Time for NATO to Close Its Door
The Alliance Is Too Big—and Too Provocative—for Its Own Good
The coming decade will set the stage for the world of the 21st century. Will that world be chaotic or orderly? Will there be growth or stagnation? Will the United States be able to play the preeminent role that it played in this century? This is the context in which we must examine the present.
The ideological walls are crumbling all over the world. The basic national objectives in both the communist and the free worlds consist of sustained economic growth, greater competitiveness and higher standards of living. The global divisions that continue to exist, and that will become more and more serious, will be between haves and have-nots, rich and poor, competitive and inadequate. Such distinctions, however, will no longer be primarily ideological in source.
The most important event since the end of World War II is the recognition by the leaders of both the U.S.S.R and China that communism is not a viable system. While Soviet and Chinese reforms have been so far mostly limited to economics, they will inevitably spread to the political sphere. The Soviets and the Chinese have embarked on reform because their economies were collapsing, their citizens wanted a higher standard of living and their military wanted up-to-date technology and educated armed forces. But the underlying cause was that their system, in addition to being philosophically unacceptable, is inefficient and noncompetitive in the modern world. Until the end of this century and later, the U.S.S.R. and China will be dealing with their internal economic and social problems.
The evolution of Western Europe toward a unified market by 1992 is driven by similar broad objectives. President François Mitterrand's attempt to govern France with a classical socialist program came to a painful end in 1983. His successful reelection this past year was due, in good part, to his adoption of a moderate social democratic program geared to a market economy and aimed at global competitiveness. The same is true of left-wing governments in Spain and Italy, as well as conservative governments in the United Kingdom and West Germany. All of these European countries seek higher standards of living, better education and lower unemployment, with varying levels of government involvement in economies driven primarily by the private sector. It is interesting to note, parenthetically, that all of these countries have more extensive social safety nets than the United States and higher levels of government spending as a percentage of GNP (between 40 and 50 percent as compared to about 35 percent for the United States).
In the less-developed parts of the world, the objectives are also the same, but the ability to achieve them is problematic. Mexico, Brazil, Argentina, the Philippines-all are crushed by a combination of debt service, corruption, high birth rates and stagnating or decreasing standards of living. The threat to political stability arising from this economic inadequacy is very great. The political fate of these countries will depend on their economic success or failure, and not vice versa.
Issues of global economic development cut across both domestic and foreign policy, and will require major efforts in both areas. The level of industrial capacity built up all over the world, and the ability to transfer technology from developed to less-developed countries, requires increased worldwide demand. This can only come from healthier economies in the less-developed countries-including, one can hope, increased demand from within the Soviet bloc and, ultimately, from India and China, together with strong, continued growth in the West.
Massive investment by the private and public sectors also will be required. This investment can best be financed by worldwide reductions in defense spending. Over the long run, it is likely that more and more countries will conclude that priority should be given to economic growth over military spending. Mikhail Gorbachev's proposal for unilateral Soviet conventional force reductions, delivered before the U.N. General Assembly in December, is a reflection of that reality. Moreover, communication and information technology, financial deregulation and worldwide capital markets have eliminated the traditional borders of our financial and economic system. The world has become totally interdependent.
As for the United States, the policies of the Reagan Administration have contributed not only to our economy's interdependence with the rest of the world, which is perfectly healthy, but to its dependence on outsiders, which is not. The necessity to finance part of the U.S. budget deficit with foreign capital; the necessity, over the last two years, for foreign central banks to acquire more than $150 billion dollars to support our currency; our trade deficit and growing foreign debt; the steep increase in domestic assets sold abroad to finance our deficits-all of these factors, and more, have created a dependence on the policies of other sovereign governments and private interests that affect every U.S. domestic issue.
Even though this phenomenon was briefly recognized during the 1970s, as a result of the energy crisis and the rapid accumulation of "petrodollars" by the member-states of the Organization of Petroleum Exporting Countries, the subsequent collapse of oil prices and the careless "recycling" of petrodollars to the Third World by the Western banking system obscured the situation. Now, however, recognition of the truth is inescapable: no meaningful domestic government decision is free of international consequences, in view of our financial situation as the world's greatest debtor.
These factors all argue for the proposition that "domestic policy" is an outmoded expression and an obsolete concept. It is obvious that government policies, with respect to education, taxes, infrastructure, entitlements and so on, affect mostly our own citizens. However, those policies can only be formulated within the framework of an economic policy that is global in nature and concept-partly because of the new world we live in, but especially because of our huge indebtedness.
A similar argument can be made with respect to national security affairs, though somewhat in reverse. Just as economic policy inevitably transcends our borders, questions of national security have become woven into the fabric of our domestic policy. The two-economic policy and national security policy-are related to each other, depend on each other, and must be considered as worldwide in their scope. Thus, the next president's vision of the world will be crucial in determining how we treat these matters.
Several aspects of U.S. economic policy have significant impact on foreign policy. Our annual trade deficit ranges somewhere between $130 billion and $150 billion. In addition, net financial outflows as a result of our increasing foreign debt are about $20 billion each year, and they are likely to go higher. It is critical to bring this deficit down for several reasons.
First, the growing foreign debt created by our trade deficit requires continued willingness on the part of our foreign partners to finance the deficit at reasonable rates. They may not always remain so willing-market forces may not leave them any choice. Second, the increasing transfer of U.S. wealth abroad, resulting from the ever-increasing interest we must pay on our foreign debt, will create consistent downward pressure on the American standard of living. Third, the inability to achieve at least rough balance in our trade accounts will perpetuate a loss of competitiveness this country cannot afford.
Achieving a positive outcome will be a daunting challenge. To bring our balance-of-payments deficit to zero by, say, 1994, will require an improvement in the trade balance of about $200 billion per annum in order to make up for increasing interest costs and other financial outflows (such as dividends and interest paid out to foreign-owned companies and rent on foreign-owned real estate). Our net foreign debt by 1994 will be about $1 trillion, and the interest thereon will approach a level somewhere between $50 billion and $60 billion per annum, at a minimum.
A $200-billion annual savings in trade would be a tremendous achievement, and may not be feasible. In order to have a chance to achieve a healthy trade balance (other than by a collapse of the U.S. import market as the result of a deep recession) the purchasing power of Third World countries must be reflated, and the dollar cannot be allowed to collapse. Clearly, this effort will involve foreign policy and national security issues.
In 1982 the Third World debt problem moved to the forefront of economic policymaking concern when Mexico announced it was unable to service its debt. Brazil, Argentina, the Philippines and other developing countries were not far behind. Neither were Poland and other Eastern European countries. The total Third World debt was then about $800 billion.
The debt-relief program that was started then involved programs of austerity imposed by the International Monetary Fund, just enough in new credits to service the old debts, and stretch-outs of existing loans. The result is that the debt now approaches $1.2 trillion; developing countries are paying out a net of between $20 billion and $30 billion every year to developed countries. As a result of their rapidly growing populations, the standard of living in these countries is eroding rapidly. In this connection, it will be ironic if two of the most conservative institutions in the West-the commercial banks and the Catholic Church-rescue communism from the brink of defeat in the developing world by, in the one case, demanding the repayment of debts that cannot be repaid, and, in the other, refusing to recognize that the control of population growth is an absolute necessity.
The United States should play the leading role in beginning to reverse this process, not only because we need world growth for our own benefit, but, more specifically, because the political and economic stability of many of these countries, especially Mexico, is vital to us. The reasons are too obvious to require much elaboration: the threat to the security of our borders, high levels of illegal immigration, potential unrest in large Hispanic communities in the United States, the financial exposure of our banks. To play such a leading role, however, we would have to lower interest rates by reducing our own borrowing needs, commit major new capital to the World Bank to enable it to play its required role, and provide our banks and financial institutions with enough capital and stability to provide future financing. None of this is possible today, because our continuing budget deficits require constant borrowing and high interest rates; our banks are too weak vis-à-vis their Japanese and European counterparts to play their required role; and increasingly negative political reactions to foreign influence in this country make support of the World Bank and other multinational institutions ever more difficult.
The new U.S. administration, together with Japan and the Western European governments, should appoint a group of experts, headed by men such as Paul Volcker and Helmut Schmidt, and including representatives of Third World borrowers. This group should be charged with elaborating a debt-relief plan to be presented in Paris at the next economic summit in July 1989. The plan will have to include, in one form or another: a plan for realistic debt service relief (i.e., interest-rate reductions and stretch-outs of schedules for the repayment of principal); protection of the integrity of the Western banking system through government guarantees in some form; a supply of new capital to stimulate growth, probably from Japan and West Germany; viable commitments on the part of indebted nations to institute economic reform and ensure the repatriation of flight capital; and more aggressive leadership on the part of the World Bank as the centralizing instrument of such a plan.
It is critically important that the West, with the United States in the lead, bring forth such a plan, rather than wait and be forced to react to unilateral debt-relief schemes adopted by the borrowers, individually or collectively. The 1989 economic summit would be an ideal forum for such an initiative.
It is most unfortunate that, at a time when the economic and political systems of the United States are the envy of the world, our failure to deal with domestic budgetary issues will create serious impediments to our ability to influence events in the rest of the world, and may create an isolationist backlash in this country. Our basic weakness is due to excessive levels of debt, both in the government and private sectors. This affects every aspect of our policies.
For example, in order for Soviet President Gorbachev's perestroika to have any chance for success, sooner or later a number of events will have to take place: large-scale Western credits will have to be extended to the Soviet Union to buy consumer goods; imports of Western technology and capital goods must be permitted for longer-term development; and some degree of geopolitical agreement will have to be reached regarding Eastern Europe.
The first of these processes has already started; in the last year private British, German, French and Italian banks have committed a total of over $12 billion to the Soviet Union. In most of these cases, government guarantees are provided to the banks. The United States may well be shut out of this process, not only because American banks lack the capacity to participate, but mostly because we have no concerted business-government strategy or structures to deal with such issues. We have wasted huge amounts of money in Eastern Europe, for instance; our commercial banks are exposed for almost $10 billion in Poland alone, with no prospect for repayment and little, if any, for political benefit.
The ability of the Federal Reserve Bank (or the Export-Import Bank) to guarantee certain types of credits to communist-bloc countries would be a useful tool in a geopolitical strategy vis-à-vis the Soviet Union and Eastern Europe, if such credits could be linked to other agreements such as one providing for a reduction of forces in Europe. Such a capability would also be useful as part of a possible Middle East settlement. It is likely that any such settlement, if it ever happens, would include massive economic assistance.
There is at present, however, no structure that would permit such a coordinated strategy; neither in the State Department nor in the Treasury Department nor in the Federal Reserve does such authority reside. Nor do we, as a country, have the surplus capital to implement this kind of strategy, even if we could manage it.
At a time when both superpowers have implicitly recognized the irrelevance of nuclear weapons (except as a deterrent), the real power in the world is coming to consist of surplus capital combined with national self-discipline, advanced technology and superior education. The leading nations of tomorrow, by those standards, are likely to be Japan and post-1992 Western Europe. The United States, once the unquestioned leader of the West, falls short in every one of these categories. The main reason for our failure is our addiction to debt, which affects every one of these areas.
This addiction to debt, fueled in the 1980s by financial deregulation, supply-side economics and stock market speculation, has occurred in the government sector as well as in the private sector; it covers both our external debt and our domestic debt. Domestic government debt has soared from about $1 trillion in 1980 to about $2.7 trillion currently, as a result of a series of annual budget deficits ranging from $140 to $220 billion. The national debt will be over $3 trillion by 1992. Our foreign debt is now about $500 billion (compared to a positive balance of about $150 billion in 1980) and will reach about $1 trillion in 1992. During this same period, the debt of U.S. non-financial companies has grown dramatically in relation to their equity. Almost $200-billion-worth of high-yield "junk bonds" have been issued, often in connection with acquisitions, leveraged buyouts or other corporate restructurings. As a result of these and similar transactions, the equity capital of American non-financial corporations has been reduced by more than $400 billion over the last five years.
The perverse linkage of our deficits and our international economic posture was evident throughout the past decade. Sky-high interest rates in the early 1980s, driven by the Federal Reserve's fight against inflation, pushed the dollar up by fifty percent and caused a recession. The resulting budget deficit, caused by tax cuts and high defense spending, resulted in a typical "Keynesian" recovery which, because of the high dollar, sucked in huge amounts of imports, creating an ever larger trade deficit. The latter was used to finance our budget deficit but, simultaneously, destroyed large sectors of U.S. manufacturing.
When the Reagan Administration's long-standing policy of "benign neglect" of the dollar was reversed in 1985, and the value of the dollar was sharply driven down, these deficits continued. But the foreign investment needed to finance the deficits shifted significantly from portfolio investment to direct investment in U.S. property and businesses. Commercial real estate and U.S. corporations were acquired by Japanese and European interests at an accelerating rate-and this trend will inevitably continue. The outcome of the recent presidential election gives no hope of a fundamental change in either the economic policy or the policymaking structure of our government. This may make it very difficult for the United States to maintain its leadership role in the world of the 1990s. As long as the United States is a huge importer of capital, and as long as it is not capable of making the domestic improvements necessary to be competitive in export markets, it will abdicate its leading role more and more to Japan and Europe.
Another area of growing importance and sensitivity is the foreign ownership of U.S. business. By the end of 1987 foreign claims on U.S. assets had reached $1.5 trillion. This figure includes ownership of government bonds, stocks, companies, real estate and so forth.
Back in 1980 the figure was one-third its present level. Direct investment, namely the full ownership of companies, stood at $263 billion last year, as opposed to $83 billion in 1980. Increases in the amount of U.S. dollars held abroad because of our trade deficit and the likely continued weakness of the dollar (assuming nothing is done about our budget deficit) will accelerate this trend. It is worth noting that the value of all companies listed on the New York Stock Exchange is about $2 trillion; the total current U.S. foreign debt of about $500 billion represents about 25 percent of that amount. The $1-trillion foreign debt level forecast for 1992-93 will most probably represent a significantly higher proportion (unless the level of the stock market doubles during this period), and the level of direct investment is likely to increase materially. If the securities markets and the dollar both go lower, it is sure that much of this $1 trillion will be invested in permanent assets (companies, real estate, etc.) instead of government bonds. Thus we will be forced to accelerate the process of selling long-term, productive businesses to finance short-term budget and trade deficits. That is unsound.
Of the major industrial powers in the world, only the United States allows the purchase of controlling interest in key companies without some type of government review, or without giving domestic purchasers some type of preference. Japan, Germany, Switzerland, France and Italy all have such safeguards. Even Great Britain recently stopped Kuwait from acquiring more than twenty percent of British Petroleum, on grounds of national interest review requirements. Insofar as acquisitions are concerned, American companies are at a considerable economic disadvantage vis-à-vis their foreign competitors, because of accounting and tax treatment-the economic differential can be as much as 25 percent. This is an important area, in which corrective action should be considered, since it will become a larger issue in the near future.
For the present, the fundamental economic issues are the budget and trade deficits. But the control issue should not be ignored-if the current economic policies that tacitly encourage the sale of American assets to finance our deficits continue. In the long run, foreign control of a larger proportion of American business, coupled with our failing educational system, will have significant implications for innovation, product development and research, in addition to increasing the level of financial transfers abroad. Those are the real determinants of America's future economic independence and the legacy of the 1980s.
There are two different ways of looking at foreign direct investment. The first, and currently dominant view, is that direct investment (such as the foreign purchase of a company) is permanent and desirable, and preferable to portfolio investment such as the purchase of government bonds which can be sold easily and thus may create significant market volatility. The alternative view is that the sale of a permanent asset (e.g., a manufacturing company or a bank) in order to pay for net imports of foreign goods is not necessarily advantageous either from a financial point of view or, ultimately, from the point of view of overall policy.
For example, if the United States sells $1 billion in 10-year U.S. bonds to pay for $1 billion of imports, we can ultimately repay the bonds for $1 billion plus interest; on the other hand, if a U.S. company is bought by foreign interests to pay for the same $1 billion of imports, the result is very different. That same company, 10 years from now, may be worth $5 billion or $10 billion; it is creating permanent and growing remittances of profits, dividends and technology abroad. The cost in terms of national wealth is ultimately much greater.
Selling permanent assets is an easy solution at this time and it relieves the U.S. government from having to sell equivalent amounts of government bonds, possibly at higher rates of interest to finance its deficits. But it creates a permanent claim on our economy, as opposed to the temporary claim represented by borrowing. It thereby reduces the pressure of the most important market discipline motivating the Congress and the administration to deal with the deficits: higher interest rates and/or a lower dollar.
The control of large business units has more serious implications now than ten years ago. This is a result of the emergence of a global economy, as well as of the revolution in communications and data-processing technology. Many industries which were then discrete and separate now overlap. The control of a large enterprise carries with it the ability to make decisions determining questions of worldwide plant-site selection, worldwide supplier selection, product design, R&D siting and control and management development. These can have an important national impact, as more and more companies are bought by foreign interests. And in the case of large financial institutions, the control of credit policy is obviously very important, especially in times of financial stress.
Technological and regulatory changes are additional factors. In the United States, in one form or another, there have been historical restrictions or limitations on the foreign ownership of sensitive defense industries, banks and certain media, such as network TV. No effort, however, has been made to define, or redefine, these categories for the current era. An adequate defense industry does not consist solely of the capacity to manufacture weapons; it includes the production of all kinds of sophisticated electronics, communications, special materials and many other types of high technology. Should restrictions be applied in any of these areas? Banking has also changed: with the expected lifting of the Glass-Steagall Act, the dividing line between commercial banking and the securities industry will be eliminated. Should restrictions on foreign ownership be extended to the securities industry, or, alternatively, eliminated from banks? The same quandary applies to the media. The major networks have seen their market share eroded from almost 100 percent of the television audience to nearly 60 percent by the advent of cable television, video cassettes, etc. Should restrictions applicable to network TV be extended to the cable industry, or alternatively, eliminated from networks?
Foreign control of American businesses, especially in light of the scale on which it is likely to take place, is a valid issue of national interest. Control of financial institutions involves our international posture. Control of the media (practically all of book publishing is now foreign-owned) can affect public opinion and our political system. Control of manufacturing will affect the know-how and technology around which much of future growth will be created.
It may be that a searching, sophisticated debate of this issue will lead to the conclusion that the United States, alone among all developed Western industrial powers, should allow practically unlimited foreign control of domestic business institutions. Such a decision would be attributed to American faith in the market system and unwillingness to interfere with free flows of capital. In reality, however, it will be a decision based on our overdependence on foreign capital and our fear of frightening that capital away.
National policies should never be based on fear, either in security matters or in economic matters. The issue of foreign control is a complicated and emotional issue. It does not lend itself to clear-cut answers and should be approached with extreme care. It is an issue to be discussed with our trading partners, and there are many subsidiary issues which should be examined: reciprocal rights of ownership; equal rules of the game for acquisition in areas such as accounting and taxes; equal regulation and sharing of financial responsibility in areas such as banking and securities; and many more. But the issue will not go away. It should be examined dispassionately before political pressure to find drastic remedies becomes too severe.
The United States once claimed the twentieth century as its own; yet the "American Century" ended up lasting little more than twenty years. Nevertheless, the United States can help shape the 21st century, but only if it changes the way it manages its domestic economic affairs. The world may not exist in fifty years because of a scientific or military catastrophe-but if it does it will be under the major influence of those powers that can export capital, that can harness and develop technology in large manufacturing enterprises, that have dominant financial institutions, that have superior educational systems, and that can finance their military requirements at whatever level their national security requires. These are likely to be Japan and a more unified Western Europe.
This is not the course on which the United States is embarked today; that course, however, cannot be avoided.
It would not require enormous national sacrifice to bring our current $150-billion budget deficit into rough balance over the next four years. It would require a firm, long-range plan acceptable to the administration and Congress; such a plan could be elaborated by the National Economic Commission.
The deficit-reduction package should consist of equal amounts of new taxes and expenditure cuts. Our energy prices are the lowest in the world. Increasing gasoline taxes by 25 to 50 cents per gallon would provide $25 billion-$50 billion per annum in new revenues and still leave U.S. gasoline prices at a level significantly below European prices. It would also conserve energy and reduce imports by a significant amount. A surcharge on personal income, raising the top effective rate to 33 percent or 35 percent would still leave tax rates significantly below their pre-1981 levels and provide significant revenue and fairer distribution. Insofar as entitlements such as social security, Medicare and Medicaid are concerned, limiting cost-of-living allowances (COLAS) to one or two percentage points below the inflation rate, or taxing the benefits of higher-income recipients, would have significant impact on the budget and still pass the test of equity. National defense is essentially frozen at present levels that the country can well afford.
The United States is a great and wealthy nation with enormous natural assets as well as a vital and free political system. However, as everyone knows, balance sheets consist of both assets and liabilities, and our liabilities are growing at fearsome rates. They can be visible (such as our domestic and external debts); they can be camouflaged (such as our $70 billion-$100 billion in contingent liabilities to the savings and loan industry or the questionable credits of our banking system); or they can be hidden, as are the failures of our educational system and the lack of public and private investment. But if those liabilities, created by our failure to deal with domestic economic policy, are not dealt with in the near future, they will cost the United States its preeminent role as a world power.
A long-term plan to deal with our economic problems, if brought forward with a strong bipartisan commitment from the White House and Congress, would generate a strong positive response from the financial markets. It should deal with our budget deficit. It should deal with our trade deficit and the Third World debt. It should deal with new domestic investment and our competitive posture in the world. It would propel us forward into the next century and would enable the United States to fulfill its necessary role as the leader of the Western world. It is an absolute necessity.