Private 'Foreign Aid' Offers Challenge to United States

By ART PINE

Sept. 9, 1997 12 AM PT

TIMES STAFF WRITER

WASHINGTON —

Not long ago, the only way most poor countries could stay afloat was to beg for ever-larger amounts of foreign aid. Western governments poured billions into costly development projects. Private industry and capital were almost nowhere to be seen.

No more. Richer countries, feeling strapped for cash themselves, have cut back their foreign aid. At the same time, however, many of the impoverished nations have abandoned socialism and embraced capitalism. As a result, private capital has become the economic mainstay in many poorer countries.

By most reckonings, that turnabout is good. Not only is private investment more productive than foreign aid, but the mere fact that foreign investors are interested shows that the countries themselves are taking solid steps to get on their feet.

But the emergence of some of the world’s onetime economic basket cases also presents the United States and other industrial countries with some new dangers, including widening U.S. trade deficits and increased competition for jobs.

There are also some risks for Americans who have invested in the stocks and bonds of the world’s newest bastions of free enterprise--a group that includes just about everyone who has some savings in mutual funds or 401(k) retirement plans.

Moreover, Jeffrey E. Garten, a former U.S. trade official, foresees clashes between the United States and the “newly emerging markets”--as the fastest-growing developing countries are known--over trade barriers, human rights and rules governing labor and the environment.

As a result, Garten contends in a new book titled “The Big Ten,” dealing with these countries--which range in size from China and India to Peru and the Czech Republic--”will be the key to our economic well-being and to our security in the decades ahead.”

The surge of private capital into poorer countries has been relatively sudden. As late as 1991, net “official” capital flows--foreign aid and World Bank loans--still exceeded private investment.

By last year, however, investors in industrial countries pumped a net $244 billion into poorer countries while net official flows fell to $41 billion.

The effect has been staggering. Foreign-owned firms account for 90% of Singapore’s exports. Foreign consortiums pump $12 billion a year into Poland’s industry. One-third of the money in Mexico’s stock market comes from abroad.

The push for new profits in emerging-market countries takes a multitude of forms--a new Boeing Co. aircraft-importing firm in Beijing, a Fidelity Investments mutual fund that specializes in Third World stocks, a buyout by General Electric Co. of a lamp-manufacturing plant in Hungary.

Worldwide trading in stocks and bonds issued by emerging-market countries totaled $5.3 trillion in 1996, according to the Emerging Markets Traders’ Assn., and it is expected to top $6 trillion this year--more than eight times the level of four years ago.

David D. Hale, economist for the Zurich Group, recites a litany of attractions that such countries offer: Together, they account for 45% of the world’s economic output, 70% of its land area, 85% of its population and 99% of its projected long-term growth.

But with only 15% of the world’s equity capital, they are hungry for more. To get it, they are paying investors about double the rates of return available in the United States and other major industrial countries--a tempting prospect for those who want to diversify their portfolios.

Yet while many countries, such as Singapore and Indonesia, are attractive from an economic standpoint, they are plagued by a wide array of institutional problems, including intractable corruption, weak financial structures and uncertainty over who will succeed the current leader.

Recently, surprising crises in star performers Thailand and Mexico provided dramatic evidence of the fragility of the emerging-market economies. Both involved policy mistakes that later spawned currency crises. And both required huge, costly bailouts by other countries.

Although the governments that stepped in to help partly sought to protect foreign investments in these countries, they were also concerned that the currency crises might spread to other emerging-market countries.

The threat of such contagion is potentially serious. The inability of Mexico to repay Western banks in August 1982 led to a global debt crisis that clouded the world economy through the end of the 1980s.

Still, analysts contend that mounting private investment in both securities and businesses overseas poses less of a threat than bank lending did in the 1980s because losses are more diffuse, spread among thousands of small investors and less likely to threaten the global economy.

Collectively, U.S. mutual funds and pension funds have only about 2% of their capital invested in emerging-market countries.

Major Changes in Foreign Investing

The gusher of foreign capital that has been spilling into poorer economies reflects major changes among both developing countries and their Western benefactors:

* Many developing countries have begun moving toward free-market-style economies, converting former government-run monopolies into private enterprises and eliminating many of the barriers to outside investors. Most have also gotten their government budgets on sounder footing.

* The rapid growth of mutual funds and pension funds in Western countries has made more money available for investment. A desire to diversify and tap new, more rewarding opportunities has sent investors flocking to ventures in emerging-market countries.

* Globalization of financial markets has accelerated the trend. A decade ago, there were fewer than 30 equity funds in the industrial countries that specialized in investments in emerging-market countries. Today, there are 1,500.

* Private investment has proved more popular than official aid with recipient countries because it comes without the strict conditions that are often attached to foreign aid and World Bank loans.

Moreover, whereas foreign aid and World Bank loans were often used to finance public works projects or pay for imports, today’s private investments are almost always geared to more productive targets, such as securities and manufacturing plants.

The economic presence of developing countries has been growing for years in the United States. Americans began gobbling up poor-country imports about 25 years ago. From steam irons to automobiles, many of the everyday products that they take for granted are routinely made in developing countries.

What has changed is that many of these countries have now revamped their economies to position themselves for even more intense competition. They are attracting billions in foreign capital to help them finance more sophisticated production facilities and faster growth.

Some of the larger emerging-market countries have already become significant competitors with the United States and other industrial countries in the manufacture of machinery, aircraft production and information services.

Brazil is on the verge of becoming a major auto supplier, both from its own auto companies and a plant that General Motors is building--one of four that GM is setting up worldwide to reach the growing number of poorer consumers.

Besides Brazil, the emerging markets include China, India, Mexico, South Korea, Argentina, Indonesia, Malaysia, Chile, Singapore, Thailand, the Philippines, South Africa, Peru, Colombia, Ecuador, Uruguay, Venezuela, Singapore, the Czech Republic, Turkey, Slovakia, Poland and Russia.

But the newly emerging markets also are facing some internal problems that some experts believe could threaten outside investors and government policymakers alike over the next several years.

Most of them are fragile democracies at best, still operating essentially under one-party rule with no guidelines or experience in how to make the transition to a new government when the current leader dies or is deposed.

The faster-growing developing countries also face the prospect in the next several years of having to finance huge and extremely costly infrastructure projects.

Pitfalls Include Corruption, Banking

Finally, for all the attractiveness of emerging-market countries for investors, their financial structures and regulatory mechanisms are weak, their banking systems are fragile and their economies are plagued by widespread mismanagement and corruption.

Morris Goldstein, an analyst at the Institute for International Economics, says poorer countries’ weak financial and banking systems are “the Achilles heel” of the push toward ever-larger investments in emerging markets.

Indeed, while economists doubt seriously that the current surge of investment is likely to lead to a 1982-style global debt crisis, there is serious concern that investment managers in particular seem oblivious to the risks involved.

Economists warn that if the Federal Reserve Board boosts U.S. interest rates sharply or if America falls into an economic slump, the ripple effects could reach poorer countries. Likewise, the U.S. economic model could fall out of favor as quickly as it rose.

“I’m frankly surprised at some of the countries into which [investment] money is flowing right now,” said Jeffrey Sachs, a Harvard University professor with experience in emerging-market countries. “Investors aren’t paying enough attention to the fundamentals.”

Policymakers of the major industrialized countries have no sure-fire formula for riding herd on the hundreds of billions of dollars flowing into emerging-market countries annually, or how to prevent financial collapses.

At a recent conference sponsored by the Federal Reserve Bank of Kansas City, top officials from around the globe urged poorer countries to avoid fixed exchange rates, make more economic data available to investors and take steps to strengthen financial systems.

But they were sharply divided over broader issues: Should the industrial countries beef up international regulation of private capital flows and poor countries’ financial systems? Or should they let private markets police themselves, much as Standard & Poor’s rating service helps regulate bonds?

Policymakers are also split over how to deal with some of the broader issues posed by the growing clout of emerging-market countries. These include the threat of a widening U.S. trade deficit as foreign competitors become more productive, job competition and potential clashes over labor and environmental issues.

International economic strategist Alan K. Stoga argues that the United States must begin placing enhanced trade with and investments in the newly emerging markets high on the list of its foreign-policy objectives.

John G. Heimann, an investment banker at Merrill Lynch & Co., offers a long-term perspective: Over the last 50 years, the term that Western analysts have used for poorer countries has evolved from “underdeveloped” to “less developed” to “developing” to “newly industrializing.” Now the phrase is “newly emerging markets.”

The point to remember, Heimann said, is that these same countries were regarded as undeveloped only a couple of decades ago. “Changing the label hasn’t changed them. You still have to be cautious and pay attention to what is going on.”

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The Big 11

The top emerging-market countries in 1996, ranked by total investments received (in billions of dollars).

Net capital flows

China:

Official: $2.1

Private: $51.9

Mexico

Official: $-6.6

Private: $28.1

Indonesia

Official: $1.4

Private: $17.9

Malaysia

Official: $0.1

Private: $16.1

Thailand

Official: $0.8

Private: $13.3

Brazil

Official: $-1.6

Private: $14.6

Argentina

Official: $0.1

Private: $11.3

India

Official: $1.7

Private: $7.9

Russia

Official: $4.5

Private: $3.6

Turkey

Official: $0.3

Private: $4.7

Hungary

Official: $-0.1

Private: $4.6

* Source: World Bank

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The Shifting Mix

Private capital flows and “official” flows--foreign aid and World Bank loans--from industrial countries to developing countries (in billions of dollars).

Net capital flows

1975

Private: $25

Official: $18

1980

Private: $52

Official: $34

1985

Private: $30

Official: $36

1990

Private: $44