos t dramati c chang e i n th e worl d econom y since th e 1960 s i s tha t exchange rates for national currencies are now driven by capital flows instead of trade in goods. 1 Internationa l financial markets have rapidly integrated. A s a consequence, a relatively minor impact of national economic policy on interest rates ma y resul t i n large-scal e internationa l shift s o f capital . Technologica l advances have reduced the costs and increased the speed of such transactions. Their effect o n exchange rates can overwhelm th e role of trad e revenues, and without polic y coordinatio n currenc y volatilit y ca n onl y increase . Indeed , Dornbusch's theory of exchange rates predicts just this.2 Over th e cours e o f severa l centuries , th e develope d wester n industria l societies have created institutional mechanisms for controlling exchanges and enforcing the normative order of property rights. Thes e institutional structures developed t o control participants and reduce transaction cost s tha t may arise from cheatin g o r foot-dragging (Becke r 1965 ; Lancaster 1966 ; North 1981 ; Barzel 1982) . Althoug h thi s elaborate set of institution s increases transaction costs fo r society , th e gain fro m stabl e predictable trad e and the low cost t o participants in any one transaction hav e led to high rates of growt h for these nations. 1. "Ge t Ready for the Phoenix," Economist, January 9,1988. 2. Goodhar t (1988 ) notes a number of event s i n whic h exchang e rate s have eithe r seeme d unaffected b y national policies o r where changes have not been tied to new information. H e also cites the "random walk" movement of exchange rates and failure of exchange rates to tend toward equilibrium as evidence of failings in the Dombusch model. H e does not, however, investigate the role of institutions affectin g transactio n costs as a factor underlying long-term trends in exchange rates, particularly greater stability than would be predicted otherwise.

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5

The complex, specialized and interdependent structure of international capital markets makes the potential cost of transacting very high, because the capacity to measure the future value of a currency may be difficult, an d enforcing th e terms of a n exchange may be problematic, particularly wit h national governments. Rapi d growth of international trade and capital flows in the postwar era has necessitate d th e developmen t o f a n institutiona l structur e tha t seek s t o decrease uncertaint y an d turbulenc e associate d wit h suc h exchanges . Th e stability o f a n institutiona l structur e governin g capita l an d product market s increases participants' confidence in their ability to predict the consequences of their activities. Thes e institutions , however , ar e governed by a n imperativ e that compels them to establish policies that contradict efficiency. Concer n for survival lead s these institution s t o formulate an d enact policies tha t enhance their abilit y t o monito r an d contro l thei r resourc e bas e an d t o ben d t o th e interests of dominant international interest groups. International transaction costs can be measured to the extent that they occur in a market economy, but in Latin America and much of the periphery of the world system, unmeasured transaction costs—including corruption and delays— are so important that they may undermine the market completely. Economi c and political institution s tha t facilitate market s and guarantee th e normativ e order should develop to reduce transaction costs, but such institutions will not necessarily produce policies that are efficient o r neutral toward all parties in the marketplace.

THE INSTITUTION S Throughout th e postwa r era , th e comple x institution s overseein g officia l capital transfers aimed at fostering development and introducing orderly market processes i n the international economy hav e functioned, i n Europe and Third World nations, to limit nationalist an d socialist groups * capacity t o influenc e state policy (Bloc k 1977 ; Payer 1982 ; Pastor 1987 ; Wood 1986). 3 Firs t the Marshall Plan and later IMF-sanctioned lendin g served to transform nationa l class relations an d political powe r and reinforce processe s o f internationali zation. Aid , grants, loans, and subsidized investment were in general linked to the liberalizatio n o f nationa l economi c policie s an d evidence o f a domesti c capacity to "control" populist demands. Nationa l regimes were presented with a limited repertoire of acceptable development policies (Sanderso n 1985 : 2021). Thus , th e deb t crisi s o f th e 1980 s i s no t a crisi s tha t threaten s th e 3. Thi s section draws on material from Canak (1988).

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monetary an d fisca l stabilit y o f th e develope d countries . Rather , i t i s a structural featur e o f a new stag e i n core-periphery dependenc y i n whic h th e integration of Latin American nations in the world market is conditioned by the disciplinary authority of supranational agencies over national regimes. Theorists attemptin g t o conceptualiz e th e structur e an d developmenta l processes o f thi s Ne w Internationa l Divisio n o f Labo r (NIDL ) hav e draw n distinct themes . Th e Postimperialis m theorist s (Becke r e t al . 1987 ) hav e focused on development o f multinational corporation s and processes of clas s formation i n th e Thir d World . The y vie w "indebte d industrialization " i n countries lik e Brazi l an d Mexic o a s th e expressio n o f a n allianc e betwee n domestic elites and international financiers that is transforming the political and economic structures of both OECD and Third World nations. The y assert that internationalization o f dominan t clas s interest s fro m OEC D nation s an d the development of a dominant national bourgeoisie in Third World nations renders the framework of dependency and imperialism obsolete. Frobel et al. (1985) also identify th e new patterns of trade and the relocation of productio n fro m OEC D countrie s t o th e Thir d World a s evidenc e fo r an NIDL. Base d o n chea p labor , fragmente d productio n processes , an d ne w technologies of transportation and communication, a truly world market is now possible. The y argue that in the 1960s these conditions first became operative and set in place tendencies that are transforming the historical division between industrialized and developing countries on the one hand, and encouraging the increased geographic and operational division of manufacturing processes on the other (1980: 45). One se t o f theorist s ha s focuse d o n th e developmenta l logi c o f capita l accumulation in the world system (Sanderson 1985 ; Marcussen and Torp 1982; Nyilas 1982) . Thes e analyse s depic t worl d economi c processe s a s " . . . a function o f the expansion of capital and its valorization and reproduction at a global level. .. " (Sanderso n 1985 : 9). Whil e this perspective recognizes the importance of multinational corporation s and national states, their importance is secondar y t o fundamental processe s o f capita l accumulatio n tha t are both national and international. Capita l accumulation—the expanded reproduction of capitalist socia l relation s throug h the transformation o f surplu s valu e to new constant an d variabl e capital—i s th e drivin g forc e tha t incorporate s an d integrates specifi c institution s an d locations int o a capitalist world economy . As capitalist social relations (proletarianization ) becom e a global reality, and the transnationa l coordinatio n o f capita l (ban k an d production ) occurs , th e significance o f trad e ha s bee n reduce d b y th e capacit y t o internationaliz e production (1985: 15) . Finally , international production and global coordination o f capita l increasingl y requir e th e structura l adjustmen t o f nationa l

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economic policies . I n contras t t o th e prediction s o f Postindustrializatio n theorists, this perspective asserts that transnational production undermines the autonomous politica l capacit y o f nationa l regimes . Protectionis m i s no t an option for countries whose critical "resource dependency" is tied to foreign debt refinancing an d structural adjustmen t programs presented a s a condition fo r access to world credit markets.4 Global coordination of capital and the direct sanctioning of national regimes has been focused on a set of institutions founded in the 1940s . W e will briefly review thes e multilatera l institution s an d their developing rol e i n the NIDL. The system governin g internationa l monetar y an d trade relations fro m 194 5 until th e earl y 1970 s wa s negotiate d a t Bretto n Wood s i n 1944 . Representatives o f forty-fou r nation s attended , bu t th e proceeding s wer e dominated by the two principal industrial powers, Britain and the United States. At Bretton Woods, U.S. official s wer e concerne d tha t the postwar monetary system shoul d avoi d th e uncertaintie s an d instabilit y create d b y floatin g exchange rates and uncontrolled devaluations of the 1920 s and 1930s (Damm 1982: 88) . I t was hope d thi s monetary syste m woul d sustai n free trade and avoid the protectionist policies of the interwar period, which was to be achieved through th e creatio n o f multilatera l institutions : th e Internationa l Monetar y Fund, a n Internationa l Ban k fo r Reconstructio n an d Developmen t (Worl d Bank), and an International Trade Organization (ITO) . Th e latter was shortlived, bu t th e firs t tw o becam e fundamenta l component s o f th e postwa r internationalization process . Thes e institution s wer e a preliminary effor t o f global coordinatio n o f capita l accumulatio n withi n a syste m o f sovereig n states. Th e more complete fulfillment o f that intention necessitated the global integration of trade, finance,production, and labor markets. Th e transformation of internationa l financia l market s i n th e 1970 s an d th e subsequen t deb t crisis/credit crisi s o f th e 1980 s transformed th e role of thos e institution s and their relationship with national state s and private financial institutions. Tha t process continues with th e need for solutions to problems created by uncoordinated nationa l economi c policie s (Bel l 1988 : 24) . Th e IMF' s origina l functions wer e quite specific: t o establish fixe d exchang e rates and currency convertibility an d t o hel p government s throug h short-ter m liquidit y crises 4. "Whethe r in cases embracin g the low stat e neoliberal authoritarianism of Chil e or the high state mobilization o f Brazil , the political capacity , o r power, to guide industrial and agricultural internationalization shrinks before the transnational locus of production changes. Th e imperatives of expor t promotion , debt refinancing, impor t constraint , regressiv e wag e policies , competitiv e devaluation (realisti c exchange rates), and fiscal austerit y dictate that the states of Lati n America have les s rea l capacit y t o negotiat e thei r entr y int o th e ne w internationa l divisio n o f labor " (Sanderson 1985:21).

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resulting from a negative balance of payments. Th e aim was to eliminate the impact on international trad e of seasona l and short-term fluctuations . Loan s were tied, at least in theory, to each government's contributions (Moffitt 1983 ; Brett 1985; Pastor 1987). Althoug h conceived as an international organization, governance was to be weighted to reflect each nation's quota, thus guaranteeing the United State s an d Great Britain a dominan t role i n definin g policy . A t base, the goal was to replace the gold standard with a set of fixed exchange rates and reserve currencies that would be amenable to "regulation." Exchang e rates were t o b e regulated b y multilatera l organization s controllin g a fun d comprising members ' contributions. Th e system wa s based on the ability o f nations to maintain stable exchange rates, the convertibility of currencies, and national policie s supportin g fre e trad e and balance o f payment s equilibriu m (Brett 1985: 111-112). The World Bank, also created at the Bretton Woods conference, was to make long-term loan s a t commercia l rate s t o financ e infrastructur e developmen t projects in economically weake r nations. Ha d it been endowed with sufficien t resources, th e Worl d Ban k ma y hav e functione d t o increas e developmen t investments and promote more balanced international trade (Brett 1985) . Th e Americans at Bretton Woods worked to constrain government contributions to the Bank. Force d onto private credit markets, it reinforced commercial rates and credit policies while absorbing the risk of loans to countries otherwise unable to obtain credit I n addition, project loans were guided by performance criteria. In 1956 and 1960, additional components were created to form the World Bank Group: the International Finance Corporation (IFC) to provide loans to private corporations (withou t government guarantee ) an d the International Develop ment Associatio n (IDA ) t o provid e ver y long-ter m loan s (fift y years ) t o governments. Sinc e ID A mone y wa s targete d fo r countrie s wit h weake r economies, little went to Latin America. Indeed , the original purpose of these organizations wa s t o reestablis h trad e i n th e industrialize d world . Th e foundation of this system was a stable U.S. currency, backed by gold reserves. When that system collapsed in the early 1970s , the World Bank, like the IMF, was compelled t o find it s wa y i n a newly uncertai n international divisio n o f labor. In the 1960s , the World Bank' s priority wa s agriculture, but bank project loans focused more on poverty after 1973. 5 Ban k statements consistently assert that economi c criteri a ar e th e sol e basi s fo r it s lendin g decisions , bu t th e distribution o f Worl d Ban k loan s ha s been towar d regimes favorin g foreig n 5. Paye r (1982: 43) notes that this shift closely tracked changes in U.S. aid marked by the U.S. Foreign Assistance Act.

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investment, free trade policies, and unrestricted capital flows, even when such policies hav e exacerbate d inequalit y an d poverty an d reinforced th e us e o f violence by national regimes in defense o f internationa l interest s (Bornschie r and Chase-Dunn 1985 : 44-45). I n essence , th e World Bank' s policies sub sidized developmen t o f a nationa l capitalis t clas s allie d wit h internationa l business an d antagonisti c t o autonomou s nationa l economi c policie s (Paye r 1982: 117). The thir d multilatera l institutiona l pilla r o f th e postwa r internationa l economy wa s GATT (General Agreement on Tariffs an d Trade). I t is not an organization per se, but a treaty first signe d in 194 7 by industrial an d developing countries—currently 10 5 countries participate—formally ratifyin g thei r commitment t o end th e protectionism tha t they viewe d a s on e caus e fo r th e intractable nature of the Great Depression. I t was originally conceived as a part of th e International Trade Organization tha t would complement th e IMF and World Bank's governance of the postwar international system. Ironically, the ITO, established by the Havana Charter in 194 8 and signed by fifty-threenations, provided extensive regulatory powers but failed to secure U.S. support when American business and Congress protested external controls on trade policy. Financed by members according to their share of world trade, GATT promotes trade equity by providing that any restrictions on trade be in the form of tariffs and not discriminate against any member. Whil e members automatically have "most-favore d nation " status wit h eac h other , negotiatin g membershi p may requir e tha t applican t countrie s restructur e thei r economi c policies. 6 GATT influence promote s policies that reduce constraints on trade and capital transfers. Sinc e the adoption of the agreement forty years ago, average tariff s of industrialize d nation s have dropped from roughly 40 percent to 5 percent. Nevertheless, growing protectionism i n the 1970s—particularl y i n the United States and Common Market countries—and glaring gaps in GATT controls (for example, agriculture, services, and information) have undermined its credibility. Parallel t o trend s i n relation s amon g th e World Ban k an d th e IM F an d individual governments, GATT as an institution has emphasized development of standardized negotiation procedures for disputes and institutionalized performance criteria . Th e principa l industria l an d dominan t tradin g power s (th e European Economic Community, the United States, and Japan) have dominated past policies, bu t developing countrie s hav e ofte n violate d th e principles o f GATT. Nevertheless , they have been unable to establish a coordinated set of 6. Whe n Mexico joined GATT in 1986 , the cost involved an end to existing policies on import licenses, reduced tariffs, and lowered subsidies.

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proposals. Indeed , as with th e functioning o f th e World Bank and the IMF, GATT negotiations have reinforced the disunity of Third World interests. The functioning of thes e multilateral institutions in the immediate postwar years wa s somewha t dampene d b y th e Marshal l Plan' s massiv e transfe r o f resources t o Europe. U.S . intention s a t Bretton Woods an d in th e Marshall Plan wer e directed a t establishing a n international economi c orde r in whic h national capitalism—stat e intervention s limitin g fre e trad e and investment— would b e controlle d (Woo d 1986 ; Dietz 1987) . Europea n recover y an d the defense of capitalism against the alleged Soviet threat, however, also would be based on the development of Third World markets for industrial products and raw material s export s t o th e Unite d State s (Woo d 1986 : 40-41) . Indeed , developing countries as a whole experienced considerable growth between 195 0 and 1980 (Srinivasan 1982 : 92). Significantly , th e Bretton Woods system did not distinguish between advanced industrial nations and the Third World. N o specific mechanism s were developed to direct external finance from countries with a surplus to developing countries. Nevertheless , a succession of actors did play this role in the postwar decades. Foreig n direct investment burgeoned in the 1950s ; i n th e 1960s—afte r th e Cuban revolution—official ai d programs expanded; an d in th e 1970s—seekin g t o recycle petrodollars—internationa l banks provided funds. Th e debt crisis of the 1980s stems in part from the lack of ne w externa l financin g fo r Lati n America n developmen t (Griffith-Jone s 1984: 5), as these commercial banks restricted new loans to debtor nations.7 By th e 1960s , however , contradiction s inheren t i n th e Bretto n Wood s agreement began to compel changes . First , the incapacity o f th e U.S. economy t o eliminat e deficit s mean t tha t foreig n liabilitie s wer e outstrippin g it s capacity to fulfill gol d exchange commitments. Althoug h the dollar functioned as the reserve currency for the international monetary system, U.S. balance of payments deficits tie d to its military obligation s and the Vietnam War meant that those nations with a surplus were paying for U.S. policies if they did not convert thei r dollars int o gold. However , if th e United State s ha d ended it s balance o f payment s deficits , gol d productio n a t the fixe d valu e o f $3 5 pe r ounce wa s insufficien t t o mee t th e need s o f a n expandin g worl d econom y (Triffin 1978) . Th e leading industria l nations worked within the structure of the IMF to create new forms of credit that would counterbalance U.S. deficits. In 1967, the leading industrial nations and the IMF created an additional reserve asset called Specia l Drawin g Right s (SDR) , whic h wa s availabl e t o all IM F members. Bu t this did not halt the flow o f dollars from the United States, and 7. Se e Chapte r 4 b y Lissaker s an d Chapte r 5 b y Sack s an d Canava n fo r discussion s o n commercial bank lending (or nonlending) to developing countries in the 1980s.

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1

fixed exchang e rate s an d dolla r convertibilit y fo r gol d wer e increasingl y anachronistic commitments that eventually fell in 1971.

THE POLICIE S The IMFs function as fiscal disciplinarian was initiated in the 1950 s via a set of rules that addressed new problems relating to Third World members' currency requests. Withi n a define d proportion—"tranche"—o f eac h country' s contribution quota, approvals were virtually automatic. Beyon d this threshold, approval wa s to be conditioned o n evidence tha t the funds woul d be used to support "a n effective progra m for establishing o r keeping th e stability of th e currency of the member country at a realistic exchange rate" (IMF 1959: 404). IMF standby agreements increase d in importance in later years, and a formal bureaucratic protocol for applications and supervision came to dominate IMF activities. Thus , the IMF's relationship wit h less-develope d nation s becam e that of an auditor and fiscal disciplinarian (Frenke l and O'Donnell 1979 : 174175). Th e rationale for its actions rested on self-defined technica l and objective criteria regarding the general welfare of the national and international economy. The specific se t of measures imposed on borrower countries characteristically includes: (1) devaluation; (2) reduced public spending; (3) elimination of public subsidies; (4) wage restraint; (5) increased interest rates; (6) taxes to curb demand; (7) elimination o f state-owne d o r -supported enterprises and greater access for foreign investment; (8) reform of protection for local industries; and (9) expor t promotio n an d applicatio n o f ne w foreig n exchang e t o th e deb t service. Th e genera l thrus t i s t o promote market-oriente d ope n economie s geared to agricultural and industrial export production (Loxle y 1984 : 29). B y late 1983 , seventeen adjustment agreements wer e operating in Latin America and the Caribbean (ECLAC 1986:102) . In 1979 , the World Bank initiated a new lending instrument, the Structural Adjustment Loan (SAL), similar in most respects to IMF conditional loans and reflecting th e developin g functiona l convergenc e o f thes e tw o institution s (Wood 1986 : 185 ; Loxle y 1986b : 138-139). 8 Thes e loan s ar e aime d a t restoring balance of payments strengt h sufficient t o allow developin g nation s to finance imports . Th e loans are to sustain imports while debtors implement institutional an d polic y changes . Lik e IM F conditional loans , SALs ' mai n intent i s t o promote export s an d reduce impor t substitutio n industrializatio n (Loxley 1986b : 131) . SAL s rapidl y became th e World Bank' s predominant 8. Se e Chapter 9 by Epstein for a discussion of policy-based lending.

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form o f program lending, but, excepting Bolivi a and Panama, Latin America did not participate in the firstfew years (Wood 1986:185). Bank monitoring of economic performanc e ha s focused on specific polic y compliance and not on quantitative development performance. Th e criteria of compliance sugges t tha t informatio n an d contro l ar e th e basi c objectives . These goal s ma y b e compatibl e wit h incentive s tha t contradic t nationa l development policies. Indeed , the World Bank's review of its S ALs concludes they have lowered incomes and have an anti-consumption bias (Balassa 1981). Increased unemployment , highe r prices , an d reduce d socia l program s ma y adversely affec t th e poor, but basic huma n need s hav e no t been criteri a fo r judging polic y performance . Similarly , question s o f equit y hav e bee n deemphasized an d "growth " criteri a give n mor e weight . SALs , therefore , represent a commitmen t t o supply-side , "trickl e down " assumption s abou t social welfare. According to Robert Wood, "Outward-oriented policies with low protection are th e basi c ai m o f structura l adjustmen t lending . Althoug h th e rang e o f policy area s ha s varie d amon g differen t SA L recipients , al l hav e agree d t o institute changes in trade policy designe d to orient the economy mor e toward international market forces and exports" (Wood 1986:187). Prior to the 1970s , IMF "conditions" had only minor importance for Latin America. I n the 1960s , 75 percent of net capital flow was composed of direct investment an d officia l Credit s (Ffrench-Davi s e t al . 1985) . I n th e rus h t o recycle petrodollars, international commercial banks engaged in aggressive loan policies tha t ofte n wer e unaccompanie d b y analysi s o r judgment o f clien t solvency. Throughou t the 1970s , easy access to private loans and high infla tion combine d t o encourage man y governments ' acquisitio n o f debt . Thir d World public deb t increased fro m $75. 1 billio n i n 197 0 t o $634.4 billio n i n 1983 (Woo d 1986 : 130) . Th e rapi d growt h o f privat e ban k lendin g i n th e 1970s appeared to offer developin g countries an opportunity fo r greater autonomy (from the IMF) and a chance for debt-led growth (Griffith-Jones 1984 : 69-70). B y 1980 , however , privat e banks' lending proportio n o f ne t capital flow had reached 70 percent Whe n Federal Reserve Board policies initiated an era of high interest rates and tight money to break inflation, bank lending terms reversed. Highe r interes t rate s an d short-term amortizatio n an d refinancin g created a credi t crisi s tha t annuall y produce d larg e increase s i n tota l indebtedness. In thi s ne w environment , balanc e o f payment s deficit s an d ban k deb t compelled a rise in requests fo r standb y loans from the IMF. A s th e central institution definin g th e term s fo r acces s t o credit , th e IMF s rol e wa s mag nified. Coordinatio n o f credito r policie s (IMF , World Bank, privat e banks,

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bilateral aid ) effectivel y prevente d debtor s fro m playin g on e credit sourc e against another; 9 difference s i n specific deb t conditions, trade structure, and national resources combined with variations in the actual implementation of conditionally (Korne r e t al . 1986 : 61 ; Walton 1987 ) t o undermin e th e possibility of debtor cartels.10 Debto r governments seeking to travel their own course by placing national development priorities ahead of debt payment and IMF-mandated structural adjustments faced domestic turmoil and had nowhere to turn. Withou t IMF approval, foreign investmen t and credit flows declined precipitously.11 NEGOTIATIONS AN D RENEGOTIATIONS : THE ROL E O F INSTITUTIONA L LOGI C The harsh IMF and World Bank conditionality and structural adjustment terms for debtor government access to new credits and renegotiation of old loans are commonly noted to have a creditor bias. Th e impact of these policies on the population and economic structure of debtor countries is viewed as a necessary price t o pa y fo r maintainin g orderl y market s an d th e financia l stabilit y o f international institutions. Call s for a more equitable distribution of the costs of th e deb t crisi s receiv e littl e sympath y fro m thes e agencie s and/o r international banks. 12 I n the first years of debt accumulation, the $52 billion (ECLAC 1986) in net capital transferred to Latin America (between 197 6 and 1979), was more than matched by a net outflow o f $113 billion in 1983-198 6 (Feinberg 1987 : 205). I n short, 5 percent of Latin American GNP has been 9. "Government s in industrial countries, led by the United States, are working to increase the collaboration among these three (IMF, World Bank, IDB) multilateral institutions in order to ensure that they offer consistent advice backed by the maximum degree of leverage" (Feinber g 1987:206) . 10. Indeed , coordinated actions by private bank advisory committees and the IMF have ensured that negotiations with major debtors are staggered, thus undermining one structural basis for debtor leverage in negotiations (Riding 1988a : 1). 11. I n early 1987, a decline in currency reserves led Brazil to suspend virtually all payments on its $11 3 billio n foreig n debt . Th e immediat e goa l wa s t o ste p outsid e th e rule s o f forma l negotiation to compel improved term s from creditors . Othe r debtors wer e hopeful, bu t passive. The international financial community and OECD governments acted. Foreig n investment declined, credit flows were reduced, and trade sanctions were applied. 12. ECLA C (1986: 30) summarizes IMF and World Bank rationale as follows: "They assume t h a t . . . th e problem is one of short-ter m liquidity, that is, a temporary conjunctural crisis caused by factor s beyon d th e contro l o f th e agent s involve d . . . " I t i s claime d tha t thi s crisi s wil l automatically be resolved when the world economy recovers, since financial equilibriu m will then be restored within a few years and normal international credit operations resumed. I n other words, it is assumed that, on recovering their capacity to service external debts, the developing countries will regain their image of creditworthiness and their former access to the international credit markets.

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exported t o mee t th e condition s impose d b y th e commercia l bank s an d the IMF. Th e mandate of the IMF and the World Bank is to stabilize and regulate the international financial order and sustain open international trade . Privat e banks' objectives ar e to lowe r thei r potential losses , increas e payments, and provide th e minimu m necessar y credi t t o guarante e tha t debto r countrie s continue to pay (Foxley 1987 : 101). However , the capacity of debtor countries to implemen t th e structura l adjustmen t policie s upo n whic h ne w loan s an d credit are contingent is limited by the processes of internationalization, which characterize the New International Division of Labor. Internationalized production processes, labor markets, and financialmarkets, when coordinate d throug h th e organizatio n o f multilatera l institution s an d corporations, effectivel y undermine d nationa l regimes ' capacit y t o us e traditional monetary, trade, and fiscal policies to control the economy (Furtado 1987: 40). O n the other hand, heterodox stabilizatio n policie s an d austerity policies are fraught with contradictions that threaten the political legitimacy of national governments. Caugh t within these compelling cross-currents, debtor governments have found themselves forced to accept a routinized process fo r rescheduling loan payments. The y must present a plan for economic stabilization tha t conform s t o th e conditionalit y an d structura l adjustmen t criteri a demanded b y th e IM F an d th e Worl d Ban k a s th e certificatio n o f credit worthiness. Negotiatio n wit h agencie s o f industria l nations ' "ai d regime" follows t o obtai n officia l loan s o n below-marke t term s an d secur e trad e agreements within GATT. Finally , negotiations with commercial banks determine access to new private credit (Garten 1982: 280). In practice, thes e routine negotiations wit h one se t o f institutiona l actor s present contradictory demands that, ironically, are contingent upon satisfactory negotiation with another set of creditors. Thes e separate negotiations create an environment o f institutionall y determine d performanc e criteria , whic h ar e unrelated t o th e welfar e an d securit y o f th e debto r countr y populatio n o r traditional developmen t goals , bu t whic h redistribut e organizationa l powe r within debtor states. Th e IMF annual review procedures create an imperative for debtor governments to establish economic monitoring procedures and state institutions tha t allo w continue d supervisio n an d standardize d reportin g procedures. I n addition, the World Bank's shift from project-specific t o broad structural adjustment policies and more short- to medium-term lending reduces the role of special purpose institutions and increases the importance of central banks and finance ministries within national regimes (Carvounis 1984 : 62-84). The convergenc e o f IM F an d World Ban k loa n policie s ha s increase d th e leverage of multilateral institutions by centralizing information and negotiation strategies fo r creditors . Th e effectivenes s o f IM F conditionalit y an d th e

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negotiated rescheduling process in controlling the overall policy mix in debtor countries is based on the ability to monitor borrowers' economic performanc e (Williamson 1982 : 25). Indeed, th e negotiatin g procedur e bring s th e IM F int o th e proces s o f fashioning the economic policies for the debtor nation, including decisions that have powerful effect s o n domesti c conditions . A t th e sam e time , th e IM F insists tha t adjustmen t tak e plac e withou t recours e t o heightene d trad e and exchange controls , an d thi s als o dispose s th e IM F to g o beyon d polic y ap proval and into policymaking (Carvounis 1984 : 68; see also Neu 1979 : 239). In th e 1980s , Lati n America' s principa l debto r nation s hav e produce d a strong ne t outflow o f capita l base d on reduced wages , reduced imports , and dismantling of stat e sector programs and institutions, especially public-secto r capital investments. Conditionall y ha s required that surpluses generated by balance o f trad e surpluse s b e use d t o satisf y multilatera l an d internationa l creditors. Nationa l regimes are constrained from shifting resource dependence to the local economy by raising domestic revenues. Thus , the functions of all state institutions are increasingly buffered by those state agencies that negotiate access t o new credit . And , a s a result, IM F conditionality an d World Ban k structural adjustmen t ca n be viewe d a s a se t o f institutiona l criteri a incom patible with development goals , a set which delegitimate s th e sovereignty o f national governments. In addition, satisfactio n o f IM F "conditions" has become th e routine firs t step required for debtor country loan negotiations with OECD nations through the Paris Club. 13 Thi s structur e has produced a maximum amoun t of uncer tainty for debtor nations and a maximum amount of flexibility an d control for creditors. Debtor s seekin g bilatera l loan s and debt rescheduling fac e a d hoc procedures, short-term loans requiring constant negotiating, domestic policie s aimed a t rapid measurabl e results , an d official indifferenc e t o th e domesti c consequences of required policies (Carvounis 1984: 73). Finally, commercia l creditors ' loan s ar e conditiona l upo n Pari s Clu b agreements, an d th e negotiatio n proces s fo r reschedulin g loan s follow s n o established routine. Again , this increases debtor uncertainty. Th e information search by debto r countries attemptin g t o reschedule loan s incorporate s the m into a perpetua l roun d o f prenegotiations , negotiations , an d renegotiation s wherein the y mus t respond t o new demand s for informatio n o n policies an d 13. Th e Paris Club was created in 195 6 as a multilateral organization to coordinate the policies of OECD creditor nations that have bilateral loans with Third World nations. Credito r nations have thus been able to centralize negotiations and routinize procedures. Debto r nations therefore must confront creditors in a negotiating framework wher e bilateral loans and rescheduling of loans are uniform across sources of credit.

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policy performance. T o "play the game," debtor country negotiators thus find themselves compelled t o conduct three separate sets of parallel negotiation s with creditors wh o place mutually contingen t bu t independent performanc e demands upon the debtor government's economic and social policies. To conclude, Latin American debtor nations find themselves operating in a New International Division of Labor wherein internationalization has produced profound shift s in trade, production processes, finance, and investment. Mor e important for the processes of policy formation and implementation, however, the coordination of multilateral, official, an d commercial finance capital has created an environment of organizational priorities that are divorced from th e functioning o f th e domesti c economi c an d political marketplac e i n debto r nations. "Ai d has been structured to promote a certain type of industrialization, which is characterized by private ownership, openness to foreign capital, and reliance on market forces, and which is, increasingly, export oriented" (Wood 1986: 188) . Th e fundamental rational e o f structura l adjustmen t is , first, t o compel periphera l nation s t o accept th e logic o f comparativ e advantag e in exchange relation s b y concentratin g o n export-le d growth , and , second , t o dismantle the state capitalist institutional structures, which increase transaction costs for internationa l capital . Thes e policies are, of course, asymmetric in that the y ma y rais e transactio n cost s fo r som e socia l group s i n periphera l nations. Wag e laborers , loca l businesses , an d consumer s ar e face d wit h increased uncertainty and volatility, not greater certainty and predictability, in their market relations as a result of the actions of these multilateral agencies. SOCIAL CONSEQUENCE S O F STRUCTURA L ADJUSTMENT Demography Data on Latin American population processes must be interpreted cautiously due to the unreliability o f statistic s in the region (Hakker t and Goza 1988) . The presumption tha t structura l adjustmen t policie s implemente d i n Lati n American nations during the 1980s had a negative social impact is intuitively appealing. Unfortunately , efficient civi l registration systems are uncommon in Latin America, and fertility and mortality data must be interpreted cautiously. Moreover, decreased governmen t spending also affects collectio n of data on health, migration , an d labo r forc e characteristic s (Martin e e t al . 1984) . Demographic socia l indicators , however , ma y provid e a mor e accurat e

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assessment of structural adjustment policies' impact on the well-being and life chances than simple income distribution measures. Roett (1987) asserts that structural adjustment policies have a direct impact on health , an d UNICEF (1987 ) conclude s tha t child mortalit y i n Brazi l ha s increased, but these findings are somewhat controversial given the nature of the data. Nevertheless , IMF - an d Worl d Bank-influence d orthodo x policie s produced recessions throughout the region, resulting in increasing unemploy ment, an d declinin g level s o f consumptio n an d rea l wages . Governmen t investment spending dropped precipitously, particularly expenditures on health and education. However , time lags, countercyclical trends , and separating the impact o f austerit y fro m long-ter m trend s al l complicat e th e questio n o f determining the social costs of structural adjustment in Latin America. From 197 9 to 1983, per capita real expenditures on health in Latin America declined by nearly 60 percent and educational spending by 59 percent (UNICEF 1987). A s a consequence , on e migh t expec t th e followin g demographi c consequences: increased malnutrition, especially among children; larger proportions of deaths due to malnutrition and infectious diseases; increased labor force participation of women and children; reduced marriage rates; lower birth rates; increased marital instability and divorce rates; increased crime rates, including child abuse ; change s i n th e prevailin g pattern s o f interna l migration ; an d increased emigration where possible. In Chile , a decad e o f monetaris t economi c policie s an d overall cut s i n health care, including privatization of many services (Scarpaci 1988) , has been accompanied by continuing declines in infant mortality rates (Haignere 1983; Foxley and Raczynski 1984 ; Raczynski and Oyarzo 1981). However , increased rates of malnutrition amon g preschoolers and increased infant mortality rates for mothers with no education may be linked to reduced government nutritional aid programs (Foxle y an d Raczynski 1984) . I n 1984 , whe n unemploymen t declined and nutrition programs were improved, malnutrition declined. In Cost a Rica , Rosero' s analysi s coverin g 191 0 t o 198 1 demonstrate s a systematic increase in infant mortality during recessions, a pattern which holds in the 1980s . However , child malnutrition continued to decline between 197 9 and 1982 in spite of reduced child nutrition programs (Costa Rican Ministry of Health). Suicide s increased from 0.98 percent of deaths in 198 2 to 1.4 percent in 198 3 (Ministry o f Justice). Th e economic recession appears to have led to increased urban migration a s the differential betwee n urba n and rural wage s increased (MTSS 1986). From 1975 to 1985, slower economic growth in Brazil was accompanied by government intervention with expanded urba n services, especially sanitation , which le d t o a declin e i n infan t mortalit y rate s (Vette r 1983) . Th e infan t

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death/birth ratio , however, is up from 56 per 1,00 0 i n 198 2 to 60.9 in 198 4 (FIBGE 1987). Brazil' s homicide rate doubled in the past decade, and suicides attributable to financial problems rose from 187 in 1982 to 332 in 1983, when the financialcrisis compelled Brazil to petition the IMF for assistance. Shift s in th e marriag e rate hav e tracke d th e economy , increasin g wit h improve d economic conditions and declining with recession. A s of 1986-1987 , both the birth and marriage rates were at their lowest levels in this century. Th e impact of austerity on fertility rates, however, is difficult t o judge conclusively in the short term . Th e observed shift s ma y simply be intensifying trend s already present, o r the y ma y represen t a chang e i n timin g o f birth s an d presag e increased birth rates in the future. The recessionary impac t o f structura l adjustmen t policie s ha s le d many observers t o expect increased emigratio n fro m Sout h an d Central America . Internally, one may anticipate an increase in migration, but perhaps a decline in migration to cities where the recession and reduced government spending have hit labor markets hard. I n Colombia, Bogota's growth has remained below the predictions of the United Nations. Cost a Rica, however, where agricultural wages dropped below the official minimum wage and the differential wit h urban wages remaine d high , experience d growin g urba n migration . Mexica n migration to the United States continues at a high rate. Venezuela , historically a target of international labor migration, has experienced a net outmigration of foreigners (Va n Ro y 1984) . Finally , i n Brazil , retur n migratio n t o th e Northeast (Martine et al. 1984) and outmigration from th e new frontier state s has accompanied a decline i n job opportunitie s (SEPLAN) . I n th e United States, the Immigration and Naturalization Service estimates that annual illegal migration rose from 1 to 1.8 million between 198 0 and 1986. Income, Employment , an d th e Economi c Cost s o f Structural Adjustmen t The negative impact of low wages, oligopoly, and insufficient consume r demand on economic growth is asserted by those researchers who conclude that "inequality" is an important cause of stagnation in peripheral nations (Lustig 1980; Dut t 1984 ; Marshall 1988) . I n th e 1980s , Latin America n nation s operating unde r structura l adjustmen t policie s hav e experience d declinin g wages. Th e consumption capacit y o f th e low-income population, often a n important market even for consumer durables, has been reduced by a series of economic and political shocks. Lowe r consumption levels have been paced by slow export growth, reduced industrial production, capital flight, and/ increased

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foreign deb t Short-ter m recoveries and brief periods of economic "stability " tied t o heterodo x policie s hav e bee n followe d b y rapi d inflation , rampan t speculation i n plac e o f investment , an d a n elevate d sens e o f insecurity , uncertainty, an d turbulence . I n this context , declinin g physica l an d institutional infrastructures, and a reduced state control of contractual laws, has greatly increased transactio n cost s i n th e loca l economy . I n response , informa l economic relations have grown and may be limiting economic growth. An importan t component o f structura l adjustmen t policies i s a n attack on wages. Suc h policies assum e tha t wage increase s hav e an adverse effect o n prices and imports, contradicting the goal of servicing the foreign debt. Give n slow expor t growt h an d smal l expor t surpluses , "excessive " consumptio n i s targeted a s th e sourc e o f trad e deficits . Th e benefit s o f labor' s increase d consumption capacit y ar e unexamined. However , Clin e (1972) , Corte s and Marshall (1986), and Garcia (1987: 3-47) provide evidence from Latin America that a more equitable income distribution has no impact on imports. The economi c cos t ha s been sever e i n high-deb t countrie s implementin g structural adjustmen t policies . Brazil' s minimu m monthl y salar y o f US$5 0 will no t suppor t a family' s basi c needs . Indeed , Estad o d e Mina s (1987 ) estimates tha t a n increas e i n th e minimu m wag e o f 60 0 percen t woul d b e required to achieve that level. A t the start of the debt crisis in Mexico, over 30 percent of th e economically activ e population received th e official minimu m wage while 54 percent earned below tha t level (Car r 1986). Durin g the early 1980s, 6 0 percen t o f Chilea n urba n familie s earne d les s tha n th e minimu m income neede d t o purchase th e basic "foo d basket " (UNICE F 1987) . Cost a Rican household heads earning the minimum wage or less increased from 24.4 percent in 1979 to 30.8 percent in 1982, an increase that was accompanied by a drop in meat and dairy consumption. Between 198 0 and 1985 , Latin American per capita income i n a group of twenty-three Latin American nations dropped 9 percent (UNICEF 1987). Fro m 1979 t o 1984 , Cost a Rica n rea l wage s fel l 4 0 percen t (Pollac k an d Uthof f 1984). I n Mexico, rea l wage s decline d 3 0 percen t between 198 1 an d 198 4 (UNICEF 1987) . I n Brazil, SEADE (1987) records a 38 percent drop in urban wages i n th e 1986-198 7 period . Fro m 198 1 t o 1984 , rea l wage s i n Chil e declined 1 6 percent. I t appears that the poorest sectors of the population were most severely affecte d i n these cases. I n 1981-1982 , real income declined 1 0 percent for the poorest 40 percent of Chilean wage earners (Altimir 1984 : 91112). Argentina' s stabilization programs of th e mid 1980 s have dropped real wages below thei r level of the early 1970s . I n addition, by 198 5 labor's share of national income was only 70 percent of its 197 0 level (PREAL C 1986 : 63; Marshall 1988) . I n Mexico, real wages fell 9.6 percent in 1982 , 1 8 percent in

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1983, and 1. 3 percent in 198 4 (IDB 1985) . Mexico' s minimum agricultura l wage declined 31 percent in real terms from 198 1 to 1983 (World Bank 1986). Structural adjustment policies have also been related to increased unemployment and poverty throughout Latin America. Klei n and Wurgaft (1985) report that fro m 198 0 t o 198 4 th e weighte d averag e o f urba n unemploymen t fo r twelve Latin America n countrie s increase d fro m 5. 8 t o 7.9 percent. Som e evidence indicate s tha t unemploymen t amon g youn g worker s ha s bee n particularly strong . I n Brazi l betwee n 197 9 and 1985 , youths aged te n t o fourteen ha d their proportion o f th e labor force dro p from 6. 7 percent t o 5 percent, and the fifteen t o nineteen age stratum declined from 15.4 to 14 percent (FIBGE/PNAD). I n Mexico , unemployment rate s ros e t o 12. 3 percent i n 1986, with "underemployment " affectin g 4 5 percent of the workforce (LAM 1987). Th e impact in Bolivia, however, has been expressed i n an increased dropout rate for primary school youth, rising from 2. 2 percent in 198 0 to 8.5 percent in 198 3 (UNICEF 1987) . Ther e is also evidence of increased labor force participation of females and the elderly, as formerly dependent members have increasingly entered the labor force to counteract lower wages for heads of households. There is much evidence that structural adjustment has produced an increase of informal employmen t activities (Garci a and Tokman 1985 ; Saboia 1986 ; United Nations 1986c ; Portes and Johns 1988) . Employmen t growth in the informal secto r no w surpasse s forma l secto r job creatio n i n Latin Americ a (World Bank 1986 ; Portes and Johns 1988) . I n Brazil, Argentina, Peru, and Costa Rica, informal secto r growth ha s been associate d wit h declinin g real wages of between 23.5 percent and 39.3 percent (Hakkert and Goza 1988). I n Argentina from 197 0 to 1980 , skilled labor dropped from 4 0 percent of the workforce t o just 25 percent. Self-employmen t increase d by 5 percent in the same period. Tertiar y sector workers increased to 50 percent of the labor force (Rofman 1988). Social Response s t o Austerit y Debtor nations following IMF- and World Bank-mandated structural adjustment policies are increasingly confronted b y popular responses. Sinc e 1976, some seventy-seven strikes , riots, and demonstrations against the austerity policies typical of structural adjustment have marked the experience of twenty-six debtor nations, thirtee n i n Lati n Americ a (Walto n an d Ragi n 1988) . I t i s no t surprising that as the costs of structural adjustment policies have fallen principally on the poor and wage earners, popular resentment in Latin America is

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1

increasingly taking the form of spontaneous riots, community-based militance, and various forms of "disengagement, " which observers link directly to these policies (Portes and Johns 1988; Grindle 1988). In Mexico, peasants have engaged in popular protests against government structural adjustmen t policie s (Car r 1986 ; Priet o 1986 ; Fo x 1987 ; Grindl e 1988). Nevertheless , mobilizations and protest have not been the characteristic responses i n rural areas . Rather , disengagemen t strategie s parallelin g thos e described by Portes an d Johns in urban areas typify househol d adaptation t o ensure economi c surviva l (Grindl e 1988) . Surviva l strategie s ar e use d b y households tha t combine source s o f incom e fro m agriculture , commerce , industry, and migratory activities.14 In th e 1980s , structura l adjustment-relate d riot s hav e contribute d t o th e downfall o f Lati n America n an d Caribbean government s i n Peru (198 0 an d 1984), Brazi l (1983) , Panam a (1985) , an d Hait i (1986 ) (Walto n an d Ragi n 1988). Popula r protests have risen parallel with the debt burden and the rate with whic h austerit y measure s ar e imposed. Loxle y (1984 : 30 ) link s urba n riots directl y t o th e impac t o f structura l adjustmen t o n th e workin g class . Petras an d Bril l (1986) , however , argu e tha t stat e contro l an d legitimac y relations between the state and civil institutions determine popular responses to austerity programs. Rober t Kaufman (1986) finds that measures of "economic concentration" and "populist tradition" determine the emergence of destabilizing coalitions, such as those which developed in Brazil, Argentina, and Mexico.

CONCLUSION After World War II, rationalization o f internationa l markets was facilitated in part by th e creation of multilatera l agencie s suc h as the IMF and the World Bank, and treaties like GATT, that sought to establish a normative order within which transaction costs among diverse actors could be regulated. Th e functions of th e IMF and the World Bank hav e evolved fro m regulation o f short-ter m balance of payments crises and project-oriented development loans to coerced structural adjustmen t o f debto r nation s t o guarante e repayment . Thes e multilateral lendin g institutions ' an d GATT's influenc e ove r debto r nations* access t o credi t an d expor t market s hav e allowe d the m t o dictat e nationa l economic an d socia l policie s tha t reduc e constraint s o n capita l an d good s markets and dismantle state institutions.

14. Se e Chapter 12 by Jamal for a similar phenomenon in Tanzania.

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The policy rational e fo r IM F and World Bank structura l adjustmen t loa n policies tend s t o b e subordinate d t o thes e sam e institutions ' organizationa l interests and to those of dominan t international actors . Th e effects o f SAL s often contradic t the state d goals o f internationa l economi c developmen t an d democracy and are necessarily affected by power relations within each country and internationally. Thei r social and economic costs are unequally distributed; these costs are shifted by the more powerful actors (governments in developed nations, commercia l banks , multilatera l lendin g institutions ) ont o th e les s powerful (wag e earners , local small-scal e business). Moreover , th e specifi c measures impose d o n debto r countrie s no t onl y ma y b e ultimatel y incompatible wit h th e promotion o f development , bu t ma y als o exacerbat e already glarin g inequality , delegitimizin g an d destabilizin g democrati c governments. The response t o SALs i n Latin America is likewis e mediate d by national and internationa l powe r structures . Withi n eac h country , th e particula r constellation of social class alliances, the military, and the state will determine not onl y th e for m o f popula r responses t o austerit y measures , bu t als o th e state's own posture in reference to those responses. Brazil , Argentina, Mexico, Peru, and Venezuela are limited in their capacity to fully implement structural adjustment. Organize d constituencies of state-sector employees, labor unions, industry associations, and other interest groups confront the regime with crosscutting demand s and resistance t o SALs. A pattern o f intermitten t austerit y policies, popular mobilization, state resistance to conditionality i n the name of national interest , an d renegotiatio n wit h creditor s wil l continue . Wher e nondemocratic regimes have effectively demobilize d suc h interest groups and maintained a strong coalition o f th e military , export businesses, and foreig n capital, th e socia l cost s o f austerit y wil l no t produce simila r contradictions. Thus, Chile implemented the broadest and most sustained structural adjustment policies i n Lati n America . A s a result, rapi d improvemen t i n conventiona l economic indicator s has been accompanied by severely deteriorating physical and economic conditions for much of the population. Export-related business group s benefit fro m thei r nation's favorabl e trad e status with developed economies. Asid e from some complaints, their response to structura l adjustmen t loan s seem s t o b e acquiescence . Th e reactio n o f working classe s i s mor e problematic an d contingent o n thei r economic an d political strength vis a vis other national political actors. Wher e working-class organization and political involvemen t is high, the ability t o compel nationa l regimes an d multilatera l lendin g institution s t o moderat e SAL s increases . Where workin g clas s organizatio n i s relativel y weak , renewe d emphasi s o n subsistence agriculture and urban informal sector activities is likely.

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As S ALs produce declines in relative and absolute living standards for wage earners and local business, political unrest and destabilization may be expected. In this situation , the response o f th e military becomes a crucial factor . I n a region wit h lon g tradition s o f militar y interventio n i n politica l affairs , th e strengthening or reemergence of authoritarian regimes seems a likely outcome. The perception o f austerity policies a s a shifting o f dominant groups' obligations t o th e poor, typified b y th e sloga n "Le t the ones wh o stol e th e mone y pay bac k th e money, " ca n onl y sharpe n politica l polarizatio n i n Lati n American nations. Th e middle classes an d other hegemonic groups , in turn, will ten d to become more rigid in protecting their interests (tha t is, the status quo) an d less flexibl e towar d protests fro m below . Th e threa t of instabilit y also increases the probability of military intervention and repression. The situatio n ma y b e construe d a s a zer o su m gam e i n whic h powe r determines who bears the costs involved. Thus , developed countries, through mediation o f multilatera l lendin g institution s regulatin g flow s o f capita l and trade, ca n shif t th e cos t o f maintainin g th e internationa l regim e ont o developing economies whose critical dependence on foreign debt refinancing and access t o worl d credi t market s make s resistanc e t o structura l adjustmen t policies, which are conditions for further credits, virtually impossible. I n the national setting , th e cos t o f adjustmen t i s passe d dow n th e pat h o f leas t resistance t o th e les s powerfu l classes , thos e no t unde r protectio n o f th e international regime or unable to establish coalitions to gain some protection.

1 1 POLITICA L CHANG E AN D 1 1 ECONOMI C POLIC Y I N LATIN AMERIC A AN D TH E CARIBBEAN I N 198 8 Louellen Stedman and Peter Hakim

The debt crisis has deeply affected th e lives of Latin Americans. Afte r thre e decades of uninterrupted growth, the economy of nearly every Latin American and Caribbean country went into a tailspin in 1982 and 1983. No w after fou r straight years of slow growth (1984 to 1987), the region's per capita income is still some six percent below its 1980 level. Throughou t Latin America and the Caribbean, wage s hav e fallen ; job s hav e disappeared ; housing , schools , hospitals, and other public services have deteriorated; and Latin Americans have endured food shortages and mounting street crime. Povert y and already skewed distributions of incom e have worsened i n most countries, bringing to a halt promising improvements in nutrition standards and infant mortality rates. Yet these developments have not brought the outright social and economic turmoil that many predicted would result from th e debt crisis of the 1980s. 1 At times, austerity measure s hav e provoked outcrie s fro m peopl e in debtor nations, as workers have gone on strike to protest declining real wages, and riots have greeted increases in food and transportation costs. Bu t these reactions have by and large been of short duration and have not had major political consequences. Mos t Latin Americans have quietly tolerated austerity, hardship, 1. See , for example, Roett (1984).

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and sacrifice, moderating their demands and expectations in light of the severity of the economic crisis facing thei r countries. Fo r example, after five year s of profound economi c crisi s an d more than te n years o f lessenin g governmen t popularity, no political breakdown or metamorphosis has occurred in Mexico (Aguilar 1987-1988: 53). And, in fact, Latin America's turn toward democratic rule has persisted throughout the crisis; economic setbacks have not interrupted elections in any country. The economic difficultie s brough t about by the debt crisis have, however, had political consequences in virtually every country of the region. Sinc e the crisis began six year s ago, most governments in power in Latin America and the Caribbean have suffered sharp losses of credibility and popular support that are directly attributabl e t o economic problems . I n country afte r country , a s governments have been unable to restore economic growth and meet even the minimal demand s o f thei r citizens, thei r support has eroded, and oppositio n forces have gained ground. Since 1982 , presidential election s have been held in eight Latin American and Caribbean countries in which civilian rule was already in place. I n all but one o f thes e countrie s (Cost a Rica) , th e oppositio n candidat e won . Personalities an d other political issue s certainl y playe d a n important role i n these elections, but the dominant issue in every one was economics. 1. Th e Revolutionar y Nationalis t Movement' s Victo r Pa z Estenssor o wa s elected in Bolivia in August 1985 as the successor to President Hernan Siles Zuazo. A t th e time , Bolivia' s econom y ha d virtuall y collapsed , wit h inflation raging at an annual rate of nearly 30,000 percent. Th e incumbent party received less than 10 percent of the vote. 2. I n Colombia, Conservativ e Presiden t Belisari o Betancu r was defeate d i n 1986 by Liberal Virgilio Barco Vargas in an election emphasizing economic distress and political violence in the country. 3. I n the Dominican Republic , th e aging an d nearly blind Joaquin Balague r returned t o th e presidency, defeatin g th e governin g Dominica n Revolu tionary Party's candidate. 4. I n Ecuador in 1984 , businessman an d Conservative Part y candidate Leon Febres Corder o wa s electe d president , defeatin g th e candidat e o f th e incumbent Christian Democratic Party. 5. I n Honduras, the governing Libera l Party spli t in two, with th e dissident party candidate winning 26 percent of the vote. Althoug h the candidate of the opposition Nationa l Part y too k 43 percen t o f th e vote , th e combine d vote of the two liberal candidates was higher, and the Liberals held on to the presidency.

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6. I n 1985, young and charismatic APRA Party Leader Alan Garcia was elected in Per u t o lea d th e countr y ou t o f th e economi c disarra y lef t b y hi s predecessor Terry Belaunde. Belaunde' s Popular Action Party received only 6 percent of the vote, and an APRAista became president for the first time in the party's history. 7. An d in Venezuela, 198 3 brought the election of Jaime Lusinchi, leader of the Democrati c Actio n Party , an d th e defea t o f forme r Presiden t Rafae l Caldera of the governing Social Christian Party. Notably absent in these elections was any consistent ideological trend. I n four of th e elections , th e winnin g candidat e favore d mor e open , free-marke t approaches; in three others, the reverse was true. Since this early round of elections in the 1980s, governments in power have continued t o los e prestig e an d support . Ther e ar e fe w Lati n America n presidents who are stronger today than they were two years ago. Oppositio n groups ar e winnin g legislativ e an d loca l elections , an d poll s reflec t th e declining popularity of sitting presidents. But in the subsequent round of elections in the late 1980s, there appeared to be an ideological trend. Populis t and nationalist groups seemed to gain ground. These groups called for less conciliatory postures toward international creditors and demanded relief fro m intolerabl e debt burdens. Thi s trend reflected th e growing resentmen t towar d continue d austerit y an d orthodo x economi c programs imposed to maintain debt payments and good relations with creditors. People appeare d t o los e fait h tha t such standar d approache s woul d brin g an improvement in their nations' financial an d economic circumstances , turnin g away from leaders who promised more of the same.

POLITICAL TRANSITION S AN D THEIR IMPLICATION S At the time this chapter was written, presidential elections were due in the next two years for eleven countries in the region, including the four largest debtors: Brazil, Mexico, Argentina, and Venezuela. Th e indications were that at least some of these elections will bring significant political transitions. It ha s no t bee n eas y fo r government s t o promot e economi c reform . Shortages of foreig n capita l an d cramped domestic budget s hav e constrained efforts a t structural change. Publi c and private enterprises, for example, lack the resources t o exploit ne w expor t opportunities . Man y countrie s initiate d tough measure s t o contro l fisca l deficit s an d inflation , bu t the y coul d no t

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sustain them because of political opposition. Th e stop-and-go performance of most Latin America n economie s ha s erode d th e confidence o f busines s an d financial communitie s throughou t the region, reducing incentives t o invest in future production . I n sum, there is littl e willingness i n any secto r t o accep t further sacrifices because few Latin Americans still believe that such sacrifices will produce significant and lasting results. In many places , oppositio n i s increasin g t o market-oriented policie s tha t people ofte n associat e wit h austerity , unemployment , an d reduce d socia l expenditures. Organize d labor actively resists reforms that threaten to eliminate jobs an d lowe r wages . Othe r resistance come s fro m owner s o f businesse s anxious t o preserv e protecte d market s an d stat e subsidies , an d fro m publi c employees concerne d about their jobs and influence. Fo r most Latin Americans, th e standar d approac h t o deb t management—austerit y a t hom e an d massive interest payments abroad—has come to a dead end because it has failed to bring growth. Althoug h election s in all countries are not necessarily full y representative of the attitudes and interests of all population groups, the broad public frustration with economic management is certainly likely to be reflected in upcoming election results. Thes e results will in turn significantly influenc e the cours e o f economi c polic y an d th e managemen t o f foreig n deb t i n th e hemisphere.

Mexico Mexico will be the first major debtor to face presidential elections in 1988 . I n an upcomin g election , th e PR I wil l almos t certainl y asser t it s continuin g dominance o f Mexica n politic s throug h th e victor y o f th e party' s Carlo s Salinas de Gortari, one of the main architects of current President de la Madrid's economic policies . Salina s i s mor e likel y t o brin g continuit y tha n marke d change t o th e Mexica n economy . Nonetheless , ther e hav e bee n significan t shifts i n Mexica n politic s i n th e past si x years . Th e upcomin g electio n ha s brought more debate about economic policy, and is more contested, than any in Mexico in the recent past. Assuming office i n December 1982 , President Miguel de la Madrid adopted a policy of accommodation with the international financial community , which he has maintained throughout his term of office. Mexic o was rewarded with larger amount s o f ne w externa l financin g tha n an y othe r Lati n America n country. Wit h the help of thes e funds and a shift toward exports, the country was able to produce a sizable trade surplus, build up large foreign reserves, and strengthen its economy overall . Ye t the Mexican people have suffered grea t

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hardship. Rea l economic growth, manufacturing output, and investment have declined (Bailey and Watkins 1987). 2 Rea l wages remain extremely low and by mid 198 7 were 50 percent of thei r 197 6 level and 9 percent lower than in the previous yea r (1987). Governmen t efforts t o maintain reserves and the trade balance through devaluations have produced considerable discontent among the Mexican people. Consequently, th e PRI in this election year is more vulnerable than in the past. Salina s does not have the enthusiastic backing of the PRI rank and file that previous candidate s had . Criticis m o f th e party's undemocratic interna l governance is loud, led by former PRI member Cuauhtemoc Cardenas, the son of Mexico's mos t popular president, who is running for the presidency under the auspice s o f thre e small , left-oriente d parties . Bot h Cardena s an d th e candidate of the business-based National Action Party are highly critical of the PRI's economic management . Thes e oppositio n candidate s ar e likely t o d o better at the polls (presuming reasonably fair elections) than they ever have.3 PRI candidate Salinas will withstand these challenges and win the election. But another battle will begin once he enters office. Hi s own campaign reveals concern wit h th e changin g dynamic s o f Mexica n politic s an d th e desig n o f acceptable economic policies. Salina s himself now maintains that repaying the country's $10 5 billio n foreig n deb t mus t b e linke d t o th e achievemen t o f sustainable economic growth. 4 H e also acknowledges that the severe economic crisis has made more imperative the need for change in the Mexican political system. Bu t Mexico i s not likely t o alter in any fundamenta l wa y it s economic course or its close economic relationship with the United States.

Venezuela The likely return of Carlos Andres Perez to the presidency in Venezuela would produce changes in domestic economic management and relations with foreign creditors. Th e nominatio n o f Perez , wh o hel d th e presidency fro m 197 4 t o 1979, followed a struggle within the Democratic Action Party that pitted Perez against curren t President Jaim e Lusinchi . Pere z advance s a mor e populis t

2. Se e th e discussio n o f Mexico' s experienc e wit h structura l adjustmen t i n Chapte r 1 4 by Dornbusch. 3. Variou s source s recor d this trend , includin g "Th e Peons Tur n on Mexico' s Ever-Rulin g Party," Economist, March 5,1988, pp. 43-44. 4. "Salina s Begins to Define Positions," Latin American Weekly Report, Oc t 22,1987 , p. 4.

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alternative to the governance of Venezuela than did either of the previous two presidents. During his earlier term, Perez nationalized the oil industry and promoted a series o f socia l reforms tha t made him popular wit h th e poor an d workin g classes. Industr y and business sectors, on the other hand, have always been wary of him (Collet 1988) . Perez' s former priorities in domestic matters will probably not change significantly, although economic and financialconstraints will limit his policy choices. I n the international sphere, Perez has called for debt repayment to be conditioned to new loans and stronger export earnings (1988). Pere z seems more willing than his predecessors to consider reducing growth-hindering foreign debt payments, but he has been cautious about calling for unilateral action to abandon Venezuela's foreign financialobligations. In what could prove an important development, Perez has expressed his intention—if elected—to extend his leadership beyond the borders of Venezuela. He has pledged greater priority to Venezuela's external relations and is unlikely to maintain Lusinchi's conciliatory relationship with the United States. Pere z does not advocate a debtors' cartel and cannot, therefore, be expected to lead an outright rebellio n agains t th e curren t internationa l deb t strategy . Bu t a s president, Perez might well convert Venezuela from a quiet and docile debtor to a regional leader in the search for an escape from the debt crisis. Brazil The decision of Brazil, Latin America's largest debtor, to suspend unilaterally its debt service payments to commercial banks in February 198 7 was perhaps the most dramatic and destabilizing development in the five-year-old debt crisis. The suspension le d directly to the decision by U.S. banks to establish larg e reserves against losses on Third World loans. Brazi l acted to avoid depleting its foreign exchang e reserves , which wer e dwindlin g rapidl y a s th e country' s overheated economy had caused imports to surge and exports to decline (as production shifted to satisfy domestic demand). Despit e the recovery of exports and resumption of growth that occurred before the end of 1987 , it was more than a year before Brazil reached agreement with its creditors to resume interest payments. Thi s delay reflected th e political dynamics in Brazil, which have grown more complex as the country prepares for its first presidential election since the transition to civilian rule in 1984. Domestic politics has consistently played a major role in the management of the Brazilian econom y and the country's external debt. Th e popular and innovative Cruzado Plan failed largely as a result of President Sarney's refusal,

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against the counsel o f man y advisers , to slow economi c growt h prior to key gubernatorial elections . Th e governin g part y wo n a clea r victor y i n th e elections, but inflationary pressures had been released, and foreign reserves were largely deplete d b y th e boom . Th e moratoriu m o n interes t payment s wa s almost an inevitable result. With th e subsequen t contractio n o f th e economy , th e popularit y an d credibility o f th e Sarne y governmen t plummeted , an d political divisivenes s increased. Brazi l i s no w politicall y an d economicall y demoralized . Th e Brazilian Popula r Democrati c Movemen t Part y (PMDB) , ostensibl y th e governing party , i s divided , makin g i t difficul t fo r Sarne y t o carr y ou t a consistent economic policy (Truell 1987) . A new strategy by Finance Minister Mailson Ferreira da Nobrega to stabilize the economy through real wage cuts and defici t reductio n i s no t give n muc h chanc e o f success , du e t o popula r opposition a s wel l a s th e resistanc e o f th e militar y t o th e wag e measure s (Cohen 1988). Presidential election s ar e due i n 1989 , an d candidate s stil l remai n t o b e chosen. Man y consider Leonel Brizola, a former governor of Rio de Janeiro, to be the leading candidate. Brizol a offers a strongly populist approach to Brazil's economy an d its deb t problems. H e favor s nationalizatio n o f th e banks , a harder lin e o n externa l debt , an d inward-lookin g solution s t o th e country' s economic pligh t (Whitefiel d 1988) . I f election s wer e hel d today , man y observers believe he would be the likely victor. Despite his popularity, Brizola, or whoever gains the presidency i n 1989 , will be constrained by political and economic realities. Amon g these realities is th e military , whic h continue s t o pla y a majo r rol e i n Brazil' s politica l affairs, an d it is possible tha t the military would prevent Brizola from takin g power a t all . Arm y Ministe r Genera l Leonida s Pire s Goncalve s sounde d a warning when he declared in December 198 7 that "military interventions are provoked not by 'the nature of regimes but rather by the incompetence of those in government'" (Riding 1988b) . Presiden t Goulart's ties to Brizola contributed to the military takeover in 1984. Brazil is in a political an d economic quandary , with little popular support for economi c austerit y o r continue d cooperatio n wit h privat e an d officia l creditors. Ye t i t i s difficul t t o se e an y eas y resolutio n o f th e country' s economic problem s withou t suc h measures . Populis m an d nationalism ma y propel Brizola or a similar candidate to the presidency in 1989 , and the results may be greater confrontation wit h external creditor s and further setback s fo r Brazil's economy.

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Argentina Argentina face s th e mos t difficul t economi c futur e o f th e majo r debto r countries. Whil e its debt level ranks third in the region, its ratio of interest payments t o exports , a crucia l indicato r o f solvency , i n 198 7 reached 5 6 percent, compared to 35 percent for Brazil and 38 percent for Mexico (ECLAC 1987). An d gross domestic product per capita has declined further than in other debtor countrie s (Worl d Ban k 1987c : xi) . Today , observer s describ e th e Argentine econom y a s "exhausted , chaotic , an d ou t o f control " (Christia n 1988). Strike s for wag e adjustments hav e become commonplace; a general strike debilitated the entire country in early 1988 . Th e labor movement has been particularly voca l in rebelling against the government's "submissio n to the 'policies of hunger' of the IMF'" (1988). In September 1987 , voters dealt a stunning defeat t o President Alfonsin' s Radical Part y i n gubernatoria l an d legislativ e elections . Th e victoriou s Peronists based thei r campaig n o n a populist condemnatio n o f th e government's failure to take a stronger position on debt repayment and improve living standards. A s 1989 presidential elections approach, the Peronists now seem to have the upper hand over President Alfonsin's Radical Party. Popula r support for Peronist economic positions will clearly influence policy over the next few years as Alfonsin trie s to regain lost ground. Thi s is not the same Peronist party tha t lost the election t o Alfonsin. I t has moderated it s positions on a number of fronts. Th e party no longer advocates deficit spending, development through import-substitution , protectionism, or fervent economi c nationalis m (Hewko and Chediek 1988) . Th e new Peronist Party favors a tougher stance toward the IMF and external creditors, but it also calls for privatization an d reduction of the immense budget deficit i n Argentina (1988). An d the party may become even more moderate if it gains national office. But the Peronists must still satisfy thei r labor constituency, even as they have been abl e t o broade n th e party's base . The y oppos e toug h austerit y measures tha t keep wag e increase s belo w pric e rises an d ar e no t ready t o dismantle state-owned enterprises or raise taxes. Man y of their supporters will continue to press for a suspension or reduction of external debt payments. Other Countrie s Elections in other countries of the region are likely to follow pattern s similar to those of the four largest debtors. Continue d economic stress seems likely to lead t o increase d suppor t fo r populis t approache s t o economi c polic y an d

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external debt management. Politica l developments in Jamaica and Ecuador provide further evidence of this trend. Current Prime Minister Seag a of Jamaic a ha s sought for seve n year s to promote a market-oriente d econom y fo r hi s country . I n thi s h e ha s bee n strongly supported by the United States and international financial institutions. He can point to significant improvement s in the economy, but the people are tired of the relentless austerity they have faced. It now appears that Michael Manley, whom Seaga replaced i n 1981 , wil l return to power. Manle y contends that the Seaga-orchestrated recovery of the past seven years has never reached the poor, condemning the serious decline in public education , health , an d socia l welfar e standards . Althoug h h e ha s moderated many of his stated positions and plans to retain many of the Seaga economic reforms, Manley still advocates a stronger role for the state in the economy an d is likely t o have a far les s cordial relationship with Jamaica's creditors. Ecuador provides another example of the hemispheric trend toward populism. Presiden t Febres Cordero pursued free market, export-oriented economic policies, again with stron g support from th e United States . Althoug h thes e policies initiall y brough t reductions i n inflatio n an d th e budget defici t an d promoted growth in exports and production, the sharp drop in oil prices and a devastating earthquak e brought thi s progress t o a halt (Holliha n 1988) . I n January 1988 , Febres Corder o wa s soundl y defeate d i n th e firs t roun d o f presidential elections, and two more populist candidates reached the run-off election. Bot h Democratic Left candidate Rodrigo Borja and Roldo-sista Party candidate Abdal a Bucara m calle d fo r a greate r rol e fo r th e stat e an d les s cooperation with external creditors (Golden 1988). Borja , the more moderate of the two, won the election, but a clear turn away from marke t approaches to economic managemen t an d towar d toughe r negotiation s wit h internationa l organizations and banks can still be anticipated. TRENDS AN D OUTLOOK S We have discussed thus far six upcoming elections in Latin America and the Caribbean. A s in the earlier round of elections held in the 1980s, the parties in power in most countries face probable rejection a t the polls in the next few years. Unlik e the previous elections, however, the leading candidates at this stage ten d t o favo r mor e populis t policie s an d t o rejec t market-oriente d approaches. The y will call for higher wages, price controls, and greater social spending. Thes e prospective leaders are also less prone to promote exports at

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the expense of internal consumption and are likely to be less accommodating to their international creditors. The determinatio n an d abilit y o f politica l leader s t o carr y ou t electio n promises is always difficult t o assess. Politica l rhetoric reflecting ideologica l positions can be particularly hars h and polarized in Latin America, and most successful presidential candidates are likely to moderate their policy objectives once they assume office an d are faced with the task of governing. Nonetheless , preelection statements do distinguish candidates. An d if they do not precisely predict the course a government—once in power—will follow, such statements do suggest likely policy directions. Given the preelection debates emerging throughout the region, this round of elections may well bring important shifts in economic policy in Latin America and the Caribbean. Th e internal economic consequences of less orthodox and more populis t approache s ar e uncertain . Bu t countrie s followin g thes e approaches—Peru, for example, which after two years of expansion and growth is now out of reserves and on the brink of collapse—have not fared particularly well over the past several years.

12

THE DEMIS E O F THE LABOR ARISTOCRAC Y I N AFRICA: STRUCTURA L ADJUSTMENT I N TANZANIA Vali Jamal

Structural adjustment programs as currently applied in African countries exhibit many common features, including restraints on wages, suspension of subsidie s on food products, liberalization of markets, and devaluation. Th e objective of these measure s i s t o shif t resource s i n favo r o f rura l areas . Th e commo n justification fo r thi s shif t i s tha t past policie s hav e create d distortion s tha t support inflate d livin g standard s i n th e urba n areas . Pricin g policie s fo r agricultural crops and wages policies for urban workers are particularly singled out as culprits. A s a result, urban wage earner s allegedly gai n through price twists and terms of trade transfers at the expense o f farmers. Th e squeeze on agriculture destroys farmers' incentives to produce for the market, precipitating This paper draws upon analysi s of the Tanzanian econom y don e during severa l ILO missions, particularly th e Basi c Needs Mission i n 198 1 under the leadership o f Paul Streeten . Th e autho r would like to thank, without implicating, Fred Bienefeld, Joh n Harris, Ian Livingstone, Ajit Singh , Frances Stewart , an d Paul Streete n fo r helpfu l suggestion s an d discussion s durin g the writin g o f that report. Man y of them have also commented on the author's subsequent papers on Tanzania, on which this paper also draws. Th e author would also like to thank Brian Van Arkadie, Reg Green , Rolph van der Hoeven, and John Loxley for discussions on recent trends in the Tanzanian economy. Opinions expressed are solely those of the author.

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crises in African countries . Wha t is allegedly needed to raise these countries out o f th e crisi s ar e structura l adjustmen t program s t o correc t th e majo r imbalances in the economy. Adjustment program s in Africa ar e thus based on some notion of "urba n bias," which in Africa was almost invariably translated to imply a bias in favor of the urban wage earners. Tha t such a bias exists in African countrie s has been a feature o f Africa n economi c analysis ever since serious analysis got underway. Ellio t Berg was certainly not the first to remark on it, but he did it most forcefully, deliberatel y seeking controversy on the grounds that "there had been too little of it [controversy ] i n the past" (Berg 1966 : 185). Writin g in 1964 on wages policy in Africa for a conference of the International Institute of Labour Studies, he observed: "Africa n wage earners are in general a relatively privileged group . The y enjo y mor e o f th e benefits o f modernizatio n an d growth than any African socia l group" (1966: 189). Hi s point of reference was the "nonwage sector," by which he meant the agricultural sector. H e quoted figures from th e Belgian Congo and Senegal to show a gap of up to 2.5 times between the incomes of wage earners and farmers (1966:190). Th e notion of a wide and widening rural-urban gap in Africa became entrenched in the literature. Tanzania became caught in this scheme of thing s quite early on . I n the same yea r a s Ber g wa s writing , a n IL O documen t (IL O 1964 ) identifie d Tanganyika a s th e African countr y i n which mone y wages increased a t the highest rate between 1959 and 1962 (62 percent). A t the subsequent conference in 1967 , Tanzania's positio n wa s mor e tha n confirmed , a s i t emerge d firs t among al l Africa n countrie s surveye d i n terms o f wag e increases. Mone y wages increased by 175 percent between 1956 and 1964, translating into a 153 percent increase in real wages (Smith 1969 : table 1) . Notin g that per capita income rose by much less, it was remarked that "very high increases in real wages . . . have been accompanied by a relative—and sometimes absolute— deterioration i n livin g standard s i n the subsistence sector . Sinc e the living standards of wage earners were... above those of subsistence workers the large increases in real wages need special scrutiny" (1969: 32). The farm-wag e inequalit y gav e rise t o a schoo l o f "ga p economics" by which almost all economic trends in African countrie s were to be understood. This school , a s w e migh t hav e gleane d fro m th e passag e wit h respec t t o Tanzania, sought to establish a causal link between the two poles of the gap— workers' wages and farmers' income. I f wage earners were gaining, it was at the expense of farmers. Ber g showed some of the axes of the transfer: farmer s pay the most taxes in African countrie s and hence finance the wage-induced increases i n th e governmen t wag e bill; an d farmer s fac e highe r price s fo r commodities they buy and receive lower prices for export crops to offset higher

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wages (Berg 1966 : 204). I n essence, this was the forerunner of the urban bias model unveile d by Lipto n i n 1977 , a model sai d t o be o f universa l validit y (Lipton 1977). 1 B y the time Lipton wrote his influential book , the urban bias model as described above had been standard fare in African economic analysis for at least a decade and a half. It s manifestations in Tanzania were the "Turner Reports" to government on wages policies (IL O 196 7 and 1975) , a chapter in the ILO/Jobs and Skills Programme for Africa (J ASP A) Employment Mission report (ILO/JASPA 1978) , and the invaluable terms of trade studies of Frank Ellis i n th e earl y 1980 s (Elli s 1982 , 1983 , an d 1984) . I n 1982 , JASPA' s Basic Need s Missio n repor t wa s als o publishe d (ILO/JASP A 1982 ; als o published in part in Jamal 1982) , which pointed out for the first time the dire consequences of the Tanzanian crisis for the real income of wage earners. Th e World Bank' s censoriou s repor t on Afric a i n 198 1 (IBR D 1981) , writte n by Elliot Berg, epitomized the urban bias model as an explanation of the malaise afflicting Africa n countries , whil e Bate s (1981) , i n another influential book , brought together all the various strands of urban bias in Africa. One reason for the general acceptance of the urban bias model in Africa was its suppose d link to rural-urban migration. Michae l Todar o (1969) accorde d center stag e t o th e rural-urba n ga p a s th e caus e o f migration , give n th e probability o f securin g a town job: the higher the gap, the bigger the flow o f migrants into towns; and because urba n employment wa s no t increasing fas t enough, th e highe r th e gap , th e highe r th e leve l o f urba n unemployment . Thus, th e complet e "ga p model " i n Afric a wen t somethin g a s follows : Government wa s squeezin g th e agricultural secto r throug h variou s form s o f taxes and terms of trade twists, the benefits of which went to wage earners; the consequent farm-wage gap encouraged migration and hence unemployment; and in the rural areas the squeeze on agriculture was the cause of stagnating output. In short, everything one ever wanted to know about Africa could be found in the gap model. I n particular, when the "African crisis" gripped world attention, the gap analysts knew the cause—economic mismanagement, which was really shorthand for all past misguided wages and pricing policies. Thes e questions were never asked: To what extent was the assertion of the rural-urban gap true? What wa s it s siz e a t an y give n time ? I f th e rural-urban ga p existe d i n th e 1960s an d 1970s , doe s i t stil l exis t (a s implie d by th e structura l adjustmen t 1. A s a curiosity, it should be mentioned that Lipton put Tanzania in the category of countries in which there was no urban bias (Lipton 1977: 74 and 264). Later , under some attack, he retracted, saying h e wa s "to o read y t o accep t claim s tha t [socialist , les s developin g countrie s suc h a s Tanzania] featured relatively little urban bias" (Lipton 1984b : 142). H e was quite likely mistaken on both accounts—at the time of his book there was urban bias in Tanzania, notwithstanding the avowed socialism, and by 1984 , most of the overt signs of urban bias had disapperared.

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remedy)? I examine these questions, using the case of Tanzania as an example. (For other countries see Jamal and Weeks 1987,1988, and forthcoming b). WAGES AN D PRICE S POLICIE S The policie s tha t ar e mos t relevan t i n analyzin g th e wage-far m ga p ar e government policies affectin g price s and wages. Far m prices have a direct bearing on agricultural incomes (though, as we shall see, not as much as might be thought) and an indirect bearing on wage earners' real incomes. Wage s may congruently affect farmers ' real incomes by their impact on the general price level. Indeed , a s we saw earlier , man y analyst s mad e a direct connectio n between the two incomes, taking it as axiomatic that a gain in one implies a loss in the other through price impacts. Suc h a simple connection was made in Tanzania by Turner. Wage Polic y As far as government policy for wage earners is concerned we can discern seven periods in Tanzania: 1959-1962 , laissez faire; 1963-1966 , laissez faire; 19671972, wage policy; 1973-1975 , "catch up"; 1976-1979, wage restraint; 19801981, "catch up"; and 1982-present, market-oriented restraint. The firsttwo periods merge, with the operative theme being market-oriented wage policies. A t the start of the first period, a minimum wage was laid down for the first time in Tanganyika (as it then was) at Sh. 82 per month in Dar-esSalaam (Tabl e 12-1) . Thi s minimum remained in force unti l January 1963, when it was almost doubled, to Sh. 150 per month. I n the meantime, the nonagricultural sector wage increased by 62 percent between 1957 and 1962 (a year before th e promulgation o f th e new minimu m wage) , attesting t o the labor market conditions prevailing in the country at the time. I t may be noted that this is the trend captured by the two ILO reports previously cited that did so much to project Tanzani a as a "high-wage economy." I f wag e increases in Tanzania wer e higher tha n elsewher e i t was because o f underlyin g marke t forces. At thi s time , a s i n th e othe r Eas t Africa n countries , th e Tanzania n government had embarked on a policy of "stabilization" of the labor force. Th e "target worker," the worker who sought a fixedmoney income for a set period, was at the center of thi s policy. I t was believed tha t the target worker was

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Table 12-1 . Wages i n Curren t an d Rea l (1969 ) Terms, 1957-198 3 (Shillings per month)

Current Term s

Real Terms

Minimum Nonagricultura l Minimum Wage3 Wage Secto r Wage 1957 1963 1964 1965 1967 1968 1969 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

82 (Apr.) 150 (Jan.) it it H H

170 (July) 240 (July) it

340 (July) 380 (May) M ti •i it

480 (May) 600 (May) it H

810 (June) 810 (June) 1035 (June) 1230 (July)

100 210 224 302 347 359 381 416 432 686 659 672 708 710 967 1036 1105 1191 1060 [1400]

103 186 182 170 160 153 170 206 186 221 174 183 164 146 129 126 131 97 76 65 57 47

National Nonagricultural Consumer Sector Wage Price Index*3 125 261 272 343 370 366 381 356 335 445 339 324 305 273 329 271 230 192 135

80.0 80.5 82.6 88.0 93.8 98.1 100.0 116.7 128.9 154.1 194.3 207.6 231.8 260.0 293.0 382.0 480.0 619.5 787.0 1071.9 1428.8 1892.8

a. Deflatio n is based on effective minimum wage for the whole year. b. Nationa l Consumer Price Index is used rather than the Dar-es-Salaam wag e earners' index foi reasons explained in footnote 4. Sources: Jamal (1982) and ILO (1988), supplemented by ILO (1967 and 1975).

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harmful to both urban and rural sectors, as he would have no foothold in either sector an d n o incentiv e t o improv e hi s productivity . Th e transitor y an d migratory pattern of wage employment this engendered could only be broken by enablin g th e worke r t o ear n a sufficien t wag e i n th e cit y t o suppor t hi s family. Th e wage increase granted between 195 7 an d 196 4 wa s designed to curb circulatory migration . I t pushed up the purchasing power o f th e minimum wage from an ability to buy th e necessities fo r two adults to the ability to buy for a four-member family. 2 During th e secon d period , government' s wag e polic y existe d onl y i n a negative sense, as government did very littl e to influence th e wage structure, either b y changin g th e minimu m wag e o r b y legislatin g th e maximu m permissible wag e increase s i n th e private sector . I n the meantime—an d n o doubt because of th e lack of policy—trade union s managed to get huge wage awards. Th e averag e wag e increase d perceptibly , wit h th e nonagricultura l average earnings rising fro m Sh . 16 3 per month in 196 2 to Sh. 347 i n 1967 . These increase s wer e necessaril y confine d t o a smal l sectio n o f th e population—those represented by powerful trade unions who were concentrated in larger firms. Thus , the notion of "labo r aristocracy," comprising this small group of wage earners, arose. Professo r Turner, who was asked at this time to advise government on its wages policy, made the strong case that wage earners were gainin g a t th e expens e o f farmer s b y mean s o f a trad e squeeze . H e compared this t o the tendency fo r the primary producin g countries ' terms of trade to fall on the external market (ILO 1967). Turner recommende d a wag e freeze. Th e governmen t acquiesce d an d inaugurated a wage policy in 1967 . Prio r to this came the Arusha Declaration, which signaled a reordering of Tanzania' s economic structures . Th e ensuing nationalizations and expansion in the number of parastatal bodies increased the government's power over wages. Thus , by 196 8 the government controlled 53 percent of the wage employment and 57 percent of the wage bill in the country. This contro l increase d continuall y throughou t th e earl y 1970s , reachin g 6 5 percent and 70 percent respectively by 1976 . Th e government used this power to implemen t it s polic y o f wag e restraint . Th e averag e wag e increase d altogether by only 8 percent between 196 8 and 1971, the nonagricultural wage by 11. 6 percent, and the minimum wage by a mere 20 shillings.

2. I should make it clear that in looking a t African wage s my prejudice is for a family wage . Berg, in his EL S article , argued strongl y agains t it, viewing th e migratory syste m "a s the most efficient wa y to meet money needs in the village" (Berg 1966 : 147). H e also argued that the labor stabilization polic y wa s costly, requiring large socia l overhea d investments i n housing an d other facilities.

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But th e perio d o f wag e restrain t coul d no t surviv e th e grea t increas e i n inflation tha t started around 1972 . B y thi s time the purchasing power of th e minimum wage—fixed a t Sh. 17 0 since 1969—ha d fallen to Sh. 14 5 in terms of 196 9 prices. I n the face of this, the government abandoned its wage-restraint policy an d sough t t o compensate th e wag e earner s by raisin g th e minimu m wage. Compare d t o the single adjustmen t in the minimum wag e i n th e firs t nine years after its introduction, there were three increases between 197 2 and 1975, raising the minimum wage successively from Sh. 17 0 to Sh. 380. The government once again called in Professor Turner. Turne r gave a clean bill of healt h to the incomes policy tha t had been i n operation between 196 7 and 1971 , which of course he saw as "his" incomes policy; befor e the policy, 1960 to 1966, wages increased by around 20 percent per annum, whereas during the income s policy , 196 6 t o 1971 , the y increase d b y onl y 5. 5 percen t pe r annum (IL O 1975 : 210) . Befor e th e incomes policy , tota l employmen t declined a t 3. 4 percen t pe r annum , wherea s durin g th e income s policy , i t increased b y 3. 1 percen t pe r annum . A s fo r inflation , Turne r wrote , "Th e average annual rate of inflation in Tanzania, which had risendangerously in the three year s 196 4 t o 1967 , wa s approximatel y halve d i n th e fou r followin g years" (1975: 34). 3 However , everythin g wa s not rosy, as "th e gap between employees' and peasants' living standards (and probably that between urban and rural living standards) continued to widen between 196 7 and 1972, though at a very much slower rate than before the incomes policy" (1975: 39). Turner, we shoul d note, was writin g hi s secon d report toward th e end o f 1974. B y the n th e wage s policy , wit h th e raising o f th e minimum wag e i n 1972 and 1974, had been abandoned; Turner lamented this (1975:41-42). Th e problem fo r th e future , however , wa s wha t t o do abou t wage s give n th e "violent inflation " i n th e last few year s (show n t o be 5 3 percen t i n 197 3 t o 1974). Th e inflation tha t so disturbed Turner and that he tried to explain i n terms of the "wage-price spiral" (1975: 48) was actually caused by a statistical error during the changeover to the metric system.4 3. Th e figures were as follows (percen t per annum change in Dar-es-Salaam wage earners' retail price): up to and including 1963-1964 , 1. 3 percent ; 1964-196 5 to 1966-1967 , 4.6 percent; 1967 1968 to 1970-1971,2. 9 percent (ILO 1967 : 34). 4. Th e error exists in the Dar-es-Salaam wage earners' price index only . Th e full stor y can be found in ILO/JASPA (1982: Technical Paper 15). Aroun d this time Tanzania changed to the metric system an d prices starte d to be collecte d o n the basis o f kilogram . Thes e price s wer e entere d untreated in the Dar-es-Salaam wag e earners' index along with the previous per pound prices. Fo r example, the price of maizemeal was Sh. 0.40 per pound in December 197 3 and Sh. 1.0 0 per kg in December 1974. Thes e two prices were entered directly in the price index. O f such raw material are economic theories made and important policies recommended ! Not e that in Table 12- 1 w e have used the National Consumer Price Index as a deflator because of th e problems wit h the Dar-esSalaam wage earners' index.

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Turner recommended that future wage policy aim to establish a "viable level of minimum wages " (1975: 62), which he took to mean the 196 9 real wage plus 5 percent (1975 : 50). Onc e such a wage was attained, "th e broad aim should be to stabilize the real purchasing power of the legal minimum wage. This should be done by adding a cost of living allowance to th e minimum wage periodically" (1975 : 50). Al l this is rather curious, because the 196 9 wage increase was Turners main culprit in causing the widening rural-urban gap; now he was recommending a restoration o f th e real wag e to the 1969 level. A s fo r th e rural-urba n gap , i n a rathe r confusin g argumen t Turne r suggested that "changes in the general level of food prices must be decided at the same time, and through the same central machinery as the average increase in wages for each forthcoming year" (1975: 56). H e then said that "food prices and the prices of industrial goods and services should be kept in step" (1975: 56). On e might wonder if this would not encourage the wage-price spiral that had so concerned him. The minimum wage was raised soon after Turner' s mission, and its value returned in real terms to the 196 9 level. However , there then followed fiv e years of remarkable wage restraint during which the minimum wage lost around one-third of its purchasing power. Betwee n 198 0 and 1981 there was another period of "catch up," followed by wage restraint, followed by some halfhearted attempts to raise the minimum wage. Tanzani a by this time had indeed gone into the league of the hyperinflation countries , and the wage increases granted after th e mid 1980 s made hardly a dent in the erosion o f purchasing power. Altogether the value of the minimum wage fell by almost 80 percent between 1974 and 1986 , while the value of the nonagricultural-sector wag e fell by 70 percent within even a shorter period—1974 to 1983. What is remarkable about Tanzanian wage trends is the turnaround in wage earners' fortunes aroun d 1975 . A t precisely thi s tim e we see a reversal in agricultural prices , so that the wage-farm ga p began t o narrow sharpl y and finally went in favor of farmers. Agricultural Price s Farm prices of export crops have been controlled by the Tanzanian government for many years now. Ove r the years food crops also became subject to official control, wit h price s bein g se t fo r mos t importan t crops , suc h a s cereals , oilseeds, beans , an d sugar . Thi s lef t bananas , plantains , potatoes , swee t potatoes—fruits an d vegetables—and eggs as about the only agricultural items traded without state intervention. However , it should be pointed out that even

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where price s wer e officiall y set , a large par t o f th e produc e wa s markete d outside officia l channels . I n mos t case s a parallel marke t existe d becaus e marketing arrangements were lacking in particular localities, or because farmers could get a better price by supplying on the open markets. As a criterion for setting prices, the government tried to ensure that farmers got a "fair" return for their crops. I n the case of export crops, the department within the Ministry of Agriculture concerned with recommending agricultural prices, th e Marketin g Developmen t Burea u (MDB) , advocate d tha t farmer s should receive th e highest possible proportion of th e "expor t realization." I n between expor t realizatio n (o r expor t parity , on e migh t say ) an d wha t th e farmers actually receive is the export tax, over which the MDB has no control. Its pric e recommendation s ar e base d o n it s forecas t o f expor t price s an d accommodate themselves within the export tax structure.5 As far as food prices are concerned, the criterion of "fairness" to the farmer was tempere d by th e need for "fairness " to th e consumer. Th e balance wa s struck by bringing in other considerations, such as trends in farmers' and wage earners' real incomes, the need to provide farmers an incentive to increase food production, and trends in farmers' input costs. Unti l 1973-1974 , the desire to keep down urban food prices outweighed other considerations, and farm prices stagnated. Bu t the food crisis in that year, combined with the poor performance of export volumes, led to a drastic change in policy. Th e prices of food crops were increased significantly i n the 1974-1975 season, again in 1975-1976 , and to a smaller extent in 1976-1977 . I n the next two seasons the prices remained steady, but they were again raised in 1979-1980. Th e full time series is shown in Table 12-2 , where t o carry th e discussion forwar d w e hav e also provide d prices of maize and cotton as representative. The series divides into two periods, with the break at mid 1970. Unti l then government policy could be said to have favored wage earners, with minimum wage bein g raise d twice , altogethe r b y 6 0 percen t betwee n 1963-196 4 an d 1974. I n the meantime, foo d prices stagnated , increasing by just 1 6 percent. In 1974, food crop prices were raised significantly, by 36 percent, for the first time. The swin g t o th e farmer , discernibl e i n 1974-1975 , becam e a well established trend in the next five years as the minimum wage stagnated, while food cro p price s increase d b y 5 1 percen t (197 5 t o 1980) . Th e freez e o n

5. I t should be noted that since 198 0 no export taxes have been collected from export crops.

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Table 12-2 . Indices o f Cro p Price s an d Minimu m Wag e in Current Terms, 1963-198 8 (Selected Yearsf

Food Crop Expor Prices Price 1963 1969-70 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88

100 100 105 116 151 228 253 309 315 345 354 464 534 713 1055

[2100]

t Crop Maiz s Price

100 105 109 113 128 217 295 225 214 246 262 327 380 518 717

100 100 100 118 179 278 286 304 304 357 357 625 789 1429

e Cotto s Price

n Minimu m Mem o Item: b s Wag e NCPI

100 106 110 110 145 190 191 217 230 283 320

600 630

100 113 160 160 227 253 253 253 253 253 320 400 400 400 540 540 690 820

100.0 126.4 152.6 175.9 216.4 249.7 272.9 305.6 343.5 419.3 535.5 683.1 873.7 1154.9 1553.6 2063.5

a. Al l figures ar e in current terms because our objective is to compare trends. Deflatin g b y a common price index would give similar trends. b. Nationa l Consumer Price Index (NCPI) is averaged for corresponding years. Source: For all crop prices (including maize and cotton) between 1969-1970 and 1979-1980, Ellis (1982); 1963 fro m ILO/JASPA (1978: table 4.3); food crop and export crop prices for latter years from Marketing Development Bureau data as quoted in Ndulu (n.d.), and ILO (1988). Minimu m wages from Table 12-1.

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minimum wage, as we saw, resulted in a great erosion in its purchasing power. Partly i n compensation , a t th e star t o f th e 1980 s ther e wa s somewha t o f a swing bac k t o wag e earners , whic h prove d short-lived . Wage s i n nomina l terms doubled in seven years after 1980 , whereas food prices doubled within four years and doubled again by 1987-198 8 compare d to 1984-1985 . Maiz e prices show similar trends to food prices in general. These findings may come as somewhat of a surprise to those who know the justly renowne d wor k o f Fran k Ellis , whic h highlighte d th e catastrophi c declines in Tanzanian farmers' terms of trade in the 1970s . Altogether , Ellis's estimates show that between 1969-197 0 and 1979-1980 farmers' terms of trade (for all crops) fell by 36 percent (Ellis 1982 : 273). However , in line with our argument of a turnaround at mid 1970 , Ellis's figures confirm tha t the decline happened before 1974-1975 . Farmers ' terms actually improved (by 7.2 percent) in th e nex t five years , led b y a n increas e o f 15. 8 percen t i n rea l foo d cro p prices. Durin g th e same years, the purchasing power of th e minimum wag e fell b y almos t a quarter. Tw o points ar e worth underlining regarding Ellis' s analysis: (1 ) pricin g polic y change d i n favo r o f farmer s afte r 1975 , an d (2 ) farmers fared much better than wage earners. I t is also worth noting that food crop price s remaine d stron g beyon d th e perio d analyze d b y Ellis . Thus , between 1980-198 1 and 1984-1985 the figures given in Table 12-2 , along with the cost of living data in Table 12-1 , suggest that terms of trad e of food crops declined at the most by 9 percent, while real wages practically halved. A point of wider applicability should also be noted vis-a-vis Ellis's terms of trade analysis. Elli s calculate d farmers ' income term s of trad e an d found a decline o f 3 3 percent , fro m whic h h e tende d t o conclud e tha t farmers ' real incomes fell by 33 percent. Thi s is erroneous. Term s of trade figures merel y show what happened to the purchasing power of agricultural crops sold. I f all crops ar e sold , the n w e ma y translat e change s i n th e term s o f trad e t o corresponding change s i n rea l income . Bu t wher e crop s ar e use d fo r ow n consumption, term s o f trad e calculation s hav e n o direc t bearin g o n rea l income.6 I n Tanzania, retaine d crop s compris e one-hal f t o two-third s o f a farmer's incom e properl y counte d (incom e gaine d fro m cas h crop s plu s th e 6. Fo r example, if in two successive periods price terms of trade fell by 36 percent but farmers produced (and consumed) the same amount of produce, then while the so-called "income terms of trade" would indicat e a 36 percent decline , in rea l terms there woul d b e no decline a t all. Th e purchasing powe r o f crop s fell , bu t sinc e farmer s wer e no t sellin g crop s bu t consumin g the m themselves, their real income was unaffected by the market prices. Thes e points were first made by the author in ILO/JASPA's Basi c Needs Mission repor t (ILO/JASPA 1982 : Technical Paper 16 ) regarding Ellis's terms of trade analysis. I n a later study (1984), Ellis took full note of this as well as o f th e finding abou t th e fal l i n wages . Tha t subsistence-oriente d farmer s ar e immune fro m government price policies forms the core of Goran Hyden's study (1980).

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valuation place d o n own-consumption) . An y term s o f trad e declin e woul d translate into a decline of only one-third or one-half as much in total income. The full story from terms of trade analysis is that farmers' income terms of trade or real cash incomes declined by up to two-thirds between 1969-1970 and 1983-1984, whic h translates int o a drop of 2 5 t o 3 3 percent in total income. Compared to this, minimum wage declined by over 60 percent. I f we carried the story up to the present period, we would find that things got even worse for the wage earners compared to the farmers in the second half of the 1980s.

THE FARM-WAG E GA P No doubt after the above analysis we could dispense with showing what happened to the farm-wage gap. Quit e obviously it declined. Bu t it is still worth showing that the gap now stands in favor of farmers, and even at its height was much smaller than all the talk of "labor aristocracy" would have one believe. Clearly, the important thing in deriving the rural-urban gap is not its exact magnitude, but the order of magnitude : D o we believe tha t an urban famil y depending o n the minimum wag e is wors e off no w tha n a farm family, o r is the urban family considerabl y better off? Answerin g this question requires a perception o f th e two types o f familie s i n terms of thei r consumption levels . Let u s approac h th e matte r heuristicall y b y notin g th e nondiscretionar y expenditures a Tanzanian town family woul d have to incur simply to survive. The total o f thes e expenditure s woul d the n be compared t o th e urban wage. The nondiscretionar y expenditure s tha t hav e t o b e include d ar e food , transportation, housing, clothing, fuel, lighting , and water. Suc h calculations are normally referred to as a poverty datum line. Tabl e 12-3 shows an estimate of a poverty lin e fo r a town-base d famil y a t th e end o f 1985 , an d th e tota l comes t o Sh . 1865 . Compare d t o this , th e minimu m wag e wa s Sh . 810 . Food expenditure alone would over-exhaust the minimum wage by 64 percent Even th e averag e nonagricultural-secto r wag e (estimate d a t Sh . 140 0 pe r month) would not have sufficed t o buy the minimum food basket A s opposed to this, one would find that an average rural family provided at least 80 percent of it s food fro m it s own farm , and provisioned itsel f wit h housing, fuel , an d water. I f we value the farm family's ow n production at town prices, then we put a figure o f Sh . 133 0 a s its incom e i n 198 5 (Sh . 106 0 wort h of foo d an d Sh. 270 wort h of othe r items). O n top of this , rural families ha d around Sh. 150 in cash income. Thus , a Tanzanian farm famil y i n mid 198 0 was much better off than an urban family seeking to subsist on the minimum wage.

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Table 12-3 . Poverty Lin e for a n Urban Family, Decembe r 198 5 (Shillings per month)

Food 132 Maizemeal (75 percent) 95 Beans (15 percent) 17 Fats (5 percent) 13 Sugar (5 percent) 6

5 0 6 3 7

Nonfood 5 4 Clothing 15 Rent 15 Fuel and Water 12 Transport 12

0 0 0 0 0

Total 186

5

Memo Item s Minimum Wage (Sh . p.m.) 81 Nonagricultural-Sector Wage (Sh. p.m.) 140 Maizemeal Price (Sh. /kg) 13.7

0 0 5

Source: Estimates to provide a minimum consumption basket for a five-member family based on prices prevailing in Dar-es-Salaam i n December 1985 . I n the case of food, the basket is set to provide 2,200 calories per capita day, with the composition as indicated.

Picking u p the stor y o f "labo r aristocracy," i n 1974 , whe n th e minimu m wage wa s a t it s highes t leve l i n rea l terms , and , a s previousl y mentioned , government policies tended to favor the wage earner, an average food basket of the type described in Table 12- 3 would have cost around Sh. 17 0 per month— that is , minimu m wag e a t it s maximu m represente d th e abilit y t o bu y tw o basic food baskets. Addin g other nondiscretionary expenditures would exhaust the minimum wage . Compare d to this, a farm family produce d its own foo d (Sh. 17 0 per month) and had Sh. 40 wort h of cas h income . Obviously , on e should not push such figures too far, but at the order-of-magnitude levels , they illustrate tha t even a t the height of th e rural-urban gap there was not all that much to choose between farmers and wage earners in Tanzania.

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IMPLICATIONS FO R STRUCTURA L ADJUSTMEN T If by structural adjustment is meant restoring the price structure in favor of the rural areas, then that sort of adjustment had already occurred in Tanzania prior to 1984 , when Tanzani a finall y adopte d th e structura l adjustmen t progra m proposed by the IMF. Th e ILO had taken great pains to point this out in two reports (ILO/JASPA 1982 ; ILO 1988 [written in 1984]), advising government on th e pro s an d con s o f th e IM F remedies . Notwithstandin g that , th e government finallyacceded to IMF demands, not because it was convinced by the IMF's argument, but to receive the IMF stamp of approval, a requirement these days to achieve a resumption of aid from donors. The policy changes Tanzania had to accept accelerated the turnaround in the rural-urban gap. Tw o policies in particular were important in this: devaluation and remova l o f subsidie s o n maizemeal . Betwee n 198 3 an d 1986 , th e Tanzanian shillin g declined fro m 1 3 to the dollar to 63 to the dollar. Thi s decline enabled higher prices to be paid to farmers for export crops—the reason d'etre of the devaluation remedy in developing countries. Bu t devaluation also meant highe r price s fo r th e consumer s a s shillin g price s o f import s rose . These price increases contributed to the inflation i n Tanzania in the last few years (Tabl e 12-1) , exacerbating th e fal l i n rea l wages . Further , i n 1985 , Tanzania di d wha t a t on e tim e wa s though t unthinkabl e an d completel y removed the subsidy on maizemeal, the major stapl e of the urban population. The price shot up 450 percent, increasing from Sh . 2.5 per kilo to Sh. 13.75 per kilo, and the purchasing power of the minimum wage dropped from 8kg of maizemeal per day to 2kg. There is no doubt that as the adjustment progra m proceeds ther e will be further declines in the value of the minimum wage and further increases in food prices. T o what avail? Wha t do such huge shifts i n relative prices achieve? And what are their social and economic implications? Th e answers to these questions require answering a series of prior questions: Wha t is the rationale for structura l adjustmen t programs ? Ho w fa r doe s th e Tanzani a situatio n correspond to this? An d what is the expected outcome of structural programs compared to the actual?7 As w e ha d note d a t th e star t o f thi s paper , th e rational e fo r structura l adjustment program s in Africa i s the alleged existence of urban bias and the presumption that urban bias is wrong. Thi s is the model that certainly guided 7. I n keeping wit h the theme of th e paper, the analysis her e is confine d t o the distributiona l consequences o f adjustmen t programs . Fo r the pro s an d con s o f devaluation—usuall y a ke y component of adjustmen t packages—see Van Arkadie (1983); Green (1983); Singh (1986); Jamal (1986); and Loxley (1986a). Fro m a wider angle, see also Sharpley (1985) and Stewart (1986).

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the IMF, though it is quite evident that no particular analysis was made of the Tanzanian case to establish its relevance. I t was simply assumed that there was urban bias in Tanzania in the early 1980s , just as allegedly ther e was in most African countries . I n fact , th e Tanzania n situatio n a t thi s tim e wa s quit e different Wage s had been falling catastrophically , and food and export crop prices wer e rising sinc e a t least th e mid 1970s . I n other words, all tha t the structural adjustment remedy was supposed to accomplish had already happened. Turning no w t o th e las t question—th e expecte d outcom e o f structura l adjustment program s versu s th e actua l outcome—th e expecte d outcom e i s predicated on the massive shift s i n relative prices in favor of rural areas. I n consequence, agricultura l outpu t shoul d increas e an d migration slo w down . What has bee n th e actual outcome ? I t is to o soo n t o sa y anythin g definit e about output, although i t would be surprisin g i f i t did increase t o th e extent hoped for by the Fund and its supporters. Bu t given the oft-repeated point that in th e typica l Africa n econom y th e constrain t t o outpu t thes e day s i s no t prices, but by th e physical difficult y o f growin g an d marketing agricultura l crops, the lack of tools and fertilizers, and the breakdown of weighing scales, processing plants, and roads, increases in output are unlikely. As for migration, there is no evidence that it is slowing down. Rea l wages have been falling for at least a decade, so one would expect trends to manifest themselves. T o press the point, since in the last few years income differential s have gone in favor of th e rural areas, migration should have reversed itself i f orthodox theories are to be believed. Ther e is no sign of this, and the reason is quite simple: migrant s come to town for whatever cash income they can earn to supplement total family income. Thus , a migrant's decision i s not made in terms o f movin g a whol e family—i n whic h cas e comparison s o f expecte d income in rural and urban areas would be relevant—but in terms of moving one member of a settled family. Th e decision is based on the supplement to family income to be expected fro m migratin g t o town or staying o n the farm. Thi s decision stil l goes in favor of th e urban areas, more so because a migrant can expect to add cash to his family's income. The above discussion suggests that more and more we have to see African families as conglomerates that pursue diversified survival strategies. Thi s was always so, but the economic crisis has intensified thes e tendencies. A t least in the urba n areas , surviva l strategie s hav e give n ris e t o structure s tha t ar e fundamentally differen t fro m thos e that one assumed up to now. Al l familie s now straddl e rural and urban sectors, formal as well a s informal, and wage as well as nonwage. Onl y thus can we understand figures like those in Table 121. I f the wage has fallen to 20 percent of its level and can buy only a few days' requirement o f foo d fo r a n averag e family , wh y i s i t tha t w e d o no t se e

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increasing malnutritio n i n urba n areas? Why , wit h suc h a massive redistri bution of income to rural areas, has there been no social turmoil? Th e answer stems fro m th e fundamenta l transformation s tha t hav e occurre d i n Africa n economies in the last decade. That hard-won structural characteristic of African countries—a stable wageearning class—ha s disappeared , wit h familie s havin g t o resor t t o divers e strategies t o ensur e survival . Thre e particula r type s o f response s ca n b e discerned: (1 ) gro w foo d crop s i n urba n areas , (2 ) allo w informa l tradin g activities by family members , and (3) make trips back to rural areas to collect food from the family farm. 8 Eac h urban family ha s become more rural than before by increasing its ties to the rural areas and undertaking garden farming on househol d plots . Eac h normall y wage-earnin g famil y ha s become mor e "informal" as members have extended their activities into the informal sector. Thus, there has been a fusion o f sectors—rural/urban , formal/informal , wag e earner/farmer. Th e "sid e activities" that urban families no w undertak e quite likely contribut e th e bulk o f thei r total incom e an d explain wh y ther e i s n o obvious evidence of malnutrition in urban areas despite falling wages. The "conglomeration " o f Africa n urba n familie s thu s understoo d als o explains the lack of social unrest despite a massive redistribution of income in favor of the rural areas. I f urban family members have lost, those operating in the informal sector have gained. Hence , gains and losses stay within the same family. I f urban families thu s do not protest rising foo d prices , it is because the beneficiarie s ar e thei r ow n rura l kin . I f rura l extension s o f urba n households canno t hel p ou t wit h cash , the y ca n a t leas t b e cajole d int o materializing a debe (can ) or two of maize during the city folks' periodic visits to the family farm . Further , urban families d o not protest rising foo d price s because they themselves have become subsistence farmers. One point shoul d be noted , however : While i t i s tru e that urban familie s have not suffered as much as implied by wage statistics, there is no doubt they have suffered considerable losses in their nonfood consumption. Unfortunately , the structura l adjustmen t program s no w i n operatio n i n Afric a offe r th e prospect of more of the same because of their emphasis on devaluation to catch up with the real exchange rate. I n consequence, urban incomes will fall eve n further, and urban areas will suffer further deindustrialization. Tw o outcomes that will no t occur: labor markets will no t clear, and migration wil l not stop. If unemployment and migration were to be cured by falling wages, that should have happened a long time ago with the catastrophic fall in urban incomes.

8. Se e Jamal (1985) on the case of Uganda.

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CONCLUSION All African countries have at some time or other been classified a s urban bias economies, with urban wage earners posited as the main beneficiaries o f thi s bias. Tha t is still the operative model of African economies for most analysts. Indeed, the structural adjustment programs that aim to shift relativ e prices in favor o f th e agricultura l secto r ar e base d o n thi s perceptio n o f Africa n economies. We hav e show n wit h th e case o f Tanzani a that the objective situatio n o f most African countries is now totally different from that which existed even up to a few years ago. I n the decade after independence the notions of urban bias and labor aristocracy had perhaps some relevance. Th e famous—or infamous— rural-urban ga p ha s disappeared, a s has th e wage-earnin g clas s a s a distinc t entity. Economie s hav e become fused, with distinctions suc h as rural/urban, formal/informal, an d wage earners/farmers rendered increasingly redundant as each family has extended its outreach in the quest for basic survival. The central problem is that the structural adjustment programs now in force in Africa tak e scan t notice o f thes e ne w structura l characteristic s o f Africa n economies. Give n that urban wages have fallen and prices shifted in favor of rural areas, these structural characteristics actually resemble those envisaged by the structural adjustment programs. Ye t there is no evidence tha t two of th e more important objectives of structural adjustment programs have been attained in consequence, nor much hope that they will be attained in the future despite the likely furthe r declines in urban incomes. Unemploymen t has not fallen in response t o falling wage s and migration ha s not stopped—let alon e reversed itself—in response to the turnaround in the rural-urban gap. Th e only hope for African countrie s i s tha t th e thir d o f th e majo r objective s o f structura l adjustment programs—an increase in agricultural production—will be fulfille d as a result of the shift in prices in favor of th e rural areas. Th e signs thus far are not encouraging.

\ r\ FACIN G TH E REALITIE S 1 J O F TH E DEB T CRISI S Representative Bruce Morrison

It is educational to see how the debt issue has and has not been presented in the context o f Congres s an d the U.S. politica l system . M y experienc e wit h th e debt problem tell s a bit about the growth of—importance ma y be too strong a word—recognition withi n th e Congres s o f th e issue . I shal l the n examin e current actions that are being taken, both in terms of the proposed innovations in the trade legislation Congress passed and the debate over the General Capital Increase (GCI) for the World Bank. I was elected to Congress for the first time in 1982 . M y background is that of a lega l ai d lawyer . I a m no t a banker , no t a n economist—whic h wil l become evident, I suppose, as I proceed. I came to the Banking Committee not because i t deal s wit h Thir d Worl d deb t an d banks , bu t becaus e i t ha s a subcommittee on housing, which addresses th e critical problem o f housin g in the Unite d States . Th e Bankin g Committee' s firs t ite m o f busines s afte r I became a member was IMF replenishment, on which we held hearings in early 1983. Tha t process was enlightening. I t is important to step back and realize the extent to which we have all become victims of word games and have failed to come t o grips with th e real problems. W e have failed t o acknowledge th e problem o r conside r th e rang e o f solutions . Th e Bankin g Committe e wa s treated to presentations, primarily fro m commercia l banks, with the messag e This chapte r is a lighUy edite d versio n o f th e closing addres s delivere d a t the Firs t Annua l Conference o n North-Sout h Political-Economi c Polic y Issues , sponsore d b y th e Geonomic s Institute, Middlebury , Vermont , Apri l 30 , 1988 . N o effor t ha s bee n mad e t o concea l th e informality of the oral presentation.

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that w e wer e dealin g wit h a short-ter m liquidit y problem , no t a solvenc y problem or a fundamental dilemma. I t was argued that the solution was shortterm bridge financing and some economic reforms—structural adjustments , if you will—whic h woul d lea d t o a reemergence o f hig h rate s o f growt h an d voluntary lending. Thi s was, of course, in the midst of worldwide recession. Following suc h testimony wa s a period of recovery, with a relatively hig h rate of growth in the United States and moderate rates elsewhere in the world. It is importan t t o conside r whethe r th e rhetori c o f th e period wa s base d o n excessively optimisti c assumptions . A number of us , feeling perhap s that all was not as it seemed, were skeptica l an d suggested tw o lines o f questioning : How did we get into this circumstance in the first place, and do these numbers really work, can these countries really pay? The first round of answers to such questions was essentially a rejection of the question: None of your damn business. W e were lectured that our questions were impertinent , tha t w e di d no t understand , tha t w e ough t t o min d ou r business, whic h wa s merel y t o appropriat e th e necessar y funds . Th e IM F replenishment was a commitment the United States had made, we were told, a multilateral agreement being presented to Congress as a formality. Thi s view changed a bit over the course of debate when it became obvious that it was not a winnin g strateg y i n term s o f votes . Eventuall y th e administratio n wa s slightly more forthcoming an d assured us all would be okay if we just plowed ahead. I daresa y tha t I , a s a ne w membe r o f Congress , an d als o m y colleagues—including Chuc k Schume r from Ne w York , wh o was one of th e people asking a lot of questions—were novices; we clearly did not approach the issue with great expertise. The rejection of our questions also induced rejection of examining whether all the lending in the 1970s had made any sense in the first place—whether the commercial ban k lendin g bing e i n th e developin g worl d ha d eve r ha d a fundamentally soun d economic basis. Tha t was the second question for which we received no answer. Bu t I think those were and are the important questions, and they remain the questions we face now. I would suggest that the central problem, the one we must solve before w e come u p with Th e Solution , i s tha t w e ar e lying t o ourselve s (or , i f on e i s outside the system, being lied to). W e have lied to ourselves about the scope, severity, an d risk s o f th e problem . W e mus t recogniz e tha t ther e will b e losses, and we must address who will bear them, who will decide who will bear them, an d ho w the y wil l b e distribute d ove r time . Ther e ar e choices wit h respect to costs and burdens that are better or worse, depending on your point of view, choice s tha t involve publi c debate , no t the narrow interest s o f privat e banks or the private economy.

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The myth the Reagan administration propagates is that this is a matter to be resolved by a mechanism tha t is allegedly a marketplace but is not a marketplace; interests ar e alleged t o be privat e whe n the y ar e in fac t quit e public, which leave s th e publi c sector—Congres s i n particular—i n a relativel y noninfluential position , no t becaus e th e issue s ar e unimportan t t o ou r constituents, but because someon e decide d tha t the best way t o serv e certain interests at risk in the process was to pretend they were private matters not to be interfered wit h by Congress. Thi s i s the context in whic h th e debate has moved to the present time. The Banking Committe e wa s dragge d kicking an d screaming throug h th e IMF replenishment episode. I confess t o having sold my vote in exchange for a housing bill, as did most Democrats that year, which explains why there was any IM F approva l a t al l i n Congress . Subsequently , a numbe r o f u s wer e concerned about the issue and began to focus on it more actively, particularly Senator Bil l Bradley , who , mor e effectivel y tha n anyon e o n th e America n political scene, has defined to Americans the costs in terms of debts that could not be serviced . I think th e observation s h e mad e a fe w year s ag o ar e stil l critically importan t to recall, for they address ho w w e can solve the problem within a political context. One problem i s th e mismatch betwee n th e global economi c situatio n and the nation-state political processe s tha t must address th e problem. I n many ways, I feel schizophrenic . I f I am in a meeting at which a global perspective is take n and a very carefu l an d appropriate analysis o f th e problem fro m th e global perspective is presented, I am struck that there are no votes for solutions from this perspective. I t is difficult t o explain the global perspective i n terms that ar e helpfu l i n organizin g a domesti c politica l majorit y (referrin g t o members o f Congress , no t individua l voters) , whic h i s a problem I assume occurs in all industrialize d countries , as wel l a s developing countries , whos e perspective is not global, but nation-state. According to Senator Bradley, from a domestic standpoint the debt crisis is first and foremost a problem of banks with insured deposits in the United States that have significan t exposur e t o Third World loans . Ther e was a time, say 1982, when we did not realize the full implication s of the issue—for example, what insured deposits meant. I t had been a long time since many banks failed. Banks bega n t o fai l agai n i n 198 2 an d 1983 , bu t th e implication s ha d no t caught the public consciousness . Toda y i t means something t o say, "Insure d deposit bank s ar e i n trouble , o r a t risk , an d migh t fail. " Therefore , issu e number on e i s tha t th e taxpaye r stand s ultimatel y behin d th e bank s wit h exposure. Bank s have reduced their exposure since 1982 and are now better able to tak e a hit, fo r th e ratio of thes e loans t o capital i s lowe r than it was , and

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precautions hav e been take n against defaul t t o a significant degree . T o that extent, the problem is somewhat less severe now, but there is no question that there are banks, such as Manufacturers Hanover, that do not have the capital to withstand a reasonable scenario of default or moratorium from a number of the major countries. Relate d to exposure are financial securit y and stability. Th e problem i s no t just that the taxpaye r migh t not pay, but also tha t we canno t sustain collaps e b y ou r largest financial institutions withou t effect s ripplin g through the economy, which is clearly a legitimate concern. The secon d issu e relate s t o th e trad e bil l tha t Congres s passe d an d th e President vetoed. 1 Fro m 198 1 t o 1985 , the loss i n dollars in th e balance of trade to Latin America was greater than the loss in trade to Japan. A significant trade surplus, which has become a significant trade deficit, arose from structural adjustment. Thi s change in policy orientatio n i n Latin America resulted in a decline o f import s an d impor t substitutio n an d was no t the result o f expor t promotion. Ou r government has encouraged export promotion, which has had a very clear effect i n terms of the U.S. Treasury. Th e reason our debt proposal is in the trade bill, aside from the convenience of having a vehicle to bring the issue forward, is because Third World debt is probably the largest contributor to the U.S. trade deficit (secon d only to the domestic budget deficit). Althoug h Third World debt is far more important than other issues raised when the trade bill is discussed, other issues are more politically appealing. Yo u can scarcely find in any article of the bill provisions or effects o f the debt, even though as a dollar issue it is probably more important than the rest of the bill put together. The White House would not bother to veto the bill over the Third World debt issue, although it did threaten to at one point, and the President did cite our debt provision as one of just six provisions he objected to in his veto message. Third i s th e issu e o f politica l civility . Ther e i s i n Lati n Americ a a significant an d very promising growt h i n democratic regimes . Ther e is als o less toleranc e o f huma n right s abuse s an d growt h i n th e numbe r o f Lati n Americans who participate in determining their political and economic systems. I have always taken such measures to be significant foreign policy goals of the United States . Th e abilit y o f democrati c regime s t o functio n i s ver y muc h related t o thei r abilit y t o delive r i n term s o f economi c well-bein g fo r thei r populations. I f fledglin g democrati c regime s fai l t o deliver economically — especially i n Latin America, wit h it s lon g histor y o f militar y takeovers—w e reasonably canno t expect democracy to spread or flourish. Regime s trying to 1. Presiden t Reagan eventually signe d the trade bill on August 23, 1988 . Th e bill, as signed, contains the identical language with respect to Third World debt that was in the bill the President initially vetoed and which Representative Morrison discusses here.

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establish democrati c tradition s i n th e majo r countrie s o f Lati n Americ a are unlikely t o succeed withou t economic growth . Yo u can interpret it as just a defense agains t th e leftis t extreme , bu t I believe i t i s a defense agains t th e extremes on both sides, in the hope that the political system s will evolve int o truly open and successful economies, which is unlikely if they are threatened by the debt problem. I do not naively sa y tha t debt relief woul d produce dramatic growth, and democracy woul d the n b e eas y t o sustain . W e fac e difficul t challenge s n o matter what actions we take, but I think it is the difference betwee n som e and none in terms of chances. I f the problem is not alleviated, there is no chance of long-run politica l stability . I f som e pressur e i s diffused , the n ther e ar e reasonable prospects fo r the growth o f democracy , whic h wil l als o stimulat e other important elements of free activity in the economic sphere . Centra l to a solution, however, is determining how burdens will fal l and how choices wil l be made. When I was in Chile, I had an interesting conversation on human rightsand economics with a businessman who supported the Pinochet regime. Regardin g the problem o f human rights abuses, he said, " I will conced e tha t people may be tortured or imprisoned without charge; I know o f no one personally, but I will assum e tha t it doe s happen . Bu t th e on e thin g I want t o stres s i s tha t when action s ar e take n t o improv e th e situation , I do no t wan t to upse t th e economic model that we have here. Thi s government has the economics right." (No pu n intended. ) I aske d hi m wha t i t mean t t o hav e th e governmen t economic model "right." H e answered, "The rightbalance between public and private." I took a deep breath and asked, "Where is that written? Wher e is it written tha t w e kno w th e correc t balanc e o f thes e question s o f equit y an d efficiency and long-run versus short-run benefits?" My sense is that political scientists , economists, and all the rest of us have been debating those questions in every country around the world for at least a century, and yet he was saying, "Get it right." Withou t democratic processes in the countries involved, who will decid e ho w t o allocate the burdens of thes e problems? Withou t democratization there is no long-term credibility fo r U.S. policies; we canno t mobilize suppor t for policies i n th e United State s unles s there are democratic governments with legitimacy, and hard choices should be made in accordance with the preferences o f those who have to live with them. That sounds idealistic , bu t it seem s t o m e th e only wa y fo r developmen t t o function with real grass-roots support. The cost s born e b y developin g countrie s ar e importan t an d affec t U.S . resolve to generate a solution to the debt problem. Th e major reason there has been n o significan t breakthroug h o n th e deb t proble m i s th e polic y o f th e

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Reagan administration, which is the policy of Treasury Secretary James Baker. We wind up playing word games that affect reactions of the World Bank, the IMF, an d commercia l banks . Th e debat e i s ofte n downrigh t silly . I wil l recount a n exampl e o f thi s from hearings befor e ou r subcommittee . Davi d Mulford, th e Assistan t Secretar y t o Mr . Baker , testifie d befor e u s o n th e Mexican bon d plan, praising th e reductions i n th e stock o f deb t and interest service costs (before th e actual auction took place, of course). I asked, "Does that mean you are supportive of mechanisms that lead to debt relief?" H e said no. I then asked, "Won' t banks take losses not only when they buy this debt, but also, if they tendered their debt, when they mark down the value of what they tendered on their books?" Again , he said no, but that some would have a reduction in profits. I do not repeat this exchange to make fun of Mr. Mulford, although the temptation is great. I repeat it because this is the level to which we have sunk in the U.S. political process when discussing such issues; we are playing word games over issues that are extraordinarily important to the future of all debtor countries. And yet, th e preservation o f mytholog y seem s t o be centra l t o th e Baker policy, which is never to admit there is a significant problem of payment. I t is a "muddling-through" policy that never acknowledges that people are going to suffer losses . I think the most important step we can take is to break through that mythology , t o begi n recognizin g tha t losse s ar e there . I t i s criticall y important t o identif y th e real losses , whic h means , a t leas t fo r th e politica l process in the United States, the risk to the taxpayer, the loss of jobs affecte d by the trade imbalance, and the national security concerns prompted by political stability in Latin America. W e are talking about real concerns and real costs. Who within th e U.S. politica l proces s woul d say it is more important for the banks to get paid 10 0 cents on the dollar than for debt problems to be solved? In that context, it seems to me, virtually no one votes for the banks. That i s no t t o sa y thi s i s solel y a matte r o f ban k bailout ; rather , i t i s a matter of lettin g th e banks tak e thei r losses. I t is importan t t o examine th e origin of the problem, to return to the great boon in banking and development, the recycling of petrodollars, the Walter Wriston (with some help from Henry Kissinger) gif t t o th e world . Acceptin g th e notio n tha t commercia l ban k lending wa s th e magic wan d of developmen t di d no one a favor. I question whether commercial banks are the appropriate vehicle for development finance at all; I do no t thin k the y ar e equipped fo r it . The y mismatche d short-ter m lending to long-term needs, which was fine for trade, but not for development. Problems were inherent in the lending from the outset. In the course of gettin g from there to here, bankers made a lot of money . They tend not to remind us of the extraordinary amounts earned on these loans

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and restructuring fees. Althoug h profits hav e been whittled down and spreads are relatively small now, stockholders did not do badly either during the period of lending. I t is not a matter of taking revenge on the banks, but we need not weep fo r them ; the las t thin g w e nee d i s t o fee l sorr y fo r them . Som e U.S. political leaders have very much encouraged such sympathy. As an aside, I have never understood why the developed world thought it in its interest t o help OPEC finance its cartel prices o f oil , whic h i s essentiall y what the recycling of petrodollars involved. I t was deemed appropriate to allow OPEC to shift it s credit risk to U.S., European, and Japanese banks, a choice we did not have to make, one that in effect facilitate d th e raising of oil prices by OPEC. Publi c policy allowe d th e accumulation o f Third World debt such that commercial banks took risks, profits wer e made as a result of those risks, and the risks have now come home to roost. I think banks do recognize tha t losses mus t be sustained. The y ma y need help, certainly in regulatory terms, to make it easier, and there is interest from creditor country governments , includin g th e United States , in providing tha t help. Bu t it will tak e leadership. I t is a unilateral disarmament problem, one that wil l no t be solve d withou t politica l leadership , whic h take s u s bac k t o getting the executive branch of the government to admit that we need more than a "muddling-through " approach lik e th e failed Bake r Plan. Everyon e i n the world knows the Baker Plan does not hold the answer, everyone, that is, except Mr. Baker—and he too probably knows it, but just will not admit it. Someon e has to be clever enough to write a new Baker Plan that Mr. Baker can introduce to ge t himsel f of f th e hook , bu t I d o no t thin k tha t will happe n befor e th e election. Th e issue is what the next U.S. administration is willing and able to do, which brings us to two further issues: (1) what we did on the trade bill and what we hope to accomplish, and (2) wher e that leaves us with respect to the General Capital Increase. A littl e ove r a yea r ago , I file d a bil l (simila r bill s wer e file d b y Representative Joh n LaFalc e o f Ne w Yor k an d Senato r Pau l Sarbane s o f Maryland) proposin g U.S . negotiatio n wit h othe r OEC D countrie s fo r th e creation o f a multilatera l deb t facility . Th e ide a i s simpl e an d doe s no t originate with me or the other authors of the legislation, but with Peter Kenen. It can be structured in a variety of ways, but the facility fundamentally involve s creation of a new multilateral institutio n limite d to treating commercial debt. The official deb t is a different problem that requires a different solutio n (which the trade bill addresses). I t would be a public-sector, nonprofit institution that is problem-oriented, not a speculator looking to make an arbitrage profit The underlyin g philosoph y i s th e notio n tha t thi s i s a proble m wit h implications reaching far beyond the debtor-creditor relationship between th e

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banks and the countries. I t is a public-sector problem that needs a public-sector response. Th e function o f th e institution would be to buy the loans from the banks. Determinin g the price to be paid is a challenge yet to be resolved. As a benchmark, one has the current secondary market , though it is not a perfect guide. I think a solution ca n be found throug h negotiating th e price. The purpos e i s t o bu y th e loan s a t a market-drive n discoun t pric e an d i n exchange giv e th e bank s cas h o r a cas h equivalen t throug h th e us e o f a n instrument that can solve som e of th e bank's regulatory problems, something that can be written down over time so that losses can be absorbed slowly. Th e instrument would have to be such that it could be sold at any time in a market at par to get liquidity, because that is what the banks need. Bank s could exit with reduced losses, and taxpayers will absorb part of those losses, because the government wil l ge t les s ta x revenu e fro m bank s tha t have reduce d profits . That i s a taxpaye r bailout , accordin g t o Baker , an d constitute d hi s majo r criticism o f th e idea . O f cours e wheneve r th e banks tak e thes e losses , an d surely they will, th e taxpayer must inevitably absor b part of th e loss throug h reduced taxes paid to the government A major issue is whether banks will voluntaril y participate. Tha t depends on the attractiveness of the regulatory relief compared to what would happen if they held their debt, and the extent to which banks that do not participate are forced to mark down these loans without getting the regulatory relief. Ther e is an appropriate and perhaps escalating collection of carrots and sticks to use to induce participation. The secon d purpos e o f th e institutio n i s t o provid e th e benefi t o f th e discount to developing countries by passing it on in whatever form of reissued security the institution chooses. Beyon d that, the purpose is also to provide a mechanism for restructuring the obligation in a way that is more appropriate to the long-term developmen t strategie s of th e country. Peopl e tal k a lot about "new money, " bu t if ne w mone y mean s commercia l ban k lending , the y ar e talking about something that does not exist, and perhaps never will exist. Ne w money i n th e form o f les s mone y t o pay ou t ever y yea r is just a s good—i n fact, it is better because, in addition to being the same amount, you never have to pay it back. A reduction of $5 billion or $3 billion or even $1 billion a year in debt service payments is better than an equivalent loan of new money of the same amount. So , it seems to me that any new money, except for lending by the multilatera l institutions , woul d hav e t o com e fro m suc h a n institution . There is a lot of flexibility her e if one wants to use it, a variety of ways to use the restructuring process as an incentive for countries to reevaluate development strategies. Ther e ar e also options tha t Rudiger Dornbusc h (Chapte r 14 ) and

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Osvaldo Sunkel (Chapter 15) suggest that could be incorporated, since they are consistent with the intent of the debt strategy in the trade bill. This multilatera l institutio n doe s hav e a conditionally role . Deb t relie f alone wil l no t solve th e problem. Countrie s hav e to make productive us e of the resources that are saved by not having t o make interest payments or they will not grow. Th e difference between the conditionality, if one wants to call it that, involved in this debt facility and what we have had up to date is that it has a longer-ter m restructurin g developmen t focu s an d is positive a s opposed t o negative; it involves relief of a burden and is directing that relief in investmentoriented ways. Tha t has a lot more positive possibilities tha n the policy tha t has characterized the structural adjustment process to date, which was squeezing and then squeezing a little harder to see if you could send out more dollars to your creditors. How does one pay for such an endeavor? Thi s depends exactly on who holds the paper that will be sold, the extent to which the new multilateral serves as a brokerage function, and the extent to which it serves as an institution that buys and holds. A t the extreme, I point out that we can capitalize the World Bank an additional $7 5 billion , whic h ha s bee n decide d an d achieve d already , wit h relatively modes t paid-in capital . Thi s leve l o f financia l commitmen t coul d tackle the problems of even the most troubled countries. Th e 25 percent of the GCI allocated for structura l adjustment lending woul d go a long wa y towar d establishing th e new facility , provide d th e facility passe s off th e restructured obligations to a secondary market and does not try to hold all the debt by itself. Thus, i t i s no t a problem tha t requires taxpayer s o f develope d countrie s t o contribute more than they currently do. What does thi s all mea n wit h regard to th e World Bank an d the Genera l Capital Increase? Withi n the trade bill there is a provision calling for a study to address the problem of official debt . Th e study is based on the fundamental proposition of a distribution of a new issue of Special Drawing Rights (SDRs) of th e IMF , whic h woul d b e allocate d base d o n variou s officia l debtors ' indebtedness an d inabilit y t o pay. I t targets thos e countrie s wit h ver y hig h levels o f officia l deb t compare d t o thei r GNPs , an d i t i s intende d t o b e a mechanism by which the SDRs can be used as a vehicle for debt repayment I t is essentially a debt cancellation or debt forgiveness scheme, presented in a way that does not undermine the official rhetori c with respect to whether or not such forgiveness is granted. Th e study has not generated much controversy because there is a fairly widespread belief that significant restructuring of official debt , especially in Africa, is absolutely necessary. Th e problem has not drawn much attention in the U.S. political context because it addresses the African problem rather than the Latin American problem, and the U.S. government i s far more

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focused o n th e latter . A growin g grou p withi n th e U.S. Congres s see s th e problem of official deb t in Africa t o be as important as commercial debt , but the tw o problem s nee d t o b e pursue d o n differen t track s becaus e eac h ha s different politica l constituencie s an d uniqu e problems . Fo r example , ho w commercial debt and the fight with banks will be handled is a significant factor that is not relevant to the official debt . The Genera l Capita l Increas e i s th e nex t ste p afte r havin g th e trad e bil l passed. Th e facilit y tha t I described wa s lai d ou t i n th e trad e bill, an d the Secretary o f th e Treasury was directed to enter into discussions wit h OECD countries abou t it. However , a s a result of a compromise i n th e Senate , the Secretary wa s given the opportunity t o make a finding. Wer e he to find that the proposa l depreciate d th e debt , h e coul d declin e t o ente r int o thos e discussions. I assume that Secretary Baker had the letter already written, and we would have received it shortly thereafter had the President signed the trade bill.2 But it was also a recurring obligation; the next administration would be required to consider the trade bill again within twelve months after it originally passed. It would hav e move d th e process forwar d t o put i t o n th e des k o f th e nex t Secretary of the Treasury. W e are back to the GCI. Whether or not the facility proposal moves forward, and it may not because of the "escape hatch" that may be utilized by the Treasury Secretary. I hope the idea of debt relief will be incorporated into the legislation authorizing the GCI. The General Capital Increase is a significant ne w commitment being asked of developing countries for Third World development, and it is rather bizarre that the request is proceeding as if there were no questions about what ought to be done. Th e approac h i s simila r t o th e IM F increas e i n 1983 , wit h official s saying, "Yes, we are concerned about debt, and yes, there are these questions of development, bu t we nee d thi s money." I t is no t just th e Jim Bakers o r the Barber Conable s o f th e worl d wh o deserv e th e blam e fo r this ; developin g countries have also contributed to the problem. The governments of developin g countrie s hav e treated the GCI as needed resources and have not used it as a vehicle fo r debate. I t is as if they believe they will not get the money unless they are respectful an d do not make a fuss. A fuss should be made about how the money will be used, to what extent the capital increas e i s relate d t o an y relie f fro m th e deb t problem, an d t o wha t extent the funds ar e going t o be used in the structural adjustment process (2 5 percent of th e GCI is slate d fo r structura l adjustmen t lending) . Th e lack o f 2. A t the time of publication, the trade bill had been signed into law and Secretary Baker had left the administration . H e wa s t o b e succeede d b y forme r Senato r Nicholas Brady , t o who m th e mandate to initiate multilateral discussion to create a debt facility now applies.

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discourse i s unfortunate ; peopl e wan t thes e issue s t o b e debate d i n a constructive way. Th e GCI should not be allowed to pass on the notion that it is necessary and therefore cannot be held up. Why is this a legitimate debate? First , World Bank and regional development bank resources ar e being laundere d to pay current interest. Balanc e o f payments lendin g i s really deb t finance, and it extends t o project lendin g a s well. Fast-disbursin g project lending is simply more money to be paid back to the banks, and so there is no question—and no question in the figures—thatthe World Bank and other multilateral institutions are taking up an increasing share of the burden, which amounts to a taxpayer bailout. Th e taxpayer bailout has the multilatera l developmen t bank s pic k u p th e slac k fro m th e commercia l banks and pay th e mone y back , i n effect turnin g a commercial deb t int o an official debt . Th e situation is similar to the first round of the debt crisis (19821983), when private obligations o f industrie s withi n countries wer e nationalized as a result of strong-arm tactics by banks.3 In practice, the Third World debt is being socialized when the World Bank and the Inter-American Developmen t Ban k pick u p these obligations , whic h raises th e issu e o f whethe r or not w e ar e going t o bail ou t th e banks. Tha t debate ough t t o b e carrie d o n wit h respec t t o th e Genera l Capita l Increas e because we need a debt strategy not just a GCI. Th e World Bank, without any legislation in Congress, is certainly in a position to devise a debt strategy, but it has yet to do so. There i s anothe r reaso n wh y thi s i s a legitimat e debat e an d wh y a deb t strategy i s necessar y befor e $7 5 billio n i n ne w capita l i s committe d t o th e World Bank. Wha t about the World Bank's credit standing? Wha t about its ability t o collec t it s debts ? Suc h question s ar e rarel y discussed , a s i f th e seniority o f officia l deb t implies tha t somehow i t wil l alway s b e paid . Th e African cas e i s a prime example tha t this is no t true. I f thi s problem i s no t addressed at some point, the World Bank will sto p being paid and will fac e a deterioration of its loan portfolio. W e should not throw $75 billion more into the ring unless we have a plan to avoid deterioration of the World Bank's credit standing. Onc e again, the taxpayers of developed countries have a legitimate interest in asking for a realistic debt strategy. The interests of LDCs and taxpayers in the developed countries overlap on this point. I t is a somewhat dangerous road to walk, because it stirs up antiforeign feeling s an d opposition t o appropriations o f an y kind fo r th e World Bank or other multilateral institutions. O n the other hand, debate over the GCI is a vehicle through which one could put pressure on those who want to see it 3. Se e the discussion of this point in Chapter 3 by Weeks.

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enacted—banks an d develope d worl d governments . W e nee d meaningfu l political discussio n o r perhaps even political confrontation . Ther e is alway s the possibility o f th e major debtors refusing t o cooperate, which would forc e confrontation an d debate . However , ther e i s ver y littl e evidenc e o f tha t occurring. There is another possibility: Use such debates about World Bank funding as a vehicl e t o forc e th e issue . Thi s i s a real politica l opportunity , a n opportunity we must seize, for it will no t come again soon. Th e GCI is essentiall y a request for time, five or six years during which the World Bank can continue muddling through. Th e debt collapse may come before then , the moratorium may come before then, the concerted action may come before then. W e should act now . I hope peopl e wil l se e th e debat e ove r th e GC I no t a s a terribl y dangerous attac k o n th e Worl d Bank , bu t as a n opportunity t o put politica l pressure on those who could virtually overnight change the terms of the debate. I shall put my energy ove r the next few month s into that effort, an d we shall see what happens, if I have any allies. I hope those concerned about the issue, those eager for new terms of the debate, will support this effort.

14

FROM ADJUSTMEN T WITH RECESSIO N T O ADJUSTMENT WIT H GROWTH Rudiger Dornbusch

Where does the debt problem stand today, and how does structural adjustment fit into it? I consider these questions i n two ways. First , I review th e belief i n 1982 about the debt problem, that it would go away by itself. Ho w have views changed now that we have reached 1988 and know the debt problem is alive and well? Second , what are the good stories one might tell today, and why are they not really right? I then will addres s how the "generic " solution woul d work , focusing specifically o n a cure for Mexico. I conclude that recycling of interest payments wit h massiv e structura l adjustmen t i s probabl y th e bes t busines s proposition on the debt fronttoday. Why was the debt problem of 198 2 different from that of the 1930s ? Wh y did w e believ e w e coul d solv e th e crisi s i n 198 2 whe n th e problems o f th e 1930s had resulted in a major worldwide debt crisis, with countries going into moratoria and suspending debt payments for ten to fifteen years ? W e can return to IMF literature to uncover the issues that were on people's minds and lips in

This chapter is a lightly edite d version o f th e keynote speec h delivere d a t the Firs t Annual Conference o n North-Sout h Political-Economi c Polic y Issues , sponsore d b y th e Geonomic s Institute, Middlebury , Vermont , Apri l 28 , 1988 . N o effor t ha s bee n mad e t o concea l th e informality of the oral presentation.

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1982. W e must consider the following commonly held beliefs to determine the ways in which they were wrong. 1. Th e world economy wa s in an unusually poo r situatio n fro m th e point of view of debt service. 2. Th e debto r countrie s wer e extraordinaril y mismanaged , an d just shapin g them up would do much to put them back into a position of debt service. 3. I f on e di d no t collaborate wit h th e syste m o f adjustmen t an d rolled-ove r debts, then the return to voluntary lendin g somewher e down th e road was quite inconceivable.

THE WORL D ECONOM Y In August 1982 , when Mexico went into moratorium, the world economy was quite obviously in the worst possible shape for debtor countries. Interes t rates had reached 18 percent for federal funds, the highest level in recorded history— and thos e wer e real interes t rates . An y debto r countr y tha t ha d interes t payments geare d t o short-ru n interes t rate s inevitabl y ha d a skyrocketing — doubling, tripling—o f interes t payment s i n dollars . A t th e sam e time , th e world recession , th e wors t sinc e th e 1930s , mean t tha t expor t deman d fo r manufactures fro m developin g countrie s ha d declined, an d the real prices o f commodities, chie f export s fo r man y o f th e debto r countries , ha d falle n dramatically. Debto r countries were squeezed between th e sharp increase in interest payments an d the large decline i n export earnings available t o make those payments. Inevitably , the money was not there, and Mexico was the first to announce a moratorium. If you examine the history of the Mexican moratorium, your hair will stand on end. Th e moratorium was on and off for three months, and every time Silva Herzog wa s about to board a plane to Washington, someon e woul d come up with $10 0 million , the y woul d cance l th e plane , an d the n star t th e whol e process ove r a mont h later . I n an y event , Mexic o di d g o int o moratoriu m during this significant deterioration of the world economy. From the 1982 perspective, it was easy to say the situation had to improve: record-high interes t rate s coul d onl y com e down , an d record-low (sinc e th e 1930s) commodit y price s could onl y g o up . I n fact, commodit y price s wer e certain to increase because the y are highly cyclical , declining sharpl y i n real terms during a recession and recovering very sharply when demand in the world economy pick s u p again. Ever y recessio n i s followed b y a recovery, whic h means growt h i n deman d fo r manufacture d exports , and , mor e importantly ,

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rising rea l price s o f commodities , resultin g i n risin g expor t earning s wit h which t o pay th e interest. Th e world economy, then , had a very goo d story : The situation was so bad, it inevitably had to get better. With regard to debtor countries, there had been exemplary mismanagement. If you made a list of all the things you should not do as an economist, all had been done. I n Argentina, th e real exchange rate had been overvalue d b y 5 0 percent, almos t a s muc h a s w e hav e experience d unde r th e Reagan admini stration. Capita l flight totale d $30 billion; the central bank borrowed in New York an d gave th e mone y t o locals , wh o wer e takin g i t back t o Miami . I n Mexico, the story was very much the same. I n the middle of a large increase in revenues prompted by world oil price increases, the Mexican government ran a current account deficit that exceeded the increase in oil revenues by enough to produce a deb t crisis . Ever y debto r countr y ha d a stor y o f exchang e overvaluation, capita l flight , excessiv e consume r good s imports , an d larg e budget deficits, whic h exacerbated th e difficulties. Debtor s had a wonderfu l time becaus e exchang e rat e freeze s wer e use d t o sto p inflation , an d rea l appreciation offered a standard of living people were not earning but financing by borrowing abroad. With hindsight, al l o f thi s was quite apparent in 1982 . I t was quite clear that if debtor countries got their acts together, then debt service would be much easier, exchange rates would be more realistic, and, as a result, export earnings would increase , an d overl y larg e import s an d budge t deficit s woul d b e contracted, thus reducing financial instability . Th e list of all th e good things that could be accomplished was endless, and included cutting the inflated public sectors, wher e government s ha d entere d int o s o man y kind s o f productiv e activities tha t th e Brazilia n governmen t eve n owne d perfum e parlor s an d motels. I n short , th e 198 2 story—adjustmen t i n debto r countries—implie d moving them into a better position for debt service. The thir d argument , ver y persuasive , i s tha t an y debto r countr y face d a choice: It could collaborate with the banks, the IMF, and the U.S. Treasury in keeping its debts current, borrowing some of the interest owed, or it could walk out. Nobod y actuall y sai d you could walk out, but everybody said , "Imagine what would happe n if yo u walked out." Anyon e wh o walks out offends th e world capital market and thus would have a very hard time coming back. Tw o or three years later, everyone woul d remember the country tha t did not even discuss servicing its debt, that suspended debt service entirely. Suc h countries could not attract new lending. Developin g countries need external resources to finance development, resource s tha t supplemen t domesti c savin g t o financ e high rate s o f investment , on e o f th e basic source s o f growth . I f on e walk s away fro m th e world capital market , closing tha t source of financing , on e i s

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condemned to much poorer performance; the long-run consequences for external financing woul d be very negative. Because of the three persuasive arguments, all the debtor countries stayed in the game and entered into the process of rescheduling that now has become so familiar. Ever y year , on e goe s t o Washington , stop s a t th e IMF , get s a n adjustment program, goes across the street, gets a structural adjustment loan, stops a t the Treasury, get s th e blessing, take s th e shuttl e t o New York , an d talks t o the banks about th e fac t tha t one quarte r of th e money ha s to com e from the m (the other quarter comes from the IMF and the World Bank, and the other half has to be earned with trad e surplus and good conditionally). Th e process has been underway for the past five years. On e can now question if we have in fact observed what was believed in 1982. 1. Ha s ther e bee n th e anticipate d retur n t o voluntar y lending , wit h bank s calling Brazil and Mexico saying , "W e have not made a loan to you for a long time; could we come over and discuss one of those good loans we used to make in the 1970s?" 2. Ha s streamlinin g policie s i n debto r countries , t o th e exten t tha t i t ha s happened, i n fac t mad e i t muc h easie r t o servic e thes e debts , an d has i t enhanced financialstability, as was believed in 1982? 3. Ha s th e worl d econom y don e it s par t throug h stron g growth , declinin g interest rates, and a recovery of real commodity prices? The fact is that none of these three has happened, and as a result the debtor countries today look worse than they did in 1982. Deb t ratios today are higher than they were in 1982 . I n 1982, people said, "After five years of adjustment, you will be reducing your debt ratios because you will be reducing your interest payments an d your output wil l b e growing ; deb t ratios wil l b e lower. " Bu t today debt ratios are much higher than in 198 2 on any conceivable criterion . With regard to financial stability, inflation i s much higher today than in 198 2 in virtually al l debto r countries; in fact , w e ar e seeing th e reemergence o f a long-extinct species : hyperinflation . Althoug h hyperinflatio n ha d no t bee n seen for forty years , it has reemerged in Latin America as a byproduct of the debt crisis. I f we loo k a t per capita income growth , the 198 2 argument wa s that debt servic e wa s no t inconsisten t wit h moderat e progress i n th e debto r countries (o n the contrary, some said) . I n truth, per capita income has fallen sharply, and, if one excepts Brazil, the capital income in Latin America is 1 0 percent lower than it was in 1980. Thus, o n an y o f a numbe r o f criteria , debto r countrie s hav e no t don e s o well: the y ar e poorer debtor s toda y tha n in 1982 ; voluntary lendin g i s mor e

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remote tha n it wa s even i n 1982 ; and the worl d economy , whil e i t has been basically okay, has not made debt service much easier. I want to address each of these points because it is important to look ahead and consider whether any of the three is likely to change. The world economy did everything that was promised when we look at GNP growth o f industrialize d countries . Th e 198 2 expectatio n wa s tha t growt h would average 2.5 to 3 percent over the next five years. I n fact, output growth has been mor e than 3 percent, mor e than the IMF forecast i n 1982 . O n that basis, debtor countries have experienced large r growth in their manufactured exports and in fact have expected to experience real commodity price increases. The latte r ha s no t happened ; rea l commodit y prices , unti l lat e las t year , continued t o fal l yea r after year , until the y reached th e 1930 s leve l i n 1987 . That i s a particularl y importan t facto r fo r thos e countrie s wit h a heav y concentration i n export s o f primar y commodities . Eve n thoug h th e worl d economy wa s recovering fo r those countries—the Philippines, Peru, Bolivia, and those in Central America—export revenues declined, and subsequendy their ability to service debts became precarious. Th e outlook deteriorated for those countries after 1982 . Eve n today, though we hav e had some increas e in real commodity prices over the last year, it has been so moderate that the levels are still below 1982 . The third element, real interest rates coming down from the very high levels of th e U.S. monetar y contraction an d inflation-fighting, ha s in fact occurred . But rates did not decline as much as was anticipated in 1982 . Th e 198 2 story was that inflation-fighting inevitabl y would succeed, and interest rates by now would fall t o 1 or 2 percent. Althoug h inflation-fightin g ha s succeeded , real interest rates have averaged more than 4 percent since 1982, and that more-than4 percen t is far higher than the average of the last sixty years. Nobod y coul d guess in 198 2 how high real rates would continue to be; even today there is a real chance they will start going up again. So, the world economy did not quite do its thing, particularly on the interest rate side, which of course is central for debt service. No r did it perform wit h regard t o commodit y prices , whic h ar e centra l fo r a larg e numbe r o f smal l countries and for those with low per capita income levels. Beyon d that, it is a special story . I f you talk about oil, Mexico in 198 6 experienced a 50 percent decline in oil prices; but on the other side is Brazil, the importer of oil, which has th e advantag e o f s o larg e a declin e i n oi l prices . Th e onl y systemati c factors we can retain are interest rates, nonoil commodity prices, and growth in the world economy.

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POLICY ADJUSTMEN T The second element of the 198 2 list was policy adjustment—shaping u p the debtor countries to put them into a better position of debt service. Wha t went wrong? Th e 1982 story was very plausible: there were large budget deficits, overvalued exchange rates, and an excessively large public sector, all of which cried out for shaping up. Th e expectation was that if you shaped up, financial stability woul d follow, abilit y t o service debts by exports would be greater, and, with the public sector reduced, more efficient industr y would mean better use o f resources . I n short , everythin g shoul d loo k muc h better . I n fact , everything looks much, much worse. Fo r all of Latin America, growth rates are just about the opposite of what they were over the last thirty years. I f for per capita they were plus three, now they are minus three. I f for inflation they were twenty, now they are 100. In retrospect, nobody should have said that adjustment wa s such a joyful activity. I f we take a drunkard and say, "Good news: We are going to sober you up," nobody would expect him to report for a job at Citibank in a clean shirt the next morning. Soberin g up is a very hard exercise, made more difficul t because rather than having external resources to assist the adjustment process, debt service meant that resources were going out, putting extra strain on the adjustment Th e extra strain was felt in two areas in particular. First , to gain external competitiveness and have an increased level of exports, countries had to have larg e rea l depreciation—i n fact , al l th e debto r countrie s ha d rea l depreciation o n th e orde r o f 4 0 o r 5 0 percent. T o hav e a n effectiv e rea l depreciation, one must cut the real wage. Sellin g more abroad means people are willing to work for less. Rea l depreciation is not something mystic, it is essentially puttin g domesti c labo r o n sale , whic h ha s tw o effects : (1 ) th e reduction in domestic costs in terms of dollars means increased export potential, increased export volume growth, and (2) the problem of people who earn lower real wages spending less on domestic goods and services when the purchasing power of labor is cut. A slowdown or recession o f domestic activity is the inevitable counterpar t o f th e larg e an d rapi d real-wag e cuttin g tha t wa s experienced there. The second strain from sobering up results from the attempt to cut wages in a situation of indexation and even more from th e budget consequences of the turnaround on debt service. Unti l 1982 , debtor countries did not experience much inflation becaus e they did not print money to financebudget deficits— they borrowed i n New York . O n th e import side , borrowing provide d th e resources, and the home economy was never touched by recession; everyone felt better. Afte r 1982 , the resources to service the debts had to be found. Ther e are

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three ways of doing that: (1) raise taxes, which was as unpopular as it is here, (2) cut current expenditures, which was as impossible as it is here, and (3) cut investment spending in the public sector, which was done on a massive scale . Latin American debts were basically serviced by not investing. Government s would cancel investmen t projects an d use the resources t o make the external payments. T o turn the pesos into dollars, a large depreciation would follow. Another source of financin g wa s printing money. Startin g i n 1982 , there was no more external financing of budgets; financingshifted to the home scene. Countries with domestic money markets , like Brazil, started issuing domesti c debt to get the currency with which to service the external debt. Th e growth in external debt was replaced by a mushrooming of domestic debt. Countrie s that did no t hav e a capita l market , lik e Argentin a an d t o som e exten t Mexico , simply issued money, and wound up with even larger inflation. Ho w extreme was the inflation experience? Bolivi a at one end went to 5000 percent inflation per year and only stopped the hyperinflation by stopping external debt service. The conditions o f th e government finance changed, as they no longer had to print money to pay the interest. Argentin a only went to 3000 percent inflation at the peak, but is almost back to that level thi s year. Brazi l made it to a high of 1200 , which it may repeat. Mexic o had an exceptionally high inflation rate, 18 percen t i n Decembe r alone . Inflatio n i s no t th e resul t o f domesti c mismanagement, where governments suddenly have been seized to do a lot of spending, but rather occurs because those governments used to borrow and now must pay interest. The y do not have the taxes with which to pay, they do not have the option of expenditure cuts, so what does not come out of investmen t cuts basically comes out of printed money, or the "inflation tax." Printing money ha s made Latin America financially ver y unstable and has aggravated th e problem o f deb t service by bringing abou t capital flight . Fo r every dolla r of interes t that is being paid, there is fift y cent s o f capita l fligh t because o f th e financial instabilit y i t induces . Ho w ca n a countr y sustai n capital flight ? Onl y by havin g a large current account surplus , which mean s either that people d o not consume o r do not invest, the government doe s not invest, privat e firm s tak e thei r mone y abroa d an d do no t invest , an d th e workers' real wage is cut to generate the trade surpluses to earn the dollars to finance th e capita l flight . Tha t i s essentiall y wha t Lati n Americ a an d th e Philippines have been experiencing. Ove r the last five years, in an attempt to cope with the debt problem throug h domestic adjustment , government s hav e muddled throug h a process the y expected i n five t o seve n year s would hav e basically disappeared , with countries back t o borrowing normally , somewha t more washed and well-behaved, somewha t chastene d by th e experience, but

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basically back to the 1970s. Today , we are further awa y from th e 1970s than ever, and one must ask what comes next. One could say , "Well, let's star t all over again wit h the world economy. Can we tell a good story this time?" W e cannot tell a good story. Th e expectation is for a slowdown in the world economy. Th e U.S. budget is going to be cut with little offset throug h European expansion; Japan is helping with its growth, but not enough to make up for Europe's lack of growth. Th e restraint on world growt h wil l come inevitably i n the United States . A big, strong, sustained worl d growt h o f th e measur e on e coul d predic t i n 198 2 is ver y unlikely today. I am not saying we will have another Great Depression, but 2.5 percent growth per year on average is probably optimistic; there will not be a world boom that will make this debt problem go away. REAL COMMODIT Y PRICE S We kno w toda y tha t fo r structura l reason s rea l commodit y price s ar e permanently lower than they were in the 1960 s and 1970s , partly because of high real interest rates, partly because to earn the foreign exchange with which to service debts, all debtor countries had large real depreciation, which made them muc h large r exporter s o f al l thei r goods , competitively lowerin g rea l commodity prices. Th e low real price of commodities is thus a byproduct of the attempt to service debts. W e also have agricultural policies in the United States and Europe that lower the real prices of agricultural commodities. Ther e will be some increase inevitably on the commodity side, but one cannot expect too much. In 1973, we had a wonderful year of 5 percent interest rates and 12 percent inflation, which is what every debtor wants: the debts melt away because the real interest rates are negative. Ther e is very little expectation of that in the future, and the opposite is in fact expected. Th e Federal Reserve is itchy every morning, saying, "Is inflation coming ? Shoul d we raise interest rates to kill it before i t comes?" A possible scenari o for th e U.S. economy is a recession induced b y tigh t mone y an d hig h rea l interes t rates . N o one is willin g t o predict that the Federal Reserve will preside over a debt liquidation by high inflation an d easy money. Thus , the world economy, even if I slightly overstate the case (I do not think I do), is not going to make a major difference t o the debt crisis. Optimistically , you can say there will be no decisive change; very optimistically, you can say we are going to have high real interest rates, with the result that all debtor countries will walk away from the debts.

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FURTHER ADJUSTMEN T We can say, "For the last five years, you guys have not been doing the pushups right, and now we are really going to start adjustment. W e want serious liquidation of public-sector enterprises. W e see budget deficits—they must go. The real exchange rates are not right—youmust depreciate more. An d we want you to export more to and import less from th e United States, so that you get more dollars with which to pay your interest." Well , that advice is not exactly what people have in mind. O n the trade side, we certainly already feel that the developing countries (at least the debtors) are doing much too well on their exports. Whe n Mexico tries to export to the United States , sixteen lawyer s approach ever y carloa d t o fin d ou t i f ther e i s possibl y a bi t o f dumpin g involved. W e want the m t o open their market s t o import s fro m us , which means they will not have the foreign exchange to pay interest, because they are using the foreign exchang e to buy our goods. W e do not have a persuasive story o f adjustmen t no t havin g bee n trie d seriously , an d anothe r roun d o f adjustment should start to put those countries in a better position to service. I n fact, we are observing already in Latin America that governments are moving to the lef t simpl y a s th e economie s deteriorat e socially , politically , an d economically unde r th e weight of the adjustment process . The y are experiencing high inflation. Th e situation i s getting unsettled, polarized, and it is very difficult t o believe that there is a new age of adjustment t o pay the debt around the corner. VOLUNTARY LENDIN G We say, "Well, the story is not good, but if you do not hang in, you can never borrow again. " Tha t lin e o f thinkin g provoke s laughte r i n Lati n Americ a because governments realize they are running trade surpluses, and if they stop paying interest, that is the amount of extra goods they could have every year. If they are told to look down the road to 1992, when surely they will want to be borrowing in the world capital market, those countries say, "All we see is that the commercial banks are trying to get out rather than in." Eve n countries that hav e alway s service d thei r deb t an d ar e payin g bac k principal , lik e Colombia, cannot roll-over th e principal of thei r debt. Whe n they tried last time, the banks would not touch it. Voluntar y lending does not exist, and a massive attempt is underway by commercial banks to reduce Latin American exposure independently of what the particular country is doing, because what counts is the total exposure, not where you have it. Nobod y in Latin America

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believes tha t voluntary lendin g i s somethin g t o worr y abou t an d wor k for . There is now great awareness of the history of the last debt crisis, when, under pressure, governments walked away. During the 1930s debt crisis, governments could return to the capital market the momen t the y defaulte d o n th e ol d loans . Whe n a banker says , "I f yo u default, I will neve r len d t o yo u again, " he o r sh e i s no t reall y serious . I n uncertain times banks only len d to those wh o do not need money. Someon e who has defaulted and as a result has no debt left is a wonderful credit risk, and that temptation is inevitably there . Th e best evidence is the case of Mexico . In 1944 , after thirt y year s of no t paying a penny—always talking , but never actually paying a penny—the government talked to the bankers and said, "Good news: We will pay you off twenty cents on the dollar, no arrears." Th e bankers said, "Wonderful, we will take it." Fiv e years later, the commercial banks had already loane d a billio n dollar s t o Mexico ; nin e year s late r cam e th e firs t Mexican bon d issu e i n Ne w York , oversubscribed . Withi n th e nex t fou r months, there were eleven mor e bond issues. I t does not take long to reenter the world capital market if the prospects look good. A t that time, the Mexican government was extremely conservative, the budget was balanced; the story was investment, and everybody wante d a piece of it. Everybod y looke d back and said, "Yes , they di d have a terrible government, but the guys we are dealing with now ar e really wonderful. " Exactl y th e same happened with Brazil and every other debtor country. Toda y we do not really have a convincing story , one tha t says , "Let s g o o n becaus e w e hav e th e Bake r Plan , whic h i s a wonderful way of dealing with this problem."

ALTERNATIVES What are the alternatives? On e can say, "We have to do something about the debt problem that is market-based. W e do not believe in big, decisive, comprehensive institutional moves." Anyon e favoring market-based approaches would say, "We have two on the shelf, one of which is debt-equity swaps. W e have five years of experience with swaps, and the evidence is that in most cases the debt-equity swap s finance investment tha t would hav e taken place anyway. " For the central banks, dollars that they would have otherwise received do not actually arrive, and there is a cost of financing the pay-off of the external debt in th e budget . Ther e wil l n o doub t be debt-equit y swaps , bu t the y wil l b e small and will be targeted to those investments that governments actually think they woul d no t otherwis e obtain , an d tha t the y wan t badl y enoug h t o us e budget subsidie s t o attract . Tha t tendenc y i s quit e clea r i n Mexico , fo r

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example, where debt-equity swaps have been suspended except for very special circumstances. I n Brazil, a big debt-equity swap program is underway, though primarily becaus e i t i s th e biggest leve r fo r corruptio n eve r seen . I do no t believe that debt-equity swaps will be major, they will be small and interesting, but not decisive. A second possibility is the Mexican Morgan-style buyback operation. Buy backs were very popular in the 1930 s and 1940s . Argentin a bought back it s entire externa l debt , whic h wa s sellin g a t a discoun t eve n thoug h th e government was regularly paying interest. I t was selling at a discount because Argentina wa s locate d i n Lati n America , an d creditors though t anyon e wh o lived ther e in the end probably was not going t o pay. Th e Argentinians used that advantage to retire their whole debt through buybacks. Wh y not have that today? Bank s sel l ou t o n a voluntar y basis , countrie s reduc e thei r deb t o n advantageous terms, and everyone is ahead. Th e problem with buybacks is very simple: you need money t o do it. An d the debtor countries, since they cannot even pa y interest , certainl y canno t bu y bac k th e debt . Fo r buybacks t o b e attractive, the discount must be really large. Bu t if you have a lot of money , the discount wil l no t be larg e unles s yo u ar e particularly vicious . Thus , the only wa y a good buyback situatio n arise s is if th e creditors believe the y wil l not get a penny an d the country i s ful l o f mone y an d can actually retir e the debt Ver y tough to do, certainly, for example, in Mexico. Porfiri o Diaz said that Mexico was so close to the United States and so far from God. Tha t is not a situation where you depress your discount maximally by adverse behavior. I conclude that market-related mechanisms, while they do occur, are going to be in the $10 billion range, far from the $100 billion debt of Mexico and Brazil. That leave s tw o options . On e i s th e institutiona l approach , th e facilit y proposed by Peter Kenen a number of year s ago, that appears in the trade bill by th e grace o f th e House Bankin g Committee . Ji m Robinson o f America n Express, t o th e consternation o f hi s banker friends, ha s advocate d it . Man y people like the idea because they see the debt trading at large discounts in the secondary marke t and wan t t o capture tha t discount. The y propos e tha t the banks sell their claims to a facility at a discount and turn around and pass those discounts o n t o th e debto r countrie s a s deb t relief . Th e proble m i s th e taxpayers have to guarantee the operation. I f it is successful, th e banks have a safe asset where previously they had a crummy one, debtor countries have debt relief where they did not before, and, if everything goes well, all the taxpayer is doing is guaranteeing the reduced debts. Reduce d debts make payment much more likely, and , because w e helped out, the debtors will no t be nasty; all i s well.

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Is this scenario likely? Ther e are a couple of snags that essentially condemn the approach . First , an y ban k woul d tr y an d hol d ou t i f suc h a schem e emerged. Anyon e who holds out can go to the debtor country and say, "Now that everybody has given you debt relief, there must be a lot of money around to pay me everything you owe me." Second , the free-rider problem requires a facility t o use carrot-or-stic k mechanism s t o make th e banks sell . "Carrot " means i f yo u sell , w e ar e going t o giv e you wonderfu l ta x break s o n you r losses; "stick " means if yo u do not sell, w e wil l mak e your life miserabl e by capital requirements. Congres s is very reluctant to do this to the banks. There is a more workable plan in which debtor governments decide to pay their interest obligations in domestic currency, which cannot be converted and expatriated, but can be invested without any restrictions. Th e result would be to revitalize investment. I n the case of Mexico, for example, the trade surplus would disappear and be replaced by an equal increase in investment Th e banks, which now get the pesos, will immediatel y scurr y to buy equity, to buy land, to buy real estate, or to make loans that create an investment climate. Privat e Mexican investors would say, "Well, the peso is not going to collapse because we do not have to pay interest in dollars." Capita l flight would return. Wha t follows is a stimulation of economic activity in Mexico; everyon e would want a piece o f th e action. A s privat e capital returns, reversing capita l flight , th e central bank has enough dollar s to actually pay th e banks interest in dollars. And we have a paradox: If the banks want the money i n dollars, they cannot have it, and capital goes ou t of Mexico. I f the banks are willing to take it in pesos, the n i n fac t the y ca n ge t i t i n dollars—perhap s no t all , perhap s no t immediately, but quite rapidly.

THE CAS E O F MEXIC O What are the preconditions for something to work in the way I have described? I think in Mexico, where the budget today is balanced, they actually exist to a high degree. I f you look at the raw budget numbers, they show a deficit of 1 7 percent, but tha t is onl y becaus e th e nominal interes t payments o n th e large domestic deb t are inflated b y a 200 percen t inflatio n rate . I f yo u mak e the inflation adjustmen t o n interes t payments a s w e d o here, the n the budget in Mexico is balanced. I t means the government is collecting enough in taxes to pay the creditors in pesos the full interest they are owed. Th e government frees through taxation enough resources to tell the creditors, "Here, you can take all this—and I earne d i t withou t inflation. " Wha t happen s toda y i s tha t th e creditors take the money and say they would like dollars. A s a result, there is a

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large trad e surplus ; export s ar e hig h becaus e th e rea l exchang e rat e i s depreciated, an d imports ar e low, whic h finances th e outflow o f th e dollars earned through the budget The alternative is investment that increases sharply as the creditors put $10 billion int o Mexica n investment s o f al l kinds . Mexica n firm s impor t American goods, so the trade surplus disappears. Previously , the trade surplus was needed to pay interest, but under my plan the trade surplus is used to buy American capita l good s s o tha t extra resources ar e available t o the Mexican economy t o star t a process o f growth . Le t thi s happe n fo r three , four , five years, and Mexico will be back where it was in the 1950 s or 1960s, a country without inflation , wit h stead y 7 t o 8 percen t growt h an d private-secto r investment. A s th e economy grows , there is plenty of mone y aroun d to pay off th e bank loans, which over time will come to look very small. I n the end, I think it is the only feasible way to solve the debt problem for a large country like Mexico. Is the domestic macroeconomi c situatio n i n Mexic o suc h as t o mak e this scenario plausible? I f you look at the Mexican economy, there are three concurrent problems. Th e first is the high inflation tha t is the counterpart of large real depreciation to cope with the debt crisis and the large collapse of oil (which meant 3 0 percen t reductio n i n expor t revenues) . Las t fall , inflatio n wa s running at 200 percent and sharply accelerating. Sinc e January, the government has introduced a stabilization program of the kind Israel, Argentina, and Brazil entertained over the last three years. Israe l was successful, Argentina and Brazil were not Th e Mexicans went to each of the three countries, looked carefully at what had happened, and said, "We conclude that these programs fail when there is not very tight fiscal discipline accompanying th e price-wage exchange rate freeze that puts an end to inflation." So , they postponed for a year and a half stopping inflatio n unti l th e budget wa s i n a sufficiently stron g positio n that , from the budget side, there was no inflationary pressure. Th e government was actually retiring debt. The y reached that point last year. Thei r budget is totally sound, even o n a sustainable basis, because th e improvements wer e made by closing public-secto r firms, raisin g taxes , an d broadenin g th e ta x base , al l measures that are not emergency taxation that might disappear in a year or two. On the budget side, everything has succeeded. How well have they done on disinflation? I f you look closely over the last month, inflation no w is already less tha n 20 percent, and less than 1 0 percent per yea r fo r producers 1 prices . Fo r th e momen t a t least , th e price-wag e exchange rate freeze system is working extremely well. I t has reduced inflation, even for those prices that are not actively controlled. Th e real exchange rate is still i n a very goo d position; even thoug h there is a little bit of inflation , th e

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real exchange rate is at the same level as when oil was $6—and oil is already $13. O n tha t side , everythin g i s safe . Th e problem s ar e essentiall y th e problems of adjusting from a stabilization to a growth scenario. A hug e budge t actio n o f th e kin d Mexic o ha s undertake n mean s a n enormous restraint on demand and little growth . Mexic o ha s ha d recession rather than growth over the last five years . Rea l interes t rates are extremely high—40 percent—because inflation has stopped, and the government has not allowed shar p mone y growt h t o brin g rate s down . Th e econom y i s i n a precarious situation because there is too much monetary and fiscal tightnes s to make thi s disinflatio n progra m stick . Unti l th e electio n i n July , polic y i s unlikely to change because inflation is the main problem. Afte r July, however, life ha s to normalize, and the country wil l nee d growth. Lookin g ahead, the issue facin g th e Mexica n governmen t i s no t succes s o n th e disinflatio n program—there is every reason to believe it will work because the budget is in such a wonderful position—but how to return to growth. The seriou s proble m o f growt h i n Mexico , o r in an y countr y wher e you have stabilization, is tha t everybody no w say s the fundamentals ar e right and they ar e jus t waitin g fo r th e boom , whic h woul d justif y makin g th e investments everybody think s are totally appropriate, given tha t everything i s all right . I t i s a ver y classi c coordinatio n problem , wit h everyon e saying , "After you." An d if everyone says, "After you," we will not see much action. What can the government do? Well , they cannot go out and spend because then the fundamental s ar e gone . The y ca n cal l peopl e an d say , "Wh y don' t you spend?" An d receiv e th e answer , "Yes , we ar e actually thinkin g o f it . W e think the fundamentals are right, we are just waiting." Everyon e is waiting. The country cannot afford t o wait because the sociopolitical fibe r is being tested b y thes e ver y tigh t monetar y an d fisca l policies . Somethin g ha s t o happen. Th e debt problem is on people's minds. The y say, "Imagine we had growth. Growt h fo r a year and a half woul d mea n tha t the current accoun t surplus tha t we hav e today , with whic h w e can pay all th e interest and retire debt, woul d g o away . Hig h investmen t woul d mea n larg e capita l good s imports. Increase d imports and reduced exports mean there is no more money to pay the interest on the debt, and then we have the rescheduling confrontation that will not go well, and then people say we need a real depreciation, and then capital fligh t starts , and then w e ar e back t o where w e wer e las t year. " A n essential elemen t i n moving fro m stabilizatio n t o medium-term growt h is the resolution of th e debt problem. I f we solve the debt problem in the recycling manner tha t I hav e suggested , the n o f cours e everythin g add s up . Why ? Because startin g a month fro m now , al l th e banks woul d be running around Mexico pushing loans . I t would be exactly th e coordinating device tha t gets

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investment moving , whil e a t th e sam e tim e removin g th e externa l balanc e constraint and the expectation that there could be yet another large depreciation because the debt problem is inconsistent with growth. Looking a t the Mexican economy , th e number-one proble m i s t o bring a very rapi d solutio n t o th e deb t crisis . Th e solutio n mus t b e non confrontational becaus e o f Mexico' s proximity t o the United States . I t must also be sufficientl y conservativ e s o tha t the United State s ca n regard i t as a reasonable settlement that in the end gives creditors the very best chance to get all thei r money , ever y penny , whil e a t th e sam e tim e assurin g tha t Mexic o resumes growth in a way that is sustainable and stable. Could Mexico possibly accomplish this? Yo u might say, "You've seen one Latin America n country , you'v e see n the m all, " but , o n clos e inspection , Mexico is very different. Betwee n 195 6 and 1976, Mexico actually had a fixed exchange rat e o n th e dolla r an d ver y lo w inflation . I n fact , Mexic o i s traditionally a country o f financia l stability . Th e events o f th e last ten years wreaked havo c wit h th e country , partl y becaus e oi l wealt h wa s s o poorl y digested, partly because financial instabilit y led to $40 billion of capital flight , and partly because the oil collapse exacerbated the problem. Bu t a history of financial stabilit y i s there . Th e budget efforts ca n surviv e i f ther e is strong , decisive, rugged action that turns from the debt crisis to a growth scenario. I f that does not happen, then within a year there will be real depreciation, and the Mexican political system will then open up. The Mexican cas e i s interesting becaus e i n th e end all th e illusions abou t miracles are off the mark. Th e adjustment actually is being done the hard way, by closing public-sector firms, by pulling a Reagan-style affair on AeroMexico to break the unions, and by balancing the budget and putting an extra 2 percent in for safety. Whe n adjustment has been substantially completed, as in Mexico today, the next question i s where the growth comes from . An d if i t does not come very, very fast, then there is a terrible problem. Growt h today in Mexico is inconsistent with debt service. Everybod y knows it does not add up after all the adjustments are done, and that means the onus falls on the United States, on the creditors, to fin d a way o f firs t havin g growt h i n Mexico , an d then debt service.

-I ^ FRO M ADJUSTMEN T LD AN D RESTRUCTURIN G TO DEVELOPMEN T Osvaldo Sunkel

It is necessary to understand both the present and the past when considering the restructuring o f developin g economies . I t is essential t o go back i n history before movin g forwar d because, as I have argue d since 198 4 (Sunkel 1984 ; Sunkel 1985 ; Griffith-Jones an d Sunke l 1986) , th e deb t crisi s i s n o mer e financial phenomenon , but the culmination of a profound developmen t crisi s that was emerging in Latin America already by the late 1960s. Wha t is needed, therefore, is not just a solution to the debt crisis, although this is a necessary condition, but a renewed development effort to overcome this double crisis. I mus t emphasiz e tha t I do not subscribe t o the now prevailing vie w o f Latin American development tha t condemns all that happened there from the 1930s to the 1970 s as a monumental failure . Tha t is a seriously misleadin g interpretation, becaus e Lati n Americ a durin g th e 1950 s an d 1960 s becam e semi-industrialized, highl y urbanized , an d partially modernized . Relativel y modern states evolved out of rather primitive nations, and that can hardly be described as a failure. This positive historical process of economic and social change was brought about b y th e breakdow n o f th e ol d regime s establishe d i n th e nineteent h century, whic h crumble d unde r th e effects o f th e Great Depressio n an d its The opinions expresse d in this paper are strictly personal and should not be attributed to the institutions with which the author is associated.

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aftermath, including World War n. Th e Depression weakened the power of the landed oligarchies and the related commercial and financial interests linked to international primary commodity trade , commerce, and banking. I n its stead gradually emerge d a ne w politica l coalitio n o f socia l group s tha t had bee n struggling against the old regimes: industrialists, middle classes, professiona l groups, and organized labor. That coalition sustaine d a n exceptionall y rapi d an d intense developmen t process during the 1950 s and 1960s . Th e way in which th e coalition articulated political interests and economic development was basically through a very active role of an expanding state apparatus. A s a consequence of the substantial decline in the power of th e old elites, such new political group s were able to use the state to tax away the surplus generated in the foreign-trade sector, which was achieve d throug h variou s means, including exchang e rate manipulation, increased taxation, and eventually through the nationalization of certain primary export activities. During subsequent decades, the state and the public sector grew considerably and took on a large number of important new functions: 1. Th e state increased its role as an investor, playing a substantial role in the creation of th e transportation, communication, an d energy infrastructures , and thereby preparing the way for industrial development. 2. Th e state created public enterprises in areas in which the private sector was not interested, willing, or able to invest, such as iron and steel, machinery, and petrochemical industries. 3. Th e stat e provide d capita l t o financ e privat e entrepreneur s throug h institutions lik e th e Corporatio n d e Foment o d e l a Producci6 n i n Chile , Banco Nacional do Desenvolvimento in Brazil, and Nacional Financiera in Mexico. Thes e powerful financial and technical state agencies were designed to promote and support industrialization an d agricultural modernization in the private sector. 4. Th e state, to complete the demands and interests of th e political coalitio n behind thi s ne w role , als o establishe d i n som e cases , an d significantl y increased in others, the basic socia l service s of a n incipient welfar e state: education, health, social security , and housing. Th e middle classes and the organized urban labor force benefited greatly from this process. With significan t difference s amon g countries , thi s wa s a n extremel y successful program , one which brought about a high rate of economic growth, industrialization, an d modernizatio n bot h i n relatio n t o pas t histor y an d contemporary world experience. However , a number of serious problems began

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to surface by the late 1960s , as was amply recognized in the critical literature of the period—from the right (neoliberal), left (dependency), and center (more of the same development, with some changes in emphasis). The policy o f industrializatio n wa s from the beginning proposed with the explicit aim of exporting manufactures, because specialization i n the exportation o f a few primar y commoditie s le d t o stagnation , externa l vulnerability , instability, an d an asymmetric relationshi p wit h developed nations . Bu t the actual process of industrializatio n emphasize d import substitution rather than exports o f manufactures . Althoug h thi s wa s initiall y justifie d bot h o n th e grounds o f th e developmen t o f infan t domesti c industr y an d th e negativ e conditions prevailing until the late 1950 s in the world market, those conditions changed in the 1960s, and the emphasis should have shifted more decisively to exports of manufactures. The increasing taxation of the primary-export sector also started to reach its limits. Taxatio n made that sector less profitable an d therefore lacking in new investments an d technology , whic h contribute d t o th e balanc e o f payment s problem. I t was also generating a growing structura l fiscal crisis, as revenues extracted from the export secto r faile d t o increase sufficientl y t o matc h th e increasing publi c expenditure s o f a state pursuing th e development policie s mentioned before. A t the same time , some o f thes e expenditures ra n out of control. Risin g expenditures should have been limited and rationalized, and a very substantia l transformatio n o f th e taxatio n structur e shoul d hav e take n place t o radically increas e the reliance on domestic revenues . Bu t it was, of course, easier and politically more expedient to continue spending and depend on taxatio n o f exports , inflation , and , later, external financing . Multilatera l and bilatera l developmen t assistanc e an d foreig n privat e direc t investmen t provided funds up to the 1970s, and then when borrowing on the international private financial market boomed. A social crisis was also in the making because the process of fast economic growth wa s highl y inequitable , generatin g bot h affluenc e an d poverty , particularly among the fast-growing numbe r of th e displaced rural population that move d int o urba n slu m area s wit h precariou s employmen t conditions . While thi s process o f massiv e transfe r from rura l to urban poverty migh t be considered t o hav e som e positiv e aspects , i t wa s nevertheles s a dreadfu l accumulation of visible absolute and relative poverty. Under th e growin g weigh t o f thes e problems , th e political coalitio n tha t underpinned development policies began to break down, particularly in growing marginal (or so-called informal) sectors, which did not claim much benefit from the model of growth. I n response to accumulating sociopolitical and economic tensions and contradictions, various attempts at more or less radical reforms of

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a socializin g characte r occurre d i n the lat e 1960 s an d early 1970 s i n Chile, Jamaica, Argentina, Bolivia, and Peru. Thes e were put forward as progressive solutions to the dead ends reached by the import substitution industrializatio n model base d on a populist sociopolitical coalition . Thes e attempts at further socializing the development process aimed at changing its capitalist nature and solving it s structura l problems. The y al l failed , partl y fo r political reasons , partly because of th e tremendous disorganization o f the economy, which was brought about by essentially populist policies an d the reactions of the middle classes against structural reforms and partly by external pressures. In th e 1970s , a radicall y conservative , neolibera l reactio n i n economi c policy took place in several countries, which moved in the opposite direction, liberalizing th e economy , reducin g th e rol e o f th e state , openin g u p th e economy to foreign trade, finance, an d investment, and relying on the market mechanism rathe r than planning. Othe r countrie s continue d t o practice th e development policies of th e 1960s . Th e new international financia l situatio n permitted bot h th e liberalizatio n policie s an d th e continuatio n o f th e development policie s withou t havin g t o underg o fundamenta l structura l changes, which included reform of manufacturing sector s to be able to export (Brazil did achieve this); formulation of policies in the social sector to alleviate poverty and under- and unemployment; and adoption of measures to overhaul the tax system, overcome the fiscal crisis , and introduce greater rationality and efficiency. Structural transformation was already necessary in the late 1960s and is even more necessary now. Lati n America ran heavily into debt everywhere, even in the oil-exporting countrie s wher e financia l resource s increase d enormously , because i t had accumulated great economic an d social imbalance s durin g its rapid and profound economic development process. Th e financial abundanc e and permissiveness made it possible to postpone structural readjustment during the 1970s , becaus e almos t anythin g coul d b e finance d borrowin g fro m th e quickly expanding private international banks. In summary, there was a very positive development process in the postwar period, but that process began to show serious flaws, requiring reorganization and reorientation. A numbe r o f th e element s tha t are part of th e structura l adjustment programs proposed now are therefore necessary. Bu t I am very wary of th e genera l approac h o r philosophy tha t accompanie s them , whic h i s a revulsion agains t everything tha t went before. Thi s attitude is incorrec t and very costly indeed , as shown by some of the most extreme examples, namely the countries of th e Southern Cone. Th e programs are largely an ideological cover for neoliberal reform rather than policies for the resumption of a genuine economic and social development effort

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Once the debt situation erupted in 1982 , an additional financia l crisi s was created on top of th e development crisis that had been looming sinc e the late 1960s. Th e most damaging consequence of the debt crisis is a reversal of Latin America's financial relationship with the developed world. Unti l 1982 , the rest of th e world transferred savings to Latin America, which allowe d it to invest more tha n wha t i t wa s abl e t o save . Sinc e 1982 , Lati n Americ a ha s bee n transferring t o the rest of th e world around 3 or 4 percen t of it s GDP, which means a ver y larg e proportio n o f it s savings . Therefore , th e adjustmen t programs have meant a substantial reduction of investments. Thi s reversal of the international transfe r process ha s been goin g o n now a t a rate of aroun d US$30 billion per year, totaling nearly US$150 billion over the last five years. Thus, a large proportion of th e savings of the Latin American countries is being shippe d abroad , an d thi s ha s bee n occurrin g withou t an y significan t change in the adjustment policies that have been followed over the last five or six years. Suc h adjustment policies have in fact made it possible to enforce an unacceptable situatio n i n whic h developin g countrie s ar e contributin g t o finance developed countries . Th e transfers mea n that there is a fundamenta l contradiction betwee n achievin g reasonabl e rate s o f economi c growt h an d servicing the debt. T o service the debt, Latin America as a whole has had to reduce it s investmen t rat e fro m abou t 23 percen t before 198 2 t o aroun d 1 6 percent since. This is a recipe fo r stagnatio n tha t must end. Th e end is not likely t o be initiated fro m abroa d becaus e ther e i s n o expectatio n tha t th e internationa l economy wil l improv e dramaticall y i n th e nea r future . Ther e i s genera l agreement abou t th e thing s tha t wil l no t happen : th e worl d econom y an d international trade will no t soon start growing to renew their lending; foreign private investmen t i s no t comin g bac k soon ; interes t rate s ar e no t comin g down; and international cooperation and assistance policies have been more or less abandoned. So what are the scenarios for the next few years ? On e is to continue debt service fo r a fe w years , sto p whe n i t become s impossible , an d the n begi n payments again, as during the last years. Thi s stop-go debt-servic e situatio n has led to a continuing deterioration of the debtor countries. Afte r six years of drastic adjustmen t policie s an d oppressiv e externa l deb t negotiations , th e indebtedness besetting most Latin American countries continues to increase. A precarious externa l balanc e ha s bee n struc k a t th e cos t o f utte r interna l imbalance. I n the short term, the result has been a sharp and steady contraction of economies (leaving substantial unused production capacity), drastic cutbacks

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in imports , an d an accentuatio n o f inflationar y pressures. 1 I n the medium term, we hav e see n a seriou s degradatio n i n th e employment situation , real wages, social services , and the distribution of income. Ove r the longer term, the consequenc e wil l b e a sever e deterioratio n i n th e capita l accumulatio n process, wit h negativ e effect s o n productive an d technological capabilit y a s well as economic and social infrastructure. A further macroeconomic imbalanc e is involved, that of th e public sector, which ha s to generate a surplus of incom e ove r current expenditure t o cop e with domestic an d foreign publi c deb t servicing. Thi s burden has increased sharply as the state has assumed many a private debt and as, during external debt renegotiations , th e stat e ha s bee n force d t o accep t liabilit y an d stan d guarantor fo r privat e deb t servicing . Consequently , th e stat e i s i n fac t responsible for all foreign debt servicing, public and private, unless the private debtors are capable of servicing their debt themselves. I n the case of those who are not (which i s the general case), the state assumes liability for the debt or has t o subsidiz e privat e debtor s s o tha t the y i n tur n ma y servic e thei r obligations. I n short, the state has to make an extraordinary effort t o limit its expenditure and increase its income. As far as public expenditure is concerned, public investment usually suffer s the quickest and sharpest contraction, but the contraction soon moves on to the civil service , transfer payments, and subsidies. Socia l security , public health care, and education, which are major items in public budgets, are frequentl y those most affected (especiall y sinc e military expenditures prove quite inflexible). Concerning revenue , i t i s ver y probabl e tha t virtually th e entire effor t i s concentrated on indirect taxation, such as VAT or sales taxes, which provide a higher yiel d over th e shor t term , bu t directl y an d regressivel y affec t th e majority of poorer consumers. A s for public corporations, an effort is made to sell the m off t o domestic o r foreign privat e interest (th e debt-equity swa p i s being use d fo r thi s purpose ) o r t o mak e the m self-financin g b y increasin g prices, reducin g staf f an d wages , an d introducin g variou s form s o f rationalization. Th e specifi c ai m i s t o avoi d burdenin g th e budge t wit h subsidies, making enterprises pay for themselves, which is no easy task under recessionary conditions. The purpose of suc h policies i s t o generate a surplus on curren t accoun t available for servicing the foreign deb t Th e political cos t of maintaining the recessive adjustmen t policie s an d servicin g th e foreig n deb t increase s exponentially. Th e supposed advantages of these policies rapidly fritter away, 1. Se e the discussion of debt and inflation in Chapter 14 by Dornbusch.

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while a n alternative polic y o f economi c reactivatio n o f a populist characte r becomes eve r mor e probable . Fo r wan t o f a bette r option , sociopolitica l pressure inevitably will tend to impose the latter solution, as has already been seen i n a numbe r o f countries . Nevertheless , give n th e shar p reduction i n imports an d th e sever e externa l strangulation , a n indiscriminat e polic y o f expansion will immediately upset the precarious external balance and bring the threat o f runawa y domesti c inflation . O n th e othe r hand , b y maintainin g recessive adjustment policies, investment and savings necessary for financing increased expenditur e i s inhibite d just whe n thes e ar e neede d t o stimulat e employment and growth without exerting excessive inflationary pressure. If externa l conditions , interes t rates , trad e conditions , exports , foreig n demand, foreig n investment , an d external financing d o no t improv e drama tically—and ther e i s nothin g t o indicat e tha t thi s wil l b e th e cas e ove r th e medium term—ou r countrie s wil l continu e t o b e adjuste d t o a stagnatio n "equilibrium" wit h massiv e underutilizatio n o f resource s an d increasin g poverty. Unde r the most favorable conditions, improving export performance will be a difficult and longer-term task while the economic, social, and political situation continue s t o deteriorate , especiall y i n thos e sector s no t relate d t o tradeable goods. I suggest that there is an alternative to these regressive structural adjustment programs an d t o populis t strategie s fo r copin g wit h th e crisis : th e tota l o r partial suspension of the transfer abroad of internal savings earmarked for debt servicing. Not e tha t I refer to a suspension o f th e transfer, not an end to the corresponding domestic savings effort. Suc h a measure would make available a considerable volume of foreign currency, the specific amount depending on the weight of th e foreign deb t borne by any given country, the proportion of th e payment of th e debt that the country decide d t o suspend, and the retaliatory action taken by creditor countries and banks. If , throug h the interplay of these various factors, it was possible effectively t o make available a large part of this potential volume of resources, the resulting capacity to import would allow for an increas e o f severa l percentag e point s i n growt h o f nationa l product , th e increase varyin g b y country . Unde r curren t conditions , th e resul t o f m y proposal woul d be a move fro m a state of stagnatio n t o one o f growth an d a recuperation in per capita income. If an appreciable part of th e foreign currenc y earmarke d for servicin g th e foreign debt was made available for imports, it would make for a considerable increase i n investment fro m th e abysmal leve l t o which it ha s had to adjust, back t o abou t th e norma l postwa r level . Give n curren t idl e productio n capacity, thi s would generat e i n turn a steady increas e in economi c activity , employment, and incomes. Growt h would allow for an increase in domesti c

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savings t o th e exten t necessar y fo r financin g hig h priorit y domesti c investments. Bea r in mind that a truly Herculean savings task is necessary to compensate not only for the drop in savings brought about by the recession and adjustment policies, but also to replace the considerable contribution made by external savings until 1981 . I t would be possible to achieve this improvement in the savings-investment equation over the short and medium terms only if all or a substantial part of external debt servicing was suspended. Unde r present circumstances, an increase in imports is essential if new investment efforts are to have any real and lasting effects. Th e external restriction o n reactivation would be removed over the short term, and the internal restriction on productive capacity and savings would be relieved over the medium term, thus making for sustained growth. If, conversely , th e newl y availabl e impor t margi n wer e t o b e use d t o increase consumer expenditure, economic activity would expand over the short term, but no medium term growth could be maintained. W e woul d fall onc e again o n th e populist alternative , followe d i n du e tim e b y th e recessionar y adjustment medicine. Current policies, both populist and recessionary, are such that they cannot offer an y hope of an increase in savings that might possibly lead to increased investment; indeed, they inhibit any such increase in savings. A n autonomous increase in investments is required, which would trigger a process of recuperation of economi c activity , employment, incomes , and wages. Th e restriction that hinders such a line of action is debt servicing, which is why such servicing should take second place, until exports and external financing ca n be brought up to levels that make the servicing charges tolerable. I stress that suspending or reducing debt servicing should not mean suspending the domestic savings effort. Quit e to the contrary, this exceptional saving s effort shoul d continue and be entrusted t o an institutional bod y as it were, a national fun d fo r economi c an d socia l development . Al l majo r group s o f society should be democratically represented within such a fund and would be able t o direc t th e nationa l saving s driv e exclusivel y t o financing priorit y projects to tackle the most acute short- and long-term socia l problems and to raise the efficient production of tradeable goods. My proposal would be the internal technically and politically indispensabl e complement to the external measure of limiting or suspending debt servicing. It woul d b e a polic y tha t coul d rall y majorit y domesti c support , bringin g consensus amon g entrepreneurs , middl e classes , workers , an d th e margina l sectors. Th e purpose would be to create a social pact for the reactivation and social developmen t o f th e economy . Cautiou s an d selectiv e expansio n o f economic activity would have permanent and positive effects on key economic

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and social sectors, without major inflationary consequences , all of it aimed at overcoming both the long-term development crisis and the debt problem. A domesti c effor t o f suc h proportion s shoul d arous e sympath y i n th e international community, particularly among those actors not directly affecte d by the total or partial suspension of debt-servicing payments. On e would hope that a development-oriente d progra m woul d hav e a positiv e effec t o n th e governments of industrialized countries and international organizations and even lead to a new form of international cooperation. Even the most affected party in this proposal, the banks, could be positively associated with it by participating in the investment ventures launched by the national fund for economic and social development, part of a gradual repayment of th e principal o f th e debt owed t o them, duly discounte d accordin g t o the values prevailing in the secondary market Bank s could even be offered som e interest payments in return for contributing new funds to the investment effor t and to the export drive. Instea d of th e present debt-equity swaps , with their highly negative characteristics, banks could be offered attractiv e debt-investment and debt-export swaps, which would be a contribution t o the solution of both the debt and development crises. We are currently engaged in an international "negative-sum game" situation in which almost everyone loses or, at the very least, ceases to win. Th e debtor countries, more particularly thei r poorer classes, are those most affected. Bu t the creditor countries als o lose , or cease t o win. Th e shar p reduction i n the imports o f th e debto r countrie s affect s th e export s o f th e creditor s an d th e income an d employmen t o f hundred s o f thousands . Likewise , ther e i s a reduction i n direc t investmen t an d private loa n financin g opportunities , a s profit an d interes t remittance s fro m debto r countrie s ar e restricted . Th e reduction in domestic economic activity and in international trade, investments and financial flow s ha s a further recessive effec t o n th e world economy an d contributes to instability and uncertainty. In th e industrialize d countries , individual s an d groups o f importanc e ar e expressing increasin g dissatisfactio n wit h officia l polic y towar d developin g country debt . Lati n Americ a mus t advanc e concret e proposal s an d soun d technical an d political argument s t o suppor t an d fortify thi s dissatisfaction . Discussion and the resulting internal political pressure in industrialized countries could be crucial in changing official stances . On the other hand, Latin America will have to develop a credible negotiation position t o threate n importan t institutions an d groups wit h considerabl e costs. Withou t hard pressure and negotiating positions, or at least a credible threat, there can be no negotiation. Withou t such attitudes, Latin America will not be taken seriously, or even be considered, except when yet another financial

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crisis in an important country of th e region forces the centers of internationa l financial power t o reac t t o defen d thei r ow n interests , wit h al l th e seriou s consequences that this has been having and continues to have for the peoples of Latin America.

16

IS T O FORGIV E TH E DEBT DIVINE ? William Darity, Jr.

Why no t call th e whole thin g off ? Th e lingerin g externa l deb t crisis o f th e developing countries lingers into the late 1980 s with no apparent resolution in sight. Forma l repudiatio n i s no t i n th e offing ; Brazil' s moratoriu m o n payments wa s a short-live d attemp t a t temporary repudiation . Th e precise points of leverage that preclude national leaders of debtor LDCs from declaring their government's refusal to continue to service foreign claims are not known with certainty. Bulo w an d Rogoff (1988 ) recently hav e shown tha t it is misleading t o argue tha t leaders fea r tha t their nation's credit reputation wil l b e tarnished so badly that their respective regimes will be barred permanently from access t o international credi t markets. Afte r all , reputations can change with regimes. Bulow and Rogoff conten d that the leverage must be more substantive than fear o f los t reputation ; instead , i t mus t encompas s th e possibilit y tha t a nation's creditors can expropriate assets held abroad or the prospect of outright military intervention. Indeed , the former point of leverage for the creditors is reinforced by what Horn and I have called the bankers' "true insurance": thei r possession a s liabilitie s th e deposit s o f th e elite s o f developin g nations , i n large part via episodic capital flight (Darit y and Horn 1988 : chapter 5). Suc h liabilities could be impounded if any government of a debtor nation undertakes formal repudiation or nonconciliatory default (see Kaletsky 1985) . Repudiatio n only become s likel y wit h th e ris e t o powe r o f revolutionar y regime s wit h

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leaders uninterested in protecting fund s placed abroad by elites as deposits in multinational banks. If the debtor LDCs will not repudiate, then why not have the governments of the creditor nations' banks simply declar e the loans forgiven? Woul d that not effectively pu t an end t o the crisis? Ther e would be no more rounds of rescheduling, n o mor e nervousnes s abou t whethe r Argentina woul d g o int o default o n it s entir e debt , no mor e worr y abou t whethe r 10 , 20 , 30 , o r 4 0 percent o f Peru' s expor t earnings woul d eve r servic e a single year' s interest obligations to the multinational commercial banks, and indeed, no more conferences o n th e deb t crisis . Wh y not , a s Bulo w an d Rogoff suggest , simpl y forgive and forget? A n obvious consequence of a declaration of forgiveness, if it wer e feasible , woul d b e th e necessit y o f th e credito r institution s writin g down thei r loan s a t substantia l losses . U.S . banks , specificall y th e mone y center banks , hav e move d recentl y t o buil d loa n los s reserves , particularl y against thei r claims o n Latin nations . Bu t the U.S. (an d British) bank loa n loss reserve ratios on LDC debt of 25 to 30 percent are still well below the 70 percent ratio being maintained on LDC loans by continental European banks (Truell 1988c : 2), suggesting muc h greater vulnerability t o a complete writeoff of the loans for U.S.-based banks. There is even speculation that if the money center banks were compelled to write-down their loans partially to the discounted values at which the Latin debt sells on the secondary market , at least one of them , Manufacturers Hanover , would be bankrupted (Baile y an d Hill 1988 : 1) . I n fact, Standar d and Poor downgraded th e creditworthines s o f Manufacturer s Hanove r an d four othe r money cente r bank s a t th e star t o f Februar y 1988 , explicitl y becaus e o f "concerns over the five banks' loans to Latin American and other less developed countries, low equity-capital levels and an increasingly competitive operating environment" (Truel l 1988d : 3) . Correspondingly , b y Februar y 1988 , corporate bond offerings for the money center banks were being sold at the highest margin of yield or spread over U.S. Treasury issues with similar maturity dates relative to the bond issues of other major corporations. Th e yields required by investors t o purchase bi g ban k bond s wer e s o hig h a t the star t of 198 8 tha t they were approaching the characteristics ascribed to junk bonds (Winkler 1988: 14). A furthe r consequence o f forgivenes s o f LDC debts would be to call int o question th e legitimac y o f othe r asset s hel d b y th e commercia l banks . I f sovereign or semi-sovereign loans are to be forgiven, why not also forgive the loans made by U.S. banks to troubled farmers, homeowners, and independent petroleum producers? Deb t forgiveness targeted in one direction toward one set

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of borrower s open s u p a n unsettlin g Pandora' s bo x o f possibilitie s fo r questioning th e entire se t of contractua l relationship s betwee n creditor s and debtors. Th e differentiae specified for forgiveness of the obligations to one set of borrowers and not another—particularly if both sets of borrowers have been overextended by the bankers1 overlending—is not obvious. Indeed, there is a subversive school of thought that says that the big banks' managers have no one to blame but themselves for this precarious situation. I t includes a quit e divers e arra y o f scholars , rangin g fro m tw o Universit y o f Pennsylvania finance professors, Guttentag and Herring (1985), to the scion of financial liberalization, Ronal d McKinno n (1984) . Thes e partie s agre e tha t major banks have a tendency to herd in their lending decisions and periodically to overlend. Thi s being the case, why not let them suffer the effects of writing off th e Latin loans in full? Afte r all, this is the same community o f commercial institutions tha t made loans to Panama and is now unclear with whom to negotiate wit h over debts that are now i n arrears (see Bennett 1988 : A8, and Truell 1988b) . Thes e are the same institutions that paid their executives large bonuses in 1987 despite huge losses for all the money center banks (Bailey and Guenther 1988 : 34). Wh y not go ahead and let one or two of these big banks go under? Woul d this not bring much needed discipline to the banking industry and winnow away the most imprudential and inefficient enterprises? The essentia l questio n is : D o w e wis h t o protec t th e innocen t fro m th e repercussions o f developin g countr y loan-induce d failur e o f a majo r bank ? Recall that the upstream linkages of a bank as relatively small as Penn Square in Oklahom a wer e s o significan t a s t o hav e advers e repercussion s o n Continental Illinoi s whe n the former failed. An d when the latter failed, U.S. bank official s wer e s o nervou s abou t th e potential systemwid e effects , the y moved to prevent Continental from closing it s doors. Ca n the system handl e the closing of, say , Manufacturers Hanover and Bank America? On e can only speculate at the downstream linkage s of these large banks. Whil e they are not innocent—nor are most of thei r institutional depositor s (often othe r banks)— the impac t o f failure s o f bank s o f thi s magnitud e certainl y woul d hav e a n adverse effec t o n th e fiduciary soundness o f man y regional an d local banks, which would in turn undermine the security of thousands, perhaps millions, of everyday deposit holders with branch banks. Th e fundamental fea r is that the collapse of a big bank will engender generalized financial collapse and economic and social chaos. I t is already apparent that the Federal Deposit Insurance Corporation (FDIC ) doe s no t hav e adequat e insuranc e fund s t o protec t al l insured depositors who could be threatened by a proliferating bank panic (Bailey

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and Hill 1988:1), a panic supposedly rendered impossible by the very existence oftheFDIC. But without significant forgivenes s o f the extant debt—without a requisite modicum o f divinity—th e LDC s wil l retai n intolerabl e repaymen t burdens . The officials o f the nations that contracted such enormous external debts, now estimated to be close to $390 billion for the Latin American region alone, were not innocents either. Bu t the brunt of the burden of repayment does not fall on them. Rather , it falls o n th e masses o f thei r relatively impoverishe d fello w citizens who must endure a litany of policies that frequently spel l recession in the name of expande d export earnings, coupled with the clubbed hand of the IMF. The difficult tas k i s t o drastically reliev e th e LD C debt burdens withou t inducing financial collapse. Ther e is an additional task, however, that receives considerably les s attentio n i n conversation s abou t ho w t o manag e th e deb t crisis. Becaus e the banks get into these types of situation s routinely, how do we prevent them from producing a new international (or domestic) debt crisis at a later date?1 Relie f from debt burdens for LDCs requires some mode of debt forgiveness. Certainl y suc h forgivenes s i s no t part and parcel of th e banks' tactic o f buildin g u p loan los s reserves . A s Tarshi s ha s observe d recently , "From th e standpoin t o f th e debtors , the y fac e just a s muc h pressur e whe n creditor banks ad d to thei r reserves a s the y woul d hav e face d wit h no suc h action. Thei r debt remains unchanged..." (Tarshis 1988 : 12). Sale o f deb t o n th e secondar y marke t d e fact o ca n amoun t t o partia l forgiveness, given th e magnitude of the discounts at which the debt is sellin g at present, if countries can buy back their own debt at the discount. A s of late 1987, one dollar of deb t from Venezuela , Chile, and Mexico wa s selling fo r fifty t o sixty cents, while the debt of Bolivia was selling for ten to fifteen cents per dollar (Bridge s 1987 : 12) . Bu t th e secondar y marke t fo r deb t remain s relatively thin. Bank s are unwilling to unload large portions of their claims on the resale market, for such dumping would presumably drive prices down even further.2 T o the extent that Folkerts-Landau (1985) is correct in his claim that the spread s offere d developin g countr y borrower s b y th e bank s di d no t incorporate risk of defaul t (o r repudiation o r forgiveness), the n resale o f th e loans at very shar p discounts, understandably , woul d b e a most unattractiv e option. 1. An d presumably it must be a later date. U.S . commercial banks are so deep into the phase of revulsion fro m eas y lendin g tha t they hav e become tight-fiste d wit h al l manne r of borrowers , especially local businesses. See , for example, Apcar and Brown (1988: 1 and 18) , and Ladendorf (1988: HI and H4). 2. Se e the discussion of the secondary market in Chapter 3 by Weeks.

IS TO FORGIVE THE DEBT DIVINE? 23

7

Folkerts-Landau's evidence that the spreads offered by commercial banks to LDC borrowers did not include default risk is the following: (1 ) spreads over LIBOR o n loans to nonoil developing countrie s generally staye d at less than one-half percentag e poin t abov e rate s pai d b y industria l countr y borrower s between 197 4 and 1983 , although the debt crisis was apparent by early 1982 ; (2) the difference between the spread paid by developing country borrowers with a rescheduling and the spread paid by industrial country borrowers was less than one percentage point until 1981 , when it rose to one and one-half percentag e points; (3 ) generally , th e rat e o f interes t o n loan s t o nonoi l developin g countries has been less tha n that charged to major U.S. corporations; and (4) interest rates in the multinational ban k loan market generally hav e been les s than rates on international bonds (1985: 332-335). Folkerts-Landa u contend s that the latter must have default risk incorporated into the returns they promise, given the familiar history of actual bond defaults. Debt-equity swaps, 3 to the extent that the property obtained by the creditor is valued at less tha n the contractual valu e of th e initial debt , hav e a similar flavor o f resal e o f th e debt at a discount. Thi s is essentiall y a scheme tha t constitutes a n ex post collateralizatio n o f uncollateralize d loans , typicall y accompanied by a change in ownership. A s Helpman (1987) points out, debtequity swap s ca n amoun t t o scheme s o f partia l forgivenes s o f th e debt, and complete forgiveness in the special case "in which a positive amount of debt is exchanged for zero equity" (1987:2). Tarshis (1988: 13) is skeptical about the enthusiasm of the bankers for such schemes: . . . just a s it would b e amazin g t o fin d bank s offering t o forgiv e eve n 3 0 percent of their claims as creditors, so it would be surprising for these creditors to take an equity interes t in return for surrenderin g thei r status a s creditors. Who wants, anyway, to become a part owner of a corporation in a country thai cannot gain access to the foreign exchange it needs for the service of its debt? And with the banks eager to keep the discounts on their debt-claims low, and with debtor countries not a t all ready t o give thei r creditors to o generou s a serving of equity, the process of bargaining should be quite a spectacle!

After all, ownership rights to Pemex (th e Mexican national oil company)—o r anything else of genuine substance, for that matter—were not part and parcel of the offerings made available to creditors by the Mexican government under the terms of the plan they established with Morgan Guaranty for debt-equity swaps. 3. A n example is the recent arrangement between Morgan Guaranty and Mexico involving U.S. bonds as debt-backing. Se e the ensuing discussion.

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The plan appears likely to fall far short of reducing the Mexican government's estimated external debt of mor e than $53 billion by the initially projected $10 billion. A s o f lat e Ma y 1988 , th e pla n ha d achieved a n actual reductio n i n Mexico's externa l debt of les s than $1.5 billion (Truel l and Moffett 1988 : 4). If anything, th e banks may hunger for rights to public-sector enterprises that they believe will be more efficient an d profitable unde r private control. 4 Bu t one wonders how often other Third World governments will follow the Chilean regime's lead in privatizing a public-sector company and then exchanging it in a debt-equity swap , as it did in giving America n Express a stake in Soquimich (Bridges 1987:18). 5 What about the U.S. Congress simply declaring that all debts of developing country borrowers t o U.S. mone y cente r banks are now nul l an d void? Thi s would be th e purest form o f forgiveness . Th e total of U.S. banks' claims on the developing worl d were estimated to be $84.8 billio n i n June 1987 , $56. 1 billion of which was owed to the nine money center banks (Truell 1988a : 20). If Congres s coul d wip e ou t th e claim s o f U.S . bank s overnight , i t woul d amount to a rather healthy cup of absolution. O f course, the banks would be likely t o rus h t o th e court s a s di d variou s offende d partie s upse t b y th e abrogation o f th e gol d claus e i n th e 1930 s i n th e Unite d States . I f th e legislature was to prevail, debts would have to be written down. T o protect the financial system fro m collapse , th e Federa l Reserv e coul d ru n an intensiv e monetary expansion or, more directly, simply create deposits at the endangered institutions. Recal l tha t on e o f th e proximate , althoug h no t fundamental , factors i n th e emergenc e o f th e deb t crisi s wa s th e Fed' s contractionary , disinflationary polic y between late 197 9 and 198 2 that induced a recession in the United States. Th e Fed simply could take the opposite step and induce an

4. Robi n King made the following relate d points to me in correspondence dated May 2,1988: "a. [I] t i s currentl y illega l unde r U.S . la w fo r U.S . bank s t o ow n corporation s tha t ar e actually productive. The y change d the law last year to allow fo r temporary (fiv e t o ten years, I think) ownership o f companie s tha t were formerly public-secto r enterprises an d that ar e in the process o f privatizatio n vi a debt-equit y swaps , bu t th e ban k i s stil l require d t o sel l of f th e investment after a certain amount of time . . . "b. Base d on interviews I did with bankers in Mexico last summer, the foreign bankers are interested primarily ...i n projects that produce foreign exchange, not pesos. "c. The Mexican-Morgan bonds were/are known as tortibonos internacionales. Tortibonos are Mexican food stamp s (short for tortilla-bonos, or tortilla bonds). A resultof the Salomon Brothers memo/prospectus, maybe." 5. Debt-equit y swap s may be no more than an exit rout e from th e market in LD C debts fo r "smaller" banks (see Truell 1988c : 2). Thes e banks are not small, and, given the unbridled swath of acquisitions being cut by the regional banks, now often dubbed "super-regionals," some may not be smaller than the money center banks in the near future.

IS TO FORGIVE THE DEBT DIVINE? 2 3

9

inflationary expansio n t o offset th e potential destabilizatio n o f th e banking system. The legal capability of Congress to declare the debt forgiven would rest on the whims of th e judiciary. Bu t there are other major type s of forgivenes s schemes that are less murky from a judicial standpoint. On e scheme advanced by American Express would create a new institution or corporation to purchase LDC debt from the banks, presumably at a discount, and then arrange renewed debt service on terms adjusted fo r such a discount (see Bartels 1988) . Thi s is, however, a less promising route toward genuine forgiveness because the banks have a right of refusal of sale of the debt at discounts they view as unacceptably large. Th e scheme could be workable if the new institution was designed to operate at a substantial loss , in which cas e it could buy up the debt at fac e value and forgive it partially or in its entirety. Her e the true spirit of magnanimity would be abroad, for both debtors and creditors would be forgiven thei r indiscretions. I n short, the banks would not even get their hands slapped for their imprudential lending. In an alternative scheme , Tarshis would rely on existing institutions, the central banks of each of the creditor nations, to function a s the agent that purchases the debt and then eliminates some percentage of it, perhaps 100 percent, for each country (1988: 23-27). Tarshis 1 forgiveness also is universal in spirit. He woul d compensat e th e commercia l bank s b y havin g th e centra l bank s directly create additional deposits for them. The n the world could get back on the path towar d a condition wher e th e developed countrie s coul d sel l thei r exports to the debtor countries without endangering the latter's capacity to repay the debt. Th e debtors woul d no t all be scrambling agains t on e another fo r market shares merely to earn foreign exchange to meet debt obligations.6 Trad e and growth could proceed with a certain cosmopolitanism lacking on the debtdriven scene prevailing today. Perhaps it does make sense to spread forgiveness all around in heaping doses to resolv e th e existin g crisis . Forgivenes s an d inflatio n i n th e credito r countries might turn the trick of relieving debt burdens and preventing financial collapse. Bu t tha t stil l leave s ope n th e questio n o f ho w t o preven t th e recurrence of such circumstances in the future. I n fact, although the bankers are in a phase of revulsion from lending to Latin America (and Sub-Saharan Africa, for that matter) they apparently are shifting their focus toward Asia rather than

6. Although , as Robin King observes, "Instead, the scrambling of the LDCs will be replacedby MDCs scrambling to capture market shares for their exports."

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pulling bac k entirel y (Ridin g 1988a). 7 Banker s ar e alway s lookin g fo r customers. The y will seek new ones when the enchantment of older customers fades. I t is simply the nature of the banking beast Unless one accepts the position that the debt crisis was due primarily to bad policies i n LDCs an d unforeseeable externa l shock s (se e Sach s 1987-1988) , then major responsibility must be given to the natural practices of commercial banks. T o keep a debt crisis fromreoccurring bankers must be deprived of what they consider their normal freedoms. This is certainly not an opportune time to cave in to the bankers' clamor to repeal the Glass-Steagall Act, which separates commercial an d investment banking (see Axilrod 1988 ; Litan 1988) . I t is not wise, i n suc h a turbulen t financial environment , t o permi t deposit-takin g institutions t o mov e freel y int o participation o n securitie s markets . Curren t conditions sugges t th e contrary. I t may be time to reevaluate Glass-Steagal l with an eye toward strengthening it—to restore its effectiveness i n light of the potential circumventing operations of commercial bank holding companies and to overcom e it s failur e t o reac h th e offshor e operation s o f th e commercia l banks. It may eve n b e appropriate t o contemplate suc h "impractical " but "ideal" (Axilrod 1988 : 61) proposal s a s th e ol d Henr y Simon s radical-conservativ e proposal o f imposin g 10 0 percen t reserv e requirement s o n deposit-takin g institutions. Regulator s woul d the n hav e t o be vigilant i n ensurin g tha t the managers of such institutions do not devise new labels for accounts that would permit depositors' funds t o be use d as a basis fo r lending. 8 Thei r source of profit would be the fees charge d to depositors for the service of holding their accounts in secure fashions. Thi s is tantamount to making commercial banks behave like medieval goldsmiths. Suc h institutions would not require deposit insurance, for customers would only need adequate legal recourse fromfraud. For those bankers who really wan t "th e adventure of banking"—which s o many see m t o want—the y coul d operat e institution s tha t mad e loan s bu t obtained thei r funds exclusivel y b y issuin g equit y i n thei r operations. Suc h institutions should not receive public-sector insurance, because they would be in a sense tru e venture capital operations . Unde r th e scheme the y woul d be truly free—fre e o f th e mundane retail bankin g duties , free t o do investmen t banking with minimal supervision , and free to shoulder the high risks and to reap the high returns. 7. Se e Chapter 4 by Lissakers and Chapter 5 by Sacks and Canavan, where it is argued that a general pull-back has occurred. 8. On e evasio n tha t regulators woul d hav e to be aler t abou t is th e relabelin g o f depositors ' accounts as equity accounts.

IS TO FORGIVE THE DEBT DIVINE? 2 4

1

While makin g investmen t bankin g a venu e fo r unparallele d excitement , commercial bankin g shoul d be mad e as boring a n enterpris e a s man y o f u s grew u p believing i t was before adulthoo d shattere d our illusions. No w w e know that bankers are not reluctant to part with our money. I n fact they will part with ou r money before the y actuall y receiv e it , because thei r loans are many multiple s o f deposit s i n place , a s wel l a s anticipate d deposits . I f commercial banking can be transformed into a truly dull activity, it would be an outcome o f th e internationa l deb t crisis tha t is trul y divine . I t will b e a moment for the angels of finance, rather than the demons.

n

FOREIGN LENDIN G AT TH E BRIN K Michael P. Claudon

Is th e world debt situatio n a temporary liquidit y proble m o r a debt crisis o f major proportions? Wringin g our collective hand s over the U.S twi n deficit s (federal governmen t budget and trade) is very much in vogue of late . Thes e deficits are highly visible, close to home, and relatively easy to perceive. LD C debt, by contrast, is a distant, poorly understoo d problem betwee n som e tiny countries and isolated U.S. banks. I n the halls of Congress and on Main Street USA, globa l deb t i s viewe d a s a curiosum, unrelate d and nonthreatening t o American economic well-being, that will sort itself out in time. Nothing i s furthe r fro m th e truth. Ove r 1,50 0 U.S . bank s (mor e tha n 1 0 percent of tota l U.S . banks) , operating i n every stat e of th e union, extende d loans either directly or indirectly t o Latin America. Ban k income statement s and balance sheets are losing credibility. Ban k stocks have been consistentl y selling on Wall Street for less than their stated book value, making it harder for them t o acquir e ne w equit y capita l an d als o harde r fo r the m t o satisf y th e financing need s o f a robust U.S. economy . Th e debt problem i s a profound social an d economi c crisi s tha t ha s alread y take n a hug e tol l o n U.S . rea l incomes, jobs, exports, and banks. I t has fostered austerity, strangled economic development, and caused incalculable political, human, and economic misery in the Third World. Muddling throug h on a case by case basis promises dire consequences fo r U.S. commercia l bankin g institutions , an d fo r th e globa l econom y a s well . 243

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The post-World War II economic boom is over. Globa l growth in the 1990s is unlikely t o matc h tha t of th e 1950 s an d 1960s . Continuatio n o f balanc e o f payments and market liberalization conditionall y policie s wil l no t contribute to enough meaningful growt h in the South to offer a reliable debt resolution. Structural adjustment , a s traditionall y conceive d an d execute d b y th e multilateral institutions (the IMF and the World Bank), needs to be reassessed and redirected in light of the realities of the next decade. Th e IMF and World Bank nee d t o revie w an d redirect lendin g program s t o promote growt h an d development rather than focus singularl y on balance of payments and internal relative price issues. LDCs mus t develo p a growt h strateg y fo r th e 1990 s consisten t wit h anticipated globall y declinin g growt h rate s an d th e South' s long-ter m basi c needs. Abov e all , LDC domestic investmen t spendin g mus t be dramaticall y increased, it s targetin g an d sequencin g brough t int o greate r harmon y wit h individual economies, and its pace, scope, and timing improved. Countrie s in the South mus t develop industrializatio n strategie s consisten t wit h thei r own needs and resource-labor mixes. Unfortunately , new lending from banks of the North, desperately needed to service debt and finance internal growth, declined precipitously after 1983 , until by 198 6 it had completely dried up. Th e debtors lost creditworthiness in the banks' eyes. Her e is strong evidence of how fruitless efforts t o devise credit packages between th e banks and debtor countries have been. Executing suc h a growth strateg y i s al l bu t impossibl e unti l developin g debtor countries' interest liabilities are comfortably within net export earnings. The $3 0 billio n t o $5 0 billio n i n desperatel y neede d financia l resource s currently bein g transferre d t o th e Nort h eac h yea r ar e quickl y depletin g investment spendin g an d debto r LD C growt h potential . Althoug h eac h country's situatio n tend s t o be unique , all debtor s shar e on e commo n need : interest liabilitie s mus t b e discounte d t o th e minimu m politicall y feasibl e levels. Th e ke y elemen t i n resolvin g th e crisi s i s tha t privat e bank s an d multilateral agencies officially an d explicitly recognize that their loans will not be completely repaid. In this chapter, I argue that some form of public intervention is an essential ingredient of a long-term resolution strategy because private banks are unlikely to voluntarily accomplis h th e requisite debt-discounting. Th e policy chang e must come fro m Washingto n i n cooperation wit h othe r OECD countr y gov ernments, the IMF, and the World Bank.

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245

ORIGIN When and why did foreign loans "go bad?" The Internationa l Monetar y Fun d (IMF ) wa s abou t t o conven e it s annua l meeting i n Toronto, Canada , when , i n August 1982 , Mexic o shocke d th e financial communit y b y declarin g itsel f unabl e t o mee t it s deb t service obligations. Brazi l and a host of other major borrowers quickly followed suit. Those declarations pushed the world banking system to the brink of financia l chaos. Foreig n lending was on trial.1

University o f Nort h Carolin a economis t Willia m Darity , Jr . ha s argue d persuasively tha t the deb t explosion an d LDC overborrowin g ma y no t hav e been totall y benign . Di d privat e bank s o f th e North , especiall y larg e U.S . money cente r banks, push bad loans on LDCs? Di d they offer credi t lines at interest level s unsupporte d b y pruden t risk analysis ? Di d the y imprudentl y lengthen maturitie s and offer unjustifiabl y larg e loans? I n other words, have the big banks victimized themselve s by making absurd lending decisions and advancing credit to foreign borrowers having less than a prayer of repaying? . . . [B ] ankers as loan pushers become active door-to-door salesmen (albeit in pinstripe suits). The y persuade borrowers to agree to credits when borrowers have n o thought s o f obtainin g a loa n a t all , o r a t least no t a larg e one . Moreover, fro m this perspective, i n euphoric times (suc h a s the late 1970 s and very early 1980s ) banks will sell loans to borrowers in regions they [the banks] customarily leave alone.2

The early phases of explosive private bank lending to developing countries were intoxicating for all participants. Th e loans promised handsome returns to banks in the North and much needed development funds to LDCs of the South. A life-threatening post-party hangover began with Mexico's default in August 1982, and it continues unabated today. LDCs' external debt increased 400 percent between 197 2 and 1979, primarily in the form of loans from private banks. However , largely because of successful expor t programs and low interes t rates, only fiftee n developin g countrie s were i n arrear s o n paymen t o f externa l deb t i n 1975 . B y th e en d o f 1981 , thirty-two countries were having problems making payments on time. Disaste r struck i n 198 2 whe n U.S . interes t rates , and subsequentl y thos e charge d o n commercial ban k loans to LDCs, skyrocketed. Th e twenty-four majo r debtor 1. Qaudo n (1985: xix). 2. Darit y and Horn (1988 xii).

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LDCs shipped $37 billion in interest payments, money desperately needed for local development, to the U.S. and Europe that year. U.S . banks alone had lent $99 billion, 14 9 percent of their total worth , to these countries. Argentina , Brazil, and Mexico borrowed $52.4 billion, 84 percent of th e banks' worth. Incredibly, these three countries had managed to borrow $31 billion from the nine largest U.S. money center banks. Wors e yet, these same banks lent $60.3 billion, 222 percent of their combined worth, to all non-OPEC LDCs. Interest Rate s When debt servicing problems first emerged, interest rates were significantl y lower than they have been in recent years. I n the United States, where most LDC deb t i s held , nomina l interes t rate s ros e faste r tha n inflatio n rates , resulting in a significant upward trend in real interest rates applied against most LDC debt. U.S . money center banks responded t o the trend and increasing volatility o f U.S . interes t rate s wit h floatin g rate s o f interes t o n deb t extensions, rather tha n on continuing th e practice o f havin g a fixed rat e of interest appl y durin g th e ter m o f a loan. 3 Banker s insiste d o n passing th e interest rat e risk of financia l intermediatio n from lender t o borrower. Th e LDCs, however, could not afford to absor b interest rate volatility during the protracted upswing of interest rates in the United States. Dollar Appreciatio n Real U.S. interest rates rose relative to real interest rates in other industrialized nations, causing significant appreciation of the U.S. dollar against other major currencies. Sinc e most commodity prices in world markets are quoted in terms of dollars , appreciatio n i n exchang e market s increase s th e rea l cos t o f commodity purchases by countries whose currencies have depreciated against the dollar. Suc h cost increases tend to dampen commodity demands over an extended period of time, which can either depress commodity prices or prevent them from rising further. An LDCs ability to meet its external debt servicing obligations is first and foremost constrained by its net export earnings, particularly when the debt is denominated i n foreign currencie s (mainl y th e U.S. dollar). LDC s tend t o concentrate o n ra w material s an d agricultura l exports , commodities whos e 3. Se e the discussion of the impetus to floating rate s in Chapter 9 by Epstein.

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247

markets ar e insensitiv e t o falling prices . Whe n th e dollar pricing o f com modities is depressed by dollar appreciation, the value of LDCs* net exports often declines , even whe n th e volume of ne t exports rises. Accordingly , a rising dollar in currency exchange markets increases the difficulty o f LDC debt servicing. Indeed , increase d strengt h o f th e U.S. dollar i n th e early 1980 s triggered widespread defaults on LDC debt held by American banks. Rescheduling Deb t Default s Every one of the banks appearing in Table 17-1 , and each of the countries in Table 17-2 , was in dire straits in 1982 , especially after Mexico' s default wa s quickly matche d by Brazil and Argentina. U.S . banks, the IMF, the World Bank, and the United States government have responded to chronic post-1982 reschedulings, interes t paymen t moratoria , an d growin g threat s o f deb t repudiation wit h a cas e b y cas e crisi s managemen t posture . Regiona l policymakers hav e trie d mos t o f th e orthodo x approache s t o balanc e o f payments and debt management. Ever y combination of muddling through, debt rescheduling, and North-inspired LDC austerity has been tried. Rescheduling LDC debt added accrued interest on default to the principal amount due, causing the total volume of outstanding LDC debt to rise, even though no additional funds were advanced to LDCs. U.S . interest rates have declined significantly fro m thei r peak in 1981 , but interest payments due on LDC deb t hav e remaine d ver y hig h becaus e o f th e risin g amoun t o f deb t incurred fro m rescheduling . Moreover , while the dollar's foreig n exchang e value ha s decline d substantiall y sinc e 1985 , commodit y price s hav e no t rebounded much from previousl y depressed levels. A s a result, a number of LDCs have and are facing annual interest obligations substantially in excess of their net export earnings.4 Years o f negotiation s an d myria d structura l adjustmen t program s hav e produced little beyond a widening feeling of debt fatigue. Wit h few exceptions, orthodox polic y ha s barel y hel d impendin g political , social , an d financia l disaster a t bay. Debto r LDCs are now facin g interes t payment s greatl y in excess of their net export earnings. Deb t repudiation, defaults (such as Brazil's unilateral suspension of interest payments on some commercial bank loans in 1987), and a debtors' cartel are looming on the horizon. U.S . banks have been

4. I n several widel y publicized cases , the net export positions o f LDC s are valued a t slightl y more than half the annual interest due on debt.

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Table 17-1 . Exposur e o f U.S . Banks t o Si x Trouble d Developing Countries, 1984 ($ Billions, Percent)

Institution Tota Bank of America Citicorp Chase Manhattan Manufacturers Hanover Morgan Guaranty Continental Illinois*5 Chemical Bankers Trust First Chicago First Interstate Security Pacific Wells Fargo Nine Money Center Banks

l Loans Stockholder 7.8 12.5 7.4 7.8 4.9 2.4 4.6 3.3 2.4 1.5 1.6 1.7 53.2

Total as a Percent of s Equity* 150.9 206.7 212.7 268.5 143.3 129.9 196.7 177.6 126.9 70.8 88.8 129.8 179.2

a. Include s common and preferred. b. Continenta l Illinois has since gone bankrupt . Source: Pool and Stamos (1987: 82).

accumulating loa n loss reserves t o help cover possible defaults , i f an d when they begin. Som e banks have been able to unload their LDC loans, albeit at discounts rangin g from as hig h a s 4 0 percen t o f loa n fac e values . Perhap s banks' creative financia l gymnastic s ca n hol d of f th e crisi s fo r awhile , bu t stopgap strategie s affec t symptoms , not causes. The y certainl y d o not make banks or business communities they serve any healthier. The popular view notwithstanding, developing debtor countries will not (and cannot) trad e thei r wa y ou t o f deb t troubles . Mos t larg e debtor s realize d substantial export gains during the early 1980s , but debtors' export growth rates turned negative in 1985 , reaching over 4 percent per year by 1987 . Th e very success o f thes e expor t drive s ha s begu n t o wor k agains t th e LDCs . Th e United State s ha s been runnin g a $13 billio n annua l trad e deficit wit h Latin America since 1982 . Th e Omnibus Trade Bill bristles with new impediment s to expanded LDC exports to the United States , their largest customer. Lati n American commodity imports have been cut in half since 1981.

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Table 17-2 . Financia l Resourc e Balanc e ($ Billions, Percent)

Financial Resource Balance Compared to War Reparations of Germany an d Franc e

Latin Americ a Year Total 1978 1979 1980 1981 1982 1983 1984 1985

a

10,327 6,628 5,070 5,582 -22,419 -38,537 -38,345 -39,627

Country/Period

Balance/GNP Balance/Export

Germany (1925-1932) France (1872-1975) Latin America (1982-1985) Argentina Brazil Chile Colombia Costa Rica Ecuador Mexico Peru Uruguay Venezuela

2.5 5.6 5.3 5.6 3.3 4.8 0.1 6.3 3.8 7.4 1.7 0.4 11.7

s

13.4 30.0 32.5 38.2 28.9 21.7 1.1 16.7 16.5 40.0 9.4 1.7 42.3

a. A negative entry means that financial resource s are flowing from Sout h to North. Source: Devlin (1987).

The danger in the present situation i s tha t banks and LDCs can fal l int o a war of attrition , grinding eac h othe r down i n a n effort t o gai n a negotiatin g advantage. A t some point, that struggle could turn into a mutual suicide pact, crippling both banks and LDCs (Robinson 1988 : 7).

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5

The future is not bright if debt rescheduling and muddling through continue to be th e onl y financia l tool s use d t o addres s th e LD C deb t problem. 6 Th e 5. Thi s proposa l wa s originally conceive d b y Robert A . Jones, Chairma n o f the Board , Geonomics Institute for International Economic Advancement. 6. Th e rescheduling o f LDC deb t must not always mandat e repaymen t of principal. I n most instances, paydowns on LDC debt are completely beyond any possibility. Indeed , it is the inability to service interest payments on LDC debt, not the impossibility of paying down LDC debt, that has required many large banks to write off LDC debt from their balance sheets and reported income.

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situation promises t o worsen throug h tim e an d portends a banking crisi s (o r collapse). T o make matters even worse, there appears to be a widespread notion that LDC s mus t someho w reduc e thei r nationa l deb t whe n industrialize d countries are not expected to reduce theirs (and, in fact, sometimes continue to rapidly expand their national debt because of fiscal deficit financing). Demand s from internationa l lending organizations that LDC governments raise taxes and cut government spending are not only politically unacceptable, but they smack of imperialism. Demand s for tighter fiscal policy, greater wage restraint, and lower inflatio n ar e intended t o raise th e LDC net export earnings t o servic e huge interes t liabilities , an d t o achiev e thi s en d b y limitin g LD C livin g standards. I f IMF and World Bank conditionality demands were fully met, an economic crisi s migh t b e temporaril y averted , bu t onl y a t th e expens e o f creating a much more damaging political crisis. Now is the moment to consider bold, new, comprehensive policy initiative s involving som e for m o f deb t servic e forgiveness , o r some sor t of ne w inter national institutio n tha t ca n ameliorat e th e curren t exposur e situation . I t should also provide adequate new lending to LDCs so they can regain their prior growth levels, and facilitate adjustmen t of debt service requirements so as to guarantee these will remain within debtors' net export earnings. Given th e benefi t o f hindsight , i t appear s no w tha t competitio n amon g major bank s fo r LD C loa n busines s encourage d the m t o overloo k pruden t lending standards. Credi t became excessively availabl e to LDC officials wh o had seemingly insatiable desires to employ more capital within their countries. LDC externa l deb t volum e increase d muc h to o rapidl y relativ e t o financia l resource constraints . I t soon becam e ver y difficul t fo r man y LDC s t o meet their debt service obligations, their debt in terms of interest payments, and the contractual reductions in outstanding principal. U.S. ban k reclassificatio n o f LD C deb t t o nonperformin g loan s ha s seriously impaire d th e capital positio n o f larg e mone y cente r banks. Write downs of the LDC debt have also begun to reduce the general level of depositor confidence i n the American banking system. I n the equities market for bank stock (shares) there are daily rumors about whether all problem loans of large banks are being rigidly monitored by banking regulators or properly reported on accounting statements released by the large banks. I n some instances, there is speculation tha t proper reporting o f proble m loan s migh t result in write-off s that could exceed the capital position of several large banks. U.S. thrif t an d bankin g institutio n regulator s hav e lon g bee n concerne d about potentially inadequat e fundin g fo r deposit insuranc e programs. I f the officials administerin g these programs were to ask Congress for full funding of potential deposi t insuranc e liabilities , th e hug e su m likel y t o b e requeste d

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would shoc k an d frighte n th e American people . I f funde d b y Congress , it would greatly enlarge the federal government deficit I t is therefore suspected that banking regulators do not want to force large banks to write down all LDC debt that might be questionable, or the related reduction of bank capital might further scare depositors and create a need for emergency funding of deposit insurance programs. Underlying Assumption s LDC interest payments on debt must be reduced to within reasonable net export limits o r deb t reschedulin g wil l continu e t o inflat e th e principa l o n whic h interest i s payable an d wil l soon push interes t defaults u p to 50 percent on interest due. Achievin g a reduction in interest payments will avert a crisis and stabilize the debt situation. Th e only way to achieve lower interest payments is to substantially reduce the interest rate applied to LDC debt THE PROPOSA L The interes t rat e reductio n ca n b e initiate d b y th e U.S . Congres s i n th e following manner: 1. Congres s can enact a law authorizing the U.S. Treasury to guarantee LDC debt held by American banks. Unde r such a law, American bankers could petition the Treasury for the LDC debt guarantee provided that a petitioning bank agrees to price the guaranteed debt according to a legislated formula . The formula would allow pricing of guaranteed debt at about one percentage point more than the average cost (excluding administration and marketing) of demand deposit funds at an average bank. Unde r present circumstances, the intent of the pricing formula would be the calculation of a lending rate of 5 percent, perhap s a s muc h a s 5. 5 percent . Th e formula migh t also include marginal as well as average cost and all or part of savings passbook account cost 2. Congres s ca n direc t curren t an d supplementa l fundin g o f internationa l lending organizations to assume roughly half of the interest payments due on guaranteed LDC debt Suc h funding could reduce interest rates payable on LDC debt to 2.5 percent, which shoul d reduce LDC interest payment liabilities comfortably belo w ne t export levels . Congres s shoul d extend discretion to administrators of this funding. Suc h power to fund or not fund

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guaranteed LDC interest payments should not be linked with any demands on LDC s regardin g fisca l an d other governmenta l policies . Instead , th e discretion to fund should be based on debt-level monitorin g of each LDC. The interest program enables LDCs to pay down debt, but this should not be a condition o f funding . Deb t levels shoul d be allowed t o increase, but only if interes t payment s remai n comfortabl y withi n ne t expor t values . Congress might want to give administrators additional authority to vary the interest funding proportion based on general financialcriteria it establishes. 3. Banker s who successfully petition the Treasury for a loan guarantee will be able to reclassify loan s back to a performing status , which of course helps boost reported profits and the capital position of the bank.

EVALUATION Most o f th e initia l congressiona l reactio n t o th e proposa l i s likel y t o b e negative. Member s o f Congres s ma y b e politicall y uncomfortabl e wit h proposals appearing to remove the American bank stockholder's loss risk from the LD C deb t crisis . Ye t Congress , throug h it s fundin g o f internationa l lending organizations , i s alread y helpin g th e ban k shareholder , albei t onl y temporarily, accordin g t o thi s analysis . I n effect , ther e i s currentl y publi c intervention in the debt crisis on a massive scale through the World Bank and the IMF. Bu t this intervention is poorly planned and leads to no solution. Th e proposal outline d i n thi s chapte r woul d no t initiat e publi c intervention — intervention is rampant—it would result in effective intervention. Moreover, whil e th e public ma y vie w th e suggested legislation a s a bank bailout, th e Washington bankin g lobb y wil l initiall y reac t very negativel y t o the proposed reduction of LDC lending rates from prime-plus to a percentage point above their lowest cost of funds . Obviously , potential interes t earnings of participating banks will be reduced, but not as much as will occur without some resolution to the LDC debt crisis. I f the banking lobby is vocal this may be to the good, for the legislation will look to the public less like a bailout for large banks. If there is no protection for large banks in the form of a guarantee, it can be argued that Congress will be forced to bail out the Federal Deposit Insurance program (an d th e ban k shareholder ) fo r a considerable su m o f money . O f course, the public might well complai n about funding LDC interest payments on debt . Ye t if al l default s ar e permitted, th e America n publi c wil l b e th e biggest lose r o f all , an d at a very heft y price . Th e legislation migh t appear one-sided in favor of LDCs, but it is not. Administrators ' financial oversigh t

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responsibility t o the interest funding hold s an enormous club over LDCs, one which shoul d b e use d wit h prope r discretio n fo r benefi t t o al l concerned . Threats of deb t boycotts ar e currently ver y serious , but would surel y vanis h under the suggested plan. The capita l strengthenin g o f th e bankin g syste m achievabl e throug h reclassification i s precisely what is needed now. Suc h banking benefits shoul d be provided at the cost of stric t loan reviews b y the Federal Reserve Syste m prior to Treasury actio n o n the guarantee. Throug h a strict loa n review , al l nonperforming and questionable loans could be properly accounted for, perhaps offsetting muc h of th e benefit t o bank capital structure s provided by th e loan guarantee. Suc h loan review nonetheless will help restore public confidence in the banking system. It i s doubtfu l tha t banks holdin g LD C deb t wil l refus e t o appl y fo r th e federal guarantee. Th e cost of applying a lower lending rate is far less than the cost of default , an d the interest cos t i s likel y t o be offse t b y profits accrue d from loan upgrading. I n addition, with a government guarantee, bankers could probably issue marketable LDC certificates from a pool of LDC debt. Suc h an underwriting woul d broade n LD C deb t ownershi p and , mor e importantly , provide American bankers with a needed new source of liquidity.

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INDEX

Adjustment, structural. See Structural adjustment Adjustment program, objective of, 2 8 Africa (see also individual countries) debt repayments as reparations, 6263 depression in, 41-42 GDP in, 1 0 intransigence of the debt crisis in, 30-31 migration in, 177-8 9 output per capita, 8,9,1 0 perceptions of the debt crisis in, 203-4 structural adjustment and, 175-76 Sub-Saharan adjustment policies in, 30-36 development policies in, 92 economies of, 30-3 4 food supplies in, 92 growth in, 92 income per capita, 24

transfer of financial resources and, 14 , 15, 16 Agriculture growth in, 16 and pricing policies in Tanzania, 182-86 American Express, 238 Andean Pact, 61 Argentina (Argentine Republic) buyback of debt by, 217 capital flight from, 24 debt and, 14n.l 6 debt rescheduling by, 85,123 debt service, costs of, 21 3 default by, 247 exchange rates in, 209 financial resource s of, 24 9 PBL and, 138 political change in, 170-71 productivity per capita, 172 solvency of, 17 2 tariff barriers in, 135 n. l

271

272 INDE

X

trade structure of, 4 unemployment in, 26 wages in, 159 Asia growth in, 9, 16 , 91-92 output per capita, 8, 9 Australia deregulation in, 70 trade structure of, 4 Baker, James A., Ill, 14 , 14 n.16, 78-79,80,131,139,200,201, 204 Baker Plan (Initiative), 30,73,7879,80,85, 11 2 n.8 criticism of, 200 , 201, 216 Balance of payments Kenyan, 38-39 viable, 23 n. 2 Bangladesh, trade structure of, 4, 4 n. 2 Bank of America, 71, 236,248 Bank of Boston, loan write-downs by, 81 Bank of England, 71 Bankers Trust, 248 Banking merchant, effect of, on foreign loans, 79 monopoly in international, 49-55, 152-53, 15 3 n.1 2 Banking Committee, testimony before, on the LDC debt crisis, 195-97 Banks, commercial U.S. (private) and costs of debt relief, 30 effect of debt forgiveness on, 234 effect of writing down LDC debt on, 25 0 exposure of, to the Latin American debt crisis, 243, 247, 248 foreign loans made by, 68 lending policies of, 4 7

monopoly of, 49-5 5 program financingby, 133-35 regulations for, and loan policies, 240-41 repercussions of failure of, 235-3 6 reserve requirements of, 240 responsibility of, fo r LDC debt crisis, 235 shortcomings of as sovereign lenders, 200-201 size of, and competition for sovereign loans, 76-77 as venture capitalists, 240-41 Bauer, Lord Peter, 6-7 Belgian Congo, wages in, 176 Berg, Elliot, 17 6 Bias in debt renegotiation, 153-54. See also Banking, monopoly in urban, in structural adjustment policies for Africa, 176-77,188 91 Bolivia, 1 4 n.16, 12 3 debt service, costs of, 21 3 discounted debt of, 23 6 exports from, 211 political change in, 166 unemployment in, 16 0 Bradley, Senator Bill, 197 Brady, Senator Nicholas, 204 n.2 Brazil, 1 4 n.16,123 ability to service debts of, 116 , 117 capital flight from, 24 n.3 debt-equity swaps and, 217 debt repayment by, 72 debt service, costs of, 21 3 default by. See Brazil, moratorium of development in, 11 effect of oil prices on, 43, 211 exports by, 47 n. 9 financial resources of, 249

INDEX 27 GDP of , 1 0 imports into , 13 5 n. l loans for , 6 8 moratorium of , o n debt , 75 , 80 , 81, 233 , 24 7 PBLand,138 political chang e in, 170-7 1 public healt h policies in , 157-5 8 riots in , 16 1 structural adjustment in, 2 8 unemployment in , 26, 16 0 urban migration in , 15 8 wages in , 15 9 Bresser-Pereira, Luiz Carlos, 6 8 Bretton Woods, 44, 52-55,147,148 , 150 Britain, deregulation in, 70 British West Indies, undervaluation in, 12 7 Burden-sharing, as an element of structural adjustment, 104,10 5 Burma, growt h in , 1 2 n.12, 1 7 n.1 8 Cameroon, growt h in , 1 2 n.1 2 Canada, deregulation in, 70 Capital flight, 55 , 209 , 21 3 reversing, 21 8 Capital requirements, and foreig n loans, 7 2 Capital strength , banking, an d divestiture, 8 1 Caribbean output per capita, 9 political costs of structura l adjustment in, 165-66,173-7 4 Central America , exports by, 47 n. 9 Central American Commo n Market , 61 Chase Manhattan Bank, 24 8 Chemical Bank , 24 8 Chile, 1 4 n.16 , 28 , 12 3 debt-equity swa p in, 238 discounted debt of, 23 6

3

financial resource s of, 11 6 n.12 , 249 perception of th e debt crisis in, 19 9 privatization in , 53-54,23 8 public healt h policies in , 15 7 unemployment in , 25, 2 6 wages in , 15 9 China, People's Republi c o f as a developing country , 4 , 6 growth in , 16 , 1 7 n.18 , 12 6 Citibank (Citicorp) , 68 , 71 , 75 , 81 , 84, 24 8 Coffee prices , 3 7 Colombia, 1 4 n.16 , 12 3 financial resource s of, 24 9 GDP of , 1 0 political chang e in , 16 6 trade structure of, 4 unemployment in , 25, 2 6 urban migratio n in , 15 8 Commodity prices , 16 , 21, 208-9 , 211 and the debt crisis, 214 in Kenya, 3 7 Conditionally, 5 6 devaluation in, 12 5 and the disbursement of funds, 97 98 effects of , 153,154-55,25 0 and a multilateral institutio n t o buy back LDC debt , 20 3 andPBL, 133,135-3 6 as policymaking, 15 5 political consequence s of , 167-6 8 principles of , 104 , 15 1 and SALs, 135-37,145^ 6 Congress, United States, and the debt crisis, 195-20 6 proposal fo r amelioration by, 25153 repercussions of forgiveness by , 238-39 Continental Illinoi s Bank , 24 8

274 INDE

X

Costa Rica emergency loan for, 57,61 financial resources of, 249 GDP of, 1 0 growth in, 99 public health policies in, 157 urban migration in, 158 wages in, 92,159 Costs political of the debt crisis, 199-200 of structural adjustment, 165-7 4 transaction, and trade, 143-44 Cote d'lvoire, 1 4 n.16,123 GDP of, 1 0 growth in, 99 Countries developing. See Less developed countries middle income, transfer of financial resources and, 14,14 n.14,1 5 CPEs. See Economies, centrally planned Credit, private, and debt, 14. See also Banks, commercial U.S. Creditworthiness of U.S. commercial banks, 234 of the World Bank, 205 Crisis, social, in Latin America and Sub-Saharan Africa,, 92 Cruzado Plan (Brazil), 170-71 Currency domestic, for debt servicing, 218 foreign. See Foreign exchange reserve, and LDC debt, 43-44 Darity, William, Jr., 245 Debt crisis, 67-68 contributory causes of, 92,93 , 207-216 creditors' responses to, 57-62 effect of, i n the U.S., 197-9 8 origins of, 245-4 9

proportions of, 243-5 3 solutions for, 244, 251-53 Debt-for-debt swap, 80,83 Debt-for-equity swap , 80,216-17, 237-38, 238 n.5 Debt, LDC buyback plans for, 217 effects of repudiating, 233-34 forgiveness of, 233-41 growth of, 15 2 perceptions of, i n the U.S. Congress, 195-20 6 as reparations, 41-63 rescheduling (see also Structural adjustment), 123 Latin American, 247-49 outlook for, 249-50 and reserve currencies, 42-49 and transfer of financialresources, 12-16 Debtor, motivations of, i n the debt crisis, 83-84 Debt service in domestic currency, 218 effect of, on the debtor's economy, 212 equable, 244 Latin American, effect of, on world financial markets , 227 as a percentage of GNP, 153-54 proportions of, 245-4 6 proposed moratorium on exporting, 229-232 simulation of ability in, 114-1 8 structural adjustment and, 105,10 7 Default effect of on the American public, 252-53 on credit ratings, 216 imminence of, and structural adjustment, 104 in Latin America, 42 as a policy, 42 n.3

INDEX 27

Deficit budget, in Sub-Saharan Africa, 32, 33 current account, 22-25 during structural adjustment, 107 Deflation in industrialized countries, 22 and structural adjustment, 61,105 Deindustrialization as a consequence of structural adjustment, in Tanzania, 190-91 in Sub-Saharan Africa, 34 deLarosifere, J., 53 Demography, structural adjustment and, 156-58 Deposit insurance, inadequacy of, 250-51 Depository Institution s Deregulation and Monetary Control Act, 70 Depression in Africa, 41-42 in Latin America, 41-42 Deregulation in the international financial markets, 69-70 in Latin America, 27 in U.S. banking, 7 0 Destabilization, political in Latin America, 225-26 and structural adjustment, 160-61, 163 Devaluation effectiveness of, 12 6 as "exchange rate adjustment," 12530 in Latin America, 25,26, 28 moral issues in, 13 0 and structural adjustment, 59-60, 94-95, 106 , 10 7 in Sub-Saharan Africa, 32-33 successful, 128-2 9 in Tanzania, 188,19 0

5

Development, economic discussed, 5-7 outlook for, in developing countries, 3-19 and structural adjustment, 223-32 Disclosure, public, of foreign loans, 72 Disinflation, in Mexico, 219-20 Divestiture, from sovereign loans, 75-87 DMEs. See Economies, developed market Dollar, U.S. appreciation of, and debt servicing, 246^7 depreciation of, and foreign debt, 79-80 as a reserve currency, 44,150-51 Dominican Republic GDP of, 1 0 political change in, 166 "Dutch Disease" in, 128 Economies centrally planned (CPEs) growth rate in, 9 output per capita, 7, 7 n.7, 8 developed market (DMEs) compared with LDCs, 10,1 0 n.10 growth rate in, 9 output per capita, 7, 8 Ecuador, 1 4 n. 16,123 financial resource s of, 24 9 GDP of, 1 0 moratorium on debt service by, 81 political change in, 166,17 3 Efficiency, in structural adjustment, 94 Ellis, Frank, 18 5 Employment declines in, 160 growth of, i n Latin America, 16 0

276 INDE

X

in Sub-Saharan Africa, 30,3 1 Eurodollars, and program financing, 133-34 Europe, Eastern, 4 output per capita, 7 n.7 Exchange control, as socialized private debt, 53-54 Exchange rates "adjustment" of. See Devaluation pegging, 12 9 regulation of, 14 8 and structural adjustment, 95 and the world economy, 144-45 Exports and devaluation, 126,127,128-2 9 and economic shocks, 23 and growth, 16 inadequacy of, to finance debt servicing, 248 from Kenya, 36-37 Latin American, 25, 29-30,47,4 7 n.9 and structural adjustment, 94,95, 99,107-8 from Sub-Saharan Africa, 33 Falkland (Malvinas) War, 68 FDIC. See Federal Deposit Insurance Corporation Federal Deposit Insurance Corporation (FDIC), 235, 252 Federal Reserve System, 238 loan review by, 253 Finance, international market, and structural adjustment, 67-73 First Chicago Bank, 248 First Interstate Bank, 248 Food as aid, 101 production of in Kenya, 37-38 in Zambia, 36 n. 12

Foreign exchange controls on, and structural adjustment, 106 importance of, 2 8 reallocation of, t o stimulate Latin American economies, 229-32 France, reparations paid by, 62,249 Free market orthodoxy of, 60-6 2 andPBL,138 Garcia, Alan, 119,16 7 GATT. See General Agreement on Tariffs and Trade GCI. See General Capital Increase GDP. See Gross Domestic Product General Agreement on Tariffs and Trade (GATT), 149 General Capital Increase (GCI), of the World Bank, 203-6 Germany, reparations paid by, 62, 249 Germany, Federal Republic of bank regulations in, 82 deregulation in, 70,71 hidden banking reserves in, 82 and oil prices, 42-43 Ghana growth in, 99 measure of success in, 93 Glass-Steagall Act , 70, 79 n.l, 24 0 GNP. See Gross National Product Gold standard, 150-51 Greece, as a developing country, 4 Greenidge, Carl, 125 Gross Domestic Product (GDP) declines in, 10 growth in, 11-1 2 and structural adjustment, 99 Gross National Product (GNP) decline in, in Latin America, 25 growth of, 21 1

INDEX 27

Group of 77, 4 Group of Seven, 19 Growth, economic deterrents to, 220 and development policy, 7-12 inhibition of, b y structural adjustment, 105 in the LDCs, 91-92 model for, 143-4 4 patterns in, 16-18 per capita, 9 slowdown in, 10 , 21 and structural adjustment, 60-61, 110-12, 11 2 n.8 in U.S., 4 6 Guatemala, GDP of, 1 0 Gulf States, oil from, 47 Guyana SALS for, 13 6 sectoral adjustment loans for, 137 Haiti, 123 , 16 1 Havana Charter (1948), 149 Health, and public expenditures, in Latin America, 157-5 8 Honduras, 123,16 6 Hong Kong development in, 11 growth in, 1 2 n.12, 1 7 n.18, 12 6 Hyperinflation, 210,21 3 IDA. See International Development Association IDB. See International Development Bank IFC. See International Finance Corporation M . See International Financial Institutions Illiquidity, and sovereign loans, 78 ILO. See International Labour Office IMF. See International Monetary Fund

7

Immigration, illegal, int o the U.S., 158 Imports foreign currency for, 229-30 into Latin America, 26-27 into Sub-Saharan Africa, 34 substitution in , 95 Income declines in, and structural adjustment, 158-6 0 distribution of, and adjustment policies, 35 per capita, 24 in Latin America, 24, 159 , 165, 210 as a measure of development, 3-4 India, growth in, 16, 1 7 n.18 Industrialization, as a policy, in Latin America, 225 Inflation domestic, and structural adjustment, 95 and growth, 17 in Latin America, 24,2 6 in Mexico, 219 and structural adjustment, 59,10 6 in Sub-Saharan Africa, 32 Institutional Investor, 13 5 Institution, multilateral, to buy back LDC debt, 201-3,217-18,23 9 Institutions, weakness in, and structural adjustment, 101- 2 Inter-American Development Bank, function of, 5 5 Interest rates, 46,46 n.8,48-4 9 debt servicing and, 246 and Eurodollars, 134 and Latin American debt crisis, 6768,211,214 in Mexico, 220 proposed regulations on, for LDC debt, 251-52,253 real, 21-22

278 INDE

X

and structural adjustment, 97,10 8 International Bank for Reconstructio n and Development. See World Bank International Coffee Organization , 37 International Debt Managemen t Authority, 85 International Developmen t Association (IDA) , 148 International Development Bank (IDB), sectoral adjustment loans from, 13 7 International Finance Corporatio n (IFC), 148 International Financial Institution s (Ms), 13 2 International Labour Office (ILO), World Employment Programme, 6 International Monetary Fund (IMF) and Africa, 30 classification of developing countries by, 4 conditionality policies of. See Conditionality economic development and, 5 and economic restructuring, 92-93 establishment of, 14 7 free market orthodoxy of, 61-6 2 function of, 55,147-48,15 1 postwar lending by, 145 on privatization, 52 replenishment funds for, 195-96, 252 SDRs of, 43 , 150 , 203 and structural adjustment. See Structural adjustment International Trade Organization (ITO), 147,14 9 Internationalization, effect of, 154 , 156 Investment, stimulating , 219 in Latin America, 229-30 Ireland, per capita income in, 3-4 Israel, as a developing country, 4

ITO. See International Trade Organization Jamaica, 99,123,17 3 Japan bank regulations in, 82 as a capital exporter, 69 deregulation in, 70-71 hidden banking reserves in, 82 oil prices and, 42-43 Kaufman, Henry, 71 Kenen, Peter, 201, 217 Kenya adjustment policies in, 36-39 economy of, 3 9 employment in, 31 food production in, 37-38 GDP of, 1 0 revenue in, 31 King, Robin, 238 n. 4 Korea, Republic of debt of, 43 development in, 11 exports from, 99 growth in, 1 2 n.12, 1 7 n.18, 99, 126 Kuwait, per capita income in, 3 Labor devaluation as exploitation of, 13 0 effect of structural adjustment on, 105, 10 6 New International Division of , 148, 154 , 15 6 LaFalce, John, 201 Latin America debt crisis in, 67-68,93 debt rescheduling in, 247-49 debt service in, 153-54,155,22 7 simulation of ability to provide, 114-18 default in, 42, 51

INDEX 27

deficit in, 24-25 depression in, 41-42 deregulation in, 27 devaluation in, 25, 26, 28 development policies in, 223-26 employment in, 25, 26, 28 exports from, 25, 29-47,47 n. 9 financial resource s of, 247,24 9 imports into, 26-27 income per capita, 24, 159,165 , 210 industrialization policy in, 225 inflation in , 24, 26. investment in, 229-30 market liberalization in, 27-28 migration in, 15 8 output per capita, 8,9,1 0 and PBL, 138-14 0 political outlook for, 173-74 , 19899,225-26 population growth in, 56-57 structural adjustment in, 24-30, 165-74 U.S. policy toward, 198 wages in, 25, 27 LDC. See Less developed countries Lending policy-based (PBL) Baker on, 131-32 focus of, 136,13 8 history of, 131-4 0 in Latin America, 138-4 0 structural adjustment (SAL) (see also Structural adjustment) conditionally in , 57 defined, 132-33 effects of, 15 2 focus of, 136 , 137-38,151-5 2 growth of, 13 6 voluntary, to Latin America, 215 Less developed countries (LDCs) development strategies of, and the debt crisis, 92

9

effect of devaluation on, 125-30 external debt of, 245-4 6 growth in, 3-19, 91-92, 244 and the international financial markets, 71-73 productivity in , 7, 8, 13 0 transfer of financial resources in, 12-14 Lewis, W. A., 12 7 Liberalization (see also Deregulation) market, in Latin America, 27,2 8 and structural adjustment, 106,10 8 Liquidity excess domestic, in Africa, 31 and PBL, 138 and sovereign debt, 80-81, 85,86, 236, 25 3 Loan forgiveness of, a s a policy, 234-35 policy-based. See Lending, structural adjustment program. See Structural adjustment reclassifying, under U.S. Treasury guarantees, 252,253 sectoral adjustment, 137 sovereign, 75 competition in the market for, 76-77 divestiture from, 75-87,80-84 freezing of , 77-80 syndication of, 7 6 and U.S. capital reserves, 81 and the U.S. government, 84 Structural adjustment lending (SAL). See Lending , structural adjustment Madagascar, revenue in, 31 Malaysia, growth in, 1 7 n.18 Malnutrition, and the debt crisis, 92 Manufacturers Hanover Bank, 234, 235, 248

280 INDE

X

Market, international financia l changes in, and sovereign loans , 68-71, 7 5 and public policy, 8 5 Marshall Plan , 145,15 0 Mauritius, growt h in , 31 , 9 9 McNamara, Robert, 6 Mexico, 1 4 n.1 6 bond issue of, 85-86,20 0 buyback o f debt by, 21 7 capital fligh t from, 2 4 debt crisis in, 2 2 debt-equity swaps and, 216-17, 237-38, 23 8 n. 5 debt-for-debt swap in, 8 2 debt service, 213,218-2 1 default by , 75 , 77 , 208 , 216 , 24 7 discounted debt of, 23 6 domestic currency for debt servicing, 218-2 1 exchange rates in, 20 9 exports by, 47 n. 9 financial resource s of, 24 9 GDP of , 1 0 inflation in , 21 9 interest rates in, 22 0 loans for , 6 8 as a member of GATT , 14 9 n. 6 moratorium on debt service by. See Mexico , default b y oil and , 47, 21 1 PBLand, 13 8 political chang e in , 168-6 9 riots in , 16 1 unemployment in , 25 , 26 , 92 , 16 0 urban migration in , 15 8 wages in , 159-6 0 Migration in Latin America, 15 8 urban, in Africa, 177,18 9 Mismanagement, economic , 20 9 Model, vector autoregression (VAR) , of structura l adjustment, 112 ,

114, 11 6 n . l l , 118 , 120-12 2 Morgan Guaranty Bank, 85,237 , 248 Morocco debt and, 1 4 n . l 6 GDP of , 1 0 growth in , 9 9 Mulford, David, 20 0 New Zealand, trade structure of, 4 Nigeria, debt and, 1 4 n.16,1 5 OECD. See Organizatio n o f Economic Cooperation and Development Oil price s and the international financ e market, 7 6 and the LDC debt, 42-4 6 and recession, 6 8 Oman, growt h in , 1 2 n.12, 1 7 n.1 8 OPEC, changing statu s of , 68-6 9 Organization of Economic Coopera tion and Development (OECD ) growth in , 29 , 9 1 imports into , from LDCs , 12 7 lending by , 68, 84-85 , 155-5 6 andtheNIDL, 14 6 Output per capita, 7-8, 10,1 1 Pakistan growth in , 1 2 n.12 , 1 7 n.18 , 9 9 SALs for , 13 6 Panama, riot s in , 16 1 Paraguay, GD P of , 1 0 Paris Club , 104 , 105 , 109 , 155 , 15 5 n.13 PBL. See Lending , policy-base d Pearson Commissio n Report , 5 5 Pemex, 23 7 Peru, 1 4 n.1 6 debt service ability in , 116 , 11 7

INDEX 28

moratorium on, 17 4 economic difficulties of, 10 0 exports from, 211 financial resources of, 24 9 political change in, 167 riots in, 16 1 sectoral adjustment loans for, 137 unemployment in, 25, 26 Petrodollars, recycling of, 43,7 6 Philippines, 1 4 n.1 6 debt service, costs of, 21 3 exports from, 211 growth in, 99 Poland, debt crisis in, 68,77 Policy adjustment. See Structural adjustment, policies of development, and growth, 7-12 incomes and prices, 29 public and the divestiture of sovereign loans, 84-86 and the monopoly of international banks, 52 reform of, and PBL, 140 social, and development, 6-7 trade, and structural adjustment, 2829 Politics and devaluation, 125,127-2 8 and program financing, 134-3 5 and structural adjustment policies in Latin America, 165-74 Population growth , 9, 9 n.8, 10 , 156-57 Portugal deregulation in, 70 as a developing country, 4 Pound sterling, as a reserve currency, 44 Poverty and development programs, 6 and IMF policies, 62 n.32

1

as a selling point, 6-7 and structural adjustment, 35-36, 100-101 in Sub-Saharan Africa, 33-34 Prebisch, Raul, 6 n. 5 Prebisch-Singer hypothesis, 47 Prices, policies on, 96,182-8 6 Privatization and bank debt, 53-54 and structural adjustment, 97 World Bank and, 52 Program, stabilization, 10 5 Program financing by commercial banks, 133-35 policy-based lending as, 133 Protection, effects of tariff, 28 Regulation, of banks, and sovereign loans, 8 2 Reparations France, 62,249 Germany, 62,249 LDC debt as, 41-63 Reserves, banking, and divestiture, 81-82 Resources financial and debt, 12-16 of Latin America, 247,249 use of, i n structural adjustment, 94,97 Risk accounting for default as, 49-50, 76-77, 236, 237 changing perceptions of, 134,13 5 elimination of, b y international banks, 53, 54-55 Robinson, Jim, 217 Robinson, Joan, 13 0 Rockefeller Report, 55 SAL. See Lending, structural adjustment

282 INDE

X

Sarbanes, Paul, 201 Scandinavia, deregulation in, 70 Schumer, Chuck, 19 6 SDRs. See Special Drawing Rights SEC. See Securities and Exchange Commission Securities and Exchange Commission (SEC), 86 Security Pacific Bank, 248 Sen, Amartya, 5 Senegal SALs for, 13 6 wages in, 176 Shock, economic effects of, 21-4 0 and the international financial market, 76-77 Simons, Henry, 240 Singapore growth in, 1 2 n.12,17 n.18,12 6 per capita income in, 4 Soquimich, 238 South Africa, as a developing country, 4 Soviet Union, output per capita, 7 n.7 Spain, per capita income in, 3-4 Special Drawing Rights (SDRs), 43, 150, 203 Sri Lanka, growth in, 1 7 n.18 Stabilization in Mexico, 219 in structural adjustment, 94 Structural adjustment and ability to service debts, 114-18 analysis of economic change and, 112-14 assessment of, 103-2 3 comparison of economic performance and, 110-12 criticism of, 10 5 defined, 58 definition of successful, 108-1 0

design of, 10 2 and development, 223-32 economic climate during, 107-8 effects of , 98-99,105-8,114,175 91,212-15,227-29,247-48 in LDCs, 227 modelled, 110-14 social, 16 5 financing of , 10 0 hypothetical problems with, 109 implementation of, 97-9 8 and incomes and prices, 29 institutions involved in, 145-5 1 and the international finance markets, 67-73 issues in, 143-4 5 origins of, 91-9 3 outlook for, 99-102 policies of, 28-29 , 36-40, 58-62, 104-5,106,151-53 political unrest and, 160-61,16 3 rationale for, 119,156,209-1 0 strategy of, 93-9 7 trade and, 28-29 World Bank and, 91-102 Subsidy, on foodstuffs, i n Tanzania, 188 Switzerland, per capita income in, 3 Tanzania employment in, 31 revenue in, 31 structural adjustment and, 176-91 wages in, 33, 176 , 178-82 , 184, 186-87 Tariffs, trends in, 149. See also General Agreement on Tarshis, Lorie, 236, 237, 239 Taxation changes in, and foreign loans, 7273,86 and development, in Latin America, 225

INDEX 28 and structural adjustment, 96-9 7 Taxpayer, U.S., as guarantor of LD C debt, 205, 217 , 244,251-5 2 Tax Reform Ac t (1986), 7 2 Tea Prices, 3 7 Thailand, growt h in , 1 2 n.12,1 7 n.18, 9 9 Timing, i n devaluation, 128-2 9 Trade as a measure of development, 4 and structural adjustment, 94-9 6 transaction costs and, 143-4 4 Trade Bill , 1 9 8 8 , 1 9 8 , 2 0 1 , 204 , 21 7 Trinidad and Tobago, per capita income in , 4 Tunisia, GD P of , 1 0 Tuikey exports from, 9 9 growth in , 1 2 n.12 , 1 7 n.18 , 18 , 18 n.19 , 9 9 SALs for , 136 , 13 8 trade structure of, 4 Turner, Professor, 180-8 2 Uganda, growth in , 1 2 n.1 2 Undervaluation effect of , a s policy, 126-2 7 political constraint s against , 127 28 Unemployment, an d wages, 2 5 , 2 6 United Arab Emirates, per capita income in , 3 United Nation s Committee for Developmen t Planning, 5 Secretariat, 4 , 7 , 1 7 United States of Americ a as a capital importer , 6 9 current account deficit in, 2 2 economic developmen t in, 5 per capita income in, 3 recovery in, and effect o n LD C debt, 47

3

Uruguay, 1 4 n.1 6 financial resource s of, 24 9 US AID, program financing by , 13 3 U.S. Treasury, as guarantor of LD C debt held by American banks, 251 VAR. See Model , vecto r autoregression Venezuela, 1 4 n.1 6 capital fligh t from, 2 4 discounted debt of, 23 6 financial resource s of, 24 9 oil from, 4 7 political chang e in , 167,169-7 0 unemployment in , 25, 2 6 Wages in Latin America , 2 5 , 2 7 policies of, i n Tanzania, 178-8 2 and structural adjustment, 5 9 , 6 0 n.27, 61 , 158-6 0 in Sub-Saharan Africa, 30 , 3 1 Wells Fargo Bank, 24 8 Wood, Robert, 15 2 World Bank (International Bank fo r Reconstruction and Development) approach of, t o development, 56-5 7 capitalization for , 20 3 creditworthiness of, 20 5 on default, 41 n. l dependence of, o n the U.S. taxpayer, 25 2 economic development and, 5 and economic restructuring, 92-9 3 establishment of , 14 7 function of , 55,148-4 9 World Bank Group, 14 8 World economy, 24 4 exchange rates and, 144-4 5 and the Latin American debt crisis, 208-11 theories of, 14 6

284 INDE

X

Yugoslavia, 1 4 n.1 6 as a developing country, 4 Zaire, revenue in, 3 1 Zambia economic difficultie s of , 10 0 employment in , 3 1 food pricing in, 9 6 foreign exchange in , 36 n.1 2 revenue in, 3 1 wages in , 3 3

ABOUT TH E CONTRIBUTOR S

William L . Cana k i s Assistant Professo r i n th e Department o f Sociolog y at Tulane University. H e holds a joint appointment in the Roger Thayer Stone Center for Latin American Studies, Tulane University. Chris Canava n i s Directo r o f th e Latin Americ a Grou p a t Multinationa l Strategies, Inc . H e wa s previousl y employe d b y th e Worl d Bank , Lati n America Programs Department. Michael P, Claudon is President and Managing Director of the Geonomics Institute for International Economic Advancement, and Professor of Economics at Middlebury College. William Darity , Jr. is Associate Professor o f Economics at the University of Nort h Carolin a a t Chape l Hill , an d wa s a Visitin g Scholar , Boar d o f Governors of the Federal Reserve. Rudiger Dornbusc h i s Professo r o f Economic s a t th e Massachusett s Institute of Technology.

285

2 8 6 ABOU

T THE CONTRIBUTORS

Jose D . Epstei n i s Professo r o f Economic s an d Director , Maste r o f Art s Program i n Developmen t Banking , Th e American University , Washington , D.C. H e was Manager of the Plans and Programs Department at the InterAmerican Development Bank, Washington, D.C. Richard D . Fletcher ha s been Actin g Manager of th e Plans and Programs Department of the Inter-American Development Bank since March 1986. H e served as Deputy Manager of the same department beginning July 1985, and as Deputy Manage r fo r Integratio n i n th e Economic an d Socia l Developmen t Department of the Bank from 1980 to 1985. Peter Hakim is staff director of the Inter-American Dialogue in Washington, D.C. H e was formerly Vic e President of the Inter-American Foundation and writes frequently on U.S.-Latin American relations. Barry Herma n i s a n Economis t i n th e Unite d Nation s Departmen t o f International Economic and Social Affairs. H e recently led the staff wor k for the Secretary-General's Advisory Group on Financial Flows for Africa. Vali Jama l i s Senio r Researc h Economist , Employmen t Department , International Labour Organization, Geneva. Betwee n 1976 and 1984, he was a member of ILO's Regional Employment Team for Africa—JASPA (Job s and Skills Program for Africa)—for whic h he participated in employment-advisory missions to several African countries. Robin A . Kin g i s a Ph.D. Candidat e i n Economic s a t th e Universit y o f Texas at Austin. Sh e previously worked in the International Department of a major regional bank. Danilo Levi is a Graduate Student in the Department of Sociology at Tulane University. Hi s dissertatio n researc h focuse s o n th e relationshi p o f international technology transfers, state policy, and national development. Robert Liebentha l i s Chief o f th e Policy Analysis and Review Division of the World Bank. Prio r to joining the Bank he worked as an economist with the government of Zambia. H e has worked in East and North Africa and Southern Europe, and ha s been a Research Office r a t th e Institute fo r Developmen t Studies at Sussex.

ABOUT THE CONTRIBUTORS 2 8

7

Karin Lissaker s i s a Lecture r a t th e Columbi a Universit y Schoo l o f International an d Publi c Affairs , focusin g o n Internationa l Bankin g an d Finance. Sh e wa s formerl y th e Deputy Directo r fo r Polic y Plannin g a t the U.S. State Department. Bruce Morriso n serve s th e stat e o f Connecticu t a s a Democrat in th e U.S. House of Representatives. Peter Nichola s i s a n Economis t wit h th e Polic y Analysi s an d Revie w Division of the World Bank, and has written on adjustment and poverty issues. He ha s worke d fo r consultin g firm s i n th e United Kingdo m an d the United States. Michael D . Robinso n i s Assistan t Professo r o f Economic s a t Moun t Holyoke College. Paul M . Sack s i s Presiden t o f Multinationa l Strategies , Inc. , a New York based consulting hous e specializing i n political and economic analysis . Prio r to establishin g thi s firm , h e taugh t Politica l Scienc e a t UCLA , an d wa s employed by Chase Manhattan Bank and The Conference Board. Louellen Stedma n i s a n Economis t i n th e Offic e o f Internationa l Deb t Policy a t th e U.S . Treasur y Department . Sh e wa s previousl y a Progra m Associate with the Inter-American Dialogue in Washington, D.C. Osvaldo Sunkel , i s Adviso r t o th e Economi c Commissio n fo r Lati n America an d the Caribbean , Santiago , an d Director o f Pensamiento Iberoamericano. Revista de Economia Politica, Madrid . H e wa s a Professoria l Fellow, Institute of Development Studies , University of Sussex , from 197 5 to 1987, and was associated in various capacities with ECLAC and ILPES from 1955 to 1968 and since 1978. Rolph va n de r Hoeve n i s Senio r Plannin g Officer , Adjustment , a t th e United Nation s Children' s Fun d (UNICEF) . Befor e joinin g UNICEF , h e occupied variou s position s i n th e Internationa l Labou r Organizatio n (ILO) , including Senio r Economist , an d wa s responsibl e fo r th e ILO' s wor k o n employment and adjustment issues.

ABOUT TH E EDITO R

John F . Week s i s Professo r o f Internationa l Politic s an d Economic s a t Middlebury College . H e i s a n internationall y recognize d developmen t economist with extensive policy-related work in developing countries. H e has advised government s o r conducte d researc h i n Nigeria , Kenya , Somalia , Jamaica, Peru, and Nicaragua. H e has served as a consultant for most of the major multilatera l agencies , including th e World Bank, the Inter-America n Development Bank , th e Food an d Agricultura l Organizatio n o f th e United Nations, and the International Labour Office. Hi s publications in the areas of development economics , macroeconomi c theory , an d classica l politica l economy include The Economies of Central America (Holmes & Meier, 1985); The Limits to Capitalist Development: The Industrialization of Peru, 19501980 (Westview Press, 1985) ; A Critique of Neoclassical Macroeconomics (Macmillan, 1989) ; and (with Vali Jamal) Africa Misunderstood (Rutledge , forthcoming). Professor Weeks obtained his Ph.D. from the University of Michigan, Ann Arbor, an d ha s taugh t a t universitie s o n fou r continents , includin g th e University of London, Universite Catholique de Louvain, and universities in Peru and Nigeria.

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