UNIVERSITY OF ILLINOIS LIBRARY AT URBANA-CHAMPAIGN BOOKSTACKS CENTRAL CIRCULATION BOOKSTACKS The person charging this material is re- sponsible for its renewal or its return to the library from which it was borrowed on or before the Latest Date stamped below. You may be charged a minimum fee of $75.00 for each lost book. Theft, mutilation, and underlining of books are reasons for disciplinary action and may result in dismissal from the University. TO RENEW CALL TELEPHONE CENTER, 333-8400 UNIVERSITY OF IlllNQIS LIBRARY AT URBANA-CHAMPAIGN 4 2000 When renewing by phone, write new due date below previous due date. L162 COPY 2 ^"•■w '»wi!5»mBq« -ngjB^ $LJ ill FACULTY WORKING PAPER NO 1122 IHE LIBRARY OF THE UNIV ■ MO)S A New Dependency? Outcome of the Reagan Administration's Economic Policy Toward »&lli i /"Xi j itoi «.^d Coiisge cf Commerce anci Business Acministralion Burs&u of Economic and Business Rssearcn University or Itsinois. Urbana-Cnampatan FACULTY WORKING PAPER NO. 1122 College of Commerce and Business Administration University of Illinois at Urbana-Champaign March, 1985 A New Dependency? Outcome of the Reagan Administrations Economic Policy Toward Latin America Peter Richter, Visiting Scholar Department of Economics Digitized by the Internet Archive in 2011 with funding from University of Illinois Urbana-Champaign http://www.archive.org/details/newdependencyout1122rich PETER RICHTER A New e p e n d e n c y ,A Outcome of the Reagan Administrations Economic Policy toward Latin American ABSTRACT The United States is currently in a strong position economically and politically which enables the Reagan Administration to implement its new economic policy towards Latin America. Together with the debt crisis, this policy, determined by U.S. geopolitical interests and a strong belief in the advantages o-f a free-market economy, has forced Latin American countries into a painful adjustment process. They cannot look any longer for external solutions to their problems but must instead carry out long delayed internal reforms. The situation is both a challenge and an opportunity for new democratic leaders. Peter Richter* A New Dependency? Outcome of the Reagan Administration's Economic Policy toward Latin America The 1970s have often been characterized as a period of growing interdependence and power diversity in interamerican relations, thereby "ending the hegemonic presumption" of the United States. Such views have been combined with the expectation that greater self-determination and more diversified international relations would foster the social and economic development of Latin America. Reasons given for the de- cline of the United States as a hegemonic power were internal problems (Vietnam-syndrome, Watergate, economic stagnation), the emerging influ- ence of other powers in the Western Hemisphere (Japan, West-Germany, . Soviet-Union) and a growing global importance of some Latin American nations (Brazil, Mexico, Cuba). Nowadays former President Carter's policy is often seen as a weakening factor itself. But assuming the trends above have been analyzed correctly, his policy should rather be judged as a realistic attempt to cope with a changed international environment. The Carter administration accepted an ideological plural- ism in the Hemisphere and defined U.S. policy toward Latin America as part of its overall approach to the developing world, including concerns 2 about human rights in this part of the world. Yet this approach did not survive long. President Reagan quickly made it clear that one of his prime goals is to reassert U.S. influence *This paper was completed when the author was a visiting scholar at the University of Illinois at Urbana/Champaign. The author would like to thank Werner Baer, Larry Neal and Robert Scott for their valuable contributions. -2- in the Western Hemisphere. The background to this effort is the Reagan Administration's preoccupation with the global balance vis-a-vis the Soviet Union. "On the basis that the United States' global posture will suffer greatly if it does not control political developments in the immediate vicinity considered hostile to national interests, the re-establishment of U.S. influence in Latin America has become a high 3 priority." That means the new policy follows in the first place U.S. geopolitical and security interests and neglects to a great extent the social and economic needs of the region. A secondary, but in its impact on the well-being of the region just as decisive, factor deter- mining the new U.S. policy is the economic ideology of the Reagan Administration ("miracle of the market-place"). The consequences of this approach for the development prospects of Latin American countries can only be fully understood by taking into account the present international environment and especially those fac- tors determining the power balance in the Americas: The North-South-dialogue has run out of steam. The Latin American countries are struggling with a deep structural crisis (which takes different forms in the various countries). Due to their large foreign debts they are extremely vulnerable. The European partners are very much concerned with their own economic problems . A new Latin American solidarity is not in sight. - The U.S. economy has regained strength; the U.S. currency is again dominating the international financial markets. -3- These circumstances suggest that the dependence of Latin American countries on the predominant partner in the North is again growing, thereby reversing — at least partially — the trend of the 1970s. As Reagan's approach to Latin America is very much influenced by security concerns, most studies focus on political issues. The intention of this paper is to analyze the Reagan Administration's foreign economic policy and its influence on the economic relations between the United States and Latin America in order to get a more substantial picture of the new dependency of Latin American countries. Reaganomics and Foreign Economic Policy One has to understand first that under the Reagan Administration the concern for international economic matters has been subordinated to domestic economic interests to a much higher degree than in former administrations. The new Administration's preeminent goal has been and still is to create the necessary conditions for a strong growth per- formance of the U.S. economy without rekindling inflation. "An improved domestic economy was seen as both the key to the Admini- stration's political fortune and the necessary underpinning for the 4 resurgence of American military and diplomatic strength abroad." When President Reagan came into office in 1981 the U.S. economy was in big trouble. The situation can best be described by referring to the term "stagflation." The GNP was stagnating while inflation was soaring and interest rates were sky-rocketing. The President's and his advisers' diagnosis was basically that the government in the past decade had gained too much influence in the economy so that private -4- initiative, seen as crucial to economic development, had been severely hampered. The cure consisted in a rather unique mixture of economic steps derived from the thinking of "supply side" economists (reductions in personal and business taxes, cuts in social welfare programs, regu- latory relief) and of monetarists (stable and restrictive monetary policy). Although not undertaken for economic reasons, the large military build-up is usually considered another fundamental element of the so- called "Reaganomics" because of its enormous economic implications. The same ideas and convictions can be found again in the Administra- tion's attitude to international economic matters. Its basic belief is that if each government were practicing sound economic policies, the need for interventions on an international scale would be minimal. The international exchange of goods, services and capital would be func- tioning for the best of all nations, if governments restricted them- selves permanently from intervening. Just as the role of national government in the eyes of the Reagan Administration should be minimized, so should the international action of governments and of multinational institutions. "The Administration has (therefore) sought to promote an open international environment where economic decisions respond to market signals, and where U.S. finns could prosper. (Besides) the Administration has sought to implement its free-market principles in ..6 various bilateral and multilateral institutions. The developing countries are being looked at basically in the same way, especially when they are more advanced as are many Latin American countries. Most of today's economic problems in the Third World are traced back to excessive governmental Interventionist) , to ideological -5- inclinations and the resulting distortion of internal prices and re- source allocation. As the present stagnation and impoverishment of many developing countries seem to be caused by mistaken internal policies, self-efforts of those countries and their governments are, in the Administration's opinion, crucial in a process aimed to overcome back- wardness and underdevelopment. They should follow the U.S. example, and devote itself to policies like liberalization, deregulation and opening-up the economy. An important role in this new concept is played by the promotion of a deeper integration of developing countries into the world economy. The Administration points in particular to the success of various countries in South East Asia with export-led strate- gies. The importance of foreign aid is played down by the Reagan Admini- stration. Revenues stemming from exports, direct investments and pri- vate bank lending are today in most developing countries much higher than foreign assistance payments. Therefore, a healthy, strong and open U.S. economy would be the best contribution to the welfare of developing countries. Those arguments were used by the Reagan Administration to justify the rejection of all claims for an increase in foreign assistance. Besides, a quite radical realignment of the development aid concept was planned. First, U.S. contributions to multinational institutions should be diminished in favor of bilateral assignments whose use can be monitored directly. Second, instead of feeding further governmental funds, whose effectiveness is doubted, foreign assistance should be used to help the widely neglected private sector. -6- How this concept influenced the actual U.S. policy towards Latin America will be presented below. At this point some general remarks have to be made to set the new development policy of the Reagan Administration into perspective. First, the whole approach doesn't show much understanding about the real problems of Third World countries. Most of them have not yet developed a socio-economic struc- ture comparable to that of industrialized or developed countries. It is thus not reasonable, at least for most developing countries, to adopt a model that is used on a different stage of development. To name only a few of the structural defects which are typically found in developing economies: lack of technological, entrepreneurial and administrative know-how, lack of investment capital, backwardness of the non-export orientated agricultural sector, high concentration of firms in most modern branches, - a low commitment of national entrepreneurs to export and inter- national competition. The neo-liberal model that operates on a macro-economic level is not suited to deal with these and other structural defects. What happens when such a model is applied to an inadequate environ- ment can be studied in the cases of Chile and Uruguay (1973-1981) and g Argentina (1976-1982) extensively. The then ruling military govern- ments, envisioning a complete restructuring of the economy, tried vigorously to stimulate private initiative in their respective countries by curbing the economic role of the state sector, by opening-up the economy to foreign competition and by attracting foreign capital. -7- After an initial boom phase caused rather by financial speculation and marketing of foreign goods than by a build-up of productive units the economies slowed down dramatically in 1981 and 1982. The heavy influx of foreign goods had hurt many industries badly. At the same time the flow of foreign money to the Southern Cone countries slowed down because the level of accumulated debts was considered increasingly risky. Consequently, all three countries became insolvent and had to approach the IMF for stand-by help. The monetarist experiment of the Southern Cone countries is today evaluated broadly as a complete failure. Secondly, with Reagan in office the on-going North-South dialogue came to a complete standstill. The attendance of President Reagan at the Cancun summit, which was a surprise and gave room for hopes, has to be judged in retrospect as above all a diplomatic step in order to pre- sent the position of the new Administration and to avoid being iso- lated. In short, the presented position was that the U.S. would only take part in "global negotiations" if these would occur within the spe- cialized agencies and the principle of weighted voting within these 9 agencies was not challenged. Of course, the question arises if such negotiations would still mean the same as the North-South dialogue was supposed to be: a bargaining process between equal partners taking the full spectrum of international economic relations into account. Anyhow, Reagan did not make any concrete commitment and consensus was not even reached about where and how to begin "global negotiations." Admittedly, the North-South dialogue never proceeded really smoothly; every concession on the part of the industrialized countries had been obtained only after a fierce struggle; and there was a lot of criticism about the bureaucratic organization of this dialogue (UNCTAD, UNIDO, -8- etc). But still, many imbalances exist in the economic relations between developing and developed countries stemming from different endowments of technology, human skills and capital. Most international institutions reflect those imbalances by being dominated by the indus- trialized countries. If a deeper integration of the developing countries into the world economy is actually wanted, as well as a sustained growth in the Third World, some modifications of the international economic order are unavoidable. But at the present time, no move by the U.S. — the biggest economic power in the world — is being undertaken to revive the dialogue in any way whatsoever. Thirdly, and this is what hurts the developing countries most: The Reagan Administration shows little concern about the foreign implica- tions of its economic program. As many predicted, the unique mix of tax cuts and increased military spending, the core of Reaganomics, resulted in a sharp widening of the fiscal deficit and a remarkable increase in the governmental quest for financial resources. As the third element of Reaganomics has been a tight monetary policy, interest rates necessarily went up. In a world of closely integrated capital markets the result was a world-wide upsurge of interest rates causing a deep international recession which is still ongoing. In 1983 and 1984 the U.S. economy showed a strong recovery, but is still dependent upon a heavy influx of foreign money to finance the still rising fiscal and balance of trade deficit. The developing countries suffered most from high interest rates and the resulting international recession. By the end of 1983, the external debt of developing countries owed to private sources -9- amounted to roughly $400 billion (excluding short term loans). This means every one percent increase of the interest rates due to the widening U.S. fiscal deficit deteriorated the balance of payments of 7 developing countries by around $4 billion. But that's not the whole story. Because of rising problems on the part of the developing countries in meeting their financial commitments, private banks vir- tually stopped lending money — on a voluntary basis — to the highly indebted ranked countries, further worsening their financial situation. Most had to approach the IMF for help and are currently undergoing a painful process of adjustment. There are several other effects produced by the U.S. economic policy and the world recession that threaten the well-being of the developing countries: High U.S. interest rates further enhance capital flight. - Investors from the United States and other developed countries prefer the high-return, low-risk financial Investments available at home to risky direct investments in developing countries. With growth in the industrial countries slowing down, the prices of primary commodities, which still constitute the bigger part of the exports of developing countries, slumped dramatically. Trade Policy and Trade Relations The Reagan Administration sees free international trade of goods and services as beneficial for all participating countries. Especially for the developing countries with their relatively small internal markets international trade is considered an engine of growth. The -10- fact that three-quarters of their foreign trade takes place with in- dustrialized countries explains the Administration's accentuation of the crucial importance of high growth rates in OECD countries for the well-being of the Third World. Nevertheless, this conviction never resulted in a radical initiative to remove all existing barriers to trade. In the late 70s barriers to exports of developing countries had been reduced quite substantially through the Generalized System of Preferences (GSP), which allowed many manufactured and agricultural products to enter the U.S. market duty free, and as a result of agree- ments reached during the Tokyo Round of Multilateral Trade Negotiations, which provided tariff reductions plus several new codes of conduct. Yet this policy never applied to the whole range of developing countries exports. Product lines in which developing countries are predominant, such as textiles and apparel, footwear, etc., still face substantial trade barriers. These barriers can either take the form of extraordinarily high tariffs or of orderly marketing quotas. The Administration's attitude toward pressures coming from enter- prises and trade unions to impose new restrictions on the access of products from developing countries to the U.S. market is quite ambiva- lent. Those pressures resulted from growing foreign competition during the recent boom of the U.S. economy, which produced high interest rates and a rising value of the Dollar. One agreement on shoe imports was not renewed by the Reagan Administration and expired in 1981. Against that, the Administration consented to a renewal of the important multifibre -11- arrangement (MFA), which restricts the rate of textile imports to the rate of domestic market growth. Another arrangement, which was reached in 1984, restricts steel imports. Among the countries hit by this arrangement is Brazil. The global approach to trade policy was left, when the Reagan Administration announced in 1982 its Caribbean Basin Initiative (CBI) which is a perfect example of the close linkage between security interests and foreign economic policy. Principal elements of the CBI program are a Free Trade Area (FTA) and increased economic and military aid. The program was quickly labeled as the most important U.S. ini- tiative in the Western Hemisphere since the Alliance for Progress. Background of the initiative is the deep concern about social unrest, "imported terrorism" and economic instability in a neighboring 12 region. Consequently, the aim of CBI is to help the nations of Central America and the Caribbean to cope with the economic crisis and to fight the socio-economic roots of anti-U.S. and revolutionary move- ments. The centerpiece of the CBI is the Free Trade Area which provides one- way, duty-free access to U.S. market for Caribbean Basin exports during 13 a 12 year period. But again, as in the case of GSP, the Free Trade Area doesn't apply to all Caribbean Basin exports. Several products, including petroleum, footwear, textiles and leather products are exempted from duty-free treatment. Because of these exemptions and the fact that 87 percent of the region's total export into the United States already enters duty free, the short-term results are likely to be small. Experts figured out that only about five percent of the region's total -12- exports will be affected. In money terms these five percent are equi- 14 valent to $450 million. The amount of new trade generated for the CBI countries through FTA treatment depends on two variables: (1) How many additional consumers buy these products because prices fall, and (2) how many consumers shift away from similar imported goods produced elsewhere. To predict such changes is always hazardous. Economist Richard Feinberg estimates the newly generated trade per year to lie somehow between $70 million and $100 million, about 1 percent of the region's 1980 exports. In the eyes of Feinberg "the real hopes for an eventual import surge lies in products not currently produced in the region, and in the decision of foreign-owned firms to locate new factories there." The potential seen for new direct investments is based on competitive wages in the Caribbean Basin and the geographic proximity to the U.S. market. One study, cited by Feinberg, found that CBI countries would have a distinct price advantage to gain U.S. markets equivalent to $2.5 billion in 1982. 16 This figure sounds quite impressive, but one has to take into account that foreign investors base their decisions not only on market- related data, but equally on the macro-economic performance of a country and its political stability. In both areas the medium-term outlook for the Caribbean Basin is not very good. It is too early for a definitive appraisal of the CBI program. What can be stated is that the CBI is not designed to help the Caribbean and Central American countries to overcome their deep and long- lasting socio-economic crisis. This would require a redistribution of income, structural reforms in the agricultural and industrial sector -13- and large investments in infrastructure. Otherwise a certain stability could only be guaranteed by a large and steady flow of foreign aid. The United States doesn't seem to be ready to guarantee such a flow. Consequently the countries of the region will solve their problems furtheron by exporting part of the labor force to the U.S. and by keeping the majority of population in poverty and dependence. The results of CBI will be a strengthening of the modern private sector in Caribbean and Central American countries and a stronger alignment of their foreign trade flows with the United States. Since the 1950s U.S. dominance of foreign trade linkages of Latin American countries declined steadily. In 1950 Latin America sent almost half of its exports to the United States, in 1980 the U.S. share was only 34 percent. The corresponding figures for the Latin American imports are: 50 percent in 1950 and 30 percent in 1980. U.S. domi- nance declined as Latin American countries began to trade more equally with the other major economic powers of the world, especially with Western Europe and Japan. This diversification of economic linkages offered Latin America a number of economic and political advantages: - less dependence on one huge market and its cycles; - more favorable conditions through competition between several economic powers; - less frictions because of the geographical distance; pursuit of mutual interests in the relations with other middle powers; offer of a plurality of concepts of political and economic develop- ment. -14- There are several reasons to expect that as a result of the Reagan Administration's policy the dependence of Latin American countries in their trade relations on the powerful neighbor in the North will grow again: The U.S. economy is currently booming, whereas the European countries haven't yet recovered from the recession. The Japanese market re- mains strongly protected. The high foreign debts in Dollars forces the Latin American coun- tries to earn hard currencies. The depreciation of Latin American currencies spurs export to the United States. The CBI program will align Central American and Caribbean trade relations with the United States even more strongly. The high and growing number of aliens in the United States origi- nating from Latin American countries will lead in the long run to increased export into the region (because of the transfer of consumer patterns) . The available figures confirm these reflections. Although exports from Latin countries fell $10 billion in 1982 due to the recession of their major trading partners, U.S. imports from Latin America remained steady. 1 O The U.S. share of Latin exports therefore rose to 40 percent in 1982. A further rise of the share will have occurred since then. In 1984 alone exports to the United States rose 20 percent. The situation is, of course, different on the import side. The debt-servicing problems have forced the Latin American countries to severe and steady reduc- tions of their merchandise imports. In 1982 Latin imports fell 20 per- cent, in 1983 another 13 percent. Because U.S. exports to Latin America -15- fell at similar rates, U.S. share of Latin imports remained nearly unchanged. Policy on Private Foreign Investments and U.S. Investments in Latin America In the same way the Reagan Administration favors the private sector for its dynamism and efficiency in the domestic policy, it is advocat- ing the virtues of market mechanism in developing countries. It sees constant government interventions and size of the state sector as the main reasons for the current crisis in the Third World. Consequently, it is very skeptical of concessional government-to-government help and prefers direct foreign investment as most effective medium for the transfer of capital and technology to developing countries. To attract a sufficient amount of foreign investments the host countries are ad- vised to establish a stable business climate and adopt an export-led strategy. Thus far, the responsibility for an increased flow of private investment capital has been left predominantly with the developing coun- tries themselves. This attitude is reflected in the Administration's own behavior. » There have been no major changes in U.S. policy toward the activities of U.S. firms abroad or new initiatives for stimulating investments 19 (perhaps with the exception of CBI). The Administration reaffirmed the traditional position that foreign investors should be treated in the same way as domestic enterprises. And the old demand was reiterated that expropriations of investors' property should be accompanied by prompt, adequate and effective compensation. The Administration's efforts were concentrated on an expansion of existing institutions and programs, whose effects on Latin America have -16- been small, however. One of those institutions is the Overseas Private Investment Corporation (OPIC), a U.S. government agency that stimulates investments in developing countries by insuring firms against certain political risks. Although the lessening of restrictions resulted in an FY1983 tripling of total insured investment, Latin America and the 20 Caribbean accounted for under 4 percent of the total. One of the reasons is the Calvo doctrine, which prevents many Latin American coun- tries from agreeing to the OPIC requirement of an international arbitration in the event of investor dispute. A second institution which is devoted to stimulate private investments in developing countries is the Inter- national Finance Corporation (IFC), an affiliate of the World Bank. Its task is to make equity investments and provide loans to private firms in developing countries. The Administration favors a proposal to give the IFC a $750 million capital injection. But as a result of the deep recession and the decline in investment, IFC activities in Latin America remain small ($214 million in FY1983). 21 The only activity of the Reagan Administration in the field of direct investment directed specifically to Latin America has been the CBI. Originally the Administration envisaged an investment tax credit of 10 percent for U.S. business investing in the Caribbean Basin. The Congress, however, rejected the proposal. But, as outlined before, the FTA could provide strong incentives for future investments in Central America and the Caribbean. Moreover, the government currently makes strong efforts to promote its initiative and to encourage private in- vestments in the Caribbean Basin. An inter-agency task force as well as several task force subcommittees have been formed to serve those purposes. The Commerce Department has established a Caribbean Basin -17- Information Center that not only informs U.S. businessmen of export opportunities, but also promotes imports and investments. In addition, special task, forces have been established at each U.S. embassy in the Basin, which seek to stimulate interest in trade and joint ventures. Today the bulk of U.S. direct investments is located in the deve- 22 loped countries (1980:73 percent). U.S. investments in developing countries, however, are heavily concentrated in Latin America (1980:72 percent). Expressed in absolute figures, U.S. direct investment posi- tion in Latin America amounted in the same year to $38.8 billion. The largest single recipients are Brazil, Mexico, Argentina and Venezuela, which account together for nearly 47 percent of U.S. investments in Latin America. The magnitude of those direct investments furtheron guarantees to U.S. enterprises a major role in the Latin American eco- nomy, although a certain decline in U.S. superiority since the 60s has to be noted. In 1965 the U.S. share of direct foreign investments in 23 Latin America was about 70-75 percent, while estimates for 1980 indi- cate a drop of the U.S. share to about 60 percent. It must be con- sidered, however, that the remaining 40 percent have to be divided up between several other nations, of which the most important are West Germany, Great Britain and Japan. Of course, the situation in each Latin American country is dif- ferent. In Brazil, for example, the U.S. share is lower than the Latin American average; in neighboring Mexico it lies over the average. In Costa Rica it even reaches 80 percent. These figures, however, don't paint the full picture of the role of foreign enterprises, mainly U.S. -18- enterprise, in Che Latin American economies. Foreign direct invest- ments are concentrated in a few dynamic branches like the chemical, electrical and automobile industry, the petroleum sector, machinery and banking. These branches are often monopolized by foreign enterprises, the access of national firms to modern techniques of production and marketing is limited. A large portion of Latin American exports of manufactured products originates from foreign firms, which at the same time depend heavily on imports, mostly from their home country. Remittances of profits and royalties are another burden in the current account. Finally, important decision-making power is transferred to institutions whose first loyalty lies with their home offices. U.S. direct investment position in Latin America declined to $32.5 24 billion in 1982 and $29.5 billion in 1983. This decline can be traced back, however, nearly exclusively to borrowing by U.S. parents from their Netherland Antilles finance affiliates; such borrowing gives rise to capital inflows which reduce the balance of payments deficit. In the manufacturing sector there was only a slight reduction, while invest- ments in the petroleum sector and banking expanded. Anyhow, the role of U.S. enterprises in the Latin American economy is not determined by the greatly varying annual flows, but by the accumulated stock of investments. For the near future a new increase of U.S. investments in Latin America can be expected. One reason for this prediction is the fact that the CBI program offers a variety of new possibilities for U.S. investors in Central America and the Caribbean. Secondly, under pres- sure from the IMF and the United States many Latin American countries -19- had in recent years to adopt more liberal and export-oriented policies, which make those countries anew attractive for foreign investments. Financial Policies and Debt Crisis The debt crisis not only darkens the economic prospects of Latin American countries but also overshadows the totality of their foreign economic relations. Because of the crucial role of U.S. banks and the heavy U.S. influence in the IMF it is the clearest expression of the new dependency. In the 1970s private bank lending became the principal mean of moving funds from the wealthy to the developing world, replacing direct investments. In every year since 1971 credits from the private 25 banking system exceeded direct investments. What conditions have led to the rise of bank lending? After the first oil price shock, the oil-importing developing countries were confronted with energy price hikes, global inflation and slow growth in exports to the industrial countries. Especially the NICs, among them many Latin American countries, which relied in their growth strategy heavily on energy and industrial imports and on manufacturing exports, experienced growing trade and current-account deficits. Consequently these countries looked for financial sources to cover the deficits. At the same time, the banking system disposed of enough liquid means originating from deposits made by OPEC countries and multinationals. Because demand for loans was sluggish in the stagnant industrial coun- tries, the commercial banks were willing to make loans to governmental agencies and private firms in countries they once ranked as risky clients. -20- Latin America, with its higher level of per capita income and improving prospects at the beginning of the 1970s, was particularly attractive to private capital. The unprecedented influx of capital enabled the oil-importing countries of the region to continue their growth-led policies and to avoid painful austerity measures. Between 1973 and 1980 the public debt of Latin American countries rose from 26 $27 billion to $123 billion, of which a great part is owed to U.S. banks. As mentioned before, the Reagan Administration entered with highly favorable attitudes toward the free flow of capital across borders and considered commercial bank lending as a welcome substitute for con- cessional government-to-government aid which it wanted to restrict to the neediest countries. At the same time, the Administration made it clear that it would use all of its influence to induce the IMF* to return to its traditional role and serve primarily as a provider of short-term 27 finance to assist countries facing immediate foreign exchange shortages. This commitment was especially directed at new IMF facilities which in- cluded structural measures and allowed a more gradual approach to adjust- ment. The Administration didn't want a blurring of the division of responsibility for short-term adjustment — the proper role of the IMF — and longer term development. Likewise the Reagan Administration was initially opposed to an increase of IMF resources because it feared a large quota increase would result in less rigorous conditionality and an undesirable expansion of global liquidity and inflation. *The United States is the biggest contributor. -21- The Reagan Administration was reluctant to recognize the severity of the debt crisis. As a result of the second oil-price shock and worldwide rising interest rates, the foreign debt of developing countries had even grown faster. At the end of 1982 the total debt of Latin American countries had reached around $250 billion, of which U.S. banks 28 hold about 40 percent. Brazil and Mexico had become the major debtors 29 among developing countries. In addition, Argentina, Venezuela and Chile ranked with the 13 highest debtors among developing countries. Finally, the crisis over Mexico and Poland as well as rising prob- lems in Brazil and Argentina forced the Reagan Administration to depart — at least gradually — from its previous conservative strategy toward the Third World debt. When Mexico in August 1982 suspended payments on its foreign debts, the whole international financial system and, of course, the creditor banks seemed in great danger. This time, driven by security concerns in the economic sphere, the Administration made the following policy departures: - It now agreed to a substantial increase in IMF resources. - Whereas swap arrangements had been previously reserved for industrial countries, U.S. Treasury and the Federal Reserve were prepared to extend such "bridge financing" to countries like Mexico, Brazil and 31 Argentina. The U.S. government, acting primarily through the Federal Reserve, became an accomplice of the IMF as this institution conditioned its own lending on commercial banks extending new net loans to debtor nations. -22- The U.S. government, the IMF and the commercial banks are today cooperating closely to keep financial markets functioning. Having been traditionally reserved for exceptional emergencies, rescheduling of debt — whether owed to official or private creditors — became in the mean- time a matter of routine. In the case of Latin American countries, U.S. banks, as the most important creditors, are usually heading the negotia- tions on rescheduling and new credits. Since 1982 10 Latin American countries had to approach the IMF, among them all Newly Industrialized Countries of the sub-continent: Argentina, Chile, Ecuador, Venezuela, Guatemala, Panama, Peru, Uruguay, 32 Brazil and Mexico. As 'lender of last resort ' and international monetary authority the IMF ties its help with heavy policy strings. It constantly monitors whether a borrowing nation observes those con- ditions . As mentioned before, the U.S. government exerted all its influence to reduce the IMF's responsibility to only short-term adjustments in the overdebted countries. The aim of the measures negotiated by the Fund and the borrowing nation is to produce during a period of two to three years a surplus in the trade balance, which enables the country to pay back its debts. Typically, the Fund requires reductions In government spending and subsidies, slower growth of the money supply, devaluation of the currency and restraints on wage increases. By these measures the IMF intends to restrict demand and to slow down the economy. As a consequence, it is expected that imports will decrease and exports increase. In many ways the IMF's policy resembles the Reagan Administration's philosophy on how to overcome the current crisis in -23- many developing countries. One could even go so far as to state that the Administration's ideas about the Third World are implemented by the IMF in cooperation with some other multilateral organizations. In 1983 and 1984 Mexico and Brazil have been quite successful in producing a surplus in the trade balance and the balance of current account, although the surplus never reached the dimensions necessary to start paying back the accumulated debts. But for this success many 33 sacrifices had to be made. The gross domestic product fell sharply, industrial production declined even more sharply, inflation went up further and unemployment showed new record highs. But most frustrating is that in spite of all efforts the foreign debt of Latin American countries is rising further. The region's debt is estimated to stand currently at $350 billion. This indicates that the debt problem will stay on the agenda and keep Latin American countries for quite a number of years dependent upon foreign banks and the IMF. How long is indi- cated by an accord between Mexico and its foreign-bank creditors, which 34 allows the repayment of that country's debt over a period of 14 years. Foreign Aid Policy and Aid Flows to Latin America The foreign aid policy perfectly reflects the major guidelines used by the Reagan Administration in the formulation of its international policies: Primarily, foreign aid, which comprises military and economic assistance is seen as just another tool which has to serve the govern- ment's short-term strategic and political gaols abroad. Because of the provision of greater diplomatic leverage bilateral is favored over multilateral aid. Bilateral aid is restricted to countries which -24- show a friendly attitude toward the United States and its free market economy. Not surprisingly, the bilateral aid flows are highly concen- trated to countries which are of special interest in the Administration's 35 political and security concept (e.g. Israel, Egypt and El Salvador). Within bilateral aid military assistance and security-related aid (the Economic Support Fund) is accented compared to development assistance. The Reagan Administration's standpoint on development assistance strongly reflects its opinion on domestic social welfare programs. Administration officials hold government-to-government aid as inherently inefficient, because it diminishes the capacity of the recipient nation to engage in self-help activities. Moreover, in most cases development assistance further enlarges the state sector's influence in the economy at the expenses of the private sector. Therefore, the Administration feels that development aid cannot be effective unless recipient coun- tries first adjust their domestic economic structures to give adequate scope to market mechanisms and incentives to the private sector. To ensure such an environment the Administration favors combining nego- tiations on development projects with a dialogue about the economic policy of the host-country. Finally, the Administration seems deter- mined to turn the Agency for International Development (AID) into an 36 instrument to promote the private sector. New programs have been announced which will, e.g. , provide assistance to agro-industry, finance privately owned development finance companies which lend to private firms, encourage the growth of capital markets, and allow AID Itself to make investments in private firms. -25- When Reagan carae to office, he cut development assistance by 26 percent compared with the last budget under the responsibility of former President Carter. In 1981, the United States gave $5.8 billion as official development aid and had, except for Italy, the lowest ODA-GNP ratio among the seventeen members of the OECD's Development Assistance 37 Committee. The U.S. figure of 0.20 percent has to be contrasted with an average of 0.46 percent for other DAC members and the international target of 0.7 percent. Because the development aid budget was kept virtually unchanged during the last years, the ODA-GNP ratio will have fallen even further behind the DAC average. These figures clearly express the Administration's neglect of the economic and social problems of the Third World and the development pattern of those countries. 74.7 percent of the 1981 ODA was disbursed bilaterally compared with 61.2 percent in 1980. This means in absolute terms that bilateral ODA stayed nearly untouched, whereas contributions to multilateral institutions were cut sharply. The bilateral approach of the Reagan Administration is further underlined by the build-up of the security- related Economic Support Fund (ESF). The Fund is also open to countries which do not meet criteria for development assistance and is therefore a flexible instrument in the hands of the Administration. ESF assis- tance is often used to support a country's balance of payments. In FY 1982 the U.S. budget for bilateral economic aid allocated 41 percent of 38 the total to the ESF and 59 percent to development assistance. This compared with percentages of 22 and 78 nine years earlier. Latin America receives only a relatively small portion of the bi- lateral economic aid. In 1981 the countries of the region received -26- 39 S588 million, which equals 8 percent of the total budget. The main reason is that all larger Latin American countries, viewed as rela- tively advanced, are excluded from concessional assistance as provided 40 by the AID (following a decision of former President Carter). These countries are: Argentina, Brazil, Colombia, Chile, Ecuador, Uruguay and Venezuela. Consequently, bilateral aid flows are concentrated on countries in Central America and the Caribbean. E.g. , in 1981 El Salvador, which plays a crucial role in the Administration's counter strategy, ranked seventh (after Egypt, Israel, India, Turkey, Bangladesh and Indonesia) under the major recipients of U.S. economic assistance. Peru ranked tenth in the same year and Jamaica twelfth. In 1983 economic assistance to Latin America increased considerably 41 because of an additional $350 million which was part of the CBI package. $299 million was allocated for balance-of-payment support. The main beneficiaries were El Salvador and Costa Rica with $75 million each. Though the $350 million was only a one-year appropriation it can be expected that economic assistance will stay on a higher level than in the years 1981 and 1982 because of the strategical importance of the Caribbean Basin to the Reagan Administration. In its approach to foreign aid the Reagan Administration is least enthusiastic about multilateral programs, especially highly concessional ones. It accuses the multilateral institutions of fostering socialism in the Third World and promoting income redistribution. Moreover, they didn't serve adequately U.S. interests taking into account the high contributions of the United States. Consequently the Administration an- nounced that it would seek a major reduction of roughly 30 - 45 percent -27- in U.S. contributions to the "soft loan" windows of the multilateral development banks (mdbs), primarily the International Development 42 Association (IDA) of the World Bank. At the same time it expressed support for continued expansion of the hard-loan World Bank windows, which require less donor government financing, but at reduced growth rates. In addition, the Administration recommended that the mdbs should condition their loans closer to sound — that is, private-sector, market- oriented — policies at the macro-economic level. Because IDA-loans are restricted to poorer developing countries (under a per capita income of $500) the sharp reduction in the IDA lending level following the Administration's decision to lower U.S. contributions didn't hit Latin American countries very hard. A dif- ferent story, of course, is the reduction of the Inter-American Bank concessional lendings. In 1983 the U.S. government succeeded in lower- ing the annual lending levels for the Fund for Special Operations from $786 million in 1982 to an average of $500 million during the four-year 43 replenishment period. The more favorable attitude toward hard loans was demonstrated when the Administration approved a $15 billion increase in the authorized capital stock for the World Bank's conventional lend- ing program. This will allow hard loans to rise in volume from $1.9 billion in 1982 to $3.45 billion in 1986. Latin American countries will benefit from this increase. Nevertheless, four Latin American countries, which are among the major World Bank borrowers, are follow- ing a recommendation of the Reagan Administration under the threat of 44 being graduated from IBRD lending. -28- So far, the picture is very complex. It seems that economic assis- tance to Latin American countries derived from U.S. and multilateral sources remained quite unchanged under the Reagan Administration, but is even more concentrated toward the Caribbean Basin. This clearly reflects the strategic object the Administration pursues with the foreign aid instrument. Most South American countries don't receive any assistance on favorable terms, although sharp imbalances exist in those societies, too. Moreover, some countries are threatened with being phased out from World Bank, lending which would leave them totally dependent on the private capital market. Another questionable develop- ment is the growing conditional! ty of foreign aid on the initiative of the Reagan Administration. It urges the recipient countries to adopt an economic philosophy which is not necessarily suitable to their own environment. Conclusions The United States at present is politically and economically in a strong position. This consequently enables the Reagan Administration to carry out its economic policy toward Latin America, which appears to be determined as well by geopolitical interests as by a strong belief in the advantages of a free-market economy. In addition, international circumstances have been favorable for the Reagan Administration quest to restore U.S. superiority in the Americas. There are several indica- tions for a new dependency of Latin American countries on the predom- inant U.S. economy as a result of the Reagan Administration's policy. The strongest are: -29- The U.S. share of Latin exports rose considerably. The CBI will reorientate Caribbean trade flows even stronger toward the United States. The Latin American countries are highly indebted to U.S. banks and „." in desperate need of new loans. - The U.S. government itself is heavily involved in the management of the debt crisis, e.g. by extending "bridge financing" and by enforcing stricter rules upon IMF lendings. The Reagan Administration is using bilateral aid as a leverage for its geopolitical and economic goals. The debt crisis together with the economic policy of the Reagan Administration has forced Latin American countries into a painful adjustment process. They have had to accept lower living standards, they are experiencing high unemployment rates and they are faced with a new upsurge of inflation rates. Moreover, they are under constant pressure to expose themselves fully to the international competition and to continue with the liberalization of their economies. This would mean a complete departure from the long-term pattern of economic policy in Latin America. The international environment will remain unfavorable for Latin American countries. A change of U.S. foreign policy is not in sight. Reagan was reelected in 1984. His policy will therefore have a strong impact on interamerican relations for nearly the rest of the decade. An increase of development aid for Latin America is not on the agenda of the reinstated Administration, perhaps with the exception of some troubled countries in the Caribbean. The private banks will remain -30- reluctant to provide fresh credits to Latin American countries. Also the flow of direct investments will only pick up slowly. This situation is a challenge and an opportunity at the same time. The Latin American countries cannot any longer look for external solu- tions to their problems. They can stabilize themselves only by carrying out a number of long delayed internal reforms, e.g. reforms in the neglected agrarian sector, promotion of small and middle-sized enter- prises, improvement of the national education system and broadening of the technological basis. The foundation for such a policy change has been laid. In recent years, many Latin American countries turned away from authoritarian regimes and returned to democracy. It is now up to the new leaders to prove their commitment to a more equal social and economic development of their countries. D/286 -31- Footnotes : The quoted line stems from the following article: Abraham F. Lowenthal, The United States and Latin America: Ending the Hegemonic Presumption, Foreign Affairs, Vol. 55, No. 1, 1976. 2 See Richard R. Fagen, The Carter Administration and Latin America: Business as Usual? Foreign Affairs, Vol. 57, No. 3, 1979. See also Alfred Stepan, The United States and Latin America: Vital Interests and the Instruments of Power, Foreign Affairs, Vol. 58, No. 3, 1980. 3 Wolf Grabbendorf f , The United States and Western Europe: Competition or Co-Operation in Latin America, International Affairs, Vol. 58, No. 2, 1982, p. 627. The new approach to Latin America is clearly presented in: Jeanne Kirkpatrick, U.S. Security and Latin America, Commentary, Vol. 71, No. 1, 1981. 4 Richard E. Feinberg, The Reagan Administration's Economic Policies and the Third World, ODI Review, (Overseas Development Institute, London), No. 2, 1982, p. 25. This judgment has to be contrasted with the much higher economic influence of European governments. Feinberg, op. cit., p. 21 For an insider's view, see Myer Rashid, Die amerikanische Politik gegenueber Entwicklungslaendern (U.S. Policy toward Developing Countries), Europa Archiv, No. 17, 1981. Q For example, see Ricardo French-Davis, The Monetarist Experiment in Chile: A Critical Survey, World Development, No. 11, 1983. 9 See Feinberg, op. cit., p. 22. For a discussion of the many inconsistencies of Reagan's economic program, see Lester C. Thurow, Reaganomics , Aussenwirtschaf t, Vol. 37, No. 4, 1982. See Thomas Ehrlich and Cathrine Gwin, A Third World Strategy, Foreign Policy, No. 44, Fall 1981. 12 The concept of the Caribbean Basin is discussed in: Robert Pastor, Sinking in the Caribbean Basin, Foreign Affairs, Vol. 40, No. 5, 1982. "The FTA was implemented on January 1, 1984. President Reagan declared 20 nations beneficiaries of the CBI. 14 See R. E. Feinberg, The Caribbean Basin Initiative: First Steps Toward Implmentation, conference paper, 1984, p. 5. -32- Feinberg, op. cit. , p. 8. International Parks Inc. , Taking Advantage of the Caribbean Basin Initiative in Central America and Panama, Report to U.S. AID, mimeo, 1983. See Table 1; for the importance of Latin America for U.S. exports and imports see Table 2. 1 8 Sanjay Dhar, U.S. Trade with Latin America: Consequences of Financial Constraints, Quarterly Review, Federal Reserve Bank of New York, Autumn 1983, pp. 14-18. 19 For an extensive presentation, see R. E. Feinberg, United States Financial and Investment Policies Toward Latin America: The Bureaucracy Copes with Crisis, conference paper, 1984. 20 Feinberg, op. cit., p. 18. 21 Ibid. 22 Margret Daly Hayes, Latin America and the U.S. National Interest, Boulder and London: Westview Press, 1984, p. 68. 23 Herbert Goldhamer, The Foreign Powers in Latin America, Princeton: Princeton University Press, 1972, pp. 40-41. 24 Ned G. Howenstine, U.S. Direct Investment abroad in 1983, Survey of Current Business, Vol. 64, No. 8. See also Table 3. 25 R. E. Feinberg, The Intemperate Zone - The Third World Challenge to U.S. Foreign Policy, New York and London: W. W. Norton & Company, p. 85. Daly Hayes, op. cit., p. 71; public debt = publicly guaranteed liabilities with maturity of more than one year. See also Table 4. 27 For a detailed description of the Administration's policy regarding international financial markets, see Feinberg, United States Financial and Investment Policies ..., op. cit. 28 See Table 4. In some countries the U.S. exposure was even higher. 29 John P. Lewis and Valeriana Kallab (eds.), U.S. Foreign Policy and the Third World, Agenda 1983, New York: Praeger, p. 200. 30 For the nine largest U.S. banks, credits to non-oil developing countries had reached 2.2 times their collective capital by mid 1982. Lewis/Kallab (eds.), op. cit., p. 11. 31 U.S. agencies extended as bridging loans $4.5 billion to Mexico, $1.2 bilion to Brazil and $300 million to Argentina. -33- 32 The New York Times, May 4, 1984. 33 See Riordan Roett, Brazil's Debt Crisis, and Lance Taylor, Mexico's Adjustment in the 1980's, in: R. E. Feinberg and V. Kallab (eds.), Adjustment Crisis in the Third World, New Brunswick and London: Transaction Books, 1984. 34 The New York Times, August 28, 1984. 35 See Harry J. Shaw, U.S. Security Assistance: Debts & Dependency, Foreign Policy, No. 50, Spring 1983. See Feinberg, The Reagan Administration's Economic Policies ..., op. cit. , p. 34f f . 37 Lewis/Kallab (eds.), op. cit., p. 26. 38 T ... Ibid. 39 See Table 5. 40 See C. Fred Bergsten, Economic Relations between the United States and Latin America, in: The International Economic Policy of the United States: Selected papers of C. Fred Bergsten, Lexington and Toronto: Lexington Books, 1980. 41 See Feinberg, The Caribbean Basin Initiative ..., op. cit., p. 13ff. 42 Feinberg, United States Financial and Investment Policies ..., op. cit . , p. 14f f . 43 Ibid. 44 Argentina, Brazil, Chile, Mexico. Lewis/Kallab (eds.), op. cit., p. 153. Table 1 Distribution of Latin American Trade Flows, 1950-1982 (Percentages) Exports Imports U.S. L.A. E.E.C. Japan 1950 48.3 9.3 a 27. 8 a — 1960 39.5 16.5 — 2.6 1970 32.9 17.1 25.7 5.5 1978 34.1 — — — 1979 34.4 21.9 18.7 3.9 1980 34.0 — — — 1982 ~ 40.0 — — — 1950 50.1 10. 9 a 14. 5 a — 1960 38.5 16.7 — 3.2 1970 34.8 16.3 23.9 6.0 1978 28.7 — — — 1979 28.2 19.0 17.6 6.4 1980 30.4 — — — 1982 ~ 30.0 — — — a 1948 Source: Pan American Union, IMF, UNCTAD Table 2 Share of the Latin American Region in U.S. Trade 1978-1982 (Percentages) Imports 1978 1979 1980 1981 1982 South America 9.3 10.5 11.0 11.0 12.1 Central America 0.9 0.9 0.8 0.6 0.6 Caribbean 2.8 3.0 3.3 3.0 2.5 Mexico 3. A 4.1 5.1 5.2 6.2 Venezuela 2.1 2.5 2.2 2.1 2.0 Brazil 1.6 1.5 1.5 1.7 1.8 Exports South America 12.2 13.0 14.7 15.2 12.6 Central America 1.1 0.9 0.9 0.8 0.6 Caribbean 1.5 1.5 1.5 1.6 1.9 Mexico 4.6 5.4 6.9 7.7 5.6 Venezuela 2.6 2.2 2.1 2.3 2.4 Brazil 2.0 1.9 1.9 1.5 1.6 Source: United Nations, Yearbook of International Trade Statistics, Vol. I, New York, 1984, p. 1049. Table 3 U.S. Direct Investment Position in Latin America, 1966-1983 (millions of dollars) 1966 1977 1981 1982 1983 Total 9.752 27.514 38.838 32.546 29.501 Argentina 758 1.262 2.757 3.002 3.054 Brazil 882 5.695 8.247 8.995 9.022 Mexico 1.329 3.201 6.979 5.544 4.999 Netherlands Antilles — -792 -7.143 -15.885 -19.722 Panama — 2.442 3.785 4.396 4.519 Peru — 1.160 1.926 2.266 2.316 Venezuela 2.136 1.560 2.252 2.328 1.641 Source: U.S. Department of Commerce Table 4 Latin American Foreign Debt, 1980-1984 (billions of dollars) Total Argentina Brazil Chile Colombia Mexico Pern Venezuela Short-term debt not included Short-term debt included Share of U.S. end of end of end of end of Banks in 1980 a 1981 b 1982 b 1984 1982 123.0 — 250.0 350.0 12.2 35.6 43.0 45.0 35% 51.5 61.4 87.0 98.0 37% 5.1 12.6 17.2 20.0 52% 6.7 8.5 10.3 13.0 55% 39.0 73.0 80.1 93.0 39% 8.4 8.8 11.5 13.0 44% 11.1 26.0 29.5 35.0 37% Source: M. 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