Let's Create Wealth, Not Allocate Shortages

Wriston, Walter B.


In recent months there has been a great deal of discussion about the less developed countries and their relation to the industrialized world and international capital markets. Some of the rhetoric flows from various forums of Third World gatherings, some from scholarly studies, and some from the pages of Sunday supplements.

The drumfire of criticism of loans to, and investments in, developing countries is a far cry from the genuine excitement which greeted President Kennedy's announcement of the Alliance for Progress. It was only yesterday when our government was urging the private sector to lend to, and invest in, the developing world. Our present climate of accusatory investigation is apparently designed to prove that we did in fact heed President Kennedy's words.

In the atmosphere thus created, the general public, which often gets its expert advice through the newspapers, has understandably formed some erroneous and potentially dangerous opinions about aid to developing countries. It is widely believed, for example, that all LDCs are poor; that money and capital are the same thing; and that banks can make loans whenever and wherever they choose. Perhaps the greatest contribution one can hope to make at this moment is to return to fundamentals and attempt to define what it is we are talking about.

Calling a dog a horse does not change it into a horse even if done in a firm voice or on nationwide television. But labels are important. The mathematician Pascal once wrote that "definitions are never subject to contradiction ... nothing is more permissible than to give whatever name we please to a thing." In view of this, he said,"we must be careful not to take advantage of our freedom to impose names by giving the same name to two different things." Part of our problem today is that we have indeed given the same name not only to two, but to many different things. The term "less developed countries" is given to a great diversity of nations. It is a definition that tries to lump together India, with its six hundred million people, and Singapore, with fewer than three million; or Tanzania, where nine out of ten people live in the country, and Argentina, where eight out of ten live in the cities. And it challenges us to devise a loan policy that is supposed to apply equally to a country like Brazil, with annual gross national savings of more than $15 billion, and Sri Lanka, with less than $400 million.

The most commonly ignored fact about developing countries is that the term "LDC" is a very broad generalization, covering a diverse group of countries in many different stages of development. They also have vastly different resources and national goals. Political differences between some of them escalated into actual warfare. Per capita income, in the non-oil - producing LDCs, ranges from a low of $70 to a high of $2,600. What many of them do have in common is a desire to accelerate their growth in order to raise the living standards of their citizens, while at the same time they share an inability to generate enough internal savings to fuel that acceleration. Their chronic need for foreign investment and credit is, fundamentally, something for which they deserve more praise than criticism. It is testimony to their concern for the welfare of their own people. Stagnant poor societies, which do not worry about raising their people's living standards, do not perceive that they have capital shortages. Historically, in fact, those have been the best places to hoard gold, collect diamonds, and build palaces.

The developing countries which do want to raise the lot of their citizens have been assisted in their efforts to accelerate growth by large transfers of resources from the industrialized countries ever since the Second World War. The nature of those transfers has evolved steadily over that period of time. In the beginning, most aid took the form of grants to former colonies. This was followed by official loans on concessionary or preferential terms. In almost every instance, however, as soon as a country created conditions where it was possible to borrow commercially, it began turning to commercial banks and other private financial institutions. By the end of 1967, the share of lending by private creditors in the total external public debt of the LDCs had risen to about 30% and is now probably in the neighborhood of 40% to 45%.

Whether this trend toward private financing will continue cannot be predicted with certainty, since no one can be sure what policies governments may choose to adopt. But to the extent that normal economic forces are permitted to operate, private international finance will undoubtedly become increasingly important to the LDCs. Since there will be a strong continuing need for the developing countries to attract more external capital than official sources can hope to provide, private capital will move toward those countries which manage their affairs in such a way as to constitute a good credit risk.

If this is so, it will only be a case of history repeating itself. In the absence of political restraints-and frequently in spite of them-the foreign creditor and the foreign investor have always been major sources of capital for developing countries. The United States is a prime example. Foreign capital financed both our public and private sectors. In 1854 the Secretary of the Treasury presented a detailed statement of American government and corporate securities held abroad, and according to this report almost one-half of the federal debt was in foreign hands.

The Dutch floated a bond issue to help build Washington, D.C., the Manhattan Banking Company was owned by a Welsh nobleman, the Boston Copper and Gold Mining Company was incorporated in London, the Arizona Copper Company was Scottish, and the Alabama, New Orleans, Texas and Pacific Junction Railroad was 100% British.

Like every other developing country, the U.S. was built with borrowed money. We started borrowing abroad about the time the Pilgrims landed at Plymouth Rock, and did not get completely out of debt to foreign creditors until the First World War. As a typical developing country, we imported more than we exported year by year, and we paid the interest on one year's borrowings out of money we borrowed the next. Our exports did not begin to exceed our imports until 1873, and even then the net balance of exports was not enough to pay the interest on our accumulated debts. We were still a debtor and still a borrower until well into the twentieth century.

Even today, foreign capital controls directly 14 companies on the Fortune 500 list, and several foreign banks rank among our top 50. Two hundred years after we became a nation, I am glad to say we are still attracting foreign capital to create American jobs.

Although the development pattern was the same, the LDCs of the eighteenth and nineteenth centuries did have one significant advantage over those of today: there were no balance of payments crises because there were no balance of payments statistics. No enterprising analyst could measure external debt against gross national product, because the GNP figures had not yet been invented. Our current tendency to take our economic blood pressure every few minutes, and then confuse short-term events for significant trends, obfuscates thought on many problems. The LDCs are no exception. Whether you consider instant statistics part of the problem or part of the solution, they are here to stay and today's LDCs have to live with them. So do bankers.

For the developing country trying to produce the kind of climate which attracts private capital, the American experience should be reassuring. It demonstrates that there is nothing intrinsically wrong about carrying a large external debt and that capital can be successfully imported over a very long period of time-so long as it remains capital and it is treated as an asset and not as an enemy.

There is no mystery about the definition of capital. Every economist from Adam Smith to Karl Marx has agreed that capital is nothing but stored-up labor, either your own or someone else's. Somebody has to work hard enough to earn a wage and then exhibit enough self denial to save some of what he earned. There is no other way to create it. To use Marx's phrase: "As values, all commodities are only definite masses of congealed labor time." Whether the commodity is money or goods, whether it belongs to a capitalist or a communist makes no difference. It is valuable because somebody's labor is stored up in it, and that is what you are paying for; or what you are borrowing; or, if you are running a controlled economy, what you are trying to allocate.

If you raise the price of a commodity, what you are really doing is trying to exchange the amount of labor stored in that commodity for a larger amount of labor stored somewhere else. Neither Adam Smith nor Karl Marx would have any quarrel with that statement, but this basic fact often gets lost when we fail to define terms.

Each year's grain harvest illustrates the point. The grain bin holds the result of last year's labor. You can do one of two things with it: you can bake some bread and eat it, or you can use part of it to plant next year's crop. If you do the first, you have consumed your capital; if you do the second, you have invested it.

The problem is precisely the same for the capitalist farmer as for the commissar of agriculture. The problem for both is how much of the grain will be used for baking today's bread and how much can be saved to reproduce itself in next year's harvest. The answer determines not only how much people are going to be eating this year, but next year and the year after next. This is a hard fact of life which cannot be hidden very long by even the most ingenious and creative political oratory.

The fundamental truth that always outs at the end of the day is that political manipulation never creates wealth-it can only allocate shortages. Even so, the process can only fool people for a limited period of time.

The reality of the need to work to produce capital is true under any economic system. Although individual LDCs are experimenting with a wide spectrum of economic alternatives, the majority are committed to raising their citizens' living standards by accelerating economic growth. In every instance this requires a net inflow of resources from abroad. Whether these external funds will actually speed up development depends a great deal on the use made of funds after they arrive, whether they are used as capital or to bake today's bread. The rate of growth of any developing country will always depend more on how it makes that decision than on the amount of funds coming in from abroad. Indeed, it will significantly influence whether or not funds will flow into a country at all.

Many LDCs are trying to modernize their agriculture, expand their manufacturing, and, in some instances, transform traditional barter societies into members of the world monetary family. At the same time their social objectives require expenditures for schools, hospitals, housing, and other building blocks of modern society.

These are all worthy goals; in fact, the effort to achieve them is the whole purpose of economic development. But if a country's policy makers ignore the need for capital to reproduce itself, if they keep converting it to current consumption, then tomorrow is never going to be better. Not only will seed corn have been eaten, but others who observe this will cease sending their capital to such a society. Capital can only be attracted. It cannot be driven. This is true because there is a limited amount of capital for which there is an unlimited demand. Capital will move toward projects and places which seem to have the best blend of good return and safety.

Countries which disregard these fundamentals find themselves with economies suffering chronic shortages of everything except inflation.

In the constant worldwide search to get something for nothing, some have embraced the idea that the elementary facts about capital formation might be overcome by relying solely on donors. It is proposed that loans be eliminated entirely and replaced by outright grants from governments and international agencies. Bothersome problems like debt service and repayment would then no longer arise. Alternatively, it is proposed that concessional loans be provided with maturity schedules so close to infinity and interest rates so close to zero as to accomplish the same result. It is an impossible dream for the simple reason that the world's people have not yet stored up enough labor to pay for it, even if people who worked hard and saved their money could be persuaded to do so.

The resources of the World Bank and the International Monetary Fund, even if greatly augmented, will fall short of being able to supply the funds which will be needed under almost any scenario that might be advanced. Although taxpayers in industrialized countries have steadily augmented these resources, their tolerance has a finite limit, partly based on their own troubles. Half of the industrialized OECD countries have been running a collective balance of payments deficit since 1974 of $16 billion a year. In these circumstances, questions may be raised about either a huge enlargement of international institutions or a restructuring of them which discriminates against industrialized countries in favor of developing countries as users of the pooled resources. This perception must be combined with the views of the developing countries which already have access to private capital markets and who are going to insist on retaining their right of choice between private and official sources.

A developing country which manages its affairs in such a way as to attract foreign capital and credit can tap into the entire world savings stream through the international banking system. The world savings system is huge, amounting to increments of probably over $500 billion per year.

A developing country which wants access to the private savings stream on a continuing basis has to adopt policies that reflect a clear understanding of what a bank is, what it can do and what it cannot do.

The principal difference between a private bank and an official agency is that governments spend tax money, which they extract from the labor of their citizens, while banks are the custodians of whatever money people have left when the tax collector gets through with them. People who forego current consumption to save money are very particular about what is done with their savings. They expect to be paid some interest and they expect to get their principal back when it is lent out. They also know that this will only happen if their money is put to productive use creating wealth.

In short, private banks can, and do, help developing countries create wealth, but they cannot help allocate shortages.

A significant number of developing countries have come to appreciate this fact. They have also recognized that the policies needed to maintain external creditworthiness with private banks are also the very same policies needed to meet their own national development objectives.

The importance many countries attach to their external creditworthiness, and their ability to maintain it, have been demonstrated again and again. The adjustment process that is triggered by burgeoning balance of payments problems can and does work. Countries implement these adjustment policies with the expectation that private banks will respond positively to demands for credit from responsible borrowers. This expectation has not been disappointed.

The capacity of the international banking system is so large in relationship to the demands of the developing countries, even taken collectively, that there is no question of its ability to handle the capital flows involved. There is, however, always the question of whether public opinion in the industrialized countries, particularly the United States, will become a major constraint on the expansion of such activity because lending to developing countries is perceived by many as intrinsically too risky. A lot depends upon the public and official perception of the private banks' capability in evaluating the countries in which they have significant assets.

For the welfare of the developing countries themselves, therefore, it is essential that the private banks' credit standards not be lowered. Private banks must maintain selectivity among borrowers and be guided by the actuarial principle of spreading risk and avoiding concentration. While many developing countries are now, and will remain, creditworthy borrowers, some will not achieve that status for a long time to come. This is one reason why the available official aid funds will have to be increasingly focused on these poorer nations and the amounts available enlarged as much as possible.

The constant search for a new Watergate-type scandal swings a sharply focused but badly aimed public spotlight from topic to topic. A few years ago, we were assured by experts that all loans to utilities were shaky because the price of fuel went up, regulatory bodies would not permit the increased costs to be passed through to customers, and few could sell equities in the market. Today, bankers are soliciting utility loans and Wall Street houses vie to sell their securities. In short, the adjustment process works in economics as it does in politics. At the moment, the spotlight falls on less developed countries, although it is beginning to lose its brilliance as the realization grows that no scandal has been lurking in the background.

Perspective is now and always has been the best antidote for hysteria about passing problems. It is also a check upon grandiose plans which are touted from time to time as having repealed the iron laws of economics. The continuing ability of private banks to play a major role in the external financing of the developing countries will be affected importantly by how borrowers and lenders act to create a true public perspective of the risks and rewards involved in lending to developing countries.

The best way to allay these fears is to eliminate from our North-South dialogue some of the unrealistic and overly political elements and get people to focus on issues which can be of true benefit to the people living in the developing countries.

The details of economic development are extremely complex. The basic economic principle involved is very simple. It has not changed since the United States emerged as the leading developing country of the eighteenth century. It was summed up nicely in a book published in the same year that the American colonies declared their independence.

The book was called "An Inquiry into the Nature and Causes of the Wealth of Nations," by Adam Smith. The first paragraph reads as follows:

The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations.

Everything said on the subject since, including these remarks, is merely one long footnote to that incontrovertible truth.

  • The document was created from the speech, "Let's Create Wealth, Not Allocate Shortages," written by Walter B. Wriston for the United Nations' Ambassadors' Dinner on 24 May 1977. The original speech is located in MS134.001.003.00015.
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