Banking on growth: The role of the inter-American development bank

Journal of Interamerican Studies and World Affairs, Spring 1997 by Scheman, L Ronald

Now that the nations of the Americas have emerged from the trauma of the debt debacle of the 1980s and are well on their way to overcoming the effects of the Mexican financial crisis of 1994, it is useful to examine more closely the instruments that brought the region through this turbulent period. During this time, in which Latin America had neither direction nor resources, the policies were incubated that propelled a prodigious transformation in the economies and governance, and the Inter-American Development Bank (IDB) matured into a major resource for the American nations.

The aftermath of the oil shocks of the 1970s left a Hemisphere of overindebted governments, rapidly depreciating currencies, capital flight, as well as people flight (the famous "brain drain") - all of which served to deplete the region. Physical infrastructure deteriorated and social safety nets melted away in the vain effort that allowed budget deficits to substitute for productive savings and investment. As strong democratic leaders began to arrive on the scene in the 1990s, a broad consensus emerged regarding the policies needed to correct the problem. However, there were no resources available to put them in place. Even if national legislatures were prepared to make bold political decisions, they had no money. The region was in a deep depression, both financially and psychologically.

All of this transpired at a time when the ability of the United States to assist the region was paralyzed by collateral issues. Commercial banks were prevented by ironclad regulations of the Federal Reserve from further lending to the region, and provisioning requirements made the cost of money unrealistic even had Latin American governments been able to borrow, which they were not. The limited bilateral resources available from the United States were largely committed to combating the civil strife that swept Central America. Only the IDB and World Bank were poised to address the needs of the region's transition.

Yet the IDB was untested for this role. Founded in 1959 as the first regional development bank, the bank had essentially been a minor player during the 1960s, taking a back seat to the venerable Organization of American States (OAS), which created the IDB and had only recently been reinvigorated with a new Charter. While the Bank was still finding its way, formulating policies and staff, bilateral aid, spurred by the spirit of the Alliance for Progress, filled the major needs. Latin America was optimistic about the Bank at the time, then under the tutelage of Felipe Herrera, but did not really count on it. Those were heady days, when the Hemisphere's accelerating economic growth reached an annual rate of 7% by the end of the decade. The nations of the Americas were the envy of the entire world, including the Asian cubs which, in 1970, had lower gross domestic products (GDP) and far higher external debt than did the Latin American nations.

In the 1970s, the IDB and, indeed, all public international finance became marginal as the policies to recycle petrodollars from the oil shocks of 1973 and 1979 swelled the flows of commercial loans to the region. The inter-American infrastructure, built with meticulous care during the Alliance for Progress, assured that the development needs of the various countries were analyzed in detail, and in concert, by all bilateral and global aid-providing agencies during the famous annual country reviews of the Inter-American Committee for the Alliance for Progress (CLAP). This entire mechanism was summarily jettisoned as commercial bankers rushed to make loans to the dynamic Latin American economies. No longer did the finance ministers have to go through the agonizing ritual of CIAP to justify their development objectives and the uses to which the money would be put. All any minister had to do was sign on the dotted line, offer a government guarantee, and whatever money he needed was made available by commercial lenders.

The oil shock of 1979 definitively altered the terms of trade for the region and cut the moorings from its hitherto thriving importsubstitution model. With few products of significant value added, exports did not earn enough to pay the region's bills. Then, rather than making the necessary adjustments, the countries began to borrow heavily in order to maintain a standard of living that was no longer sustainable. Following the dictum of Walter Wriston that governments never go bankrupt, commercial bankers continued their lending spree, bearing witness not only to the financial recklessness of the period, but also to the esteem accorded the region by the commercial bankers. The result was disaster. Little impact was made on development as a result of the massive commercial borrowing, which was largely used for current consumption rather than for investment. It is hard to trace much of that money. Economic growth slowed to a crawl. Money left the region faster than the commercial bankers could lend. It is not coincidental that those heady days also coincided with an acceleration of massive corruption in the region. The region's $400 billion of indebtedness, which had been racked up by the end of the decade, offers mute testimony of the massive flows of capital that occurred.