ALTERNATIVE SOLUTIONS TO DEVELOPING· COUNTRY DEBT PROBLEMS ALTERNATIVE SOLUTIONS TO DEVELOPING· COUNTRY DEBT PROBLEMS Edited by Rudiger Dornbusch John H. Makin David Zlowe American Enterprise Institute for Public Policy Research Washington, D.C. Distributed to the Trade by National Book Network, 15200 NBN Way, Blue Ridge Summit, PA 17214. To order call toll free 1-800-462-6420 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 20036 or call 1-800-862-5801. Distributed by arrangement with University Press of America 4720 Boston Way 3 Henrietta Street Lanham, MD 20706 London WC2E 8LU England Chapter 2 in this volume, "Developing-Country Debt Problems after Seven Years," by John H. Makin, first appeared as the May 1989 issue of the AEI Economist. ISBN 0-8447-3696-1 (pbk.) AEI Studies 494 © 1989 by the American Enterprise Institute for Public Policy Research, Washington, D.C. All rights reserved. No part of this publication may be used or reproduced in any manner whatsoever without permission in writing from the American Enterprise Institute except in the case of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publications of the American Enterprise Institute are those of the authors and do not necessarily reflect the views of the staff, advisory panels, officers, or trustees of AEI. Printed in the United States of America Contents ACKNOWLEDGMENTS ix CONTRIBUTORS xi INTRODUCTION 1 Rudiger Dornbusch and John H. Makin 1 PART ONE ApPROACHES TO THE DEBT PROBLEM DEVELOPING-COUNTRY DEBT PROBLEMS AFTER SEVEN YEARS 2 John H. Makin 9 REDUCING TRANSFERS FROM DEBTOR COUNTRIES 3 Rudiger Dornbusch 21 MARKET-BASED APPROACHES TO DEBT REDUCTION 4 Paul R. Krugman 43 INSTITUTIONAL ApPROACHES TO DEBT RELIEF 5 Eugene H. Rotberg 65 PART Two Ev ALVA TIONS OF ApPROACHES TO THE DEBT PROBLEM CAPITAL FLIGHT AND REFLIGHT 6 Allan H. Meltzer 71 THE KEy QUESTION Is THE BARGAINING 7 Stanley Fischer 75 v THE NEED FOR DEBT CONCESSIONS AND FORGIVENESS 8 Jim Kolbe 79 THE VIEW OF THE BANKING COMMUNITY 9 John B. Haseltine 83 NOT ONE DEBT PROBLEM BUT HUNDREDS 10 Slade Gorton 87 DIFFERENT TREATMENT OF DIFFERENT COUNTRIES? 11 A Discussion 91 DEBT REDUCTION, DEBT-SERVICE REDUCTION, AND NEW MONEY 12 David C. Mulford 97 MAKING THE BEST USE OF RESOURCES 13 A Discussion 105 ApPENDIX: THIRD WORLD DEBT Nicholas F. Brady 115 NOTES 123 INDEX 125 LIST OF TABLES 1-1. External Financing of Countries Experiencing Debt­ Service Difficulties, 1981-1988 3 2-1. Debt Burden of Fifteen Debtor Countries, 1981 and 1988 15 2-2. Market Valuation of Developing-Country Debt, Selected Dates, 1985-1989 16 2-3. American Banks' Exposure to Developing-Country Debt, 1987 and 1988 18 3-1. External Debt as Percentage of Gross Domestic Product for Latin America and Seventeen Indebted vi Countries, Selected Years, 1980-1987 23 3-2. Economic Growth, Inflation, Investment, and Transfer of Interest in Latin America, 1970-198824 3-3. Estimates of Capital Flight for Six Latin American Countries, 1976-1987 29 3-4. Problem Debtors in Latin America, the Philippines, and Seventeen Countries, 1988 30 3-5. US. Bank Exposure in Latin America, 1985 and 1988 30 4-1. Secondary Prices on Debt of Developing Countries, April 1989 43 4-2. Welfare Effects of Alternative Buyback Schemes of Developing-Country Debt 45 4-3. Effects of a Hypothetical Buyback of Externally Fi­ nanced Developing-Country Debt 48 4-4. Effects of a Hypothetical Pure Debt Swap of New De­ veloping-Country Debt for Old, with New Debt Senior to Old Debt 50 4-5. Hypothetical Debt Swap of New Developing-Country Debt for Old, with Incentive Effects 53 4-6. Effects of a Domestically Financed Hypothetical Buyback of Developing-Country Debt, Assuming Complete Appropriability 56 4-7. "Brady Plan" for Developing-Country Debt without Seniority for Guaranteed Debt 59 4-8. "Brady Plan" for Developing-Country Debt with Guaranteed Debt Seniority 60 LIST OF FIGURES 1-1. Secondary Market Prices of External Debt in Argen­ tina and Mexico, January 1986-March 1989 4 3-1. Latin America's per Capita Real Income, 1980-1988 22 3-2. Latin America's External Transfer of Resources, 1977- 1989 25 4-1. The Debt Laffer Curve 52 vii Acknowledgments This volume is based on the proceedings of the Alternative Solutions to Developing-Country Debt Problems Conference, held April 18, 1989. The conference and volume were made possible by a grant from the Rockefeller Foundation, and the editors wish to thank the foundation for their generous support. We also thank the American Enterprise Institute for allowing us to reprint the May 1989 AEI Economist written by John H. Makin. Secretary Brady's March 10, 1989, speech, which is in the public domain, is included as an appendix. The editors thank Chris DeMuth, David Gerson, Isabel Davidov, Pat Ford, Madeline Milligan, Meriam Walker, Shirley Blanchard, and Don Flick of the American Enterprise Institute for their assistance in making the conference a success. The Miller Reporting Company, Inc., transcribed the conference proceedings. R. D. J.H.M. D.A.Z. ix Contributors RUDIGER DoRNBUSCH is the Ford International Professor of Economics at MIT. He has held positions at the Funda<;ao Getulio Vargas in Rio de Janeiro and elsewhere. Dr. Dornbusch is an associate editor of the Quarterly Journal of Economics and the Journal of International Economics. His many publications include two of the standard texts in economics: Macroeconomics, with Stanley Fischer; and Economics, with Dr. Fischer and Richard Schmalensee. Dr. Dornbusch received his Ph.D. in eco­ nomics from the University of Chicago. STANLEY FISCHER is vice-president for development economics and chief economist of the World Bank. He is on leave from MIT, where he is a professor of economics. Dr. Fischer has taught at the University of Chicago and Hebrew University in Jerusalem. He is coauthor of the classic texts Macroeconomics, with Rudiger Dornbusch, and Economics, with Dr. Dornbusch and Richard Schmalensee. Dr. Fischer is editor of Macroeconomic Annual of the National Bureau of Economic Research. He holds a Ph.D. in economics from MIT. SLADE GORTON (R-Wash.) is a member of the Senate Commerce, Armed Services, and Agriculture Committees. He participated for two years in the Twentieth Century Fund's study of third world debt. Before his first election to the Senate in 1980, he served as Washington state attor­ ney general for twelve years. JOHN B. HASELTINE is a senior vice-president of the First National Bank of Chicago and is currently on assignment as the director of banking at the Institute of International Finance. He has an M.B.A. from the European Institute of Business Administration in Fontainebleau, France. JIM KOLBE (R-Ariz.) is in his second term in the House of Representa­ tives. He serves on the Congressional Border Caucus, which is con­ cerned with issues relevant to both Mexico and the United States. As a member of the Appropriations Committee, he is on the Subcommittee on Military Construction and the Subcommittee on Commerce, Justice, State, and the Judiciary. PAUL R. KRUGMAN is a professor of economics at MIT, a position he has xi CONTRIBUTORS held since 1984. Previously, he was an international policy economist for the Council of Economic Advisers. Dr. Krugman is a research asso­ ciate with the National Bureau of Economic Research and serves on the board of advisers of the Institute for International Economics. He has published extensively on international economics and trade, including International Economics: Theory and Policy, with Maurice Obstfeld, and Market Structure and Trade Policy, with Elhanan Helpman, which is forthcoming from the MIT Press. He received his Ph.D. in economics from MIT. JOHN H. MAKIN is a resident scholar at the American Enterprise Institute, where he has been director of the institute's fiscal policy studies pro­ gram since 1984. Previously, he was professor of economics and direc­ tor of the Institute for Economic Research at the University of Washing­ ton. Dr. Makin has written on trade policy, international economics, and general economics, including The Global Debt Crisis; Sharing World Leadership? A New Era for America and Japan; and other books and peri­ odicals. He received his Ph.D. in economics from the University of Chicago. ALLAN H. MELTZER is a visiting scholar at the American Enterprise Insti­ tute and is the University Professor and John M. Olin Professor of Politi­ cal Economy and Public Policy at Carnegie-Mellon University. From 1988 to 1989, Dr. Meltzer was an acting member of the Council of Eco­ nomic Advisers. He has been a visiting professor at Harvard Univer­ sity, the University of Chicago, the University of Rochester, and the Funda<;ao Getulio Vargas in Rio de Janeiro, among others. Dr. Meltzer is the author of several books and more than 150 papers on economic theory and policy. He is also a founder and cochairman of the Shadow Open Market Committee. DAVID C. MULFORD is the under secretary of the Treasury for interna­ tional affairs, where he is directing international debt strategies for the administration. Dr. Mulford was an assistant secretary of the Treasury for international affairs from 1984 to 1989. Earlier, he spent twenty years in the international investment banking business, including serv­ ice as senior adviser at the Saudi Arabian Monetary Agency and as a director of Merrill Lynch & Co., Inc., for ten years. Dr. Mulford re­ ceived his doctorate from Oxford University. EUGENE H. ROTBERG is executive vice-president of Merrill Lynch & Co., Inc. He joined the firm in 1987 after serving as vice-president and treas­ urer of the World Bank for nineteen years.