TASKER ON PERU

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87M00539R001602450019-1
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 26
• Document Creation Date: December 22, 2016
• Document Release Date: February 23, 2010
• Sequence Number: 19
• Publication Date: June 21, 1985
• Content Type: MEMO

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EXECUTIVE SECRETARIAT
ROUTING SLIP
Compt
NIO/LA
NIO/ECON
D/ALA/ D I
C/LA/DO
._
SUSPENSE 1500 - 1 Julr 85
oats
To 5: Please have required response
prepared
ecutive Secretory
4 June 85
Dote
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SECRET
NATIONAL SECURITY COUNCIL
WASHINGTON, D.C. 20506
June 21, 1985
Executive Secretary
Central. Intelligence Agency
SUB,7ECT: Tasker on Peru (S)
85- 24 95
SYS F~ I._ I
90678
Please provide the following information to the NSC by COB
July 1, 1985:
Breakdown of Soviet bloc/Cuban/Nicaraguan personnel,
programs, and especially hostile activities known at
present, including assessment of influence (e.g.,
economic, cultural, political). (S)
Synthesis of Peruvian political institutions--parties,
labor, civic organizations of importance, religious,
military--giving numerical strength, important leaders,
geographic regions of strength, etc. for pro-Soviet/
Cuban and/or communist institutions; democratic left to
center right institutions; and the far right. (S)
Possible Soviet/Cuban/Nicaraguan alternative strategies
to create pro-Soviet regime describing:
(a) how they might manipulate the Garcia regime from
1985-89 to this end; (S)
(b) how a pro-Soviet group could take power (e.q.,
through 1990 elections). (S)
Assessment of Alan Garcia (.including bio) his key
advisors, likely mayor economic and narcotics programs,
and likely foreign policy. (S)
L9i.lliam F. Martin
Executive Secretary
SECRET
DPClassifv on: OADR
ON-FILE NSC RELEASE INSTRUCTIONS APPLY
SECRET
P.~.2u Cy -3 5 ~--
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 STAT
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The Director of Central Intelligence
lNashin~~un.D.C.20505
The Honorable J. William Middendorf, II
U.S. Ambassador to the Organization of
American States
Room 6494, Department of State
Washington, D. C. 20520
Thank you for your letter of May 28, 1985 and the enclosed address
entitled "Free Enterprise: Key to Latin American Economic Revival."
As you well know, I concur with your views about the need for
positive steps to expand private sector development in Latin America.
While the measures you have mentioned are steps in the right direction, I
believe that more imaginative mechanisms of US support will be required
before we can expect any significant change.
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NIO/Econ/David Low: 19 June 1985 NIC 03157-85
Distribution:
Original - Addressee
1 - DCI
1 - DDCI
executive Registry
1 - C/NIC
1 - VC/NIC
1 - NIO/Econ
1 - A/NIO/Econ
2 - NIO/Econ Files
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United States Department of State
United States Permanent Mission to the
Organization of American States
Washington, D. C. 2052~Executive Fegistry~t
~... , mo o i n o c ~----- ----........~
In spite of news reports to the contrary, the economic
picture in Latin America has not substantially improved, even
though 58 percent of the entire $11.5 billion increase in
exports that the Latins registered last year worldwide came
to the U.S., and despite the fact that they had a $20.7 billion
trade surplus with us last year. For the near and long term,
everybody has good reason to be worried about the debt and
security problems in our hemisphere, and I fear that these
problems are not going to improve until a basic restructuring
of their economies takes place, redirecting them towards free
enterprise. In our country, we take free markets and the free
enterprise system for granted. What is overlooked is that
most of the largest debtor countries in our hemisphere have
over 50 percent of their productive economic activity owned
by the government, with all of its potential for inefficiency
and bureaucratic interference, to say nothing of official
corruption. Inflation rates are skyrocketing. No substantial
debt principal payments are being made, and interest payments
are being financed largely through new loans. If the U.S.
business cycle turns down, all hell could break loose and we
must be aware of it.
In 1981, Ronald Reagan began the deregulation of our economy
and the creation of incentives for vigorous economic growth.
Then Margaret Thatcher led the way in England with privatiza-
tion, and now a number of Europeans are looking at these success
stories as a model. Recently, several Latin countries have
been revising their own views on the role governments should
play in the market place. Working through the OAS, I have now
visited every country in our hemisphere carrying President
Reagan's free enterprise message.
In this regard, you might be interested in the enclosed
study--Free Enterprise: The Key to Economic Revival in Latin
America--outlining solutions for freeing up these economies.
The Honorable
William J. Casey,
Director of Central Intelligence Agency.
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Unless real progress is made in this direction, I fear the
security troubles that are now largely confined to Central
America (see my paper, Nicaragua: The Stolen Revolution, which
I sent you last week) will proliferate rom the Straits of
Magellan to the Rio Grande.
We need your help. With your own valuable contacts in the
hemisphere, can you help us in this effort to spread the Reagan
message?
J. William Middendorf, II
Ambassador
Permanent Representative
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Current
Policy
No. 692
Folk>tuiiiy i., a~~ address by Ambassador
J. William ~'fli.dcic~~~d~~r1~11, U.S. Perma-
nent Representative to fhe Organization
of American State+ /OAS), be/irre the hi-
tern.ation.al Cunfere~iee on Lalir~
America sponsored by the Ceroler fbr I~~-
tern.ation.al Relations, San. Jose, Costa
Rica, February 22, 1985.
It is a pleasure for me to join the il-
lustrious group here in the discussion of
the conference theme: "Basic Freedoms
in Latin America: Their Past, Present
and Future Prospects." The fact that
this historic conference is treating both
the political and economic aspects of
Latin America's situation is indicative of
what Secretary of State George P.
Shultz stated in his testimony before the
Senate Committee on Foreign Relations,
entitled "The Future of America Foreign
Policy: New Realities and New Ways of
Thinking" [Current Policy No. 650],
January 31, 1985:
The United States seeks peace and
security; we seek economic progress; we seek
to promote freedom, democracy, and human
rights. The conventional way of thinking is to
treat these as discrete categories of activity.
In fact, as we have seen, it is now more and
more widely recognized that there is a truly
profound connection among them. And this
has important implications for the futw?e.
Secretary Shultz expanded on these
points by saying:
... it is more and more understood that
economic progress is related to a political en-
vironment of openness and freedom. It used
to be thought in some quarters that socialism
was the appropriate model for developing
J. i>T~illiam Middendorf 11
Free Enterprise:
Key to Latin American
Economic Revival
United States Department of State
Bureau of Public Affairs
Washington, D.C.
counU?ies tkcause rcnu;il Nanning was bitter
able to mobilize and allocate resources in con-
ditions of scarcity. 1'hc historical experience
of Western Europe and \orth America,
which industrialized in an era of limited
government, was not thought to be relevant.
Yet the more recent experience of the Third
World shows that a dominant government
role in developing economies has done more
to stifle the natural forces of production and
productivity and to distort the efficient
allocation of resources. The real engine of
growth, in developing as well as industrial-
ired countries, turns out to be the natural
dynamism of societies that minimize cenu'al
planning, open themselves to trade with the
world, and give free rein to the talents .utd
efforts and risk-taking and investment ~leci-
sions of individuals.
Private and State Sector
Approaches to Development
It is becoming more and more obvious
throughout the hemisphere that without
a dynamic free enterprise system,
governments can neither stimulate nor
sustain economic groH?th nor diversify
their economies to foster economic
development. Too often in the past, one
heard the truism that first must come a
proper infrastructure, but this has led to
vastly overblown bureaucracies of
government-owned means of production
far beyond such basic infi?astructure re-
quirements as roads, utilities, and com-
munications. Without an efficient and
limited public sector at a manageable
economic cost-and without an overall
environment conducive to sound in-
vestment-privately owned enterprises
are unlikely to make their full contribu-
tion to development and commerce.
Economic development can no
longer be financed externally through
massive amounts of foreign aid or
foreign borrowing, which were
hallmarks of the 1960s and 1970s. No~c
growth, if it is to come, must begin with
each country's climate to attract and
keep in country local savings and to at-
tract foreign savings, i.e., having a set
of motivations and attitudes that are
concretely expressed in the absence of
civil conflict, a system of generally ac-
cepted and enforceable property rights,
and the ability of individuals to enjoy the
fruits of their labor without confiscatory
systems of taxation or arbitrary seizure
of property. If government controls too
much of the means of production, as is
the case in many of the high-debtor
countries in our hemisphere, or if it is
inefficient and ineffective or all of the
above, or if it pursues policies that
significantly distort free-market deci-
sionmaking, the overall prospects for
economic development suffer, and inter-
national commerce with it. As Secretary
Shultz noted in the testimony I cited
earlier:
..recent experience has fueled a broad
and long-overdue skepticism about statist
solutions, central planning, and government
directions.
This intellectual shift is partly the prod-
uct of the extraordinary vigor of the
American recovery. The United States has
revised its tax system to provide real incen-
tives to work, to save, to invest, to take
risks, to be efficient. We have reduced
government regulation, intervention, and con-
trol. We have opened opportunities for freer
competition in transport~.tion, finance, com-
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munication, manufacnu?ing, and ~lisu?ibution.
Last year's real growth in G\Y ~t;r~~s~ na-
tional product) wns the sharpest increase
since 1911; inflation was the lowest since
1967. The overall result tias the creation of
over 7 million new ?johs in `L ~~ears.
It is our sincere hope that the fac-
tors behind our present success in the
United States will be emulated in Latin
America because a return to sound
economic policies in all of the hemi-
sphere would be mutually beneficial and
ultimately create a better standard of
living for all. We are all one hemisphere,
and what affects the Latin countries af-
fects us all. Clearly, it is in my own
country's trading interest, siru?e we are
running a $20 billion trade deficit with
Latin America, largely as a result of its
sharply curtailed imports from us. It is
also in the interest of the world's finan-
cial institutions which have major loan
exposures there. Finally, the ability of
the hemisphere to withstand communist
adventurism and narco-terrorism
depends on sound economic policies for
economic recovery.
As one who has worked with the
Latins for 30 years, I don't think I can
emphasize strongly enough my feeling
that Latin America must work toward a
better balance between government and
free enterprise, which at present is so
heavily skewed toward state ownership.
Unfortunately, we seem to be losing
the semantic battle for the minds of
Latin Americans when we extol the vir-
tues of free enterprise. It is an unfor-
tunate fact that Marxist teachers have
infiltrated primary schools in many
Latin American countries. From that
key position, they take advantage of
their young charges' formative years to
make them feel that Marxism is the
natural state of affairs of any society.
Therefore, anyone who opposes it must
be against humanity. Foreign private
direct investment becomes "economic im-
perialism" in the Marxist-Leninist lex-
icon, and this economic imperialism op-
poses a "new international economic
order' which calls for redistribution of
the world's wealth. In the Marxist lex-
icon, we are in a zero-sum game where,
if one group is to attain greater wealth
(read "the exploiters"), another group
must lose it. None of this helps to en-
courage the much-needed new capital to
come in to create the jobs so desperately
needed in countries with unemployment
levels ranging up to 30% and 40%. In
fact, one wonders if Marxists in coun-
tries with non-Marxist governments
don't hope to keep unemployment levels
high, in the hopes that the resulting
unrest might help bring them to power.
The trend to? and government
ownership is c?learl~- seen in Mexico.
where, ac?crrrding t.. U?end data, there
were only 84 gmernment enterprises in
1972. By 14+52. there were 760. Dw?ing
the same period, total government
spending as a percentage of gross na-
tional product increased from 23% to
46%. By 19h'L, following the bank na-
tionalization, the great majority of
:Mexico's major industries were under
government control, and the govern-
ment's share of total capital formation
had reached 45%. It is an interesting
footnote that in the period 1957-72 (dur-
ing most of which Dr. (.)rtiz Mena, now
president of the Inter-Americ?xn
Development Bank, w?as f?iriance
minister), Mexico's compound annual
rate of GDP (gross dunrestic product)
growth was 6.6%, whereas during the
period 1973-83, after the oil boom
began, this GDP growth rate averaged
4.7%. Even in Brazil-where in 1979
President Figueiredo created a special
ministry with the objectives of (1) selling
government-owned enterprises to the
private sector-, where feasible; (2)
restricting the indiscriminate growth of
state-owned enterprises; and (3)
strengthening the frre enterprise
system-little progress has been made
and the spending of government and its
companies approaches 50% of the gross
domestic product.
A good sign fot? positive change is
that some of the empirical research
which has been conducted on the
macroeconomic consequences of the
statist "solutions" so long favored in
most of Latin America is beginning to
receive wider publicity and beginning to
affect the thinking of high-level
policymakers. Ke-Young Chu and An-
drew Feltenstein, in their paper
"Relative Price Distortions and Inflation:
The Case of Argentina, 1963-76" (Inter-
national Monetary Fund, Staff Papers,
Volume 25, September 1978), for exam-
ple, estimated that, in Argentina,
government transfers to cover public
enterprises' losses were proportionately
10 times as inflationary as the financing
of private enterprises' losses through
commercial bank borrowings, primarily
because it is assumed that only in the
former case are the losses translated in-
to high-powered money through central
bank financing of the government
deficit. Because the state in Argentina
owns the vast majority of its industrial
production, and since most of these
state-owned industries operate at enor-
mous losses which only government
printing presses can make up, the infla-
tion rate there last year approached
700%.
Other equally devastating findings
are discussed in Public Errte~~rises in.
Mixed Economies, by Robert H. Floyd,
Clive S. Gray, and R.P. Short:
For 'L5 developing countries for which
data were available. Short estimates the
average (weighted by GDP) overall public
deficit, before reduction by government cur-
rent transfers, at ;i.5 percent of GDP during
the mid-1970x. He further estimates that the
overall deficit in developing countries in-
creased h~? 2.5 percentage points of GDP be-
tween the Irate 1960s and mid-1970x.
Uefinin~ the "budgetary burden" of public
enterprises a~ the residual of government
transfers aml h~xns, less loan ser~ic~
payments h~ thr enterprises, Short estimates
this bw?dcn t~~ a~crxgr 3.3 percent of GDP
for 34 deveh~pin~ countries, compared with a
4.4 percent estimate for the central govern-
ment's overall hud>;et deficit in these coun-
tries. In other words, public enterpr?iscs ac-
counted for three-fourths of the ccnu?a~
government deficit in the countries in
question.
As I have witnessed during the last
30 years, the Latin American counu?ies
have suffered ever more stifling
bureaucratization of their economies.
Government intervention-often but-
tressed by nationalist and/or socialist
ideologies-has resulted in substantial
increases in:
? State ownership of economic ac-
tivities in, for example, extractive in-
dustries, manufacturing, financing, and
international trade and commerce, far
beyond the traditional limits of in-
frastructure and often accomplished
through expropriation without adequate
compensation;
? Regulation of private economic ac-
tivity via money, credit, and exchange
controls, licensing systems, and price
and wage controls;
? The state's consumption share of
gross national product; and
? Government investment expen-
diture-typically more than half of na-
tional capital formation.
Informal Economy
In spite of these trends, which amrrtrrrt
to a fight for survival on the part ..1' fr?.?~?
enterprise in many parts of Latin
America, there are several count~?r-
trends. Agood example of how the
private sector can triumph in slrit,? ~~f
governmental restrictions is reve:ded in
the study by Peruvian businessm:ur and
economist Hernando de Soto. liec:u,se it
takes a person 6 months to get g~~~~?rrr-
ment approval to set up a sintl~lr?
business in Peru, an informal ec~~n~~nric
system has grown to rival th~? n~~n?~?
traditional business. Accordant: t.. de
Soto, an informal economy rl~?~~?I~~I~~?~:
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and grew despite the tremendous hand-
icap of being illegal.
De Solo's study estimates that the
informal economy of Peru now accounts
for 90% of Lima's garment industry,
25% of its furniture industry, 60% of
housing construction, and even a good
part of the automobile and truck in-
dustries. The informal Peruvian
economy, says the study, has grown so
fast that it now accounts for an
estimated 60% of the total Peruvian
economy, and almost none of this output
is counted in the official $22 billion Peru-
vian gross domestic product. Perhaps
most important is the free enterprise
system's ability to create jobs: in Peru,
an estimated two out of every three jobs
are now in the informal sector.
Another factor Mr. de Solo's study
points out is that South American
economies often have two kinds of
private sectors: one that is seriously
burdened by excessive regulation and
hampered by bureaucratic inefficiency
but is officially sanctioned, and a second
one which is far more in accord with
free market principles but whose ex-
istence is barely acknowledged. This dif-
ference is made clear by an experiment
documented by a study group from Mr.
de Solo's Institute for Liberty and
Democracy, in which it tried to set up a
legal garment firm without easing the
way with bribes. According to a Wall
Street Journal article:
It took a lawyer and three others 301
days of full-time work, dealing with 11
government agencies to complete the paper-
work-which, when laid end-to-end, measured
102 feet. (One of the researchers then tried
the same experiment in Tampa, Florida, and
finished it in 3'/z hours.)
Debt Crisis Management
As we all know, Mexico's extreme illi-
quidity in August of 1982 precipitated
the "debt crisis.? The response was a
provision of immediate emergency
assistance by the U.S. Government and
other creditors which led to the develop-
ment of a rescue package and an IMF
[International Monetary Fund] stabiliza-
tion program. By the spring of 1983, the
U.S. Government had developed a
strategy designed to deal with the li-
quidity problems, primarily of the major
countries, and to encourage the adoption
of needed stabilization measures. What
has not been widely understood is that
the strategy was not intended to be one
of "solution" for the "debt crisis" but
rather one of "management" of the crisis
with the central purpose of preventing
the liquidity problems from developing
into a crisis of the entire international
financing system.
I think it would be helpful to recall
the elements of the U.S. Government
strategy for management of the debt
crisis as reaffirmed at the Williamsburg
summit:
? Credible economic stabilization
measures to be undertaken by the in-
dividual debtor countries;
? Sustainable economic growth in
the OECD [Organization for Economic
Cooperation and Development] coun-
tries, combined with the maintenance of
open markets;
? Support from the IMF and other
international financial institutions for
economic adjustment; and
? The provision of bridge financing
by creditor governments when needed.
I think we can all agree that, up to
now, the strategy has succeeded in its
central purpose of avoiding the develop-
ment of a systemic crisis while, at the
same time, supporting stabilization ef-
forts in the debtor countries.
Not Yet Out of the Woods
I believe that, with what I have said up
to this point, it should be clear that we
are not out of the woods. In fact, I
would agree with the testimony of Dr.
Norman Bailey, former Assistant to the
President for International Economic
Affairs, before the Subcommittee on
Western Hemisphere Affairs of the U.S.
House of Representatives on January
29, 1985: "...Unfortunately, we have
always been in the woods and the path
out of them is obscure and easily lost."
Agreement with this statement stems
not from an attitude of pessimism but
rather from an acute recognition that
the real world is pregnant with
danger-the economists' definition of the
real world being "the nominal world
minus inflation" notwithstanding.
One is led to this opinion by simple
arithmetic. At the end of 1981, the Latin
American countries owed approximately
$297 billion. At the end of 1984, their
external indebtedness amounted to
about $371 billion. Despite the high
visibility of U.S. banks in this situation,
they, nevertheless, only hold one-fourth
of this debt, the rest being held by
foreign banks, multilateral lending in-
stitutions, and governments. After 3
years of crisis and austerity, Latin
America, therefore, has increased its in-
debtedness by about $75 billion on
which, by the way, interest is due.
About $34 billion of the $?5 billion was
lent by commercial banks in countries
reporting to the Bank for International
Settlements, and of the $34 billion, $12.6
billion was lent by U.S. banks. During
the period 1981-84, as a result of
rescheduling agreements, the debt ser-
vice ratio-i.e., interest and principle
payments as a percentage of foreign ex-
change earnings (export earnings from
goods and services)-of the debtor coun-
tries declined from o1.2% to 43.3% of
merchandise exports. The ratio of net in-
terest payments to merchandise exports
declined somewhat to about 35% in
1984, demonstrating the sensitivity of
these economies to both export growth
and the changes in world interest rates.
From the point of view of the
balance of payments, we have seen
Latin America accumulate a $74 billion
merchandise trade surplus in the period
1982-84 inclusive, but one which is ap-
parently largely due to tremendous cuts
in imports. The most recent estimates
indicate that the value of Latin
American exports in 1984 was still
somewhat below 1981, although export
volume showed an increase. During the
same 3-year period, debt service pay-
ments amounted to $109 billion, and
new money and the surplus on the trade
balance amounted to about $148 billion,
which I read to mean that approximate-
ly $39 billion was spent on services, fled
the region, or was added to international
reserves. Even under optimistic assump-
tions, the World Bank, the Inter-
American Development Bank, and
others have concluded that it will be the
end of the decade before 1980 pre-
recession per capita levels of gross
domestic product will again be achieved.
Major Uncertainties
There remain a number of major uncer-
tainties which render the global
economic environment pregnant with
danger. Highest on my list of uncertain-
ties is the debt crisis, where we are by
no means out of the woods, despite a re-
cent spate of news articles to the con-
trary.
One fact which is often overlooked is
that the country with the largest exter-
nal debt in the world is not Brazil or
Argentina, it is the United States of
America. By the end of June last year,
foreigners had lent our treasury $171
billion, which was 15.6% of the total.
The foreign debt of the American
private sector at the end of June 1984
was estimated to be another $299 billion.
It has been estimated that, by the end of
May this year, the United States will
become a net international debtor for
the first time since shortly before World
War I. Perhaps, when we bemoan the
international "debt crisis," we should
remember the words of John Donne:
"Ask not for whom the bell tolls, it tolls
for thee." Nevertheless, the size and
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growth of our economy, coupled with
positive encouragement of free enter-
prise by President Reagan's policies,
give us grounds for more optimism than
in those countries where the parastatal,
government intervention model
predominates.
With regard to international debt
prospects, Assistant Secretary of State
for Economic and Business Affairs
Richard T. McCormack posed two ques-
tions in a speech delivered last
November ("The Medium-Term Outlook
for the World-Economy," Novem-
ber 22, 1984, Current Policy No. 664):
First, is our [worldwide] present success
in reducing these [balance-of-payments]
deficits based on a draconian depression of
activity ...that is not sustainable either
socially or politically?
Second, is the present outlook viable only
under the most favorable assumptions and
vulnerable to new shocks, such as OECD
recession or higher interest rates?
Solutions
I believe these questions remain valid,
but for these questions to be given
favorable answers in a historical sense,
the "debt crisis" must be genuinely
resolved. And for a genuinely favorable
resolution, the solution must be sought
in the reform of the domestic economies
of the debtor countries of the
hemisphere themselves.
The economic policies necessary to
achieve such a reform are relatively easy
to summarize. In terms of monetary
policy, there must exist positive
inflation-adjusted interest rates, realistic
exchange rates, economically sound
measures to control inflationary
pressures, and measures to induce the
return of flight capital. In terms of fiscal
policy, the governments of our Latin
American neighbors must rein in
parastatal enterprises-which, for the
most part, are deficit-ridden and a major
source of inflation-reform their taxa-
tion and tax collection systems, and
reduce subsidies. Simply put, they must
put their own houses in order by
creating clear and stable rules of the
game for economic activity-clear rules
which encourage productive activity by
offering a secure climate for investment,
both domestic and foreign.
What is needed was succinctly de-
fined by Secretary of State George P.
Shultz in his address of December 6,
1984, entitled: "Democracy and the Path
to Economic Growth" [Current Policy
No. 641].
i am calling here for the reversal of state
ownership and anti-import policies. These
policies have placed stifling controls on
private agriculture and industry. They have
made them dependent on restricted markets.
They have built costly protectionist barriers
at national frontiers. And they have produced
inefficient state enterprises that divert
resources from more productive activities.
I call, instead, for a development strategy
that works through an open economy, one
that rewards initiative, investment, and
thrift.
Maintaining an Open Multilateral
Trading System
The world economy continues to be
involved in a process of adjustment.
Simply put, this adjustment involves
converging the levels of consumption
and production. During the 1970s, many
countries lived beyond their means, as
reflected in their unsustainable balance-
of-payment positions. This situation
must now be corrected by either increas-
ing the "means" or living more modestly
or both. While this process is not cost
free, it is inevitable and has as its
ultimate goal the restoration of sus-
tainable noninflationary global economic
growth.
A key element in this adjustment
process is the maintenance of an open
multilateral trading system, which is
essential to position the countries of the
hemisphere for servicing their external
debt and for enabling the export and im-
port sectors of all our economies to
make their contributions to domestic
economic recovery and growth. I also
want to make three further points.
First, protectionism poses a serious
threat to the prospects for amedium-
term recovery in the world economy.
Virtually all economic projections are
predicated on open trade. If the assump-
tion about the maintenance of open
trading policies is removed, the medium-
term outlook for the world economy
becomes bleak.
Second, protectionism poses a fun-
damental threat to the?strategy that has
fostered development since 1945. Inter-
national trade is a powerful engine of
growth. The experience of the 1960s and
1970s demonstrated that countries with
"inward-looking" development strate-
gies-characterized by liberal import
regimes, adequate incentives for pro-
ducers, and the maintenance of realistic
exchange rates and prices as well as
positive real interest rates-have per-
formed better than countries with
"outward-looking" development
strategies. Protectionism would threaten
the viability of the "outward-looking"
strategies with far-reaching conse-
quences for economic efficiency and
world trade.
The postwar strategy in many Latin
countries of industrializing through im-
port substitution, with its high tariff
barriers, has been disappointing. It has
fostered dual economies, crippled
development in the agricultural sector,
resulted in frequent balance-of-payments
crises, and contributed to rapid urban
growth and political instability. Studies
by the OECD and the World Bank both
recognize that a substantial relaxation of
import restrictions coupled with moves
toward appropriate exchange rates are
necessary to expand exports and over-
come the shortage of foreign exchange
that most developing countries (except
for some of the oil exporters) seem to
face.
It should not come as a surprise that
the development strategies based on im-
port substitution have produced such
poor results. Import substitution carried
to excess is a little like a soccer team
that plays only itself. Competition hones
the skills and tactics of a soccer team,
and, by definition, Brazil could never
have won the world soccer championship
if it had not been willing to play against
foreign teams. Moreover, import
substitution policies often also violate
the law of comparative advantage since
they amount to a dirigiste attempt to
outguess the marketplace.
For these reasons, developing coun-
tries are urged to use great caution in
applying import-substitution measures,
and such countries are encouraged to
focus more actively on the possibilities
which exports offer their economies,
while striving to keep our markets open
to those exports. Since the 1970s, many
of the more successful developing coun-
tries have been pursuing precisely such
a strategy. The economic success
stories, such as Taiwan, South Korea,
and Singapore, have all adopted policies
which emphasize exports as a means of
promoting rapid industrialization.
In recent years, these and other
countries have shifted toward more
liberal trade and payment regimens.
Often, these moves have not been as
rapid nor as encompassing as we might
want. But overall, particularly in East
and Southeast Asia, there has been a
clear tendency of the more economically
progressive and successful countries to
move in the direction of liberalizing
trade barriers and adopting policies
aimed at stimulating exports. The U.S.
Mission to the OAS has recently chaired
meetings of the ambassadors of the
ASEAN [Association of South East
Asian Nations] countries with the An-
dean OAS ambassadors, with the
thought that fellow "developing coun-
tries" along the Pacific rim might com-
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pare notes so that the most successful
features of each economic system might
be examined.
Third, protectionism is, by defini-
tion, "anti-adjustment." It is an ad-
ministrative way of delaying adjustment
to changes in competitive positions stem-
ming from changes in technology and
productivity. We must jointly and
severally rise to the challenge of struc-
tural adjustment rather than run away
from it. Renewed growth and the
reinvigoration of all our economies
demand it.
I would -ike to note here that the
U.S. commitment to an open multilateral
trading system remains firm, as was
demonstrated yet again in President
fteagan's call for a new round of trade
negotiations under the GATT [General
Agreement on Tariffs and Trade] in his
State of the Union Address. It has been
contended that no country has an entire-
ly open system. In this imperfect world,
however, the United States is still the
most open market among the major
trading nations, as witnessed by our re-
cent horrendous trade deficits. What is
needed in the new trade round is a
rededication to work toward perfecting
the multilateral trading systems so that
opportunities for fair trade can be in-
creased for all participants. By fair, we
mean that the goal posts should be the
same width for each side. If ours is 20
feet wide and our trading partner wants
his to be only 2 feet, we're going to lose
a lot of games, and nobody believes
that's fair.
Vast Capital Needs
Latin America still needs vast amounts
of capital for progress or, indeed, to
maintain present living standards. Ac-
cording to an Inter-American Develop-
ment Bank study, between now and the
year 2000, Latin America and the Carib-
bean will have to create 100 million new
jobs, since half of the population is
under 20, and birth rates are running at
3% (with Mexico's at 5.8%). The average
cost for creating one new job in the
region is estimated at $12,500, leading
to an approximation that $1.25 trillion to
capital will have to be generated in the
next 15 years-a figure perhaps twice
the amount of all transfers of funds to
the hemisphere in the past 15 years,
which includes the huge borrowing
splurge of the 1970s.
For Latin America, if the decade of
the 1960s can be considered as the
decade of official aid from the developed
countries (including the Alliance for
Progress) and the decade of the 1970s as
the decade of commercial bank lending
(nearly $300 billion), then the decade of
the 1980s must be the decade of foreign
direct investment.?Why? Because, re-
garding future prospects for official aid,
it would be prudent not to expect that
support via the International Monetary
Fund, the World Bank, and other multi-
lateral lending institutions will be a re-
placement for private sector lending-
and Istress the word replacement-for
a number of reasons.
First, the sums needed are simply
too large.
Second, virtually all industrialized
country governments, including that of
the United States, are grappling with
the issue of controlling their own
government deficits.
Third, it is unlikely that industrial-
ized country central banks will be as ac-
commodating toward these deficits as
they were in the 1970s.
Further, it is now widely recognized
that Latin America will not receive even
remotely the same high level of bor-
rowed capital from the banking systems
to which it became accustomed during
the 1970s, particularly in light of debt
servicing problems on existing loans.
Of course, borrowing is only one of
the three types of international mone-
tary transfers-the other two being
direct aid, either government-to-govern-
ment or multilateral, and foreign direct
investment. It is obvious to all that
foreign direct investment, if it can be
gotten, has the advantage over the other
two of providing management know-
how, technical skills, and technology
transfers resulting in a high degree of
export potential and, therefore, of being
a source for valuable foreign exchange.
In order to attract this scarce and
needed capital-in competition with
other countries also aggressively seeking
it, such as members of the OECD and
the Pacific Basin countries-the climate
for investment must be much more con-
ducive in Latin America. The best test
of this is found where local investors
themselves find it attractive to reinvest
their own funds and where there is no
capital flight.
Capital Flight
Just at the time when Latin America
needs so much more new capital, there
has been the reverse trend of hemor-
rhaging capital outflows through flight
capital.
Henry C. Wallich, member of the
Board of Governors of the U.S. Federal
Reserve System, in a recent incisive
paper entitled, "Why is Net Interna-
tional Investment So Small?," made the
following comments:
There seems little doubt that substantial
capital exports have taken place from the
countries that were borrowing. Unfortunate-
ly, one must assume that in large part this
represents capital flight. The assets, thus ac-
quired, probably do not produce income and
taxes from the capital-exporting country, and
probably are not available to strengthen its
foreign exchange position aml its ecom~my
generally. In other words, given economic
and political conditions of the capital-
exporting countries, these forei~m .45sets are
not likely to play the same constructive role
for the home countries that capital exports
from developed countries have ordinaril~?
played. To be sure, changes in the politics
and economic policies of the respective coun-
tries, giving adequate protection to the
owners of capital and a positive real return
on domestic assets, may change that situa-
tion. They may convert what today is flight
capital into an important resource for the
country.
The irony of this situation is that, in
fact, Latin Americans own plenty of
capital. It is just not located inside Latin
America.-the amounts in Swiss and
Miami banks and in San Diego con-
dominiums probably far exceed the li-
quid funds in the home countries. In-
deed, generations of Latins claim they
have been brought up to get their money
out into "safer" havens as soon as they
make it. This trend has to be reversed if
Latin America is to grow at all.
Henry Wallich further states:
For the [world's] eight largest [non-l,'.S.]
borrowers over the years 1974-1982, .. .
calculation[s] show an increase in debt (equity
and direct investment included) of $317
billion, while the current account deficit ad-
justed for changes in official reserves,
amounts to only $2U7 billion. Thus, there
seems to have been a capital outflow of $110
billion. The degree to which borrowing
financed this capital outflow differs among
countries. For Brazil, only 12 percent of the
inflow was compensated by outflows; for
Mexico, 45 percent; for Venezuela, almost the
entire inflow was absorbed into outflows.
Nearly 100% capital flight? Clearly,
with a change in domestic policies away
from the parastatal-import substitution
approach to economic development,
there is reason to bel;eve that this
money could be attracted back to Latin
America, which would, of course, be a
major contribution to a lasting solution
of the debt crisis and job creation.
In his February 8, 1985, address,
"The International Debt Situation in an
American View: Borrowing Countries
and Lending Banks," Henry C. Wallich
states further:
Unfortunately, one must assume that a
large part of the borrowed money went for
consumption, in the form of excessive im-
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ports of high-priced oil and various consumer
goods. Frequently this spending was financed
through government budget deficits, caused
by subsidies and other unproductive expen-
ditures, including purchase of weapons. A
worldwide shift from negative real interest
rates to significantly positive real rates, and
the consequent rise in debt service, also used
up some of the funds borrowed.
In adding up incremental investment,
capital flight, and increased outlays (in
nominal terms) for consumption, there is a
danger of over-explaining the absorption of
borrowed funds. The best judgment seems to
be that the borrowing countries experienced
a substantial increase in their income and
debt-carrying capacity and that these benefits
of added investment could be enhanced in
future, if measures are taken to induce flight
capital to return.
It may be that this audience will find
itself closer to the Henry Wallich school
of thought on flight capital than the
point of view expressed to me recently
by a prominent Argentine economist
that, at least in the Argentine case, the
term `flight capital' was misleading and
that more accurate terminology would
be "portfolio diversification." -
Other Solutions
While it is relatively easy to diagnose
the ills resulting from excessive govern-
mental involvement in our economies, it
is far more difficult to find constructive
solutions. In many of the countries of
our hemisphere, the state-owned sector
is so large, relative to the domestically
owned pool of private capital, that a
simple sale of those state enterprises
that are running the largest deficits
would be difficult (who would want to
buy them?), and attracting foreign
capital for this purpose also would be
difficult, for well-known political
reasons. Indeed, there are still many in
Latin America who would view selling
off pazastatals to "transnationals" in the
same way as they view foreign direct in-
vestment-selling off their "national
patrimony." There have been ideas
floated that some debt could be ex-
changed for equity in the parastatals.
Brazil considered this for a time, but
may have given up on the idea, at least
for the present.
However, I believe that there are
other potential and feasible solutions
over the long term, for, as President
Reagan has said, ?Developing countries
need to be encouraged to experiment
with the growing variety of arrange-
ments for profit-sharing and expanded
capital ownership that can bring
economic betterment to their people."
One such method of expanded capital
ownership is advocated by Dr. Louis 0.
Kelso and Patricia Hetter in their book,
La Economia de los Dos Factures: Un
Tercer Camino. The plan involves
employee stock ownership plans, which
are nothing less than having the
employees of the corporation also
become the stockholders, i.e., owners.
There are now approximately 8,000 cor-
porations in the United States using
these plans, and the experience with
them has been quite good-productivity
goes up, worker income is linked to
profitability, etc. While they are only
one form of expanded capital ownership,
the point I am trying to make is that
there are alternatives to state owner-
ship, and they should be explored and
adapted to the conditions existing in
each of the countries of our hemisphere.
Indeed, Costa Rica and Guatemala have
rapidly increasing employee stock
ownership plans.
But the benefits of expanded capital
ownership go far beyond the economic,
as has recently been demonstrated in
the La Perla project in Guatemala. La
Perla is a 9,000-acre coffee and car-
damom plantation in northern Guate-
mala. It has 500 full-time employees,
about 1,500 family members, and ap-
proximately 4,000 other people depen-
dent on the economy of the estate. In
September 1984, the farm's owners set
up a trust in which they allocated 40%
of the stock. The stock will be paid for
out of the future profits of the fazm, but
upon the signing, full voting rights were
passed through to an employee associa-
tion.
Early this year, 120 insurgents at-
tacked the estate and actually took con-
trol of the center. The insurgents,
however, were then attacked and driven
off the fazm by 200 azmed workers, and
a number of workers and insurgents
were killed. In the week following the
attack, the estate's 300 unarmed
worker-owners petitioned the owners for
additional rifles to defend against future
insurgent attacks and volunteered to
help pay for them through a payroll
deduction plan. As Joseph Recinos (a
representative of the Solidarity Union of
Guatemala, a movement aimed at ex-
panded capital ownership as a means of
economic and social reform), has stated:
We can more clearly see what the true
message of ownership and of vested interest
in the free enterprise system means in view-
ing the La Perla model. There is no greater
sign~cance to the concept of defending the
free enterprise system than a worker laying
down his life to defend the company in which
he is co-owner.
If we want to prevent further Nicaraguan
or EI Salvadors, the American Government
must address the problem of economic and
social justice in Central America. Promoting
broad capital ownership as an alternative to
Marxist philosophy in Latin America, if they
are actively pushed now as foreign policy ob-
jectives, can go a long way in giving people a
vested interest in protecting the free-
enterprise system.
Norman Kurland, one of the
founders of the Center for Economic
and Social Justice (a group whose goal is
the promotion of employee stock owner-
ship plans) stated in a Washington.
Times interview last September:
To win over Marxism-Leninism you have
to go beyond the military. Of course, you
have to be militarily strong. On the other
hand, there is an ideological battle. Marx and
Engels stated that you could sum up the en-
tire philosophy of communism in a single
sentence: Abolish private property.
The entire case of Marxism-Leninism
disappears if we prove to the world that
private property is essential for providing
economic and social justice, and for providin};
human dignity to people in the Third Wurl~l.
Marx was wrong. However, we cannot
simph~ attack him on the basis of the prulr
lems he was focusing on but rather on the
basis of the means that he would use. The
soluti~~n is not to make enemies of the owners
but to make owners out of the nonowners.
Foreign Direct Investment
Over the past 4 years, it has been made
clear to me, in visits to every country in
the hemisphere, that private foreign
direct investment can play the key role
in future trade and commerce. Indeed, it
is the catalyst for economic development
and international economic integration
through the world trading system, as
well as being perhaps the only remaining
source of capital, technology, and
management know-how on a scale
needed for economic survival.
It seems intuitively obvious that the
high-debtor countries of our hemisphere
must take strong steps to court foreign
direct investment as the most attractive
alternative to new bank financing.
Foreign direct investment has the ad-
vantage of not requiring fixed interest
payments. Earnings are repatriated only
if the investment is profitable. Local
enterprises are able to sell to multina-
tional companies and often gain access
to new mazkets and distribution chan-
nels, both nationally and internationally.
Finally, and most importantly, foreign
direct investment creates real jobs as
opposed to state-funded make-work jobs.
Unfortunately, the trend has been in
the other direction. In 1950, U.S. direct
investment in Latin America accounted
for neazly 50% of the total U.S. invest-
ment overseas. By 1970, this figure had
dropped 17076 in Latin America and was
3076 in Asia and the Pacific. At the end
of 1982, the stock of U.S. direct invest-
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ment was down 15% in Latin America
and had doubled to 6% in Asia and the
Pacific. In a time when total flows of
U.S. foreign investment were declining.
flows to the Far East rose sharply.
I am encouraged by the increasing
recognition of the importance of internal
factors for the revitalization of Latin
American economies now being ex-
pressed by prominent Latin Americans.
Brazilian Senator and former Planning
and Finance Minister Roberto Campos
stated the issues succinctly in his speech,
"The New Demonology": "The United
States has become the magnet for Euro-
pean and Japanese investors precisely
because they have two things we lack-a
strong currency and stable rules of the
game."
The prominent Argentine economist,
Marcos Victorica, has also addressed
these issues. )Vlr. ~'ie?torica estimates
that Argentine capital abroad amounts
to about $`L7 I,illi~m and that much of
this capital left the country during the
early 1980x, despite the fact that real in-
terest rates in Argentina amounted to
about 20%,-double U.S. real interest
rates-and he has ascribed these devel-
opments to a lack of confidence. Regard-
ing policies affecting foreign direct in-
vestment, Mr. Victorcca has noted one of
the key difficulties (such as exchange
controls): "No one will come in [to in-
vest] where a way out is forbidden."
Argentine Presidential Secretary
General German Lopez recently
spotlighted this problem in comments
reported on the Buenos Aires govern-
ment radio network, when he stated
that, "President Alfonsin is determined
to modernize the country and that, to
this end, there is no alternative but to
resort to foreign capital so that the in-
vestments that will contribute to Argen-
tine development are made." The only
way to make up for the time lost, Lopez
states, is to urgently attract invest-
ments, adding that:
I want to say that the past 10 years have
been very dramatic for Argentina and that I
consider that in reviewing, in weighing our
responsibilities, we are sometimes unfair.
We have made mistake after mistake for vir-
tually 50 years. We have practiced a sort of
political cannibalism destroying each other.
[Therefore] President Alfonsin is firmly de-
termined to modernize Argentina in order to
put it at the level of efficiency asked by
public opinion.
Recently, the newly elected Presi-
dent of Uruguay, Julio Maria Sanguinet-
ti, said that "those of us who historically
defended a greater mle for the State
now have to say that we must
reestablish equilibrium and that as a
result our direction will be to reduce to
the maximum extent expenditures of the
State, and to encourage as much as we
can private production."
I am pleased to see that some
leaders of Andean Pact countries are
taking a new look at their investment
policies. During his recent visit to the
United States, President Belisario
Betancur of Colombia addressed a
number of our business leaders on
April 2. He saki:
The Latin American experience of the
past 10 ye.u?s shu+as that self-sustained
development is not stable if it is mainly
dependent on a growing foreign debt. The
development effort should be based on
domestic savings and productive investment,
supplemented by foreign loans.... From
these considerations you may well understand
why I said that ... it was better to have
more partners and fewer creditors.
We have made a proposal to the member
countries of the Cartagena agreement to
modify Decision 24 providing more flexible
terms in keeping with foreign investment
needs. The idea is to allow new investment in
certain areas to be 100'7 foreign when the
recipient country decides that its develop-
ment needs so warrant.
It is now generally recognized by
potential investors that one of the dif-
ficult impediments to foreign investment
in Latin America has been the Calvo
Doctrine. Many countries in the
hemisphere incorporate the doctrine and
other restrictions in their constitutions,
in other laws, or in multilateral
agreements, such as the Andean Pact
decision 24. With regard to decision 24,
I am pleased to note that there is in-
creasing recognition on the part of
member governments of the pact that
more flexibility is required by member
governments on foreign investment
policies. This was one of the principal
causes for Chile's withdrawal from the
pact in 1976. Moreover, under the
dynamic leadership of Craig Nalen, the
Overseas Private Investment Corpora-
tion (OPIC) recently signed agreements
with Colombia and Ecuador. These
agreements were the result of countless
hours of patient and persistent negotia-
tion between Lorin S. Weisenfeld,
Assistant General Counsel of OPIC, and
various officials of Colombia and
Ecuador, and it is to be hoped that other
Andean Pact countries will follow.
While the United States rejects the
Calvo Doctrine on the theory that the in-
vestor's government has an independent
interest in fair treatment for its na-
tionals, the Calvo Doctrine has unques-
tionably had a negative impact on the
ability of foreign governments to pro-
vide diplomatic protection in the event
of a miscarriage of justice, This doctrine
had its origin in the early part of this
century as a reaction to perceived
abuses of protection by the United
States and European powers on behalf
of their investors and traders in the last
century.
In countries that subscribe to the
Calvo Doctrine, the foreign investor is
considered to have agreed that all
disputes-including those relating to ex-
propriation-will be definitively resolved
through local legal processes, and to
have renounced any right to invoke the
diplomatic protection of his home
government in the event those processes
give rise to a miscarriage of justice
following expropriation. In the 1960s
and 1970s, there were over 300 major
expropriations in the hemisphere (ex-
cluding the $1.85 billion in thousands of
unsettled expropriation claims of former
U.S. investors in Cuba) where compen-
sation was not arrived at through inter-
national arbitration and was often gross-
ly inadequate or delayed in many cases.
Corporate boardrooms around the world
have long corporate memories, and as
Cicero said to Atticus, "It is the right
given to any man to err, but to no one,
unless he is a fool, to persist in."
Another negative consequence of
this policy is that potential U.S. in-
vestors are constrained from obtaining
OPIC insurance coverage because of re-
quirements limiting possible litigation to
local courts, and of a prohibition of
direct subrogation.
The United States has long favored
an open international investment
system. A major U.S. goal in the 1980s
is to reverse the trend toward govern-
ment-induced distortions in the invest-
ment process through international
understandings and voluntary guidelines
leading to a more open investment
climate in which investment flows are
able to respond to market forces.
Recent Positiive Steps
As part of continuing efforts in this
area, the U.S. delegation to the 14th an-
nual General Assembly of the OAS in-
troduced aresolution entitled "Pro-
moting Ecomonic Justice Through
Strengthening Private Direct and In-
direct Investment in Latin America and
the Caribbean." The operative part of
the resolution reads as follows:
To instruct the General Secretariat to
conduct a study of requirements necessary
for the creation of economic and regulatory
environments conducive to attracting and
fostering direct and indirect investment in
the countries of Latin America and the Carib-
bean. This study should identify the various
private and official, multilateral and national
agencies involved in the promotion of invest-
ment while also considering and evaluating
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the growing variety of arrangements for
profit-sharing and expanded capital owner-
ship now available for the promotion of
economic justice with a view to identifying
operational mechanisms and sources of fund-
ing for cooperative efforts with said agencies
that may be implemented in the framework
of the OAS.
While the resolution did not come to
a formal vote, the U.S. delegation was
able to secure agreement, as noted in
the rapporteur's report, that these topics
would be taken up by the Permanent
Executive Committee of the Inter-
American Economic and Social Commit-
tee of the OAS in 1985. I view this
agreement as a major achievement and
a major step forward for Latin America,
not because U.S., Japanese, or other
OECD investors have any shortage of
opportunities to invest at home or
abroad, but because of the potential
benefits to our own hemisphere that
foreign direct investment brings in
terms of improving standards of living.
The Reagan Administration is ac-
tively pursuing two programs in Central
and South America which aim to im-
prove the investment climate: the Carib-
bean Basin Initiative (CBI) and bilateral
investment treaties. The CBI, by grant-
ing various products access to the U.S.
market, provides important incentives
for the private sector. Bilateral invest-
ment treaties offer important protection
for investments. The intent of both pro-
grams is to stimulate additional foreign
investment.
As you know, the key elements of
the bilateral investment treaties are:
? New and existing investment to
be granted national treatment or most-
Bureau of Public Affairs
United States Department of State
Washington, D.C. 20520.
If address is incorrect
please Indicate change.
Do not cover or destroy
this sddress label. Mall
change of address to:
PAIOAP, qm. SB15A
favored-nation treatment, whichever is
more favorable, but both sides are
allowed to list exceptions to national
treatment in 'specified sectors of
economic activity;
? Conditions for expropriation
which accord with international law
principles, including payment of prompt,
adequate, and effective compensation;
? Unrestricted transfer of capital,
returns, compensation, and other
payments into and out of the host coun-
try; and
? Dispute settlement procedures in-
volving third-party arbitration both for
disputes between the host country and a
national or company of the other coun-
try and disputes arising between the
governments.
While these treaties are generally
reciprocal in their provisions, the major
inducement for the developing country is
the assurances such a treaty offers a
foreign investor.
As a result of the leadership of Bill
Brock of USTR [U.S. Trade Represen-
tative], several countries have nego-
tiated such agreements with us. In this
hemisphere, we signed treaties with
Panama in 1982 and with Haiti in
December 1983. We are also very close
to agreement with Costa Rica, and we
have had negotiations with Honduras
and El Salvador.
While the treaties mentioned above
are laudable achievements for the par-
ties concerned, in all candor, much re-
mains to be done for our hemisphere to
realize its full economic potential.
Conclusion
I titled my remarks today, "Free Enter-
prise: Key to Latin American Economic
Revival." I would like to end on a
positive note. Simon Bolivar said 150
years ago that Bolivia was a beggar sit-
ting on a throne of gold. In an expanded
sense, this is still true for resource-rich
but extremely poor Bolivia and for
several other countries in Latin
America. The hemisphere is so rich in
natural resources and populated by men
and women of such talent and good will
that there is no reason that our
hemisphere cannot have a bright
economic future. All that is needed is for
the economic and political leadership of
Latin America to reembrace the wisdom
of their own founding fathers, Simon
Bolivar and San Martin. These men of
vision, along with our own Founding
Fathers, were swept up with the
liberalizing writings of Locke, Rousseau,
Hume, and Adam Smith, which called
for a separation of political and
economic power and emphasized the
sanctity of private property. Similar
wisdom can be found in the words of
Muhammad Ibn Khaldoun, the 14th cen-
tury Arab jurist, historian, and
statesman: "When incentive to acquire
and obtain property is gone, people no
longer make efforts to acquire any. This
leads to destruction and ruin of
civilization." ^
Published by the United States Department
of State ? Bureau of Public Affairs
Office of Public Communication ? Editorial
Division ? Washington, D.C. ? May 1985
Editor. Cynthia Saboe ? This material is in
the public domain and may be reproduced
without permission; citation of this source is
appreciated.
Postage and Fees Paid
Department of State
STA-501
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EXECUTIVE SECRETARIAT
ROUTING SLIP
1 DCI
2 DDCI
3 EXDIR
4 D/ICS
5 DDI
6 DDA
7 DDO
g DD58T
q Chm/NIC
10 GC
it IG
12 Compt
13 D/OLL
14 D/PAO
15 VC/NIC
16 LA DO
17 ALA DI
is NIO/Econ
lq NIO/LA
0
21
22
une
Dais
Remarks ~-----~--_- ,,
To 15: Pls have NIO/Econ prepare response for
DCI signatureo
E~ cutive Secretary
17 June 85
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United States Department of State
United States Permanent Mission to the
Organization of American States
Washington, D. C. 205` Executive Registry
May 28, 1985
85- 2420
In spite of news reports to the contrary, the economic
picture in Latin America has not substantially improved, even
though 58 percent of the entire X11.5 billion increase in
exports that the Latins registered last year worldwide came
to the U.S., and despite the fact that they had a $20.7 billion
trade surplus with us last year. For the near and long term,
everybody has good reason to be worried about the debt and
security problems in our hemisphere, and I fear that these
problems are not going to improve until a basic restructuring
of their economies takes place, redirecting them towards free
enterprise. In our country, we take free markets and the free
enterprise system for granted. What is overlooked is that
most of the largest debtor countries in our hemisphere have
over 50 percent of their productive economic activity owned
by the government, with all of its potential for inefficiency
and bureaucratic interference, to say nothing of official
corruption. Inflation rates are skyrocketing. No substantial
debt principal payments are being made, and interest payments
are being financed largely through new loans. If the U.S.
business cycle turns down, all hell could break loose and we
must be aware of it.
In 1981, Ronald Reagan began the deregulation of our economy
and the creation of incentives for vigorous economic growth.
Then Margaret Thatcher led the way in England with privatiza-
tion, and now a number of Europeans are looking at these success
stories as a model. Recently, several Latin countries have
been revising their own views on the role governments should
play in the market place. Working through the OAS, I have now
visited every country in our hemisphere carrying President
Reagan's free enterprise message.
In this regard, you might be interested in the enclosed
study--Free Enterprise: The Key to Economic Revival in Latin
America--outlining solutions for freeing up these economies.
The Honorable
William J. Casey,
Director of Central Intelligence Agency.
C :35~
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Unless real progress is made in this direction, I fear the
security troubles that are now largely confined to Central
America (see my paper, Nicaragua: The Stolen Revolution, which
I sent you last week) will proliferate rom the Straits of
Magellan to the Rio Grande.
We need your help. With your own valuable contacts in the
hemisphere, can you help us in this effort to spread the Reagan
message?
J. William Middendorf, II
Ambassador
Permanent Representative
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Corr-ent
Policy
No. 692
Follurr~i?g i.~ au address by Anrbassndur
J. hI'illi-unr Midderrdor/'II, U.S. Perrrra-
rrerrt Representative to the Orgarrizatiu>r
o/~Am.eriatrr States (OAS), be/'ore t.h,e I>r-
terrurtfunul Car+Jererree urr Latin
A?rericu spurrsured by the Cer+fer for Ir+-
terr+atiarral Relatimrs, San Jose, Cr>sta
Rica, February l1, 198.
It is a pleasure for me to join the il-
lustrious group here in the discussion of
the conference theme: 'Basic Freedoms
in Latin America: Their Past, Present
and Future Prospects." The fact that
this historic conference is treating both
the political and economic aspects of
Latin America's situation is indicative of
what Secretary of State Ueorge P.
Shultz stated in his testimony before the
Senate Committee on Foreign Relations.
entitled "The Future of America Foreign
Policy: New Realities and New Ways of
Thinking" [Current Policy No. 650],
January 31, 1985:
The United States seeks peace and
security: we seek economic prngress; we seek
to promote freedom, demuc?rac?y, and human
rights. The conventional way of thinking i~ to
treat these as discrete c?ategorie~ ul activitc.
In fart, a6 we hate seen, it is now nacre and
more widely rerngnized that there is a truly
profound connection among than. And this
has important implications fur the futur~?.
Secretary Shultz expanded .m these
points by saying:
... it is inure: and more understood that
economic progress is related to a political en-
vironment of openness and freedom. It used
to be thought in some quarters that socialism
was the appropriate model for developing
J. i?T~illiam Middendorf II
Free Enterprise:
Key to Latin American
Economic Revival
United States Department of State
Bureau of Public Affairs
Washington, D.C.
countries because central planning was better
able to mobilize and allocate resources in ron-
ditions of scarcity. The historical experience
of Western Europe and North America,
which industrialized in an era of limited
government, was not thought to he relevant.
1'et the more recent experience of the Third
World shows that a dominant government
rule in developing economies has dune nacre
Ur stifle the natural fumes of production and
productivity and to distort the efficient
alluc?atiun of resources. The real engine of
#-~-ru~cth, in developing as well as industrial-
iv.ed countries, turns out to he the natural
dynamism of societies that minimize central
planning, open themselves to trade with the
world, and give free rein to the talents and
efforts and risk-taking and investment dec?i-
siuns of individuals.
Private and State Sector
Approaches to Development
It is becoming more and more obvious
throughout the hemisphere that without
a dynamic free enterprise system,
govermnents can neither stimu.ate nor
sustain economic growth nor diversify
their economies to foster economic
development. Tou often in the past, one
heard the truism that first must come a
proper infrastructure, but this has led to
vastly uverblovvn bureaucracies of
government-owned means of production
far beyond such basic? infrastructure re-
quirements as roads, utilities, and cone
munic:ations. VlVithuut an efficient and
limited public sector at a manageable
economic cost-and without an overall
environment conducive to sound in-
vestment-privately owned enterprises
are unlikely to make their full contribu-
tion to development and commerce.
Economic development can no
longer be financed externally through
massive amounts of foreign aid ur
foreign borrowing, which were
hallmarks of the 1960s and 1970s. Now
growth, if it is to come, must begin with
each country's climate to attract and
keep in country local savings and to at-
tract foreign savings, i.e., having a set
of motivations and attitudes that are
concretely expressed in the absence ui'
civil conflict, a system of generally ac-
cepted and enforceable property rights,
and the ability of individuals to enjoy the
fruits of their labor without confiscator}~
systems of taxation or arbitrary seizure
of property. If government controls too
much of the means of production, as is
the case in many of the high-debtor
countries in our hemisphere, or if it is
inefficient and ineffective or all of the
above, or if it pursues policies that.
significantly distort free-market deci-
sionmaking, the overall prospects for
economic development suffer, and inter-
national commerce with it. As Secretary
Shultz noted in the testimony I cited
earlier:
...recent experience has fuek~d a brua~i
and Inng-overdue skepticism about statist
solutions, central planning, and government
directions.
'Ibis intellectual shift is partly the prod-
uct of the extraordinary vigor of the
American recovery. The United States has
revised its tax system to provide real incen-
tives to work, to save, to invest, to take
risks, to be efficient. We have reduced
government regulation, intervention, and c~n-
trul. We have opened opportunities for freer
competition in transportrtion, finance, com-
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nuurication, manufacturing, and distribution.
Last year's real grinvth in GtiP Igross na-
[iunal produc[i was the sharpest increase
since lU:~l; int1a[ion ~cas the lowest since
19f;7. The ~werall result was the c?reati?n of
o~~or i milli~~n nc?w .?~hs in '_' ~~ears.
[t is ~~ur sincere hope that the fac-
tors behind our pt?esent success in the
United States will be emulated in Latin
America because a return to sound
economic policies in all of the hemi-
~phere would be nurtuall} beneficial and
ultimately create a better standard of
living for all. ~'e are all one hemisphere,
and what affects the Latin countries af-
fects us all. Clearly, it is in my ow?n
country's trading interest, since w?e are
running a $20 billion trade deficit with
Latin America, largely as a result of its
sharply curtailed imports from us. It is
also in the interest of the world's finan-
cial institutions which have major loan
exposures there. Finally, the ability of
the hemisphere to withstand communist
adventurism and narco-terrorism
depends on sound economic policies for
economic recovery.
As one who has worked with the
Latins for 30 years, I don't think I ran
emphasize strongly en~~ugh my feeling
that Latin America must work toward a
better balance between government and
free enterprise, which at present is so
heavily skewed toward state ownership.
Unfortunately, we seem to be losing
the semantic battle for the minds of
Latin Americans when we extol the vir-
tues of free enterprise. It is an unfor-
tunate fact that Marxist teachers have
infiltrated primary schr~ols in many
Latin American countries. From that
key position, they take advantage of
their young charges' formative years to
:hake them feel that Marxism is the
natural state of affairs of any society.
Therefore, anyone who opposes it must.
be against humanity. Foreign private
direct investment becomes "economic im-
perialism" in the Marxist-[.eninist lex-
icon, and this economic imperialism op-
poses a "new international economic
order" which calls for redistribution of
the world's wealth. In the Marxist lex-
icon, we are in a zero-sum game where,
if one group is to attain greater wealth
(read "the exploiters"), another group
must lose it. None of this helps to en-
courage the much-needed new capital to
come in to create the jobs so desperately
needed in countries with unemployment
levels ranging up to 30010 and 40010. In
fact, one wonders if Marxists in coun-
tries with non-Marxist governments
don't hope to keep unemployment levels
high, in the hopes that the resulting
unrest might help bring Chem to power.
The trend toward government
ownership is clearly seen in Mexico,
where, according to trend data, there
were only 84 government enterprises in
1972. By 1982, there were 760. During
the same period, total government
spending as a percentage of gross na-
tional product increased from 'L'3"1, to
46'x,. By 1982, following the bank na-
tionalization, the great majority of
Mexico's major industries were under
government control, and the govern-
ment's share of total capital formation
had reached 45010. It is an interesting
footnote that in the period 195?-72 (dur-
ing most of which Dr. Ortiz Mena, now
president of the Inter-American
Development Bank, was finance
minister), Mexico's compound annual
rate of GDP [gross domestic product]
growth was 6.6010, whereas during the
period 1973-83, after the oil boom
began, this GDP growth rate averaged
4.7%. Even in Brazil-where in 1979
President Figueiredo created a special
ministry with the objectives of (1) selling
government-owned enterprises to the
private sector, where feasible; (2)
restricting the indiscriminate growth of
state-owned enterprises; and (3)
strengthening the free enterprise
system-little progress has been made
and the spending of government and its
companies approaches 50?10 of the gross
domestic product.
A good sign for positive change is
that some of the empirical research
which has been conducted on the
macroeconomic consequences of the
statist "solutions" so long favored in
most of Latin America is beginning to
receive wider publicity and beginning to
affect the thinking of high-level
policymakers. Ke-Young Chu and An-
drew Feltenstein, in their paper
"Relative Price Distortions and Inflation:
The Case of Argentina, 1963-76" (Inter-
national Monetary Fund, Staff Pape~~s,
Volume 25, September 1978), for exam-
ple, estimated that, in Argentina,
government transfers to cover public
enterprises' losses were proportionately
10 times as inflationary as the financing
of private enterprises' losses through
commercial bank borrowings, primarily
because it is assumed that only in the
former case are the losses translated in-
to high-powered money through central
bank financing of the government
deficit. Because the state in Argentina
owns the vast majority of its industrial
production, and since most of these
state-owned industries operate at enor-
mous losses which only government
printing presses can make up, the infla-
tion rate there last year approached
700%.
Other equally devastating findings
are discussed in Public Enterpr2ses i~r
Mixed Eeononzies, by Robert H. Floyd,
Clive S. Gray, and R.P. Short:
For'l~ developing countries for which
data were available, Short estimates the
average (weighted by GDPI overall public
deficit, before reduction by government cur-
rent transfers, at r~.5 percent of GDP during
the mid-19i0s. He further estimates that the
ocerill deficit in developing countries in-
crea~ed by 2.5 percentage points of GDP be-
tween the late 19hOs and mid-197us.
Defining the ''budgetary burden" of public
enterprises as the residual of government
transfers and loans, less loan sen~ice
payments b}~ the enterprises, Short estimates
this burden to average 3.3 percent of GDP
for 34 developing countries, compared with a
4.d percent estimate for the central govern-
ment', overall budget deficit in these coun-
tries. In other words, public enterprises ac-
counted for three-fourths of the central
government deficit in the countries in
question.
As I have witnessed during the last
30 years, the Latin American countries
have suffered ever more stifling
bureaucratization of their economies.
Government intervention-often but-
tressed by nationalist andlor socialist
ideologies-has resulted in substantial
increases in:
? State ownership of economic ac-
tivities in, for example, extractive in-
dustries, manufacturing, financing, and
international trade and commerce, far
beyond the traditional limits of in-
frastructure and often accomplished
through expropriation without adequate
compensation;
? Regulation of private economic ac-
tivity via money, credit, and exchange
controls, licensing systems, and price
and wage controls;
? The state's consumption share of
gross national product; and
? Government im~estment expen-
diture-typically more than half of na-
tional capital formation.
Informal Economy
In spite of these trends, which amount
to a fight for survival on the part of free
enterprise in many parts of Latin
America, there are several counter-
trends. Agood example of how the
private sector can triumph in spit, of
governmental restrictions is revealed in
the study by Peruvian businessman and
economist Hernando de Soto. Because it
takes a person 6 months to get govern-
ment approval to set up a simple
business in Peru, an informal economic
system has grown to rival the more
traditional business. According to de
Soto, an informal economy develupeu
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and grew despite the tremendous harnl-
icap of being illegal.
De Soto's study estimates that the.
informal ecvnomy of Peru now accounts
for 90% of Lima s garment industry,
25?Io of its furniture industry, 60?Io of
housing construction, and even a good
part of the automobile and truck in-
dustries. The informal Peruvian
economy, says the study, has growm so
fast that it now accounts for an
estimated 60% of the total Peruvian
economy, and almost none of this output
is counted in the official $22 billion Peru-
vian gross domestic product. Perhaps
most important is the free enterprise
system's ability to create jobs: in Peru,
an estimated two out of every three jobs
are now in the informal sector.
Another factor Mr. de Soto's study
points out is that South American
economies often have two kinds of
private sectors: one that is seriously
burdened by excessive regulation and
hampered by bureaucratic inefficiency
but is officially sanctioned, and a second
one which is far more in accord with
free market principles but whose ex-
istence is barely acknowledged. This dif-
ference is made clear by an experiment
documented by a study group from Mr.
de Soto's Institute for Liberty and
Democracy, in which it tried to set up a
legal garment firm without easing the
way with bribes. According to a Wall
Street Journal article:
It took a lawyer and three others 301
days of full-time work, dealing with 11
government agencies to complete the paper-
work-which, when laid end-to?end, measured
102 feet. (One of the researchers then tried
the same experiment in Tampa, Florida, and
finished it in 3'/z hours.)
Debt Crisis Management
As we all know, Mexico's extreme illi-
quidity in August of 1982 precipitated
the "debt crisis." The response was a
provision of immediate emergency
assistance by the U.S. Government and
other creditors which led to the develop-
ment of a rescue package and an IMF
[International Monetary Fund] stabiliza-
tion program. By the spring of 1983, the
U.S. Government had developed a
strategy designed to deal with the li-
quidity problems, primarily of the major
countries, and to encourage the adoption
of needed stabilization measures. What
has not been widely understood is that
the strategy was not intended to be one
of "solution" for the "debt crisis" but
rather one of "management" of the crisis
with the central purpose of preventing
the liquidity problems from developing
into a crisis of the entire international
financing system.
I think it would he helpful to r?erall
the elements of the I'.S. Government
stratek~y fur management of the debt
crisis as reaffirmed at the Williamsburg
summit:
? Credible economic stabilization
measures to be undertaken by the in-
dividual debtor countries;
? Sustainable economic growth in
the OECD [Organization for Economic
Cooperation and Development) coun-
tries, combined with the maintenance of
open markets;
? Support from the IMF and other
international financial institutions for
economic adjustment; and
? The provision of bridge financing
by creditor governments when needed.
I think we can all agree that, up to
now, the strategy has succeeded in its
central purpose of avoiding the develop-
ment of a systemic crisis while, at the
same time, supporting stabilization ef-
forts in the debtor countries.
Not Yet Out of the Woods
I believe that, with what I have said up
to this point, it should be clear that we
are not out of the woods. In fact, I
would agree with the testimony of Dr.
Norman Bailey, former Assistant to the
President for International Economic
Affairs, before the Subcommittee on
Western Hemisphere Affairs of the U.S.
House of Representatives on January
29, 1985: "...Unfortunately, we have
always been in the woods and the path
out of them is obscure and easily lost."
Agreement with this statement stems
not from an attitude of pessimism but
rather from an acute recognition that
the real world is pregnant with
danger-the economists' definition of the
real world being "the nominal world
minus inflation" notwithstanding.
One is led to this opinion by simple
arithmetic. At the end of 1981, the Latin
American countries owed approximately
$297 billion. At the end of 1984, their
external indebtedness amounted to
about $371 billion. Despite the high
visibility of U.S. banks in this situation,
they, nevertheless, only hold one-fourth
of this debt, the rest being held by
foreign banks, multilateral lending in-
stitutions, and governments. After 3
years of crisis and austerity, Latin
America, therefore, has increased its in-
debtedness by about $75 billion on
which, by the way, interest is due.
About $34 billion of the $75 billivn was
lent by commercial banks in countries
reporting to the Bank for International
Settlements, and of the $34 billion, $12.6
billion was lent by U.S. banks. During
tht? period 19ti1-~a, ns a result of
resrhrduling ;tgr,?cme?nls, the debt sec
vice ratio-i.e., interest and principle
pa}~ments as :r percentage of forei~n~ ex-
ehange earnings (export earnings front
goods and seryires)-of the dehtnr coun~
tries declined from i>1.2'~, to 43.:~'7~ of
merchandise exports. The ratio of net in-
terest payments U, nu?rrhandise exports
declined somewhat to about 35'7, in
1984, demonstrating the sensitivity ul'
these economies to both export growth
and the changes in world interest rates.
From the point of view of the
balance of payments, we have seen
Latin America accumulate a $74 billion
merchandise trade surplus in the period
1982-84 inclusive, but one which is ap-
parently largely due to tremendous cuts
in imports. The must recent estimates
indicate that the value of Latin
American exports in 1984 was still
somewhat below 1981, although export
volume showed an increase. During the
same 3-year period, debt service pay-
ments amounted to $109 billion, and
new- money and the surplus on the trade
balance amounted to about $148 billion,
which I read to mean that approximate-
ly $39 billion was spent on services, fled
the region, or was added to international
reserves. Even under optimistic assump-
tions, the World Bank, the Inter-
American Development Bank, and
others have concluded that it will be the
end of the decade before 1980 pre-
recession per capita levels of gross
domestic product will again be achieved.
Major Uncertainties
There remain a number of major uncer-
tainties which render the global
economic em?irvnment pregnant with
danger. Highest on my list of uncertain-
ties is the debt crisis, where we are by
no means out of the woods, despite a re-
cent spate of news articles to the con-
trary.
One fact which is often overlooked is
that the country with the largest exter-
nal debt in the world is not Brazil or
Argentina, it is the United States of
America. By the end of June last ,year,
foreigners had lent our treasury $171
billion, which was 15.6?Io of the total.
The foreign debt of the American
private sector at the end of June 1984
was estimated to be another $299 billion.
It has been estimated that, by the end of
May this year, the United States will
become a net international debtor for
the first time since shortly before World
War I. Perhaps, when we bemoan the
international "debt crisis," we should
remember the words of John Donne:
"Ask not for whom the bell tolls, it tolls
for thee." Nevertheless, the size and
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growth of our economy, coupled with
positive encouragement of free enter-
prise by President Reagan's policies,
give us grounds for more optimism than
in those countries where the parastatal,
government intervention model
predominates.
With regard to international debt
prospects, Assistant Secretary of State
for Economic and Business Affairs
Richard T. McCormack posed two ques-
tions in a speech delivered last
November ("The Medium-Term Outlook
for the World-Economy," Novem-
ber 22, 1984, Current Policy No. 664):
First, is our [worldwide) present success
in reducing these [balance-of-payments]
deficits based on a draconian depression of
activity ...that is not sustainable either
socially or politically?
Second, is the present outlook viable only
under the most favorable assumptions and
vulnerable to new shocks, such as OECD
recession or higher interest rates?
Solutions
I believe these questions remain valid,
but for these questions to be given
favorable answers in a historical sense,
the "debt crisis" must be genuinely
resolved. And for a genuinely favorable
resolution, the solution must be sought
in the reform of the domestic economies
of the debtor countries of the
hemisphere themselves.
The economic policies necessary to
achieve such a reform are relatively easy
to summarize. In terms of monetary
policy, there must exist positive
inflation-adjusted interest rates, realistic
exchange rates, economically sound
measures to control inflationary
pressures, and measures to induce the
return of flight capital. In terms of fiscal
policy, the governments of our Latin
American neighbors must rein in
parastatal enterprises-which, for the
most part, are deficit-ridden and a major
source of inflation-reform their taxa-
tion and tax collection systems, and
reduce subsidies. Simply put, they must
put their own houses in order by
creating clear and stable rules pf the
game for economic activity-clear rules
which encourage productive activity by
offering a secure climate for investment,
both domestic and foreign.
What is needed was succinctly de-
fined by Secretary of State George P.
Shultz in his address of December 6,
1984, entitled: "Democracy and the Path
to Economic Growth" [Current Policy
No. 641].
i am calling here for the reversal of state
ownership and anti-import policies. These
policies have placed stifling controls un
private agriculture and industry. They have
made them dependent on restricted markets.
They have built costly protectionist barriers
at national frontiers. And they have produced
inefficient state enterprises that divert
resources from more productive activities.
I call, instead, for a development strategy
that works through an open economy, une
that rewards initiative, investment, and
thrift.
Maintaining an Open Multilateral
Trading System
The world economy continues to be
involved in a process of adjustment.
Simply put, this adjustment involves
converging the levels of consumption
and production. During the 1970s, many
countries lived beyond their means, as
reflected in their unsustainable balance-
of-payment positions. This situation
must now be corrected by either increas-
ing the "means" or living more modestly
or both. While this process is not cost
free, it is inevitable and has as its
ultimate goal the restoration of sus-
tainable noninflationary global economic
growth.
A key element in this adjustment
process is the maintenance of an open
multilateral trading system, which is
essential to position the countries of the
hemisphere for servicing their external
debt and for enabling the export and im-
port sectors of all our economies to
make their contributions to domestic
economic recovery and growth. I also
want to make three further points.
First, protectionism poses a serious
threat to the prospects for amedium-
term recovery in the world economy.
Virtually all economic projections are
predicated on open trade. If the assump-
tion about the maintenance of open
trading policies is removed, the medium-
term outlook for the world economy
becomes bleak.
Second, protectionism poses a fun-
damental threat to the strategy that has
fostered development since 1945. Inter-
national trade is a powerful engine of
growth. The experience of the 1960s and
1970s demonstrated that countries with
"inward-looking" development strate-
gies-characterized by liberal import
regimes, adequate incentives for pro-
ducers, and the maintenance of realistic
exchange rates and prices as well as
positive real interest rates-have per-
formed better than countries with
"outward-lookingr' development
strategies. Protectionism would threaten
the viability of the "outward-looking"
strategies with far-reaching conse-
quences for economic efficiency and
world trade.
The postwar strategy in many Latin
countries of industrializing through im-
port substitution, with its high tariff
barriers, has been disappointing. It has
fostered dual economies, crippled
development in the agricultural sector,
resulted in frequent balance-of-payments
crises, and contributed to rapid urban
growth and political instability. Studies
by the OECD and the World Bank both
recognize that a substantial relaxation of
import restrictions coupled with moves
toward appropriate exchange rates are
necessary to expand exports and over-
come the shortage of foreign exchange
that most developing countries (except
for some of the oil exporters) seem to
face.
It should not come as a surprise that
the development strategies based on im-
port substitution have produced such
poor results. Import substitution carried
to excess is a little like a soccer team
that plays only itself. Competition hones
the skills and tactics of a soccer team,
and, by definition, Brazil could never
have won the world soccer championship
if it had not been willing to play against
foreign teams. Moreover, import
substitution policies often also violate
the law of comparative advantage since
they amount to a dirigiste attempt to
outguess the marketplace.
For these reasons, developing coun-
tries are urged to use great caution in
applying import-substitution measures,
and such countries are encouraged to
focus more actively on the possibilities
which exports offer their economies,
while striving to keep our markets open
to those exports. Since the 1970s, many
of the more successful developing coun-
tries have been pursuing precisely such
a strategy. The economic success
stories, su%h as Taiwan, South Korea,
and Singapore, have all adopted policies
which emphasize exports as a means of
promoting rapid industrialization.
In recent years, these and other
countries have shifted toward more
liberal trade and payment regimens.
Often, these moves have not been as
rapid nor as encompassing as we might
want. But overall, particularly in East
and Southeast Asia, there has been a
clear tendency of the more economically
progressive and successful countries to
move in the direction of liberalizing
trade barriers and adopting policies
aimed at stimulating exports. The U.S.
Mission to the OAS has recently chaired
meetings of the ambassadors of the
ASEAN [Association of South East
Asian Nations] countries with the An-
dean OAS ambassadors, with the
thought that fellow "developing coun-
tries" along the Pacific rim might com-
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p:u?e note so that the most successful
features ..f each ecunonur systen+ Wright
be ex:unincd.
Third, protectionism is, by defini-
tion. ?anti-adjustntf?nt." It is an ad-
ministrative way ot? delaying adjustment
to change's in competitive positions stem-
ming from changes in tec?hnolokry and
productivity. We must jointly and
seyrrally rise to the challenge of struc-
tural adjustment rather than run away
from it. Renewed growth and the
reinvigoration of all our economies
demand it.
I would like to note here that the
l'.S. commitment to an open multilateral
trading system remains firm, as was
demonstrated yet again in President
Keagan's call for a new round of trade
negotiations under the GATT (General
Agreement on Tarifi?s and Trade) in his
State of the Union Address. It has been
contended that no country has an entire-
ly open system. In this imperfect world,
however, the United States is still the
most open market among the major
trading nations, as witnessed by our re-
cent horrendous trade deficits. What is
needed in the new trade round is a
rededication to work toward perfecting
the multilateral trading systems so that
opportunities for fair trade can be in-
creased for all participants. By fair, we
mean that the goal posts should be the
same width for each side. If ours is 20
feet wide and our trading partner wants
his to be only 2 feet, we're going to lose
a lot of games, and nobody believes
t.hat's fair.
Vast Capital Needs
Latin America still needs vast amounts
of capital for progress or, indeed, to
maintain present living standards. Ac-
cording to an Inter-American Develop-
ment Bank study, between now and the
year 2000, Latin America and the Carib-
bean will have to create 100 million new
jobs, since half of the population is
under 20, and birth rates are running at
3%u (with Mexico's at 5.8?Iu). The average
cost for creating one new job in the
region is estimated at $12,500, leading
to an approximation that $1.`L5 trillion in
capital will have to be generated in the
next 15 years-a figure perhaps twice
the amount of all transfers of funds to
the hemisphere in the past 15 years,
which includes the huge borrowing
splurge of the 1970x.
For Latin America, if the decade of
the 1960s can be considered as the
decade of official aid from the developed
countries (including the Alliance for
Progress) and the decade of the 1970s as
the decade of commercial bank lending
Incarly hatitl billion), then the decade ..f
the 1'.rSfls must he the decade of fureiym
direct investnu?nt. Why:' Because, re-
garding future prospects fnr official aid,
it would be prudent not to expect that
support via the International Monetary
Fund, the World Bank, and other multi-
lateral hnding institutions will he a re-
plarement i'or private senor Icnding-
and 1 stress the word replacement-fur
a number of reasons.
First, the sums needed are simply
too large.
Second, virtually all industrialised
country governments, including that o1'
the united States, are grappling with
the issue of controlling their nwn
government deficits.
Third, it is unlikely that industrial-
ized country central banks will be as ac-
commodating toward these deficits as
they were in the 1970x.
Further, it is now widely recognised
that Latin America will not receive even
remotely the same high level of bor-
rowed capital from the banking systems
to ta?hich ii became accustomed during
the 1970x, particularly in light of debt
servicing problems on existing loans.
Of course, borrowing is only one of
the three types of international mone-
tary transfers-the other two Tieing
direct aid, either government-to-govern-
ment or multilateral, and foreign direct
investment. It is obvious to all that
foreign direct investment, if it can be
gotten, has the advantage over the other
two of pritviding management know-
how, technical skills, and technology
transfers resulting in a high degree of
export potential and, therefore, of being
a source for valuable foreign exchange.
In order to attract this scarce and
needed capital-in competition with
other countries also aggressively seeking
it, such as members of the OECD and
the Pacific Basin countries-the climate
for investment must be much more con-
ducive in Latin America. The best test
of this is found where local investors
themselves find it attractive to reinvest
their own funds and where there is no
capital flight.
Capital Flight
Just at the time when Latin America
needs so much more new capital, there
has been the reverse trend of hem~r-
rhaging capital outflows through flight
capital.
Henry C.. Wallich, member of the
Board of Governors of the U.S. Federal
Reserve System, in a recent incisive
paper entitled, "Why is Net Interna-
tiunal Intr~tnx~nt ~~~ ~ntall:'." ntadr th+?
1~+llrncing ronunc~nt~:
There secn+~ little dnul~t that ~ubsu+nu;+l
r;+pital rxpnrts pace take?n plarc~ trunl t}+c?
countries U+at wero burrowing, l~nt~+rtunatc
h, one mint assunu~ that m large part this
represents capital Might. 'fhe assets, thus :++?
.{uirc~d, prohahl~~ d., not pr?uduce income :uul
txces from the capital-exporting counh?~~, an.{
probably arc nut a~~ailablc~ t.. strengthen its
foreign exchange position and its ecunonn
generaly. In other, avn?ds, gi~~c~n economic
and political conditions of the c?apital-
expurting rnuntrics, these foreign assets ar?e
nut likely h+ pla~~ the sxn+e cunstructi~r rule
fur the hunx~ counU?ies that capital exports
from deceluped countries hx~~e ordinariy
played. To he sure, changes in the politics
and economic policies .rf' the respc~rti~e cnur
tries, gi~~ing adryuatc l+rutectiun In the
owners of capital :un1 a pusiti~e real return
nn donu?stic assets, nt:ty change that situa-
tion. They Wray cumert what tuda~ is Might
capital into an important resource for the
c.+unt r~~ .
The irony of this :~ituat~,m is that, in
fact, Latin Americans own plenty of
capital. It is ,just not located inside Latin
America-the amounts in Swiss and
Miami banks and in San Diego con-
dominiums probable far exceed the Li-
quid funds in the home countries. In-
deed, generations of Latins claim they
have been brought up to get their money
out into "safer" havens as soon as they
make, it. This trend has to be reversed if
Latin America is to groin at all.
Henry Wallich further states:
Fur the (wurld'si eight largest Inun-I~.S.I
hurro~~~ers uc~er the ~'e:u?s 147-1-141h',?... .
calculatiunlsi show an inrr?ease in debt (eyuit~~
and direct im?esunent included) of :~31 7
billion, while the current ac?cuunt deficit ad-
justed for changes in official reser~~es,
amounts to un!v $2t+7 billion. Thus, there
seems to ha~~e been a capital outflow of $;1 ]lr
billion. The degree to which borrowing
financed this capital outflow differs among
countries. Fur Brazil, only 12 percent of the
influx+~ was compensated by outflows; for
:Mexico. 95 percent: for Venezuela, almost the
entire inflow was absorbed into outf1uti~s.
Nearly 100~/~ capital flight? Cleary-.
with a change in domestic policies away
from the parastatal-import substitution
approach to economic development,
there is reason to beLeve that this
money could he attracted back to Latin
America, which would, of course, he a
major contribution to a lasting solution
of the debt crisis and job creation.
]n his February S, 1985, address,
"The International Debr. Situation in an
American View: Borrowing Countries
and Lending Banks," Henry C. Wallich
states further:
Unfortunately, one must assume that a
large part of the borrowed money went for
consumption, in the form of excessive im-
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lx~rts of high-priced oil and various consumer
goods. E'reyuently this spending was financed
through government budget deficits, caused
by subsidies and other unproductive expen-
ditures, including purchase of weapons. A
worldwide shift from negative real interest
rates to significantly positive real rates, and
the conse~luent rise in debt service, also used
uu some of the funds borrowed.
In adding up incremental investment,
capital flight, and increased outlays (in
nominal terms) for consumption, there is a
danger of over-explaining the absorption of
burro~eed funds. The best judgment seems to
be that the burrowing countries experienced
a substantial increase in their income and
debt-carrying capacity and that these benefits
of added investment could be enhanced in
future, if measures are taken to induce flight
capital to return.
It may be that this audience will find
itself closer to the Henry Wallich school
of thought on flight capital than the
point of view expressed to me recently
by a prominent Argentine economist
that, at least in the Argentine case, the
term "flight capital" was misleading and
that more accurate terminology would
be "portfolio diversification."
Other Solutions
~'~'hile it is relatively easy to diagnose
the ills resulting from excessive govern-
mental involvement in our economies, it
is far more difficult to find constructive
solutions. In many of the countries of
our hemisphere, the state-owned sector
is so large, relative to the domestically
owned pool of private capital, that a
simple sale of those state enterprises
that are running the largest deficits
would be difficult (who would want to
buy them?), and attracting foreign
capital for this purpose also would be
difficult, for well-known political
reasons. Indeed, there are still many in
Latin America who would view selling
off parastatals to "transnationals" in the
same way as they view foreign direct in-
vestment-selling off their "national
patrimony." There have been ideas
floated that some debt could be ex-
changed for equity in the parastatals.
Brasil considered this for a time, but
may have given up on the idea, at least
for the present.
However, I believe that there are
other potential and feasible solutions
over the long term, for, as President
Reagan has said, "Developing countries
need to be encouraged to experiment
with the growing variety of arrange-
ments for profit-sharing and expanded
capital ownership that can bring
economic betterment to their people."
One such method of expanded capital
ownership is advocated by Dr. Louis 0.
Kelso and Patricia Hetter in their book,
Lo Economic de los Dos Factures: Un
Tercer Camino. The plan involves
employee stock ownership plans, which
are nothing less than having the
employees of the corporation also
become the stockholders, i.e., owners.
There are now approximately 8,000 cor-
porations in the United States using
these plans, and the experience with
them has been quite good-productivity
goes up, worker income is linked to
profitability, etc. While they are only
one form of expanded capital ownership,
the point I am trying to make is that
there are alternatives to state owner-
ship, and they should be explored and
adapted to the conditions existing in
each of the countries of our hemisphere.
Indeed, Costa Rica and Guatemala have
rapidly increasing employee stock
ownership plans.
But the benefits of expanded capital
ownership go far beyond the economic,
as has recently been demonstrated in
the La Perla project in Guatemala. La
Perla is a 9,000-acre coffee and car-
damom plantation in northern Guate-
mala. It has 500 full-time employees,
about 1,500 family members, and ap-
proximately 4,000 other people depen-
dent on the economy of the estate. In
September 1984, the farm's owners set
up a trust in which they allocated 40%
of the stock. The stock will be paid for
out of the future profits of the farm, but
upon the signing, full voting rights were
passed through to an employee associa-
tion.
Early this year, 120 insurgents at-
tacked the estate and actually took con-
trol of the center. The insurgents,
however, were then attacked and driven
off the farm by 200 armed workers, and
a number of workers and insurgents
were killed. In the week following the
attack, the estate's 300 unarmed
worker-owners petitioned the owners for
additional rifles to defend against future
insurgent attacks and volunteered to
help pay for them through a payroll
deduction plan. As Joseph Recinos (a
representative of the Solidarity Union of
Guatemala, a movement aimed at ex-
panded capital ownership as a means of
economic and social reform), has stated:
We can more clearly see what the true
message of ownership and of vested interest
in the free enterprise system means in view-
ing the La Perla model. There is no greater
significance to the concept of defending the
free enterprise system than a worker laying
down his life to defend the company in which
he is co-owner.
If we want to prevent further Nicaraguas
or EI Salvadors, the American Government
must address the problem of economic and
social justice in Central America. Promoting
broad capital ownership as an alternative to
Marxist philosophy in Latin America, if they
are actively pushed now as foreign policy ob-
jectives, can go a long way in giving people a
vested interest in protecting the free-
enterprise system.
Norman Kurland, one of the
founders of the Center for Economic
and Social Justice (a group whose goal is
the promotion of employee stock owner-
ship plans) stated in a Washington
Times interview last September:
To .vin over Marxism-Leninism you have
to go beyond the military. Uf course, you
have to be militarily strong. On the other
hand, there is an ideological battle. Marx and
Engels stated that you could sum up the en-
tire philosophy of communism in a single
sentence: Abolish private property.
The entire case of Marxism-Leninism
disappears if we prove to the world that
private property is essential for providing
economic and social justice, and for providing
human dignity to people in the Third World.
Marx was wrong. However, we cannot
simply attack him on the basis of the prob-
lems he was focusing on but. rather on the
basis of the means that he would use. The
solution is not to make enemies of the owners
but to make owners out of the nonowners.
Foreign Direct Investment
Over the past 4 years, it has been made
clear to me, in visits to every country in
the hemisphere, that private foreign
direct investment can play the key role
in future trade and commerce. Indeed, it
is the catalyst for economic development
and international economic integration
through the world trading system, as
well as being perhaps the only remaining
source of capital, technology, and
management know-how on a scale
needed for economic survival.
It seems intuitively obvious that the
high-debtor countries of our hemisphere
must take strong steps to court foreign
direct investment as the most attractive
alternative to new bank financing.
Foreign direct investment has the ad-
vantage of not requiring fixed interest
payments. Earnings are repatriated only
if the investment is profitable. Local
enterprises are able to sell to multina-
tional companies and often gain access
to new markets and distribution chan-
nels, both nationally and internationally.
Finally, and most importantly, foreign
direct investment creates real jobs as
opposed to state-funded make-work jobs.
Unfortunately, the trend has been in
the other direction. In 1950, U.S. direct
investment in Latin America accounted
for nearly 50% of the total U.S. invest-
ment overseas. By 1970, this figure had
dropped 17% in Latin America and was
3% in Asia and the Pacific. At the end
of 1982, the stock of U.S. direct invest-
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nu?nt ~:~?as down ]5",~r~ in Latin America
:un] had doubled to ti"~~ in Asia xnd the
Pacific. In a time when total flows of
l'.S. foreign in~'cstment were declining,
flog+~ to the Far East rose sharply.
I am encouraged by the increasing
reco},mition ul'the importance of internal
factors for the revitalisation of Latin
:1nu?riran economics now being ex-
pressed 1>.y prominent Latin Americans.
itr:lzilian Senator and former Planning
and Finance Minister Roberto Campus
stated the issues succinctly in his speech,
""I'he view I)emonolof~-y": "The United
States has become the magnet for Euro-
pean and Japanese investors precisely
because they have two things we lack-a
strung currency and stable rules of the
gallle.'
The prominent Argentine economist,
Macros Victurica, has also addressed
these issues. Mr. Victurica estimates
that Argentine capital abroad amounts
to about $27 billion ~.~td that much of
this capital left the country during the
early 1980s, despite the fact that real in-
terest rates in Argentina amounted to
about 20r7,-double L'.S. real interest
rates-and he has ascribed these devel-
opments to a lack of confidence. Regard-
ing policies affecting foreign direct in-
vestment, Mr. Victorica has noted one of
the key- difficulties (such as exchange
controls): "No one will come in [to in-
vest) where a way out is forbidden."
Argentine Presidential Secretary
General German Lopez recently
spotlighted this problem in comments
reported on the Buenos Aires govern-
ment radio network, when he stated
that, "President Alfonsin is determined
to modernize the country and that, to
this end, there is no alternative but to
resort to foreign capital so that the in-
vestments that will contribute to Argen-
tine development are made." The only
way to make up for the time lost, Lopez
states, is to urgently attract invest-
ments, adding that:
I want to say that the past 10 years have
been very dramatic for Argentina and that I
consider that in reviewing, in weighing our
responsibilities, we are sometimes unfair.
We have made mistake after mistake for vir-
tually 50 years. We have practiced a sort of
political cannibalism destroying each other.
[Therefore] President Alfonsin is firmly de-
termined to modernize Argentina in order to
put it at the level of efficiency asked by
public opinion.
Recently, the newly elected Presi-
dent of Uruguay, Julio Maria Sanguinet-
ti, said that "those of us who historically
defended a greater role for the State
now have to say that we must
reestablish equilibrium and that as a
result our direction will be to reduce to
the nraxinrum extent rxponditures of the
State, and to encourage as nuu?h as ~~ e
ran private production...
1 am pleased to see that some
leaders of Andean fact countries