Beefing Up the ‘Baker Plan’ : Part of the Interest Should Be Lent Back for Debtors’ Use

After almost four months there is still no sign of movement on the United States’ new strategy for Third World debt. The reason is simple: While the so-called Baker-Darman plan is headed in the right direction, it won’t generate enough money to have a dramatic impact on the debt.

The plan was devised in response to three developments: the deepening despair and growing militancy of the debtor countries; the concern of Federal Reserve chairman Paul A. Volcker over increasing deflationary pressure here and abroad, and the decline of net new external financing for 15 major debtors, from $69.1 billion in 1981 to a mere $9.7 billion in 1985 (estimated).

When Secretary James A. Baker III and his deputy, Richard G. Darman, came to the Treasury Department early last year, it was clear that the government’s strategy had failed. It had been predicated on the premise that the situation was one of a temporary liquidity shortage. That supposedly could be successfully addressed by a combination of traditional International Monetary Fund programs designed to improve the short-term cash flow of the debtors, coupled with a strong economic recovery in the developed world.

This prescription was doomed to failure from the outset, because it was based on false diagnosis. With rare exceptions (such as Colombia), the debt crisis was not--and is not--just a matter of liquidity shortage, but a structural and systemic disequilibrium. It is to the Baker-Darman team’s credit that it recognized this fact and ordered work on an alternative approach.

The result was announced by the Treasury secretary at the World Bank/IMF annual meeting in Seoul in early October. It consists of three elements: additional net lending by commercial banks of $20 billion over the next three years, additional lending by the World Bank and the Inter-American Bank of $9 billion beyond existing commitments, and growth-oriented conditionality (such as openness to investment) instead of the IMF’s usual austerity-oriented conditionality.

The plan was greeted with cautious enthusiasm, but there has been little movement to implement it. Many banks are reluctant to make the required commitment, and most European banks so far have refused to participate. Brazil had already announced that it will no longer submit to IMF conditionality. Yugoslavia has opted out completely. Mexico’s situation continues to deteriorate. And even Argentina, chosen as the test case and visited by Volcker and assistant Treasury secretary David C. Mulford, is approaching participation in the plan very gingerly.

There are several reasons why the plan has yet to take hold, a practical one being the necessity for regulatory changes if U.S. banks are to do their part. The Treasury and the Fed are working on ways to deal with this. More troublesome will be similar problems faced by non-U.S. banks.

What is often overlooked in the explanations is the power factor in the debtor countries: Austerity conditionality affects primarily the lower and lower-middle classes, which are relatively powerless (barring bloody revolution). Developmental conditionality, however--privatization of state enterprises, new domestic and foreign competition--strikes at the political and business power bases, which can be expected to defend themselves vigorously.

Most important as a drawback, the amount that the Baker plan suggests--$29 billion--is hopelessly inadequate for the period contemplated. It is, in fact, almost exactly the amount of net new funding that would flow to these countries if the estimated figure for 1985 (which everyone agrees is inadequate) were simply to continue over the next three years. And that’s not taking into account how much worse Mexico’s $96-billion debt may be after last week’s plunge in oil prices.

The political resistance will be more difficult to overcome, but at least the political and psychological atmosphere in key debtor countries now favors the opening of investment opportunities, deregulation and privatization. Application of innovative techniques to the latter effort, such as leveraged buy-outs through employee stock ownership plans, will help.

What is missing from the program is actual debt-service relief, not just additional funding to meet the inadequacy problem. It is well known that the debtor countries as a whole cannot sustain an interest level of about 6% on the existing stock of debt. This relief could be provided in various ways, among them:

--A compensatory funding facility for interest rates in the IMF, which then could regain a central role in the process.

--Obligatory relending of 50% of the interest that the commercial banks receive, to the World and Inter-American banks, which would then lend it to the debtors as structural adjustment and project loans. Something similar is now done for Poland; 60% of interest received is reloaned to Poland in the form of trade credits.

--Allowance for the banks to convert (directly or through a new institution) their exposure to long-term, fixed-rate 6% coupon bonds, with special discount facilities at their central banks if liquidity is seriously threatened.

It would be a tragedy if the promise of the Baker plan were allowed to dissipate due to a lack of sufficient imagination and political will to add elements that would make it work. The near future will tell whether this phase of the debt crisis will be successfully addressed by taking into account the true dimensions of the problem.

A program that resolves the problem of the banks while driving the debtor countries ever deeper into the ground is no solution at all. It is a prescription for hemispheric upheaval.