Baker Steers a New Course

By Stephen Koepp.

"We must not deceive ourselves. There are no easy solutions, and none of us can escape our responsibilities."

So said Treasury Secretary James Baker last week as he announced an ambitious U.S. scheme to rescue the Third World's floundering debtor countries. His speech was the main event for 9,000 moneymen who gathered in the South Korean capital of Seoul for the annual meeting of the World Bank and the International Monetary Fund. The bankers and Finance Ministers welcomed his message as a breakthrough. For the first time the U.S. is willing to throw its weight behind an effort to solve the dangerous debt problem. Said Pedro-Pablo Kuczynski, a managing director of the First Boston investment firm: "It is a fundamental step forward for the U.S. to say that the problem is bigger than they thought."

Until last week the Reagan Administration's attitude toward the debt crisis was that foreign countries should solve their problems by adopting austerity measures and paying off their staggering loans. As a result, such countries as Mexico, Brazil and Argentina were required to adopt tough economic policies that ran the risk of setting off severe social unrest. The new U.S. approach recognizes that borrowers will remain at the brink of collapse unless they can rev up their economic growth. Said IMF Managing Director Jacques de Larosiere: "The debtor countries must grow out of debt." To do so, they will need even more cash infusions. The plan that Baker outlined calls for a three-year lending increase of $29 billion, of which $20 billion would come from commercial banks and an additional $9 billion mostly from the World Bank.

To make sure the money is used prudently, the Administration wants the World Bank to take on a greater role in the debt problem than it has in the past. As the U.S. sees it, the bank should provide long-term help and supervision for the borrowers. This would fill a gap left by the IMF, whose loans and austerity programs are aimed at getting the debtors out of short- term jams. Until now the Administration has been unsupportive of the World Bank, which traditionally makes loans mostly for bridges, dams and other development projects. Viewing the institution as too indulgent of left-wing regimes, the Administration has even cut back the amount of money it could lend.

Now, in a dramatic reversal, the Administration wants the World Bank to do more. The organization, the U.S. feels, should increase its lending and expand the joint loans it makes with commercial banks to developing countries. The World Bank and the Inter-American Development Bank, in Baker's view, could increase their disbursements to the major debtors by roughly 50% above the current annual level of nearly $6 billion.

World Bank President A.W. Clausen, the former chairman of Bank of America, had tried for several years to widen his institution's responsibility, but he was rebuffed by the White House. Ironically, just as the Administration is adopting some of his views, Clausen said last week that he will leave office at the end of his term in July. Clausen, 62, had expressed an interest in staying longer, but the Administration apparently believes he lacks the dynamism for the job. The White House wants to nominate another official, possibly Federal Reserve Chairman Paul Volcker (see box).

Baker's plan, however, is not just a giveaway to Third World countries. Washington wants the World Bank and the IMF to supervise closely countries that receive the new loans, to make sure the funds are used for economic changes that will stimulate long-term growth. One specific U.S. prescription: the debtor nations should turn over many state-run operations to the private sector. Says Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "Latin American countries have relied far too much on government enterprises, which are usually inefficient, bureaucratic behemoths." The debtors must also take measures to slow down their capital flight so that money from the new loans does not simply go into foreign bank accounts. The classic example is Mexico, which lost at least $33 billion between 1977 and 1984 as panicky citizens poured money into U.S. real estate and other havens.

Baker will need a lot of help from private bankers to achieve his goals. The proposed $20 billion in new commercial-bank lending for the Third World represents only a 2.5% increase above this year's level. Nonetheless, most bankers dread making any new loans to developing countries, where they already have mountains of risky loans outstanding. To encourage new lending, Volcker has suggested setting up a so-called superbank that could speed up loans by commercial banks to the debtors.

The first testing ground for Baker's plan could be Mexico, which will need more than $3 billion in new money to meet its debt payments through next year. Only a few months ago, the country appeared to be one of the IMF's best turnaround cases. It had adopted austerity measures to reduce government spending, and was bringing down inflation while increasing exports. But the country has since slipped back, partly because the declining price of oil has cut down the amount of money it earns abroad. Any previous hopes that Mexico might improve economically without new borrowing now lie amid the rubble of that earthquake-devastated land. Nonetheless, the U.S. believes that fresh loans would allow Mexico to get back on the road to growth by encouraging local investment.

Baker's proposal for solving the world debt crisis came just two weeks after a pair of bold strokes by the White House to reduce the growing tension in world trade. On Sept. 22 the U.S. reached an agreement with Britain, France, Japan and West Germany to help drive down the value of the dollar, which had been soaring on world money markets for nearly five years. Next day the White House announced that it intended to get tough with countries that violated fair-trade practices, and proposed setting up a $300 million U.S. war chest to help domestic companies boost their exports. The goal was to water down the protectionist frenzy that has been taking over Congress. Last week, though, the House passed a bill that would curb textile imports from the twelve nations that are the leading suppliers by an average of 40%. The Senate is expected to begin considering a similar bill this week. Baker's measures of the past month constitute a new Reagan Administration policy in international economic affairs. During its first five years in office, the Administration had adopted a generally hands-off policy. Donald Regan, who served as Treasury Secretary during the President's first term, and Beryl Sprinkel, the Under Secretary for Monetary Affairs, did not believe in taking an activist policy role. Strong advocates of free markets, both men believed that the private sector should be left alone to solve world economic problems. They opposed intervening in currency exchanges to halt the rise of the dollar. They also believed that the world debt crisis could be handled mainly between private banks and foreign countries, with a minimum of government help. Those policies alienated many U.S. allies, particularly the Europeans, who favored a more activist approach.

After Baker switched jobs with Regan and moved into the Treasury's Greek Revival edifice directly across East Executive Avenue from the White House, policy gradually began to shift. At a meeting of top world Finance Ministers in Paris in April, Baker indicated that the U.S. might be more flexible on international monetary reform than it had been in the past.

Baker's pragmatism inspired him to look for a new approach. Says a senior Administration official: "Under the Regan team, we would still be holding back and saying we can't help." Concurs C. Fred Bergsten, director of the Institute for International Economics: "Baker had the flexibility and saw the need for change. The Administration has now joined the world."

To a certain extent, Baker's moves have been dictated by necessity. He came to recognize that the Latin debtors needed more help than they were getting. It was hardly good policy to push austerity programs that fostered social unrest in Latin America at a time when the U.S. was fighting Communist- backed revolutionaries in the same area. Former Secretary of State Henry Kissinger, contending that the monstrous debts pose a grave threat to South - America's democracies, has called for "the contemporary equivalent of the Marshall Plan." Kissinger praised Baker's plan as a "major departure," but cautioned, "I feel that the resources devoted to it are not adequate for the job."

The reaction to the sea change in the Administration's international economic policy has been generally good so far. The London Financial Times, while admitting that the plan has shortcomings, wrote in an editorial last week: "Mr. Baker's initiative could represent a 'great leap' towards balance and prosperity for the international financial system, and the Third World."

The attitude in Seoul toward Baker's debt-crisis proposal was also positive. Said West German Finance Minister Gerhard Stoltenberg: "This points in the right direction." His French colleague Pierre Beregovoy concurred: "It is an idea whose time has come." Peru, however, objected to the leadership role of the U.S. Said Finance Minister Luis Alva Castro: "We do not accept there being a single country that is subject to no control whatsoever while the countries of the Third World are condemned to hunger." Even so, Brazil's Minister of Finance, Dilson Funaro, whose country is the biggest Latin American debtor, said that he was "very optimistic" about the plan and that it was "a good way to go."

Baker's new international policies, however, cannot be separated from the domestic economic situation. The high value of the dollar and the staggering interest rates that have made the debt problem much more serious are both largely due to the high American budget deficit. Without some action to bring that down, all the moves started in the past month will not succeed. The importance of deficit reduction could be seen last week when the dollar rose in value against the Japanese yen, despite a massive attempt by the Bank of Japan to stop the increase. World currency speculators are still doubtful that the U.S. will do anything about the budget deficit and believe that the dollar will therefore not drop, as Baker and the leading Finance Ministers wish.

When Baker wants to relax from the problems of world finance and politics, he likes to go home to his ranch near San Antonio and go hunting. Says a former Treasury official: "He shoots turkeys, and that takes patience and good stalking." The biggest game Baker now has to bag is the budget deficit.

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With reporting by Gisela Bolte/Seoul and Christopher Redman/Washington