Over the last four years America’s foreign economic policy jumped its traditional track. The first few postwar administrations practiced a single-handed kind of world leadership, because there was no one else to help. As Europe and Japan gained more economic strength, recent presidents focused on ways to share the management of the world economy. But President Reagan and his team seemed far less interested in international economic policy. Above all, they were preoccupied with events at home.

Their ideas went like this. Crank up the engines of domestic growth by freeing up private enterprise. As the "magic of the market" worked in the United States, so it could be made to work by other nations. The government-to-government agenda in international economic relations could thus be kept narrow. An aphorism from Goethe captured all: "Let everyone sweep up under his own door and the whole world would be clean."

During the first term, there were some notable achievements. These included the vibrant U.S. recovery which boosted world growth; the containment of a Latin American debt crisis that threatened, time and again, to become a global banking calamity; and the promotion around the world of new respect for market-oriented policies. Nevertheless, there were also major policy failures. To sweep up around one’s door was not in itself enough, since living in such close quarters meant that it mattered how the broom was wielded and where the dirt settled. In fact, America’s foreign economic policy showed little regard for the impact of U.S. fiscal and monetary policies on the rest of the world. Moreover, it was a policy which ignored the erosion of America’s international competitive position.

The Administration’s approach might have been more viable in earlier periods in American history, when trade counted for a very minor portion of U.S. gross national product and the American dollar was not the currency for 80 percent of non-communist trade or 75 percent of reserves held by central banks. But as a strategy in the 1980s, it could only be called gunboat economic diplomacy, and it was singularly inadequate to deal with the intensifying interaction among national economies. Policy shortcomings were particularly severe in the areas of budget management, monetary policy, trade, multilateral aid and Latin American debt. As a result, by late 1984, it appeared that the Administration’s accomplishments would be transitory, and that severe problems had been created for the President’s next term.

II

The Reagan Administration entered Washington in 1981 amid deep-seated pessimism about the U.S. economy, which had been wracked by escalating energy prices, declines in GNP and dramatic jumps in the prime interest rate. The President intended to reverse America’s course with a supply-side approach to recovery. Budgets were to be balanced, taxes slashed and regulatory straitjackets removed. The fundamental goal was to reverse the growth of government in the economy and to reinvigorate American business.

At the beginning, however, Reaganomics backfired. Unemployment climbed. Budget deficits widened. The supply of money was kept tight, resulting in low rates of inflation—the one bright spot—but also in onerous interest rates. As the United States and the world economy experienced the longest recession in 50 years, the most dramatic casualties were Latin American debtors. Cries for urgent action grew louder. "If we misread the signs of the times and continue to let the reins drag," said former German Chancellor Helmut Schmidt in early 1983, "our children will compare them with the catastrophe of the 1930s."

But pessimism was overtaken by events. By mid-1983 a dramatic economic recovery was gathering force in the United States. Fueled by the stimulus of widening budget deficits and an easing of monetary policy, the American economy was coming alive. During 1983, GNP grew 6.1 percent, unemployment dropped from 10.7 percent to 8.2 percent, inflation declined from 8.7 percent to 4.1 percent. The momentum continued into 1984 with growth still averaging more than six percent, unemployment continuing to drop, and inflation remaining steady at around four percent.

This spectacular performance was the Administration’s most significant foreign economic accomplishment. America was enjoying its biggest surge in consumer demand since the Korean War, and the international spillover was stunning. In 1983, increased U.S. imports accounted for one-half of the net growth in world trade, and in 1984 imports were running at a 25-percent higher rate. The United States was by far the principal market for other nations’ new export sales. In 1984, for example, French and German exports to the United States were rising more than 33 percent compared to the previous year, while exports from Japan, Korea and Taiwan to the United States were growing even faster. Half of Brazil’s astounding $12-billion trade surplus was due to sales to the United States, as was virtually all of Mexico’s export growth.

Economic growth also helped the Administration with its second major accomplishment—the prevention of a global banking crisis. When nearly all of Latin America interrupted the servicing of foreign debt in late 1982, Washington was quick to provide emergency loans to the two biggest debtors, Mexico and Brazil. In late 1984, similar bridge financing was promised to Argentina. In several cases, the U.S. Treasury and the Federal Reserve Board worked behind the scenes to keep rescheduling negotiations from collapsing. In the end, however, it was rising Latin American exports to the United States which allowed the big debtors, and some others as well, to scrape up enough foreign exchange to meet minimum interest payments.

Finally, the exceptionally strong U.S. economic performance made other nations receptive to the Administration’s free-market philosophy. Washington, therefore, helped create the psychological environment for government after government to stimulate private investment, sell off state-owned companies, shrink budget deficits, and liberalize their markets for banking and for the raising of funds through stocks and bonds. Britain, for example, sold off half its nationalized telephone system, and Canada lured American investors for the first time in a decade. Brazil started to dismantle its import barriers, and China turned its back on Marx.

These achievements notwithstanding, America’s approach to foreign economic policy was seriously flawed. The fundamental problem was that American policy was made with little regard for anything other than the domestic recovery. At a time when interdependence among nations was growing rapidly, the Administration seemed quite willing to ignore the impact of its policies on the rest of the world. Nor did it seem to recognize the adverse feedback that U.S. foreign economic policy could have on the competitive position of American firms.

One explanation is that the Administration felt that the policies of the previous few presidents had failed, having led to repeated bouts of stagflation, a soft stand against unfair foreign trade practices, a give-away of advanced technology to our adversaries and an excessive foreign aid burden. Moreover, the Administration questioned what all those global economic conferences and summit meetings, held in the late 1970s, accomplished. The Reagan team defined the nature of its global economic responsibility in unilateral terms. The American economy would serve as an example to the rest of the world. U.S. strength also would be used to force other nations to liberalize their economies and to get tougher with the U.S.S.R. If, as a consequence, foreign policy became strained, or if America had to skirt the edges of a trade war, so be it. Policies had gone astray long enough. Almost any change would be better, and change would be pushed through quickly.

Another interpretation of the Administration’s actions is that it did not, in fact, have any consistent policies. There was, after all, an unusual amount of flip-flopping arid dissent among top U.S. economic officials. The President began his term arguing strongly for balanced budgets. Then, at times, he asserted that deficits did not really matter; by late 1984 he again seemed preoccupied with reducing them. Secretary of the Treasury Donald Regan openly argued with the director of the Office of Management and Budget (OMB), David Stockman, and with the chairman of the Council of Economic Advisers, Martin Feldstein, about whether budget deficits led to high interest rates. There were deep-seated controversies over whether taxes should be raised, or whether economic growth alone could produce enough revenues to close the deficit. A market-oriented Administration often seemed unable to decide whether free-floating exchange rates or a return to the gold standard should be the American objective. Secretary of Commerce Malcolm Baldrige vigorously pushed for a new department of trade and industry, while Ambassador William Brock, the President’s special trade representative, strongly opposed the same idea. Secretary of Defense Caspar Weinberger supported comprehensive export controls on technology-intensive products, while other departments fought against them. Two secretaries of state—Alexander Haig and George Shultz—argued for greater support for the International Monetary Fund and the World Bank; the Treasury Department and the OMB took a much tougher line, and won. In this environment, every issue was fought out as it arose, with no overarching policy.

Many of America’s trading partners complained bitterly about U.S. foreign economic policy. At a time when exchange rates were so critical to the ebb and flow of world trade, and were so clearly misaligned, the Administration watched the dollar soar, and yawned. At a time when our allies pleaded with the United States to take account in its domestic policy making of the damaging impact abroad of unprecedentedly high real U.S. interest rates, Washington turned a deaf ear. When multilateral solutions were essential for solving global problems, the Administration led the charge against the IMF, the World Bank and the General Agreement on Tariffs and Trade.

And it was not only foreign nations that objected to the Administration’s foreign economic policy. Much of American industry often resented the passive attitude toward the overvalued dollar, which priced many U.S. exports out of world markets. Domestic firms fought against the effort to impose export controls, which weakened the U.S. competitive position. And they criticized, as well, Washington’s emphasis on austerity in Latin America, which closed off billions worth of U.S. sales.

For two years, the costs of mismanaging U.S. foreign economic policy were overshadowed by America’s economic boom. But by late 1984, frustrations were mounting abroad and at home. As Washington prepared for President Reagan’s second inauguration, the price tag of past mistakes was beginning to mount.

III

At the root of the President’s growing foreign economic dilemmas was the growing interdependence between the United States and the world economy, a trend with enormous policy implications which were too often lost on Administration officials.

By 1984, 12.5 percent of America’s GNP could be related to traded goods and services, and some estimates showed that 70 percent of total U.S. production of goods was exposed to international competition. Forty percent of American farmland was devoted to exports. One-sixth of all jobs in the manufacturing sector depended on sales abroad. Half of the after-tax profits of U.S. corporations came from overseas subsidiaries. The nine largest U.S. banks had foreign exposure in the Third World alone of close to 200 percent of their primary capital base.

By last June, borrowing by American companies in the Eurodollar market was running at a rate of $18 billion per year, 13 times the volume of just six years ago. Five years ago only eight percent of America’s 1,600 largest pension funds invested in foreign securities, but by the end of 1984 some 28 percent were doing so. Funds from overseas financed 40 percent of our budget deficit. Canadian real estate firms like Olympia and York were reshaping the skylines of Manhattan, Minneapolis and Los Angeles. Nestlé S.A., a Swiss corporation, bought Carnation; Mitsubishi Bank acquired Bancal Tristate, a California bank with assets of $3.9 billion; five of Japan’s biggest steelmakers spent over $500 million to buy into their American counterparts. France’s Société Generale was financing the water system of Dayton, Ohio, and Japan’s Sumitomo Bank was guaranteeing bonds for the University of Virginia.

Underlying the growing interdependence were massive capital movements across borders. The flow of money was now dwarfing the growth of world trade. In 1984, for example, world trade in goods and services was on the order of $2 trillion, while global capital transfers reached $20-$30 trillion. It was not just that global bank lending had grown, or that the international bond markets had more than $200 billion of outstanding issues; now an international stock market had emerged, as well.

The internationalization of capital, combined with the diffusion of technology and advances in communications, made it easier for industry to expand globally. During the first Reagan Administration, companies spread their operations in new ways. Most visible was the automobile industry, where General Motors and Toyota formed a joint venture, while Honda, Nissan and Mazda were setting up shop on U.S. shores. In late 1984, Ford announced its "world truck," which would have a European-made cab and a North American-built chassis, be assembled in Brazil, and finally be imported into the United States. At the same time, American firms were marketing Japanese cars, and all were producing their own parts abroad for import into the United States.

New global arrangements were not confined to cars. Because of deregulation, AT&T, ITT and IBM competed fiercely for hook-ups with foreign firms like Japan’s Nippon Telephone and Telegraph or Italy’s Olivetti. American machine tools were increasingly "mongrels"—the design came from abroad, the parts were made in several countries, assembly was in a different location altogether and the U.S. marketing was done by recognized "brand name" firms. Even research and development were becoming truly globalized as Pratt and Whitney joined forces with Rolls Royce to develop new engine technology, and the highly nationalist France signed an agreement with 17 U.S. universities for direct access to research in robotics and artificial intelligence.

Money, exchange rates and trade were inseparable. In fact, capital shifts became the major cause of commercial frictions. When, for example, foreign funds moved en masse to the United States, they put upward pressure on the U.S. dollar. This led to a flood of cheap imports, and ultimately to quotas on autos and steel. Capital movements out of Europe undercut local investment, led to unemployment and created pressure in London, Paris and Brussels to restrict imports. Japan’s trade surpluses were now being seen not only in terms of Tokyo’s subtle import barriers, but also in the light of its management of the yen.

In sum, the world’s intrusion into America’s economic affairs made almost meaningless the distinction between foreign and domestic economic policy. Concerns about the overvalued dollar were shared by Europeans forced to pay more for oil (which was priced in dollars), by International Harvester struggling to export heavy earth-moving equipment, and by the United Steel Workers reeling from cheap imports. U.S. fiscal and monetary policy, which was driving up world interest rates, was watched as carefully in Brasília, scrambling to make its next interest payment to foreign banks, as it was in Washington by the Federal Reserve, worrying about the slowdown in midwestern housing construction.

Moreover, in the debate over America’s ability to compete in international trade, attention turned to domestic issues once seen as tangential to the global economy. The American steel industry petitioned not just for quotas but for a relaxation of antitrust rules. Major concern arose over the level of government support for non-defense research and development. A blue-ribbon California commission identified 57 ways to boost America’s commercial standing in the world; two-thirds of the recommendations concerned education and job training.

Heightened interdependence also meant that actions taken in Washington could be transmitted abroad with damaging feedback effects on the United States. A good case in point was Latin America, where high U.S. interest rates led to debt pressures and severe economic belt-tightening. As a result, U.S. trade with Latin America went from a surplus of $7.5 billion in 1981 to a deficit of $14 billion two years later. Four hundred thousand American jobs were lost.

It was becoming impossible to address individual problems in isolation. The world economy had become a gigantic waterbed: push down on one end, and new pressures would emerge somewhere else. Continue, for example, to stimulate the economy with big budget deficits and an exchange rate that made foreign goods cheap, and consumer demand would lead to a flood of imports. Tell Chile that it cannot sell its copper to the United States, thereby reducing its foreign exchange earnings, and Chile’s U.S. bank creditors would suffer. Force foreign automakers to curtail their exports of cars, and watch domestic manufacturers import axles, steering wheels, transmissions and body frames from overseas.

The Administration should have been acutely sensitive to the open and interrelated nature of the world economy and the sophistication of the policies required to deal with it effectively. Instead it embraced a naïve optimism that the unfettered market-place would handle all. As a result, there was no meaningful effort to analyze trends or to anticipate events, since, from the Administration’s perspective, both efforts would have raised the unpalatable specter of planning or intervention. Better to see what the market did first, the presumption seemed to be, and then react only if the alternative was a major political or economic crisis.

IV

Turning to specific policies, it is clear that the Administration’s most egregious error was the mix of soaring budget deficits and a restrictive monetary policy. In 1981 the fiscal shortfall was $55.6 billion; by 1985, without radical surgery on the tax code and on government spending, America would be locked into deficits on the order of $200 billion for the rest of the decade. To counteract the inflationary implications of the budget stimulus, the Federal Reserve had little choice but to hold the reins of monetary policy tight. Any consideration of the international impact of these policies—either on our trading partners or on American industry’s ability to compete—had to be secondary. Even most Administration officials acknowledged the imminent dangers. As the President’s economic report was presented in early 1984, David Stockman described America as being on the brink of Chapter 11 of the bankruptcy code. Donald Regan warned that we were heading for a deep recession if policies didn’t change. Paul Volcker said that we were playing Russian roulette with the American economy. But little was done, and the chain of events which stemmed from the combination of loose budgets and tight money over the last few years is by now evident to all.

First, there were higher interest rates. They attracted so much foreign money to the United States that the rest of the world was being decapitalized. High rates choked off investment elsewhere, as foreign funds poured into U.S. stocks, bonds, real estate and factories. Second, American banks were withdrawing funds from the world banking system, in contrast to their traditional role of providing new funds to it. Third, world debtors were particularly hard hit.

The United States was not only inducing gigantic distortions in global investments, over the next few years it would likely become a debtor nation for the first time since World War I. The traditional surplus of American assets held abroad over foreign assets held in the United States had been dwindling as overseas investments in the United States mushroomed; reputable projections showed a net U.S. investment surplus of $28 billion at the end of 1984 and a net deficit of $350 billion by 1986.

The vulnerabilities inherent in this trend are enormous. To be a debtor is to be hostage to the continuous assessment of fickle overseas creditors. If international markets were to lose confidence in the U.S. economy, for example, money could flow out as fast as it originally came in. Since the United States has become dependent on foreign funds to finance our budget, we would be forced to raise interest rates to stop the withdrawal. But the higher interest rates were raised, the larger would be our debt service abroad, and the weaker our balance-of-payments position. This would further undermine foreign confidence in the U.S. economy.

Higher interest rates also pushed up the value of the dollar. Between 1980 and 1984, America’s currency had appreciated some 60-65 percent against the weighted average of other major currencies. Our record-breaking $130-billion trade deficit in 1984 reflected the problem. The damage was not to be measured only in the surge of imports or the de facto surtax on exports, but also in the movement of American firms abroad where the dollar would buy more. Thus, basic manufacturing companies like General Motors and Ford set up factories in Mexico and South Korea. High-tech firms like IBM and Atari also moved overseas.

The Administration’s policy prescriptions for dealing with these problems became increasingly stale. The President wanted a constitutional amendment to force balanced budgets. The White House called for more budget cuts outside of programs for defense and entitlements, even as the OMB admitted that there was little left to cut. In December 1984 the Treasury released the results of its year-long study on tax reform; whatever other merits the proposals had, revenue-raising was not one of them. And at no time during its first four years did the Administration even acknowledge the need to develop policies with the specific objective of influencing the U.S. exchange rate, a critical element which, in the open U.S. economy, was affecting nearly every producer and every consumer.

Walter Heller, chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson, summed it up. "Reaganomics," he said, "is fueling our record-breaking boom in public and private consumption by drawing down our net assets at home and abroad and building up our IOUs at a record pace. Future generations will foot the bill in the form of a smaller capital stock and a big foreign debt to service." "The U.S. is conducting a raid on world savings," wrote Samuel Brittan, the distinguished British economic commentator. "The 64 trillion dollar question is how far U.S. indebtedness can grow before overseas holders of dollar assets take fright as they previously did in the case of Latin America." "The Administration’s passive exchange rate policy," wrote Lawrence Fox of the National Association of Manufacturers, "represents . . . an abdication of responsibility regarding the international consequences of domestic policy."

V

Trade represents the second area where Administration policies largely failed. To be sure, any administration would have been under pressure to devote intensive attention to America’s eroding trade position. During the last four years, however, U.S. trade and current account deficits reached unprecedented proportions, and projections showed dramatic deteriorations for 1985 and 1986. Problems resulted in almost every sector of the economy, from agriculture to machine tools.

There was in fact a debate over whether the United States was losing its ability to compete. Nevertheless, judged by countless reports from the Department of Commerce, the National Academy of Science, the International Trade Commission and months of continuous congressional hearings, the United States was either losing ground or seriously threatened by foreign competition—even in such future-oriented industries as biotechnology, ceramics, fiber optics and robotics.

Washington’s frustration was described by William Brock in April 1984. "Both internationally and domestically," he said, "things are reaching the flash point . . . others must recognize the limits of our generosity." He continued:

In Europe, the subsidization of its agricultural system has reached such proportions that now subsidized European exports undercut more efficiently produced American agricultural products.

Well, enough is enough.

In other nations, subsidized manufactured products, like steel, are exported into our market in violation of U.S. law and international agreements.

Well, enough is enough.

Then there’s Japan. . . . They fully expect an open market for their products, while delaying acceptance of the responsibility to open up their market to American goods and services.

Well, enough is enough.

The Administration offered several explanations for America’s problems. The overvalued dollar was identified as a principal culprit. The strong American recovery was drawing in imports at a rapid rate, while economic stagnation in Europe and Latin America resulted in smaller markets for American exporters. Some foreign governments were subsidizing their sales. Japan, in particular, was failing to dismantle its protectionist barriers.

All of these factors were, of course, in play. But the Administration itself must be held accountable for the management of our currency, as well as the debilitating effect that high U.S. interest rates had on consumer demand abroad. Moreover, there was inadequate acknowledgement at top government levels that a host of seemingly domestic policies—from taxes, to spending on research and development, to antitrust efforts—were in themselves undercutting the competitive position of American firms.

The Administration wanted badly to be seen as a free trader. The predisposition was to wait as long as possible before resorting to tariffs or quotas, without, however, taking any other measures to ward off mounting problems. Thus, when the Administration was forced to act, it did so after problems had festered for too long. In the end, protection was used as a substitute for the failure of broader economic policies to bring down interest rates or to achieve a realistic exchange rate for the dollar. As a result, the Administration’s trade policies were to prove ineffective in stopping imports damaging to American competitiveness, and were implemented with a last-minute desperation that left little time to consider their consequences for other sectors of the economy or for the development of a more effective system for global trade.

The two most far-reaching interventions were in the auto and steel industries. In both cases the Administration demanded that foreign producers "voluntarily" restrain their exports according to a negotiated formula. The method of protection—voluntary quotas—was not new, but over the last four years it was used with unprecedented scope, as in the 1984 steel action, which could affect as much as 90 percent of incoming steel.

This use of voluntary quotas was also noteworthy because of the way such restrictions set back the development of trade rules. Since 1945, the United States has pushed for trade based on multilateralism, nondiscrimination and international surveillance. VQS were blatant violations of all three principles. They were negotiated bilaterally. They were discriminatory, freezing large market shares for traditional but not particularly efficient European and Canadian producers, and penalizing Third World exporters. They created new problems by diverting trade to markets outside the United States. In addition, VQS eliminated the possibility of multilateral monitoring and hence pressure from other nations on Washington to ease restrictions.

The proliferation of VQS was not the only evidence of the Administration’s disregard for international rules and for the General Agreement on Tariffs and Trade, the world trade organization charged with developing trade law and monitoring compliance. During the first Reagan term, for example, the Administration’s penchant for bilateralism included a quest for exclusive trade agreements between the United States and Canada, the United States and the Caribbean Basin, the United States and Israel. By late 1984, Washington was openly threatening to initiate a wider range of discriminatory deals.

Another weakness of the Administration’s approach to trade was that, even if Washington had been under pressure to protect certain U.S. firms, it could have demanded some commitment from those being protected to reinvest in new facilities to meet future competition. This type of quid pro quo, however, was never required. While quotas held up profits for Detroit, U.S. firms accelerated the movement of facilities abroad. While a bewildering array of barriers restrained steel imports, some of the bigger companies diversified into oil, pharmaceuticals and consumer electronics. In the end, the methods used to protect American industry were at odds with the porous nature of the world economies, the ease with which foreign producers could evade barriers, and the need for U.S. firms to restructure their operations in order to compete. Trade policy did nothing to address the underlying dilemmas of America’s weakened trading position. It merely tried to buy time by plugging the dike.

A second kind of protectionism also haunted trade policy-excessive resort to export controls. In its early days the Administration tried to block construction of the Soviet pipeline intended to bring natural gas from Siberia to the West European market. Controlling the foreign sales of U.S.-based companies was not enough; Washington wanted to prohibit the export by European or Japanese firms of technology that had been sold or licensed to them by U.S. companies. In a world of complex transnational industrial ties, the embargo effort was, predictably, an economic fiasco as well as a political donnybrook. "The Reagan Administration’s frenetic efforts to obstruct the building of the Soviet-European natural gas pipeline," wrote former Under Secretary of State George Ball, "are marked by hypocrisy, self-deception and an astonishing ignorance of past experience. . . . Its greatest cost will be political—the weakening of the alliance, the erosion of our leadership, the growing doubts among our friends as to our motives and judgment." Eventually, the Administration was forced to retreat.

There was less controversy among the allies over whether Western nations should sell the Soviets technologies that might be used for military purposes. On that subject, however, disputes arose between the U.S. Departments of Commerce and Defense over who had authority to control strategic exports. In the end, an uncoordinated executive branch prohibited passage of the Export Administration Act, the legal framework for export controls. The absence of legislation left enormous uncertainties, undercutting both national security and U.S. exporters.

As 1984 drew to a close, the Administration seemed to have aggravated prospects for major trade confrontations. As the President considered a massive reduction in domestic agricultural subsidies—a precipitous policy change—his trade negotiators were threatening to offset the damage to American farmers, already swimming in $190 billion of debt, by demanding the dismantling of Europe’s long-standing agricultural policies. On another front, Washington and Tokyo were deadlocked on everything from machine tools to satellites to credit cards, and U.S. officials were threatening broad-ranging retaliatory measures if more progress was not soon made. There was also a good deal of talk about precipitating an export credit war to force other nations to reduce their trade financing subsidies.

The Administration thus helped create serious dilemmas which would plague trade policy for the second term. Existing import restraints would prove to be insufficient to protect American industry, but a growing consumer lobby would object to even more of the same. In addition, the trade deficit would create enormous pressures to "get tough" on foreign governments, resulting, most likely, in an increasingly belligerent American stance, an attitude which would no doubt be emulated abroad. Economic brinkmanship seemed to be in store, with everyone a potential loser.

VI

Administration policies toward international financial institutions and foreign aid were no better. Rhetorically, President Reagan, Treasury Secretary Regan and other top officials supported the IMF and the World Bank, as have all postwar administrations. But the underlying philosophy of the Reagan Administration had a much stronger free-market focus than any American government had tried to apply to Third World development. International institutions, so the Administration’s reasoning went, financed the expansion of foreign bureaucracies, not economic growth. Create the right internal environment for private investment, and national economies would take care of themselves. There were also other objections to multilateral aid. The programs of the institutions were too lax. The IMF and the World Bank could not be controlled by Washington as easily as bilateral aid, and hence were less capable of serving immediate and shifting American foreign policy objectives.

It was a philosophy that was politically appealing to a Congress and public which had grown weary of dispensing foreign aid. In practice, however, it led to a strategy that quickly brought trouble. When Latin American countries threatened to default on their debts, Washington, other Western governments and Japan all called the IMF to the rescue. But the Fund needed more resources, and a good chunk would have to be appropriated by Congress. Having criticized international financial institutions in its first year in office, the Administration did not find it easy to now sing the praises of the IMF. Resentful of the Administration’s flip-flop, Congress barely passed a multibillion-dollar authorization. It was a long and bitter debate, which ultimately cast grave doubt on U.S. support for the world’s most effective financial organization. It would be a long time before Congress again approved new funds for the IMF.

The Administration also undercut the programs of the International Development Agency, the World Bank’s concessional lending facility, which focuses on the poorest nations. In its earliest days, Administration officials speculated aloud about reneging on pledges which the Carter Administration had made to the IDA, but under strong protests from other governments they ultimately reconsidered. The bigger clash came in 1984, when the United States refused to go along with the overwhelming international consensus for a total IDA replenishment of $12 billion—insisting instead on a 25-percent reduction, to $9 billion. Adjusted for inflation, this meant a drop of 40 percent in the IDA’s lending programs.

Washington’s skepticism about multilateral aid was in contrast to its push for bilateral appropriations. The last four years saw highly visible solo efforts: the Caribbean Basin Initiative, the African Economic Initiative, and ever-increasing assistance to Central America, where the Administration disbursed more aid between 1981 and 1983 than Washington gave to the region in the preceding 18 years. More and more of the overall bilateral program went for security assistance. The Administration’s overall aid request for 1985 gives a snapshot. Security assistance was up 90 percent over 1984 levels, while bilateral economic aid was up five percent. Multilateral aid claimed only ten percent of the proposed budget.

It is understandable that a new Administration should want to take a fresh look at international financial institutions and the complex of foreign aid mechanisms. After all, America is the largest aid donor, and past policies have frequently fallen short of their objectives. But in shifting gears so quickly, in failing to even try to develop a consensus in Congress or abroad as to new policy directions, President Reagan did not strengthen the IMF and the World Bank, but weakened them. Intentional or not, a U.S. foreign economic strategy that downgraded multilateral structures could not have comprehended the critical need to bring on board the growing number of governments that are part of today’s economic problems.

VII

During the first Reagan Administration, no single foreign economic issue received more public attention than the Third World debt. The management of the crisis can be taken as an illustration of the best and the worst of recent foreign economic policy.

To their credit, the Treasury and the Federal Reserve lowered financial lifeboats with amazing speed once the crisis broke. Nevertheless, the Administration could be criticized for allowing the problem to reach dangerous proportions before acting to resolve it. When in 1981-82 it was clear that Reaganomics was leading to big deficits, tight money, soaring interest rates and shrinking demand in the United States, someone in the Administration should have realized that Mexico, Brazil and their neighbors could not bear the simultaneous burden of higher debt service and reduced foreign exchange from exports. Yet when Mexican officials informed the Treasury in the summer of 1982 that Mexico would need massive help, Washington appeared to be shocked. Later, when the Administration pushed severe austerity as the proper recipe for Latin America, it should have been evident that American exporters would suffer. Yet it took at least a year for the Administration to take action, by which time hundreds of companies and hundreds of thousands of workers had been badly hurt.

From the beginning, the official line was that Latin America’s problems were temporary and that emergency aid would suffice. It is not surprising, given this diagnosis, that little time was spent at higher levels in Washington thinking about the longer-term economic reconstruction of a devastated continent. The neglected agenda was, nevertheless, long. It included the need to find ways, in an exceedingly cramped financial environment, to finance the massive requirements for schools, hospitals and transportation systems for young and rapidly growing populations. There was, in addition, the critical question of how to revive a bankrupt private sector, on whose prospects future economic growth would depend.

In Latin America, Washington’s rhetorical prescriptions for these problems were viewed, at best, with some irony. America preached budget balancing, even as its own deficits ballooned. We touted the virtues of free trade, while blocking imports of sugar, steel and textiles, the foreign exchange lifelines of much of Latin America. We criticized overvalued exchange rates, while the value of our own currency soared.

And, as 1984 ended, the Administration seemed to believe that the worst of the problem was over. But Argentina’s financial situation remained precarious. Bolivia’s economy seemed truly hopeless. Chile was locked simultaneously in a state of seige and in a depression. Peru was paralyzed by an explosive combination of violence and economic stagnation. Brazil was racking up record trade surpluses, to be sure, but it suffered from 200-percent annual inflation. At the same time, the Administration was pushing again for tighter conditions on IMF lending, even as the projected slowdown in the U.S. economy and Washington’s pressing need to narrow the U.S. trade deficit all spelled trouble for the struggling Latin debtors.

VIII

An important trend during the first Reagan Administration was the growing attention being given to international economic policy by state and city governments. By 1984, individual states had set up some 68 offices abroad to promote trade and foreign investment. Maryland and South Carolina, for example, had staffs in Brussels and Tokyo, and Pennsylvania opened its doors in Frankfurt and Mexico City. In the first ten months of 1984, 42 states, 32 cities and ten port authorities organized trade and investment missions or exhibitions in 41 countries. Specific states, moreover, were moving toward far-reaching policy changes. California was putting in place a broad range of measures to stimulate high technology industry. Massachusetts was considering setting up a Reconstruction Finance Corporation to revitalize older industries. Some states were setting up venture capital funds; others were establishing their own export-import financing facilities.

In fact, nearly all of the intellectual ferment with regard to enhancing U.S. competitiveness, or to finding alternatives to simple, heavy-handed protectionism, was taking place outside the executive branch. From the universities, Harvard’s Robert B. Reich helped stimulate a national debate on industrial policy with his two books, Minding America’s Business (co-authored with Ira Magaziner) and The Next American Frontier. William Abernathy, also of Harvard, Lester Thurow of the Massachusetts Institute of Technology, John Zysman of Berkeley, Charles Schultze and Robert Lawrence of the Brookings Institution, and William Diebold of the Council on Foreign Relations were among those generating widely discussed ideas concerning the policies America needed in order to compete in the world economy. In Washington, the newly formed Institute for International Economics was producing a range of serious and widely debated policy proposals on trade, exchange rates and Third World debt.

The private sector was active, too. The Committee on Economic Development, for example, representing many of America’s top industrialists and educators, warned against further government involvement in the economy as an answer to our competitive ills. The New York Stock Exchange released an analysis debunking the idea that the United States was losing its competitive edge. But another group of blue-chip firms, including AT&T, Texaco, and Deere & Co., indicated in an extensive and widely read study conducted by Data Resources, Inc., that America had big problems. "In the absence of improvement in the current decade, [these problems] will become insoluble in the next one," they warned.

Outside the Administration, the most significant influence on foreign economic policy came, of course, from the Congress. No one would have expected a group of 435 representatives and 100 senators to speak with one voice, to be more outward looking in its approach to international affairs than the President and his cabinet, or to take the lead in developing policy. The issues had long ago become too complicated and the legislature too fragmented for that. Instead, Congress’ influence was felt in how it reacted to Administration initiatives, and how it defined key problems.

On the biggest question—federal budget deficits—Congress must share full blame with the Administration for failing to take responsible action. The legislative procrastination, confusion and hypocrisy on this question has been inexcusable. On most other issues, however, a less critical view of Congress is warranted.

Congress gradually tightened the trade laws, giving the President increasing authority to retaliate against certain policies of foreign governments and making it easier for Americans to petition for import relief. But despite the lingering economic hardships caused by the 1981-82 recession and the temptations of a long presidential campaign, Congress did not enact any major piece of protectionist legislation. Moreover, although Democrats held the majority in the House, the Administration generally got its way when it presented a coherent program. Thus Congress ultimately passed a major appropriation for the IMF and gave the President most of what he wanted for the Caribbean Basin Initiative. It was when the Administration itself was hopelessly divided, as in the case of the Export Administration Act, that a legislative stalemate ensued.

During the last four years Congress also raised policy issues that the Administration did not wish to confront, given its strong presumption that government should be kept out of the marketplace. Thus it was Congress that demanded tighter supervision of the foreign lending practices of American banks as a quid pro quo for replenishing the IMF. It was Congress that debated seriously the need for foreign countries to grant America market access similar to that available to them in the United States (reciprocity legislation), or the requirement that foreign auto makers produce substantially all of their models on U.S. soil ("domestic content" legislation). True, these bills in themselves were poorly conceived, since they would have further distorted the trading system and would have brought retaliation from abroad. They were never passed, however, and they did demonstrate that, as far as a substantial number of U.S. legislators were concerned, America’s trade problems were deeply rooted and fundamental changes in strategy would be required over the next few years.

IX

It would not be realistic to expect a major change in the course of American foreign economic policy during the current term. The President’s strong electoral mandate, and the certainty that the Administration and Congress will be preoccupied with tax reform, budget cutting, banking deregulation and the containment of bilateral trade wars, all argue that past trends will continue. It will fall to the next Administration to pick up the pieces; to manage fiscal and monetary policy with more attention to their impact abroad and effect on U.S. competitiveness; to revamp trade policy so that trade wars and deindustrialization are not the only alternatives; and to build up international economic institutions to reflect the growing interdependence of national economies. The problem is, of course, that when the opportunity to make these changes occurs, the magnitude of the required change in policies will be large, and its effectiveness problematical. How many times can the roots of American foreign economic policy be pulled up?

The consequences of current policies cannot be precisely calculated. It is, of course, quite possible that the next few years will not be marked by any tangible economic crisis. "There is," said Rudolph G. Penner, director of the Congressional Budget Office, "no easily identifiable, traumatic event that clearly illustrates the effects of the deficits . . . the word ‘collision’ which is often used to describe the clash [between public and private borrowing] may not be exactly appropriate. A collision is a readily observable, violent event. The gradual erosion of our future prospects is much harder to detect."

The same is true of monetary and trade policies. There may not be an immediate crisis. But a foreign economic strategy that is so overwhelmingly nationalistic will soon be emulated by other major trading nations. Then, if the dollar crashes, or if the industrialized nations fall back into a synchronized recession, or when another event occurs which requires a high degree of global economic collaboration, the task of concerted action will be that much more difficult. Moreover, the slow erosion of U.S. competitiveness could put America on a permanent protectionist path. And our neglect of international economic institutions will weaken them just when they are vital to the recovery of debt-ridden nations or the development of a sensible framework for trade.

In the end, it is likely that eight years of Reaganomics will be seen as a time when a U.S. Administration took its own ideological instincts to extremes and was mesmerized by its own rhetoric. Keynes had some advice which the U.S. leadership should, but is unlikely to, ponder. "Words ought to be a little wild," he said, "for they are an assault of thought upon the unthinking. But when the seats of power and authority have been attained, there should be no more poetic license. When a doctrinaire proceeds to action, he must, so to speak, forget his doctrine. For those who in action remember the letter will probably lose what they are seeking."

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  • Jeffrey E. Garten manages the Far Eastern investment banking activities of Lehman Brothers from Tokyo. He was on the staff of the White House Council on International Economic Policy in the Nixon Administration and a member of the State Department’s Policy Planning Staff under Presidents Ford and Carter. The author is grateful for research assistance provided by Maria Zammit. Copyright © 1985 by Jeffrey E. Garten.
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