Washington’s Missing China Strategy
To Counter Beijing, the Biden Administration Needs to Decide What It Wants
THE need for solidarity and understanding among the nations of the Western Hemisphere is perhaps more obvious than at any time in our history. If we are to preserve the national independence and sovereignty which we each deeply cherish we must come closer and closer together, depending more and more on each other's support. There is even less chance for isolated, individual survival today than there was in the Nazi era.
Although we may agree fully on the necessity of bringing our peoples more closely together, the opportunities for misunderstanding are great. This is especially so in cases where anti-Americanism can pay political dividends. Misunderstanding can be much reduced, however, if no action is ever taken by the United States abroad in the interests of a special group or even a party in power but only on behalf of the welfare of a people as a whole. This is particularly true in the case of loans and other financial operations, where the greatest good--or the greatest mischief-- can be done. No matter how well-meaning the United States may be, great care should be exercised when a helping hand is extended to any country. This is not an easy thing. It can be done only by people who are familiar with local conditions and know what the real needs of the country are.
Take as an example the case of a government with an unbalanced budget. There is no capital market in Latin America such as is known in the United States and some European countries, and a budgetary deficit cannot be made good by an issue of bonds. Private investors will not buy them. The Treasury then has recourse to the central bank which, by increasing the circulation through issuing more notes, can supply all the money that is wanted.
The consequent inflation causes a rise in the cost of living which is very soon felt by everyone. Workmen, employees and, in fact, the whole population feel the pinch and become progressively worse off. When inflation has continued for some time conditions become unbearable. Internal depreciation of the currency will soon lead to a weakening of the foreign exchange position. Then it may appear that the easiest thing--as has happened so often-- is to set up exchange control. Due to inflation, the fixed rate of exchange will get out of line with the market value of the currency in relation to that of other countries; there will then be a demand for more foreign exchange than is currently available. This will lead to further tightening of exchange restrictions.
Rising costs of living are bound to lead to higher costs of production. As exchange control maintains the rate at the same level, a rise in production costs causes marginal producers to start closing down. As the effects of inflation are felt more acutely, production drops even more, with the result that less is sold abroad and less exchange becomes available on current account. This leads to a further deterioration of conditions. Production and employment shrink. The resultant discontent provides a wonderful opening for Communist propaganda.
At the same time, exchange restrictions stop the flow of foreign capital from abroad, for exchange control becomes nothing but a trap from which it is hard to escape. It allows capital to enter a country but prevents investors from taking home profits, let alone repatriating capital. This is not theory, but is a harsh fact of recent economic and political history. It is difficult to imagine who will put a penny into a country where such conditions prevail. Thus to the discontent produced by a rising cost of living is added economic paralysis, unemployment and a lack of private capital just at the time when it is most needed. And this, too, is not theory, but fact.
Without any question it is easy to state the problem and arrive at the right conclusion. Had there been no exchange control, no pegged rate, then the free market for foreign exchange would have shown that something was wrong. Public opinion would have reacted against the harmful inflationary policies of the government. At the same time, rising costs would have been met by larger proceeds, in local currency, of sales abroad, thus making it possible for production to continue. Foreign capital would not have been deterred from coming into the country because, with free exchange, investors could continue to remit profits home.
It should be borne in mind that as long as inflation continues one cannot be on safe ground. With controls, the bad effects of inflation are felt more acutely even though financial help may have been forthcoming from abroad. As things get worse, the argument is made that the government should continue to receive foreign help because otherwise popular discontent will lead to its downfall. The worse the situation, the more urgent generous help becomes; without it the very people who have been agitating against the United States would seize power. But if the handouts have the effect of strengthening the government, enabling it to continue along the wrong path, Washington will be blamed more and more for the current hardships. Anti-American propagandists will tell the people: "All that you see happening is due to Washington. It has friends in the government and is helping them. Due to this help the government is so strong that we are powerless to act. Our standard of living will continue to go down while prices continue to soar."
Loans for particular projects can produce very much the same effects. The lender cannot divest himself of responsibility merely by saying that the investment in itself is sound, that it is self-liquidating. Often a foreign loan is made to take care only of the foreign exchange requirements of a given project. The International Bank for Reconstruction and Development as well as the Export-Import Bank finances foreign purchases only. If the government lacks the necessary funds in its own currency to take care of the local expenses, then a loan of foreign currency will generate inflation, for it is the central bank that will provide the rest of the money required. In a case like this, the lender cannot claim to be altogether innocent of what is happening, and anti-American propaganda will make the most of it. Neither side will profit from such a policy.
In ordinary commercial banking practice a bank will not finance a client without first seeing that he sets his house in order. It will not make loans for new investments and new projects, however attractive they may be in themselves, unless and until it has confidence in the ability of the borrower to make a success of the enterprise as a whole. Only a concern that is properly run and capable of standing on its own feet will inspire a bank with sufficient confidence to undertake the financing. If the banker were not to assume this attitude he would be blamed when the client sooner or later went on the rocks. The borrower himself would turn against the banker and blame him for the false sense of security in which he allowed him to continue on the wrong course without having made it a condition that he first put his house in order.
There is a valid parallel between this ordinary commercial banking practice and international transactions. In both there is the same responsibility to have due regard for possible implications. The determining consideration should always be the permanent interest of the country.
The common belief may be that what is needed is just money. If it is forthcoming, troubles may at first seem to have been overcome. No amount of preaching can then make much of an impression, as no one would pay any attention to it. Furthermore, the very fact that conditions improve, even though only temporarily, could lead people further astray. Permanent harm would thus be done though it might appear on the surface that the country was being helped.
If a nation relies on handouts in order to live, then no matter how convenient such help may appear to be, its future is doomed. As time goes on it finds it harder and harder to get on its feet and forge its own future. It has no sure and independent source of income. Instead it lives by what it receives for political considerations, which cannot be relied upon indefinitely. It ends by making no effort to develop its own resources or be self-supporting. As long as this state of affairs prevails, such a country will never come of age but will continue to be dependent, without prospects for the future.
It is more important, therefore, that at the outset the reason for helping should be made perfectly clear. What is needed is the development of such an orderly and progressive economy that people will come to have faith in the country's future. To build on solid foundations it must be realized that a country will achieve something real, durable and promising only through its own efforts: the determination to work out its own salvation, the opening up of new resources, the development of new lines of production and trade. All of these in turn demand monetary stability. The country should be made aware that no amount of foreign help can produce an orderly and balanced development if domestic policy runs contrary to the basic requirements for economic prosperity. On the other hand, it should be informed that the required financing will come readily to hand if wise policies are followed. When a country shows signs of giving serious consideration to its basic problems, of trying not so much to overcome temporary difficulties as to achieve permanent results, it is on its way to earning a good reputation. This is especially so if its past record is free from objectionable measures or practices. Local capital will then venture into investments with an eye to the longterm future instead of thinking only of quick and large returns. Foreign capital will soon follow suit.
In the case of Peru, for example, actual experience fully confirms what has just been said. In 1940, contrary to previous policies and no doubt influenced by what was being done in most countries, the Peruvian Government established a de facto fixed rate of exchange. When inflation developed, the demand for foreign exchange came to exceed the amounts available. The Government then had recourse to exchange control. As inflation progressed and as conditions grew worse, this led to a tightening of restrictions with all its evil consequences. It became harder and harder to apportion the supply of foreign exchange among requests as the margin between them grew, and it became correspondingly hard to prevent corruption. Production dropped. Commercial credit from foreign suppliers practically ceased as conditions deteriorated; capital would not venture into new enterprises.
Before ten years had elapsed conditions became so bad that it was decided to revert to former policies. Exchange was unpegged, controls were done away with and supply and demand were allowed to determine the equilibrium rate in a free market. Very soon a change for the better began to be felt. Production increased and so did exports. In turn, the country could afford larger imports. Exports in 1954 have been 224 percent of 1948 exports in weight and 152 percent in value (U.S. dollars). It was only in December 1948 that controls started to be relinquished and it was not till the end of 1949 that most of them had disappeared and a free market was fully established for foreign exchange.
And then, instead of counting on Washington for grants, local efforts developed to get the economy going. As government interference retreated, the free economy provided a convenient setting for progress. New industries developed markedly in various fields. Local capital became much bolder. The liberal policy evidenced by new laws regulating oil and mining led to investments of both local and foreign money in these fields. American oil companies are prospecting in new areas and already have made successful strikes. In mining, a group of American companies is about to invest $200,000,000 to open up a large new mining deposit which requires the building of a new port, a smelter and a railroad, apart from the actual work at the mines.
Meanwhile, large sums of European money are helping in the development of hydroelectric power and iron and steel production while joint enterprises of Peruvian and American capital are venturing into other fields. The International Bank for Reconstruction and Development as well as the Export-Import Bank, which for years would not lend money to Peru, now readily considers any proposal. In fact, Peru has come to be looked upon as one of the most attractive countries for foreign investment in Latin America. Commercial credit, which had practically come to a standstill under controls, has grown today to sizeable amounts, thus helping to finance imports in the cheapest way because the rate of interest in Peru, as in all new countries, is very high when compared to the cost of money in the United States. European suppliers are also freely granting medium-term credit facilities to Peruvian buyers.
The contrast between all this and the conditions prevalent in the days of controls and of a fixed rate of exchange is perhaps the best argument in favor of a free economy and a floating rate of exchange. When present conditions in Peru are compared to those in neighboring countries the difference seems to be even greater. Inflation there has gone much farther, and consequently the exchange problem is much more serious than it ever became in Peru. In fact, those countries are undergoing a very acute economic crisis. Exchange has been pegged but the rate has to be altered time and again as inflation progresses. Rather than achieving stability, everybody has lost confidence and seems to expect further deterioration of conditions, a continuous rise in the cost of living and further falls in the exchange. Under such conditions initiative is stifled, economic development comes to a standstill and production itself shrinks, while discontent and unrest become more and more evident.
In these circumstances the American Government should do its best to make the issues entirely clear. Speaking in unequivocal terms it should insist that no halfway measures will suffice. And when a country takes appropriate action, showing its determination to set its house in order with deeds and not with words, then --if needed--generous financial help should be given promptly so that there will be no delay in gaining public confidence in the new policies. In this way the American Government can help to put a country on the right road to the development of an independent economy. Private capital will then be attracted and will take care of the rest.
It should be realized that private capital can achieve what no public treasury can do, not even that of the United States. For one thing, once confidence is established the amounts of private capital that may flow into a country are almost unlimited. This can never be the case with public funds. Private investors will compete with each other and seek the opportunities that yield the most; but government money cannot do this, since risk venture is considered beyond its province. Furthermore, too many strings are tied to official funds; things have to be done according to a set pattern, with endless red tape and great loss of time. There is no regard for the fact that each problem has its own peculiarities; plans drawn up elsewhere must be carried through even though local experience may indicate that they will not work.
For a long time to come the big problem in Latin America will be the lack of capital. The United States had the same problem 100 years ago, and it was thanks to money from Europe that the country was opened up. The size of the United States gives an idea of the amount of money that was required. The problems that had to be faced were new, which meant that the risks involved were very great; but capital was free to come in and develop new resources without government interference. Private enterprise willingly and boldly accepted the challenge. Daring private investments contributed enormously to the development of the United States.
The position of Latin American countries at present is similar to that of the United States a century ago, but the problems involved are actually much simpler because they have been encountered before. Whether it is in mining or in transportation, in farming or in manufacture, experience obtained elsewhere can be applied to find the right solution. The amount of capital required may be very large, but certainly it is not in excess of what is available in the United States and in Europe.
Private capital will readily flow into a Latin American country if the investor feels that he is able to act in a free economy, without restrictions; if he can invest money and draw profits and even repatriate his capital when wanted; if there are no exchange restrictions, no controls, no ceiling prices, no inflation; and if the currency is stable; in other words, if free competition can develop without hindrance. Under such conditions investors in the United States will soon get to know the Latin American peoples and will find local partners for their projects. The joint enterprises which will develop will link the peoples of the two countries more closely. From the United States would come capital, the technical advice and the experts. The people on the spot, who have a knowledge of local conditions which it is not always easy for a foreigner to acquire, can then run the enterprise; they may also be able to put up some money as well. As the success of these enterprises becomes known in financial circles abroad, more people will seek openings for their money under similar conditions.
Even then the American Government can be of great help. For example, there may be a good project which because of its size or for other special reasons is difficult to finance privately. Washington can come forward and supply the required money. Actually, such help would hardly ever be required if Washington were to provide a sufficient tax inducement to investors in Latin America. Today, the real difficulties encountered are often in the field of taxation. In the report of the International Development Advisory Board on An Economic Program for the Americas a year ago we find the following recommendations:
Study ways and means of using tax incentives to encourage the flow of foreign private investment, including the feasibility of bilateral tax treaties incorporating reductions in tax rates.
In addition to such bilateral studies, we consider this to be a field in which constructive action can be taken unilaterally by the United States Congress. Such action should include further efforts to carry out the recommendations of the Randall Commission regarding taxes on income earned abroad, not only as regards corporate income but also income received by individuals and investment trusts.
In the Economic Report of the President transmitted to Congress last January, President Eisenhower went even further along these lines. Indeed the American Government could do a great deal in this respect. The cost would be small in comparison to what may be lost by lending direct financial help which in some cases contributes very little or nothing to the permanent good of a country and may do it untold harm. Washington has a tremendous responsibility in the task of uniting the peoples of this hemisphere for their common good. It will discharge that responsibility if it chooses the right principles and sticks to them without fear or favor.