The Multinational Monitor


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Breaking Third World Dependence

An interview with Michael Hudson

This month, Multinational Monitor spoke with two leading experts on international finance and Third World development. Their sharply divergent views reflect the wide range of opinions amongst bankers, economists and political figures on the current condition of world financial markets, the role of commercial credit in developing countries, and future prospects for development finance.

Irving Friedman, now a consultant with First Boston Corporation, is a forceful proponent of commercial bank lending to the Third World. His 35-year career includes service in the U.S. Treasury Department, the World Bank and International Monetary Fund, and, for the last six years, private banking. While a senior vice-president at Citibank, Friedman became best known for his role in negotiating controversial agreements to resolve debt crises facing Peru and Zaire. His globetrotting exploits prompted one U.S. magazine to label him the "Henry Kissinger of international finance." Friedman stressed that his views should be taken as those of an individual, reflecting his experience in public and private finance, rather than as a representative of any particular institution.

Michael Hudson, author of several books on international economics, spent six years as balance of payments economist with Chase Manhattan Bank. He has also worked with Arthur Anderson and Co., and was senior economist with Continental Oil. For the last three years, he has served as a research fellow at the United Nations Institute for Training and Research, where he developed a proposal to restructure Third World debt to be presented at the United Nations in May.

What follows are excerpts from, our conversations with Friedman and Hudson. The interviews should not be considered a debate, since neither man was asked to respond directly to arguments made by the other.

MULTINATIONAL MONITOR: Many bankers and economists consider growing Third World indebtedness a sign. that the transfer, of capital from developed to developing countries is taking place. Without a constant inflow of external capital, they say, the Third World would not acquire needed funds for development. How do you view the impact of commercial loans on the Third World?

MICHAEL HUDSON: The effect of international lending has been to finance underdevelopment and import dependency, not self-reliance. Commercial loans have not been related to growth in productive powers and debtservicing capacity. Their foundation rests simply on the good will of debtor countries, on their reluctance to become world financial outcasts like Cuba. But despite these countries' commitment to debt servicing, the earning-power just isn't there to carry today's foreign debt overhead.,

In this situation bankers have not been able to foresee how Third World countries can repay their debts. This is nothing new. For many years they didn't see how Britain could do so either. They kept lending because they felt the U.S. government would keep Britain solvent. Now they believe that the industrial-nation governments and the IMF will somehow keep Third World countries afloat.

MONITOR: But bankers talk all the time about the need for commercial loans to finance export-oriented investments so they can generate the foreign exchange necessary for repayment.

HUDSON: This is the myth they like to promote but know will never materialize. In fact, even if loans were used to increase export capacity, it would tend to be ' self-defeating because of the "transfer problem." Suppose all Third World countries borrow to increase their exports. This expansion would force down the Third World's terms of trade; export prices would fall by more than volume increases since most Third , World exports are price-inelastic. Thus, the developing country balance of payments position deteriorates. Matters are made even worse by the fact that Third World nations borrow to export raw materials and then import food.

Chile is a good example. Since 1951 all the net value returned to Chile from its copper exports has been absorbed by the growth in food imports. It used to be a grain and fertilizer exporter to areas as far north as California. Yet here it is, exploiting nonrenewable resources such as copper while importing grain that it could produce at home, given an adequate program of agricultural modernization and land reform.

MONITOR: But what about a country like Brazil, which is moving to export a diversified line of manufactures?

HUDSON: Even when such countries produce more industrial goods, they find themselves blocked by quotas and tariffs imposed by the industrial nations; they are able to export only raw materials to the increasingly protectionist North. Look at the American quotas that have been imposed on South Korean and other Asian exports. To the extent that the United States and other industrial-nation governments have prevented the Third World from earning its way out of debt, they themselves must take some responsibility for Third World inability to repay.

MONITOR: So you think it possible, with a reduction in First World protectionism, for Third World countries to export their way out of debt?

HUDSON: Only in a very limited number of cases. You can repay debt in two ways either you can increase exports, or reduce imports. There is no . reason for Third World countries to become dependent on food imports. It represents a warping of their economies. Their development in this respect has been just the opposite of the United States and Europe, where agriculture formed the foundation for industrialization. In order to stabilize their international position, these countries must modernize their internal position.

MONITOR: Given the more concessionary nature of public credit-loans from the World Bank or the IMF, for example-would public lending be a more appropriate means of financing the growth of' Third World productive capacity, particularly investments in infrastructure?

HUDSON: It would be a disaster. However bad private lending has been, lending by the World Bank, IMF and U.S. Government has been much worse, because it actively promotes a false development philosophy, an export-oriented and dependency-oriented view. However usurious commercial lending is, however short its terms, commercial banks do not insist that countries deform their development to become food-deficit monocultures imposing deflation by authoritarian fiat. And that is exactly what the World Bank and IMF do. Just look at the course of World Bank lending since the beginning. Until about 1965 all World Bank country missions emphasized the need for agriculture to serve as the foundation for development. Yet only a small percentage of loans actually went to agriculture. Most were for capital-intensive projects such as electric power generation and transportation. In the seventies, the Bank began to shift to agribusiness lending, almost entirely for export-oriented agriculture like cattle-farming, rather than subsistence agricultural production to actually feed Third World populations. Or, if agricultural lending did occur, it was for high-cost irrigation projects where no problems of land-tenure existed. The World Bank did not tackle land-tenure problems; it worked around them, within the confines of existing social rigidities-and stuck Third World governments with the bill for its inefficiencies.

MONITOR: You've been highly critical of the stabilization measures supported by the IMF and the private banks. What's wrong with current stabilization policies? Can you offer alternatives for dealing with debt crises?

HUDSON: These so-called stabilization programs are not stabilization programs at all, they are destabilization programs. They are based on the assumption that every dollar cut back in domestic consumption and investment is automatically "freed" to repay foreign debt. This represents a basic confusion between domestic budgetary problems and international transfer problems. In reality, austerity programs reduce not only consumption but production-including production for export-by even more than the amount of the new stabilization loans extended. Thus, instead ,of a zero-sum game there is actually a negative-sum game. The capital accumulation process is thus counteracted.

I think that the only solid basis for helping a country stabilize its economy and repay its debts must rely on increasing productive capacity.

On an interim basis, I don't think countries can afford to both repay their foreign debts and undertake domestic investment needed to cut back imports and increase foreign exchange earnings. Therefore, I think a debt moratorium should be negotiated, similar to the Hoover moratoria of 1931 which suspended World War I debts from Europe to the U.S. The debt moratorium should be made conditional upon countries taking active internal steps to modernize their economies.

MONITOR: Can you speak in more detail about the debt moratorium proposal?

HUDSON: One of the major issues now being discussed by the United Nations is the international debt question. On May 8 and 9 there will be a meeting in the U.N. General Assembly Hall to discuss, among other things, plans for a moratorium on Third World debt and, as a byproduct, the creation of a new World Bank for Economic Acceleration. The proposed Bank will be designed to invest between $100 billion and $200 billion to help Third World countries modernize their economies. Instead of making loans to finance dependency on industrialized nations, the projected bank will finance Third World self-dependency. Instead of loans being made on the condition that they reduce domestic investment and consumption, the projected bank will increase both their production functions and living standards.

It would begin by conducting an ongoing evaluation of each country's capacity to pay its foreign debt. No country would be expected to pay in debt servicing more than 15 percent of its net foreign exchange earnings-that is, total earnings less foreign exchange needed for the purchase of essential imports. Loans that were made with no chance of ever being repaid-those loans made in conjunction with IMF stabilization programs, for example-would be completely wiped off the books. Bona fide export credits will be paid by developing countries, unless they exceed IS percent of net export earnings. In this case, the loans will be rescheduled and repaid out of the growth in Third World productive powers.

MONITOR: How would the Bank be funded and governed?

HUDSON: The Bank would be funded largely by soft currency from developing countries. Let's say a country owes $1 billion in foreign-debts. Rather than paying $1 billion in foreign currency, the country would pay $200 million in foreign exchange and the equivalent of $800 million in domestic currency into the Bank. By and large the country will generate this money via the printing press. The Bank would then have to determine how these funds could be reinvested in the economy to provide for modernization and import displacement. The Bank must use soft currency, because so much of these countries' developmental needs are at the local level.

The Bank would say we know there are commercial debts that should be repaid, unfortunately the country .,doesn't have the money now. After the bank lends the domestic currency to generate domestic investment, however, it will eventually earn the foreign exchange. A country can raise foreign exchange not only by importing foreign capital but also through domestic, investment, so it can import less food, for example.

OPEC would also play a financing role. Right now, the oil-producing states don't seem to be able to keep their money anywhere-currency has become tremendously political. But as long as they continue to accumulate dollars, they are going to want to lend them. I think the Bank is a very good solution for them. Industrial nations would also want to buy bonds issued by the Bank, because they would supply resources to the Third World to buy developed country imports-this is especially true for the European nations.

MONITOR: Isn't this asking commercial banks and developed country governments to take a new and unprecedented approach to debt?

HUDSON: Not if you take a long historical view. Lycurgas of Sparta in 750 B.C. and Solon of Athens in 596 B.C. were put in power because lenders themselves realized that if they pressed their debtors too hard, the result would be - default and revolution. Every country has enacted bankruptcy legislation to let debtors off the hook and resume their lives as productive individuals rather than stripping them of their meager remaining assets. The Magna Carta held that a peasant's tools could ` not be seized for debt. The principle here is clear: a debtor cannot be stripped of his productive assets to repay a loan. What would occur under the May proposal is an extension of bankruptcy legislation from the private sector to governments, especially those whose foreign debts are not morally binding on their populations, such as debts which ended up in the private bank accounts of the Shah of Iran, Mr. Mobutu of Zaire, or Somoza of Nicaragua. This century has been unique in that whole populations have permitted themselves to be bankrupted and degraded in order to repay their debts. They have essentially become debt-slaves to their creditors. Now they are finally feeling angry about this. What began as a financial crisis is becoming a political crisis over the phenomenon of underdevelopment. I hope the projected Bank will mitigate world political strains by offering an economic way out of the foreign-debt tangle, by allowing the Third World to produce its way out of the problem.

MONITOR: Doesn't this program ignore political structures in the Third World? All the countries you have mentioned-Zaire, Brazil and Chile-are governed by authoritarian regimes accountable to a small economic elite. How will forgiving their debts aid those who are suffering now?

HUDSON: The projected Bank will only lend money for programs which ensure growth in productive powers. This entails steps to modernize agriculture and adopt other policies that most authoritarian regimes in the past have not been willing to do.

MONITOR: But these governments have developed a certain momentum of their own. Would the Bank attempt to play an activist role in changing the economic and political structures of these countries?

HUDSON: Yes. It would have to ,play such a role. The political structures which now exist in many countries are not consonant with the technological and economic imperatives for further development. All countries have to transform their institutional structures in the process of economic development. Although this question is not specifically addressed in the U.N. proposals being made in May, I believe it is necessary for any credit analysis to take account of the extent to which social and political institutions foster rather than impede development. The Bank should be willing to withhold funds unless countries are willing to change certain regressive social and economic policies.

MONITOR: What kind of response have these proposals, received from the representatives-both public and private-of the industrialized nations?

HUDSON: The commercial banks are, looking for some "honest broker" to avoid outright default by Third World countries. A rescheduling through a new institution may enable them to avoid having to put these loans on their bad debt list. The European countries seem to support the proposal. They support the Bank insofar as it taps OPEC and other resources to purchase European technology and transfer it to Third World countries. They realize that promoting, rather than thwarting, Third World development will create a growing market. for their exports. The U.S. banks may take their cue from the U.S. government, which is in danger of falling into an adversary position toward the Third World under the Carter administration, particularly the policies of Brzezinski.

MONITOR: What about the Third World? Are there tensions between developing countries over the moratorium proposal?

HUDSON: Initially, some of the more advanced Third World countries, such as Brazil, may have feared that if discussions got underway to arrange a debt moratorium or set up an institution which would link the debt-service obligations of countries to their capacity to pay, this would discourage further international lending. They now realize that this kind of arrangement is a precondition for putting lending on a solid footing. This should enable them to take on a higher debt. Because the proposed Bank's reforms also will help maintain the viability of the international banking system, it will benefit both creditors and debtors in promoting productive lending but discouraging unproductive lending.

Most of all, both high-growth countries such as Brazil and lower-growth Third World countries will be assured that no false and counter-effective monetarist philosophy of economic austerity will be imposed on them: they will welcome a foundation of credit and balance-of-payments stabilization based on growth of productive powers rather than the suppression of domestic consumption and investment.

MONITOR: : Is it possible that bankers are taking a favorable view of the proposal because they see the Bank as the government bailout they never thought they'd receive?

HUDSON: The proposal certainly doesn't amount to a bailout. Indeed, it is the antithesis of the bailout policies now promoted by private banks--the idea that OPEC should increase generalized lending to the Third World through the IMF. The fact is, the Third World would have to turn around and use that money to pay back the international banks.

As I said, some debts will actually be wiped off the books. Others will, be rescheduled. It will then be up to industrial-nation governments to decide how best to handle the impact of these measures on bank balance sheets. Certainly, banks will push for a direct government bailout. Unfortunately, I don't think the U.S. government distinguishes between preserving a particular bank as an institution and preserving its functions.

I don't think stockholders of a bank should be bailed out by the government. I do, however, think a bank's depositors should be saved. Basically, I hope what will happen in the future is what happened to Franklin National a few years ago-banks' assets would be allocated to other institutions who could absorb them. Again, it is imperative that the government distinguish between letting Chase Manhattan as an institution go under, for instance, and letting its functions suffer.

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