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The Case Against Incrementalism
The political problems of Central America and their implications for the United States naturally have been foremost in the minds of those few Americans who have thought about the area at all. U.S. involvement historically has been motivated mainly by political considerations, and political events dominate the media currently. The economic situation today, however, is the one that requires our most urgent attention. In Central America's current state, political solutions are more likely to flow from economic events than the other way around. The people of Central America want jobs and food more than they want either revolution or elections; they cannot understand why we don't help.
Ask Central Americans in any country or any walk of life today where they want American involvement, and nine out of ten will reply in economic terms. Most realize that there are definite limitations on the possible degree of American political or military involvement-and most are glad.
Not so with economic involvement. It is a matter of eternal puzzlement to our Central American neighbors that, after the vast sums we have spent in the most distant arenas of the world power struggle, we cannot muster the modest amounts that now would make such a telling difference in their small economies. That perception and the resulting frustrations and resentment can produce populations widely hostile to the United States-for the first time. Such a possibility, in my view, is the most worrisome Central American threat to U.S. long-term security, and to its moral position in the hemisphere.
In its report of January, the National Bipartisan Commission on Central America-generally known as the Kissinger Commission-recommended a five-year program of economic aid for Central America. At the time of writing, that recommendation is before the Congress and its disposition is uncertain. Many, both in the Congress and in the public at large, are concerned that an economic program cannot begin to take effect for some time, and that the resources required may be too vast to contemplate at the present moment, particularly given the overall budget situation.
The thesis of this article is that important steps can be taken, in the short and medium term, that could have a great effect in turning the situation upward and laying the foundation for a longer-term program. The recommendations in this article are not inconsistent with the overall economic recommendations of the Kissinger Commission. The resources they would require are relatively small and in many cases could be obtained by moderate reallocation of resources already available under existing legislation. In essence, the actions here proposed would be both doable and effective in a fairly short time frame.
These recommendations are presented here in terms of Central America as a whole. It must be recognized, of course, that political factors may, for the time being, limit their application to Nicaragua, and that the security situation in El Salvador may likewise tend to limit what can be done in the immediate future. Costa Rica is already in the midst of a dramatic economic adjustment program with great social strains.
Thus, while it is essential to consider the five countries of the area as a whole, in fact each country has its own very distinct nature and faces quite specific current problems. Solutions must be tailored accordingly.
This is not a hopelessly poor area; not a region which has never prospered; not a Biafra or Somalia or even a Grenada. Central America has experienced some of the most dramatic successes in economic development anywhere, with per capita growth rates in excess of the United States for decades at a time. For most of the postwar period, local savings and investment in Central America made great strides. The countries were not assisted by a great deal of foreign aid or investment, although they did make good use of foreign technology and management skills. Except for Costa Rica during one period, it was all done with quite manageable foreign debt.
Central America demonstrated an annual growth rate in gross domestic product of 5.2 percent in the 1950s; 7.7 percent in the 1960s; and 7.8 percent in the early 1970s (an average annual rate of growth, per capita, of close to five percent). Regional trade expanded tenfold during 1950-1980, reaching $2.2 billion (total export plus imports) by 1980, or 25 percent of total trade, with the increase mainly represented by new local manufactures.
This was not undertaken, however, at the expense of exports outside the region, which increased 13-fold, from $250 million in 1950 to $3.2 billion in 1978. The proportion of total exports to GDP increased from 18.6 percent in 1950 to 33.6 percent in 1978. Institution-building was accelerated, income distribution began and a small middle class was created.
Absence of inflation plus exchange stability accounted for a large degree of "financial deepening." The economies gradually became "monetized"; the ratio of money with respect to GDP increased from 4.4 percent in 1961 to 16.3 percent by 1978, creating private savings for investment.
Then, within a few years, everything suddenly changed. The very success of Central America in building its foreign trade, and its new industries, combined with the openness of the local economies, made the area vulnerable to external events. The second oil shock of 1978-79, and the collapse of commodity demand, as the United States and other industrialized countries reversed their inflation, induced a deep local recession which would have been traumatic even if the area had no political problems whatsoever-which, of course, it did.
The world is now recovering from recession but Central America is not, although in some sectors deterioration has slowed. Local savings have stopped accumulating or have fled. Locals and foreigners have been disinvesting and dollar income has eroded during the long recession in Central America's foreign markets. Management is departing steadily.
The Central American financial system has suffered more than any other sector. Diminished private savings, endangered exchange rates and a "flight from domestic money" have reduced the real size of the domestic financial system immensely. New flows of funds from abroad-always welcomed before as marginally helpful-are now desperately needed.
Four major categories of financial requirements for Central America should be considered in order of urgency. The first two could be addressed significantly in 1984 to different degrees in each country. The others are longer term and are more dependent on parallel efforts in the political and security fields.
The region's first requirement is working capital. Cash for monthly or seasonal differences between income and payments by agricultural, industrial and commercial companies is the most acute and severe need. All of the economic problems of Central America (and many of the solutions) net out in such a way as to deprive the private sector of access to normal credit facilities to handle those rudimentary tools for production.
The principal export crops-coffee, cotton, sugar and vegetable oils-all require very large seasonal cash outlays for harvesting, processing and transport to market. Historically, a substantial proportion of this credit was met by advances from overseas buyers (or their bankers) to the processors (coffee "beneficios," cotton gins, sugar refineries, oil crushers, etc.), who in turn financed the harvesting costs of farmers. Additional amounts were financed by local banks receiving dollar credit from their correspondents in the United States, Japan and Europe. Remaining financing needs were met in local currency from local public and private credit organizations out of domestic deposit funds; local funds, however, were never adequate for peak seasonal need, even in good times.
Credit from overseas buyers has now essentially disappeared. Companies have stopped making pre-export advances, and banks have become unwilling to finance the repayment of that type of historical company-to-company credit.
Another major portion of Central American working capital has consisted of supplier credit for imports of insecticides, fertilizers, vehicle spare parts and fuel, or for industrial raw materials and components. These company-to-company and foreign bank credits for imports have succumbed to the same contracting pattern as that seen in export financing. Finally, as inflationary pressures grew and the balance of payments problems became more acute, local currency credit availability for all businesses became more and more scarce as a result of frozen bank portfolios plus government monetary and fiscal tightening. Availability of credit was also sharply affected by declining bank deposits following the shortfall in export income and, later, by capital flight.
The resulting situation of nearly zero working capital is the number one reason for diminished production in Central America today. Its importance outranks political uncertainties and security problems in the shrinkage of employment for all of the five countries except possibly El Salvador. To be sure, political distortions and uncertainties continue to take a heavy toll on productive enterprises. In all of Central America, however, dozens of farms and factories could produce more, and in the process reduce unemployment and human suffering, if only they had more operating cash.
A significant part of this immediate problem could be solved by U.S. trade credit guarantees, in amounts which are dwarfed by the cost of just a few weeks' aid to Israel or Pakistan. Such a program should require very small, if any, funds from the current U.S. budget.
Another segment of the need might be met by amending existing loan agreements of the U.S. Agency for International Development, or entering into new ones, to divert, temporarily, any AID long-term project funds already in pipelines into short-term advances to the central banks of the individual countries. Such advances would provide rediscount of pre-export loans to farmers and credits for raw material purchases of factories through the already established lending institutions. The spring is crop planning time in Central America. It is too late to provide credit for planting this year, but many farmers will not proceed to use their own money during the crop year if they are not assured of the much larger amounts always required for harvesting in the October through February dry season. Such short-term advances by AID would not appear to require additional approvals or legislation, and when repaid would be available for the original purposes. The practical magnitudes of funds in present pipelines are not public, but historically there have always been some. It should not be too difficult to monitor such self-liquidating advances to major producing sectors by established credit channels to assure proper usage.
A parallel effort should be made to reactivate at least a portion of the intra-regional trade, which has become stagnant for many reasons (including financial ones), by encouraging and supporting bilateral arrangements and facilitating transport. Financing for the "swing" net balances of the clearings through the Central American Monetary Fund facilities would also provide working capital for private producers. Currently, for instance, a manufacturer in one country may pay hard currency costs for some components, but suffer long delays in receiving payment for the sale to another Central American nation. Small private companies, thus, are having to finance their nations' central bank regional clearings.
The next most urgent capital need of Central America is to repair, refurbish and replace equipment, and remobilize the work force to operate it. Nearly everything that moves or turns in Central America is now broken. A prolonged shortage of foreign exchange for spare parts and normal replacement, sharply diminished management disciplines and, especially, the difficulty in holding on to skilled labor have all combined to create worn-out productive machinery and stalled services. For largely the same reasons, public utilities also have deteriorated in effectiveness. Skilled people to operate equipment are needed even more than repaired machines.
It would seem that part of this requirement could be met by immediate accelerated disbursement and temporarily changed purposes for approved project loans of the multilateral credit institutions, whose funding might be assisted by the United States through co-financing or otherwise. Loans could be made for repair, for replacement and for recruitment or training of personnel.
The third priority requirement for funds in Central America is the longer-term need to reorient industrial and agricultural production toward export. A major (though not exclusive) thrust of the Central American Common Market was to create import substitution industries. The lower internal tariff and a higher common external tariff, when combined with the creation of new transport linking the countries, produced a boom in small industries. New companies were created rapidly to replace imports of such consumer products as canned foods, textiles, tires and paper products. Many of these-particularly those based on local raw materials and not requiring extremely large economies of scale-were soundly conceived on the basis of a region-wide or even national market. Furthermore, they provided a basic guaranteed volume of production on which potential new exports of some raw and processed goods to markets outside the region could be based.
Other companies, however, were destined always to need substantial protection or subsidy because they could never achieve the scale or the advantages of transport and energy cost available to foreign competitors. In addition, the new industries that required large steady imports of raw materials or components without corresponding export sales often adversely affected the balance of payments. Because of the employment they created, industries requiring foreign materials or components made it difficult for authorities to reduce imports sharply when export earnings began to fall.
Forty years of enduring monetary stability in Central America were due, in part, to the self-correcting nature of the balance of payments. Because imports were all consumer goods, a decline in export commodity income produced a rather quick decline of import demand. Furthermore, financial authorities could forbid many consumer imports directly, for fairly long periods, without interfering with production. Small-scale import substitution industries aimed at local markets have created urban employment and diversified income. Even those which were soundly conceived and economically viable, however, have made the economies of the area less agile and rendered monetary management more vulnerable.
Many Central American industries and parts of its agriculture now need to be re-equipped and reoriented toward overseas markets. Such an orientation would use capital more effectively and would assist in reducing the dependence of the area on a handful of raw material exports. This reorientation will require not only capital but-even more-assured overseas marketing connections, technical know-how and sophisticated management. It is in this facet of a revitalized development process that private foreign direct investment has the greatest probability of contributing in a positive way. Historically, the region-under both constitutional and non-constitutional governments-has had positive attitudes towards foreign private investment.
The final priority capital requirement, over a longer time-span, is for expansion of basic infrastructure-physical and human. Transport and storage are the first requirements here, followed by power, health and education.
In the educational efforts, management training at all levels in both the public and private sectors is the need of overwhelming importance, followed by basic artisan skills. Generally speaking, Central America has the institutional structure for effective production and per capita economic growth, as it has demonstrated well in the past. These institutions currently lack financial resources but, even more, they lack trained managers. The Central American educational system has never been particularly oriented in this direction, and events of the past several years have caused a steady drain of managers, at every level from executive officers to foremen and office supervisors. They must be replaced rapidly, for this shortage is now the primary constraint on ability to absorb capital effectively. Here U.S. aid can play a key coordinating role.
Various Central American projects in power, water and public health lie partially completed. Previous investment in sound projects should be salvaged by funds to finish them. There is a much smaller investment absorption problem in completing a half-finished project than with a new one.
Other constraints on ability to absorb capital all are quite secondary to the one of management. Central American labor is well motivated and has shown a high degree of adaptability to technical training. There are few cultural barriers to developing modern agricultural and industrial skills, at least as compared with many other developing societies. Racial and tribal tensions, attitudes concerning female employment, or religious barriers rarely constitute severe problems. Illiteracy is a problem which varies greatly from area to area. It is essentially zero in urban Costa Rica and very substantial in the Indian areas of the Guatemala highlands, where it is more a language than a literacy problem. Across the region in general, however, new industries in cities or towns can find adequate numbers of workers sufficiently literate to absorb training in modern productive techniques.
Transport is again a constraint in some areas, after the immense strides from 1960 to 1980. Completion of the Interamerican Highway in the late 1950s linked the countries with each other and with their northern and southern neighbors for the first time. Construction of the first paved highways between various capital cities and ocean ports then opened the way further. This network was supplemented in the 1970s by coastal highways in several countries and large numbers of all-weather secondary roads which connected new agricultural zones to markets to a degree previously unknown. As a result of these events, larger and better organized local trucking and bus companies were quickly formed and did quite well until economic and political problems began to interfere. With worsening relations between several countries, slowing production and the collapse of the Common Market, the past five years have seen very little improvement anywhere. In a few regions, shortage of air and small-cargo ocean transport is a barrier to increasing or maintaining production. Likewise, as noted, warehouses, granaries, cold storage, and such facilities are inadequate. In many cases much can be done by fixing what is there and by improving management and labor skills before undertaking new construction.
The capital and credit for a Central American revival, of course, cannot only come from abroad. Local capital formation is even more important.
The most fundamental element in the outlook for internal savings and capital formation in Central America is the question of inflation. This must be brought under control progressively with the successful implementation of development plans and with sound fiscal policy. The area historically has had a high degree of monetary stability and a tradition of sound fiscal management. Hence, inflationary psychology among the population is not as deeply entrenched as in many developing countries, and there is reasonable public support for the steps necessary to maintain good money.
Since the 1930s, Central American currencies had been held, until recently, at nearly constant parity to the U.S. dollar. This was, in part, due to fiscal and monetary management. In part, as noted previously, it was due to the simple nature of the economy. The Central American economy is now, however, more complex, and events of the past few years have created substantial distortions, with exchange rates and interest rates sometimes held at artificial levels. Domestic interest rates must be allowed to move in reasonable relationship to inflation and external markets if local savings are to grow again. Confidence, of course, is a vital factor. It will be favorably influenced by a visible U.S. commitment to assist the area even with enduring political uncertainties. Confidence probably cannot return without a strong U.S. role.
One of the problems in achieving a return to reasonable monetary stability is the narrow base of fiscal revenue, which has been heavily dependent historically upon export taxes and import duties. Efforts to increase income taxes or sales taxes have been difficult to enforce and usually have resulted in excessive overhead in relation to revenue. Land taxes, on the other hand, continue to be extremely low in most of the countries. Such taxes are among the easiest and cheapest to enforce and administer. Modest land taxes set at rates that would not be burdensome for productive properties, but which would be discouraging to speculators, would serve capital formation very well in two ways. First, this would push investment out of unproductive channels into presumably more productive ones. Second, this would allow the reduction of export duties which affect the competitiveness of Central American exports adversely. It could also, over time, reduce concentration of property ownership.
Middle-class home ownership also holds prospect as a means of capital formation. The new urban middle class is the segment of the population that really matters politically. There the priests, teachers, journalists, government officials, military leaders and managers of businesses mainly have their roots. An increasing proportion of the urban population has achieved a capacity to save which could be translated into home ownership if the financial devices existed. Mortgage guarantee schemes aimed at this capacity to save would achieve several results at once. There is a very big difference between rents paid by the middle class and the effective rental costs of ownership even with very tight credit terms. Hence, there is not much need for subsidized home financing for this income group. The governments, with our help, might guarantee mortgages soundly for an appropriate fee and provide rediscount of home mortgages paper (again for fees) through the creation of a secondary market.
Government encouragement and backing for public or private entities to create a secondary market for medium-term mortgage obligations have the prospect of contributing to local capital formation. There are indications that a market exists in some of the countries, even today, for five-to-ten-year obligations if the holders can be assured of the ability to sell them in an emergency even though at a very high discount. After real estate itself, real estate mortgages historically have been the most popular local investments by upper income individuals in Central America.
In any event, the Central Americans must make sure that they maintain policies of positive real interest rates, realistic exchange rates and reduced bureaucratic controls on credit institutions to encourage return and growth of local savings. They must also tighten up controls in the financial system to reduce political favoritism and improper use of managers' positions for personal gain.
Even with every possible self-help effort, however, Central America cannot pull itself up again by the bootstraps after all that has happened. Reestablishment of reasonable new flows of credit and investment from abroad must take place now.
Obviously there are huge practical barriers in the current situation of El Salvador and in the uncertainties about political pressures or security that affect parts of the productive apparatus of the other countries. Much economic life can continue, however, with some encouragement, while more enduring political solutions are sought.
Good land exists to expand agricultural production and the basic infrastructure now is in place in most areas to tap that potential. Land ownership has been an impediment to a crippling degree only in El Salvador. In all of the other countries, in this decade, sufficient unused land exists which can be brought into production by taxes to force sale of idle lands, combined with workable credit facilities for potential buyers and operators. Thousands of acres already are in government or communal hands in several of the countries, which could be worked more intensively.
Huge recent investments in electric power, roads, ports, granaries and agricultural processing facilities are under-utilized. A large percentage of Central America's manufacturing capacity is idle for lack of working capital, raw materials and-now-management. Rapid increases in production can come with cash injection. The absorptive capacity of a grossly under-utilized economy is very high. Results can come quickly for many key agricultural and industrial units and for their work forces. The region can absorb substantial amounts more quickly than areas that never had economic growth because so many tools are already there.
Central America had a whole generation of spectacular increases in productivity. This was because new agricultural areas were brought into intensive production and because industrial possibilities were opened by transport, by power and by the Common Market. It was pushed by the creation of a small new managerial class, backed by a hard-working, fast-learning population ready to accept management disciplines.
Most of this fuel for development still exists, but something has to restart the fire. It may never again burn at the rate it did without some fundamental political changes, and each country must move forward with its own political solutions. Positive political and social changes cannot take place, however, in the present economic paralysis.
It would be a tragic error for the United States to defer increased economic assistance until there are political solutions to the liking of one or another political viewpoint in the United States, or until new foolproof systems are created to assure our standards of long-term efficiency and equity. Political dialogue for hungry people is intrinsically difficult. By the time any political solutions can be negotiated, the multiplication of human misery from inoperable economies will have created new enemies of the United States daily, because people in Central America know how much can be done without significant strain on this country.
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