- Email: [email protected]
International debt and the stability of the world economy
This tit& book is a tour de #me, a felicitous combination of quantitative history, cunceptd analysis, modeling and projections, and policy rccommendations. Yet i its CoJIclusion ” . . . that with reasonable recovery in the global wtwrny, the problemsof international debt should prove manageable . , +” shows once again that select5ve judgment is an important ingredient in economic evaluation. Perhaps, it is only the traditional difference between “half full and half empty” th2t suggests that the same empirical results might weli support rather dif&rent toncfusions. Chine has done a bnilfiant and timely job. First, he considers the dimensions of the debt problem and its otigk Of the increas;e in debt of $4b2 biilion between 1973 and 1982, Chine at~butes $260 billion to oil price increase and $14 I billion to uther factors, such as high real interest rates, recession, gnd terms of trade, which can also be:*la&d to oil prices. He points out correctly t”lat, once the debt has been accumulated, it does not follow that the situation can be relieved by a @oIlapseof oit prices. Cline recognizes that other factors, particularly domestic policy misrn~agemel~t~ also may have played an important role. Yet, his analysis curiously lacks connection with real life. The indebtment of the LD@s refIects many unique chases. The oif producers, Mexico and Nigeria got into debr despite high oil prices: their blaated ~~e~~l~prnentexpenditures exceeded the less than expected flow of oil export eaplings. Speculat ve ~~~owi~g accounts fop much of the debt of Argentina, which ir*substaAalty self-sufIicient ir; oii. Brazi!‘s debt is linked more closely with the cast of oil, though ambitiou,z;resource deve!opmenC plans were afsia important, and the debt increase occurred despite an eminently ~u~ce~~fu~export program, Some expctrs would hew the oil impact from an a~~g~t~r diRerent petspective (Sanchez 1983), with OFEC frimdscontributing to the liquidity of the banks why were consequently willing to make loans to the LDCS. ftt any case, the lns~ word has not been lwritten on this historiwl Thf: seconc’ ~~~ti~~ of the twc& ~~~~~~~c.?n~~~~~~~~t~1~6 if;isws, the questh
OF
ban’ vuinerat ility. Clint predicts ~s~~pr~~s~v~ figures 011tf .e relation between LDC ows that mosf major WS banl;5 are mto ” two and ~~~~~~~~~~ lirxw-i in the c:ise ot ~~~ uf‘rrctula-s ~~~~~~~~ Bank. Thert: is ~~~~~~~~lil fh:se figures a 3isk of’ bank insolvancy tar oflarge net worth loosest. li have some doubt about the si~~~~~~~:$
of these rati+k A totall write-calf thdsdebts ~~~?~~d rncan t at the b~~~~w~~~~d ha~,c negative net wsr~h, bratc’btcn&at ~zN~lltp:~~~~~might rootmean that thrq crsufd F-W%
14II
W. R. Cline
continue to function. The critical issues are their liquidity, and depositor confidence. Moreover, as Clines goes to pains to point out, there are innumerable ways in which the F::deral Reserve couId and would bail out the banks, if
necessary. Another important conceptual contribution is the notion of invoiuntary tendir~. Chne shows persuasively that bankers in a ‘Vender’s trap” must p&de new funds to shore up their outiitanding loans. The major lenders are indeed extending; additional loans, a very important part of the process of loan restructuring. But it is valid to say that in order to continue this process, the banlrs must not be “taken ofI the hook?“’ Roes not the process of inv0lunUf-y lending lead to further accumulation by countries whose credit worthiness is doubtful, and might not tha: increase their incentive uhimately to renounce the debt? The projections of future debt and debt service ratios are based on a simple but elegant debt simulation model, similar to other such models, for example, Ad.ams, Sanchez, and Adams ( 1983). The base assumptions made are well in line with other current estimates, though the income elasticities usexl are probably optimistic. The positive thing about this kind of analysis is the pssibibty oftesting the sensitivity of the reEations to alterraative assumptions. The results of Cline’s simulations are, by and huge, optimistic in the base scenario, for the I9 largest debtor countries combined the current account deficit declines (though not by all that much) and the indicators of credit-worthiness show improvement. The aggregate ratio of net debt (gross debt minus reserves) to exports of goods and services falls from 1.87 in 1382 to 1.62 in 1986, and the ratio of debt service (long term debt amortization and interest on both long- a.nd shortterm debt) to
remain sluggish and their current account and debt positions deteriorate? For the importing countries, the results are quite favorable, the combined IGurrent account changes from a deficit of $35 billion in 1982 to a deficit of $13 billion in 1986. Their net debt to exports ratio derlines from 1.94 in 1982 to 1.28 in 1986, and the debt service ratio declines from 39% to 26%. These results appear to be
d
iargeiy the consequence of the assumption of sluggish oil prices (flat nominal prices at $29 a bari*ej to 1985, and an increase of $34 a barrel in 1986). That does not seem to be an unrealistic assumption, though the results are highly sensitive to the oil price assumed. With respect to growth and interest rates, the sensitivity analysis shows that improvement in the rate of growth of the industrial countries of 0.X percent ha%a .igniffcant $33 billion rffect r?n ~uxnt account d&its of tk debkur countries sbout equal to that of a 4.75 interest rate change. On this basis, Cline argues that somewhat higher growth in the industrial countries would help even if it brought Ticjderateiy higher interest rates. Cline’s simulation results are quite in line with
BOOK REVIEW
149
those of others. In his calcu!atlons, the critical threshold for deveroped country growth is 3% per year. If sucn a growth path can be maintained, the debt problem will show improvement. and it is on this basis th,at Cline’s recommendations r~st *.
remain far from the point where default M radfzal reschedulirg on nc~~~arket terms would remain an attractive op5on.” He supports only mild refor~ts, a “measured” response. T!Gs invohm continuation of the rescue prwams such as the ones recently zarried out for Brazil and Mexico, contanrtcd new lending by the commer&l banks as well as by public financial institutions and only moderate new bank regulations. Signifscantiy, Gline does not support new institutions, “proposafs for stretching out debt and reducing its interest rate through a new international agency would probably be CrHlnterproductivebecause the result would be to choke off new bank lending. . . .*’ . . . the m&x
debtor
esuntries
(except
perhaps
Potand)
still
Perhaps the outcome will indeed be as Cline projects it. Bu’, as he would c :rtainly admit, there is much that can go wrong.
The projectio.ls that are fairly optimistic in :he aggregate hide more serious problems in individual countries, e.g., Brazil, and Poland. Even these projections assume continued recession in the LlXs, negati*fe growth in Mexico and Braril during 1.982 and 1983, and only modest growh thereafter, and imply serious risks of social and political instability. The external forces may not work out as favorably with respect to oil prices, economic growth, and interest rates as has been assumed. The rescheduhng process may break down. Even a temporary breakdown rn5.J have serious consequences for the world monetary system. There could be a loss of confiaence in the banks-this is probably not so much a question of their net worth, ds of *-heconfidence of the suppliers of credit to the bank.
Even if in the aggregate the picture lmks manageable, the potential for crisis in the world economy exists, particularly on a country by country OI bank by bank basis. However, perhaps more serious is the question of the impact of the debt on the ability of the LDCs to continue on a reasonable development path. Even if ccanemie stability ‘:a.n be maintained, can we condone a situaticn where the p3r countries are making interest payments amounting to one third of their exports, i ic.* where debt service calls for trade surpluses of massive p-op~tious? Such t ansfers will set bkck ccot-v.~micdev :lopmcnt for a generation. Cline considers a I umber af ~r~~sais to dcai with the debt on a long-run basis (Kenen ( l9SS). 1Lohatyn ( 1983), Boiin and de1 Canto ( 1983). for example), kc!! t e dismisses the m t 4.1tof hand. There is neaad fo m-we 6pf3fxw5 th:wd-it ad ptd~tical Ixgc%ation in t:.ir; I egaro. We must seriously consider mechanisms for foqgving tk debt or tor turning it into very long guaranteed term, low interest !oans. This aouid go 8 long WWJbeyond Cline’s limited polky prescriptions.
W. R. (Iline
!30
I\EFEREKCES Adam, F.G., San&a. E., and Aduns, Mark E. (1983) Cm Lain America Crry lo lmwarl Dabi? A Fmqnctiw AnAlysh thing tba whutm Latin Anr*‘tm LMt Simulrtiaa Model, Jound o/hIic~ 419-441 (Ncwembar). W.H.. and 61 Canto, Joqc. LDC D&t Bcycrd Criir .@nin 1099-I (1983) Neu Yoti 7Vmes.March Felix ( Tnthnony Before Commtne~ Ike@n Rddaw, slcwt. Wuhin@n. (Jmwy 17). Sanckz. Enriqw (1983) Crisk. In Cm*& Cdrir, Crruk Whutm EconomtcricFormnin(l tbociacr.
Gcmrd Muns Mugust EndIe t’kvivcd
25 imuary
1984
P. smcbez
OF
ban’ vuinerat ility. Clint predicts ~s~~pr~~s~v~ figures 011tf .e relation between LDC ows that mosf major WS banl;5 are mto ” two and ~~~~~~~~~~ lirxw-i in the c:ise ot ~~~ uf‘rrctula-s ~~~~~~~~ Bank. Thert: is ~~~~~~~~lil fh:se figures a 3isk of’ bank insolvancy tar oflarge net worth loosest. li have some doubt about the si~~~~~~~:$
of these rati+k A totall write-calf thdsdebts ~~~?~~d rncan t at the b~~~~w~~~~d ha~,c negative net wsr~h, bratc’btcn&at ~zN~lltp:~~~~~might rootmean that thrq crsufd F-W%
14II
W. R. Cline
continue to function. The critical issues are their liquidity, and depositor confidence. Moreover, as Clines goes to pains to point out, there are innumerable ways in which the F::deral Reserve couId and would bail out the banks, if
necessary. Another important conceptual contribution is the notion of invoiuntary tendir~. Chne shows persuasively that bankers in a ‘Vender’s trap” must p&de new funds to shore up their outiitanding loans. The major lenders are indeed extending; additional loans, a very important part of the process of loan restructuring. But it is valid to say that in order to continue this process, the banlrs must not be “taken ofI the hook?“’ Roes not the process of inv0lunUf-y lending lead to further accumulation by countries whose credit worthiness is doubtful, and might not tha: increase their incentive uhimately to renounce the debt? The projections of future debt and debt service ratios are based on a simple but elegant debt simulation model, similar to other such models, for example, Ad.ams, Sanchez, and Adams ( 1983). The base assumptions made are well in line with other current estimates, though the income elasticities usexl are probably optimistic. The positive thing about this kind of analysis is the pssibibty oftesting the sensitivity of the reEations to alterraative assumptions. The results of Cline’s simulations are, by and huge, optimistic in the base scenario, for the I9 largest debtor countries combined the current account deficit declines (though not by all that much) and the indicators of credit-worthiness show improvement. The aggregate ratio of net debt (gross debt minus reserves) to exports of goods and services falls from 1.87 in 1382 to 1.62 in 1986, and the ratio of debt service (long term debt amortization and interest on both long- a.nd shortterm debt) to
remain sluggish and their current account and debt positions deteriorate? For the importing countries, the results are quite favorable, the combined IGurrent account changes from a deficit of $35 billion in 1982 to a deficit of $13 billion in 1986. Their net debt to exports ratio derlines from 1.94 in 1982 to 1.28 in 1986, and the debt service ratio declines from 39% to 26%. These results appear to be
d
iargeiy the consequence of the assumption of sluggish oil prices (flat nominal prices at $29 a bari*ej to 1985, and an increase of $34 a barrel in 1986). That does not seem to be an unrealistic assumption, though the results are highly sensitive to the oil price assumed. With respect to growth and interest rates, the sensitivity analysis shows that improvement in the rate of growth of the industrial countries of 0.X percent ha%a .igniffcant $33 billion rffect r?n ~uxnt account d&its of tk debkur countries sbout equal to that of a 4.75 interest rate change. On this basis, Cline argues that somewhat higher growth in the industrial countries would help even if it brought Ticjderateiy higher interest rates. Cline’s simulation results are quite in line with
BOOK REVIEW
149
those of others. In his calcu!atlons, the critical threshold for deveroped country growth is 3% per year. If sucn a growth path can be maintained, the debt problem will show improvement. and it is on this basis th,at Cline’s recommendations r~st *.
remain far from the point where default M radfzal reschedulirg on nc~~~arket terms would remain an attractive op5on.” He supports only mild refor~ts, a “measured” response. T!Gs invohm continuation of the rescue prwams such as the ones recently zarried out for Brazil and Mexico, contanrtcd new lending by the commer&l banks as well as by public financial institutions and only moderate new bank regulations. Signifscantiy, Gline does not support new institutions, “proposafs for stretching out debt and reducing its interest rate through a new international agency would probably be CrHlnterproductivebecause the result would be to choke off new bank lending. . . .*’ . . . the m&x
debtor
esuntries
(except
perhaps
Potand)
still
Perhaps the outcome will indeed be as Cline projects it. Bu’, as he would c :rtainly admit, there is much that can go wrong.
The projectio.ls that are fairly optimistic in :he aggregate hide more serious problems in individual countries, e.g., Brazil, and Poland. Even these projections assume continued recession in the LlXs, negati*fe growth in Mexico and Braril during 1.982 and 1983, and only modest growh thereafter, and imply serious risks of social and political instability. The external forces may not work out as favorably with respect to oil prices, economic growth, and interest rates as has been assumed. The rescheduhng process may break down. Even a temporary breakdown rn5.J have serious consequences for the world monetary system. There could be a loss of confiaence in the banks-this is probably not so much a question of their net worth, ds of *-heconfidence of the suppliers of credit to the bank.
Even if in the aggregate the picture lmks manageable, the potential for crisis in the world economy exists, particularly on a country by country OI bank by bank basis. However, perhaps more serious is the question of the impact of the debt on the ability of the LDCs to continue on a reasonable development path. Even if ccanemie stability ‘:a.n be maintained, can we condone a situaticn where the p3r countries are making interest payments amounting to one third of their exports, i ic.* where debt service calls for trade surpluses of massive p-op~tious? Such t ansfers will set bkck ccot-v.~micdev :lopmcnt for a generation. Cline considers a I umber af ~r~~sais to dcai with the debt on a long-run basis (Kenen ( l9SS). 1Lohatyn ( 1983), Boiin and de1 Canto ( 1983). for example), kc!! t e dismisses the m t 4.1tof hand. There is neaad fo m-we 6pf3fxw5 th:wd-it ad ptd~tical Ixgc%ation in t:.ir; I egaro. We must seriously consider mechanisms for foqgving tk debt or tor turning it into very long guaranteed term, low interest !oans. This aouid go 8 long WWJbeyond Cline’s limited polky prescriptions.
W. R. (Iline
!30
I\EFEREKCES Adam, F.G., San&a. E., and Aduns, Mark E. (1983) Cm Lain America Crry lo lmwarl Dabi? A Fmqnctiw AnAlysh thing tba whutm Latin Anr*‘tm LMt Simulrtiaa Model, Jound o/hIic~ 419-441 (Ncwembar). W.H.. and 61 Canto, Joqc. LDC D&t Bcycrd Criir .@nin 1099-I (1983) Neu Yoti 7Vmes.March Felix ( Tnthnony Before Commtne~ Ike@n Rddaw, slcwt. Wuhin@n. (Jmwy 17). Sanckz. Enriqw (1983) Crisk. In Cm*& Cdrir, Crruk Whutm EconomtcricFormnin(l tbociacr.
Gcmrd Muns Mugust EndIe t’kvivcd
25 imuary
1984
P. smcbez