Private Banking and International Debt

PRIVATE BANKING AND INTERNATIONAL DEBT Irving S. Friedman J. he external debt of the developing countries has moved to the forefront of international attention. After decades of being regarded as a matter of concern for those relatively few who are involved with economic and social development and its financing, the subject has now captured the imagination of commentators, novelists, and politicians. External debt of developing countries is seen as a volcano that has begun to explode—threatening the world economy and world finance. Many believe it to be caused by either the folly and greed of the lenders or the irresponsibility and stupidity of the borrowers. These emotions threaten to become the basis for private and public decisions that might endure for long periods and cripple the growth of developing countries. Important lessons can be learned from recent experiences. Improvements in international lending to developing countries can and should be made by private and public entities. We must be aware that developing countries must have major sources of external finance, and that these needs will increase steadily in the years ahead. Developing countries can restrain growth, but only for relatively short periods if restraints mean more unemployment and reduced living standards. External financing creates possibilities for more jobs, more investment, and higher living standards in countries desperately in need of all three. Unless public institutions can be sufficiently expanded or transformed so as to meet the Irving S. Friedmanjoined the First Boston Corporation as senior advisor in 1980 and has served in various senior capacities in the U.S. government, the International Monetary Fund, the World Bank, and Citicorp since the early 1940s. Dr. Friedman is also a visiting professor at the University of Virginia and has written a number of books, among them Inflation: A World-Wide Disaster (Boston: Houghton Mifflin, 1980), and The Emerging Role of Private Banh in the Developing World (New York: Citicorp, 1977). 183 184 SAIS REVIEW needs of developing countries, we must be concerned about suggestions that weaken the capabilities of private lenders. Assertions about risks and losses have to be examined in light of available facts and experience. In any case, attention needs to be given to find ways and means to improve the capabilities of existing private institutions to perform their vital function of development finance in a world of large debts and adverse economic conditions. My own forecast is that we will see further large expansion in commercial bank lending to developing countries. Modern developing countries are committed to accelerated economic growth and structural transformation, e.g., expanding modern manufacturing , agriculture, and monetarizing traditional barter societies. In addition, they have other closely related social objectives. Improving the quality of life, for example, requires capital expenditures for such things as schools, hospitals, and recreational facilities. Moreover, many are committed to consumption programs, even subsidizing food and housing , which reduce available savings for investment. Leaving aside the merits of these social policies, they create economies that are usually in deficit and often characterized by chronic inflation—even in the face of strong efforts to increase domestic savings. These deficits can be expressed in real terms, such as gaps in goods, services, and technology, or in money terms, such as saving-investment gaps and balance-of-payments deficits. However expressed, such gaps can be filled in the short run only by inflows of goods and services or by financial resources, whether in form of grants, concessional loans, or credit extended by private capital markets on commercial terms. At any given time the developing economy can do only what available resources permit. "Gaps" exist in the future; actuality eliminates these gaps, but how this is done is a central question ofdevelopment. Too often, inflation has been the adjusting mechanism, but inflation itself often creates serious problems by discouraging savings and encouraging nonproductive investments; it also creates inequities in income distribution and consumption. Currency devaluation can help such countries reduce the need for external financing, but by itself cannot bring the needed additional resources nor assure their efficient, productive use. Beneficial results depend on the entire package of government policies effectively implemented by a country. Chronic balance-of-payments deficits can be financed either by inflows...