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Debt and Crisis in Latin America
The Supply Side of the Story
By Robert Devlin
PRINCETON UNIVERSITY PRESSCopyright © 1989 Princeton University Press
All rights reserved.
Introduction: The Crisis in Latin America
Since mid-1982 Latin America has been suffering through one of the most serious economic crises in its history. A good summary statistic of the region's plight is per capita income: at the end of 1987 it was nearly 6 percent lower than the figure registered in 1980. At the outset of the crisis even the most optimistic observers expected the 1980s to be a "lost decade" for Latin America, estimating that by 1990 per capita income would barely exceed its 1980 level. Now, with six years of crisis behind us, that bleak prognosis indeed appears to have been too bright, just as some analysts feared. Barring a favorable turn of events regarding the level of debt service or the performance of the world economy, it now appears that it will be difficult for the region to recover 1980 per capita income before 1992.
While the region's crisis is a development crisis, it is most frequently referred to as "the debt crisis." Attention has tended to center on the whole issue of debt because it constitutes one of the crisis's most immediate links between North and South. On the one hand, the debtors' difficulties in servicing their obligations have represented a potential threat to the viability of the creditor nations' financial systems. On the other hand, debt servicing drains an extraordinary amount of resources from Latin America and has had strong depressionary effects on economic activity. Indeed, in the face of the high burden of payments, development policy in the 1980s has taken a back seat to the exigencies of crisis management and the politics of international debt.
Latin America found its debt burden unsustainable in 1982, a fact that was dramatically brought to the world's attention by Mexico's announcement of a temporary moratorium in August of that year. This date initiated a process in which most countries have fallen into a state of de facto default, repeatedly breaking scheduled repayment calendars. De jure default has been avoided only because the banks and their OECD governments effected widespread rescue operations, which facilitated the multiple rescheduling of debt payments. The reschedulings — undertaken in no less than seventeen countries of the region — helped to avoid the feared collapse of the international financial system. Yet we will see that the same exercises that so successfully saved the world financial system have also decisively undermined the growth and development process in the debtor countries.
The advent of crisis, and the dramatic and controversial nature of the rescue operations, has brought debt to the forefront of research agendas. Indeed, there has been a virtual explosion of writings on the debt crisis, both as to its origins as well as to potential solutions.
Analysts have tended to stress different underlying factors behind the emergence of the crisis. Perhaps the most popular argument to appear in the North referred to what some simply called bad economic management in the debtor countries. In this school of thought, primary attention is placed on expansionary macroeconomic policy, and above all on fiscal deficits. In other words, lack of fiscal and monetary discipline in the 1970s induced public-sector deficits and an unsustainable accumulation of debts. The prescription following from the diagnosis involved austerity in the debtor countries, a rolling back of the public sector, the elimination of price distortions, seen as inhibiting the functioning of the market mechanism, and export-led growth. Some of these analysts expressed support for the conventional crisis management involving commercial bank reschedulings, which leave creditor portfolios largely undamaged, while others argued that the bad economic policies have made many debtors incapable of servicing the nominal value of the debt and therefore the banks must assume write-downs and losses on their loans. Sometimes these latter analysts proposed a type of internationally supported financial plan that would help the banks write off part of their asset values in the developing countries.
A second popular interpretation supported the notion that the debtors mismanaged their economies but placed relatively greater emphasis on the role of unforeseen exogenous shocks brought on by OPEC pricing policies, high world interest rates, and prolonged world economic recession. This diagnosis leaned toward a conjunctural explanation of the problem and consequently placed greater weight on a conjunctural solution: lower interest rates, recovery of the OECD economies, and improved commodity prices. There also was recognition of the need to introduce austerity and better economic management in the borrowing countries. But given the stress on conjunctural developments, it viewed the problem in the countries as one of illiquidity and strongly supported the conventional strategy of commercial bank reschedulings and austerity in the debtor countries.
A third interpretation of the problem pointed to an overall systemic crisis of capitalism, of which debt was a major manifestation. Much of this analysis has its roots in the Marxian tradition. Solutions are not well articulated, but integral to the classic Marxian approach is the notion that a capitalist system in crisis regenerates itself through defaults, financial collapse, and the devaluation of financial assets.
In a fourth interpretation some analysts focused primarily on the tendency of banks — Latin America's principal creditor — to overlend in the 1970s. The prescription emerging here was more effective control of bank-lending practices.
While the diverse arguments have been in practice often treated as competing explanations, they all capture important dimensions of the crisis. For instance, it is difficult to quarrel with the argument that many debtor countries mismanaged their economies. There is much evidence to support the hypothesis that many of the countries in Latin America had excessively debt-leveraged development strategies in the 1970s. It also is evident that the OPEC shocks, as well as the prolonged world recession and high interest rates of the 1980s, contributed to the massive accumulation of debt and simultaneously undermined the capacity to repay it.
As for capitalist crisis, the slowdown in the world economy since the late 1960s is a matter of record. There are a number of studies that point to structural crisis in capitalism, and some are from very orthodox circles. Moreover, the external shocks that have been stressed by certain authors could easily be incorporated into a comprehensive theory of capitalist crisis. This would, however, admittedly change the underlying assumption of the shock literature, which was that the crisis is short-term and conjunctural and not a protracted structural problem.
Concern about market supply and bank lending also seems eminently reasonable since the other side of overborrowing is overlending. Nearly one hundred years ago Marshall eased the debate between the classical and neoclassical schools on whether supply or demand was the more important determinant by pointing to the two blades of his now famous scissors. Yet, unfortunately, the supply side of the debt crisis remains relatively untold, as most analytical studies in the North have largely ignored creditor behavior when evaluating the causes of the crisis; even when banks were brought into the picture they were treated, at best, parenthetically. Curiously, Latin American observers have been more respectful of Marshall; while from the outset not denying serious mistakes in the management of their economies, they also pointed to the dynamics of supply in the crisis in order to establish the principle of coresponsibility. Yet their position generally has lacked a technical base and has rested on the assertion that loans were pushed on the Latin American economies.
The purpose of this study is to explore more thoroughly the dynamics of supply in the current crisis and thereby help to round out the analytical story of Latin America's debt problems. The general argument to be presented is that banks were an endogenous source of instability in the credit cycle of Latin America, tending to overexpand on the upside and overcontract on the downside. Taken broadly, my argument about the procyclical behavior of capital is not wholly original. Such diverse economists as Karl Marx, Thorstein Veblen, and, in modern times, Hyman Minsky, have posited in their different ways that unregulated private financial markets are prone to overexpansion and crisis. Their theories, however, are developed at the very macrolevel for the capitalist economy as a whole. My analysis of the phenomenon will be more focused on the modern international bank during the 1970s, with special reference to lending to developing areas, and Latin America in particular. This approach will allow me to give an institutional dimension to the role of supply in a credit crisis as well as derive insights on bank behavior that often run counter to conventional wisdom. It also will provide some technical support to the Latin American argument of coresponsibility in the crisis.
Banks have been conventionally viewed as the most conservative of lenders, which in the context of a credit market impose discipline on the borrower. They also have been traditionally perceived as efficient intermediaries, in contrast to the public sector, which distorts credit allocation. This partly explains why many analysts were so optimistic about the expansion of the unregulated eurocurrency market and its lending to LDCs in the 1970s. It also perhaps explains why the most popular evaluations in the North of the causes of the crisis were so quick to implicate the economic management of the debtors and/or exogenous shocks but not really the banks. By examining how banks lend in practice, I will show that there was an inherent tendency of unregulated banking to overlend in the 1970s. Moreover, I will illustrate how credit markets could aid and abet any domestic forces in the debtor country directed toward overborrowing. In other words, there were important dynamics on the supply as well as the demand sides of the debt equation that pushed the system in the direction of excessive debt accumulation.
On the downside of the credit cycle the rescheduling of debts often has been touted as exemplary of the modern management of crisis at the global level, where the banks, OECD governments, and debtor countries have all assumed a fair share of the burden to protect the viability of the world financial and trading systems and to restore the debtors' creditworthiness. The rescheduling policies have conventionally been seen as market-based, efficient, and designed in the interests of the debtors and creditors alike. In contrast, I will demonstrate that with the advent of problems, banks shifted from overlending to underlending and that the management of the ensuing crisis has been primarily designed to protect the loan portfolios of the banks at a disproportionate cost for the debtors. I will also show that the technical arguments employed by the creditors to justify their policies were theoretically inconsistent, arbitrarily formulated, and could be construed as an attempt to mask the fact that debtors have been shouldering an unnecessarily large share of the costs of the crisis.
The substantive part of the study begins with Chapter Two, which provides a historical overview of the role of private banks and capital in external finance from the nineteenth century up through the 1980s. Special attention is given to the postwar expansion of banking: its origins, the magnitude of lending, and eventual articulation with the periphery.
Chapter Three retraces the postwar expansion of banking found in Chapter Two, but at a higher level of abstraction. The analysis proposes to establish generally why banks were such profusive lenders in the upside of the credit cycle and how they could contribute endogenously to an overexpansion of debt. It first presents the conventional analysis of bank behavior, which relies on ahistorical portfolio theory and concludes that banks are cautious and efficient lenders that enforce discipline on borrowers. This is later contrasted with an alternative analysis that examines the modern bank as a historical institution operating in the dynamics of a specific market structure. The approach allows me to demonstrate "why" and "how" private banks during the 1970s were inclined to lend very aggressively in the expansive phase and become an active agent in overindebtedness and crisis.
The general proposition of Chapter Three is given greater focus in Chapter Four by analyzing more specifically the transmission of overlending into overborrowing. This is done by developing an analytical framework of the bank-borrower relationship patterned on the experiences of Peru and Bolivia, two countries that went through important credit cycles with the banks during the 1970s and for which I was able to secure unusually detailed primary data concerning credit transactions.
The fifth chapter turns its attention to the downside of the credit cycle and the political economy of rescheduling. It examines how banks dealt with the debtor country once it accumulated more debt than it could pay and entered into crisis. It will demonstrate that both the theory and practice of rescheduling has been arbitrarily formulated and rooted in the monopoly power of the creditors, which has been used in turn to pass the bulk of the costs of the crisis on to the debtors. In effect, just as the banks' behavior helped to exaggerate the expansive phase of the cycle, in the contractionary phase bank management of the crisis tended to aggravate the debtors' problems and helped to induce a socially inefficient, forced adjustment process that will have long-term negative consequences for Latin America's development.
The sixth and final chapter will explore the various options for resolving Latin America's debt crisis. It will show that the debtor countries should not passively await the arrangement of international public solutions that would manage the debt crisis in a more socially efficient way. This is because disproportionalities in creditor-debtor bargaining power and other objective conditions create an inertia in the North that could make the emergence of such international public initiatives painfully slow. To relieve the excessive burden of the debt now the countries must imaginatively defend their own economic interests by developing new payments options, which can include, among other things, a unilateral limitation of debt service. To this end the chapter reviews possible nonconventional alternatives for reducing the transfer of resources from debtor to creditor country.CHAPTER 2
Growth and Transformation of International Banking: An Overview
Rather than any claim to originality the purpose of this chapter is to present background material on international bank lending that will be supportive of hypotheses and analysis developed in subsequent chapters. My main focus will be on institutional and structural aspects of private banking that I feel are important for understanding the nature of the banks' interface with Latin America during the expansionary credit cycle of the 1970s and its collapse in the 1980s.
Private Bank Lending in Historical Perspective
There is a growing analytical literature on private international capital markets. A number of good works are available on the evolution of international lending prior to the great financial collapse of 1929. The reemergence of dynamic private international capital flows in the postwar period is covered in a large literature on the eurocurrency market, and the massive expansion of private lending to less-developed countries during the 1970s has come under increasing scrutiny. Here I will draw on this and other literature to interpret some of the more relevant aspects of international banking as it pertains to the contemporary financial situation of Latin America and developing countries more generally.
Private Capital and Latin America Prior to 1929
Incompleteness of data on capital flows makes precise estimates of private transactions impossible. Nevertheless, it is well known that private foreign capital actively flowed to Latin America on a significant scale in the nineteenth and early part of the twentieth centuries. While avoiding a detailed description of these transactions, I would like to highlight some of their more interesting characteristics, because as will be seen later in the study, there are some important parallels as well as differences with modern international finance.
Excerpted from Debt and Crisis in Latin America by Robert Devlin. Copyright © 1989 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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Table of Contents
- FrontMatter, pg. i
- CONTENTS, pg. vii
- LIST OF FIGURES, pg. ix
- LIST OF TABLES, pg. xi
- PREFACE, pg. xv
- CHAPTER ONE. Introduction: The Crisis in Latin America, pg. 1
- CHAPTER TWO. Growth and Transformation of International Banking: An Overview, pg. 8
- CHAPTER THREE. International Banking: Its Structure and Performance during the 1970s, pg. 56
- CHAPTER FOUR. The Expansive Phase of an LDC Credit Cycle, pg. 123
- CHAPTER FIVE. The Crash and the Political Economy of Rescheduling, pg. 181
- CHAPTER SIX. The Outward Transfer of Resources: What Can Be Done About It?, pg. 236
- APPENDIX. The Methodology of the Case Studies on Bolivia and Peru, pg. 283
- BIBLIOGRAPHY, pg. 287
- INDEX, pg. 309