A world in which 'frugal capital' reigns.

Author:Kaufman, Henry

With capital scarce and demands limitless, the main untapped source of financing for the developing countries is the risk-taking equity investor.

Consider the following opportunities and challenges confronting the global capital markets. The United States needs capital to finance economic recovery and rebuild aging infrastructure. The other major industrial countries, especially a newly unified Germany and a financially chastened Japan, face considerable public and private investment requirements of their own that will generate a formidable demand for capital. Many of the largest developing countries of Latin America and Asia are moving into a new stage of industrialization, based on market liberalization and private enterprise, and that process, too, will necessitate capital for investment purposes. On top of all of these substantial capital demands, a new set of countries has arrived in the international financial arena with needs for financial and physical capital that are essentially limitless. These are the former Soviet bloc countries of Eastern Europe and the numerous republics of the defunct Soviet Union itself that have to reconstruct their economies from the ground up.

Given these vast, impending demands for capital, it is only logical that concerned people, even those with considerable familiarity with economics and finance, are wondering where these huge sums of money will come from and who will provide them. They frequently ask whether the basic institutional structures, which together comprise the global capital markets, are in sound enough shape to support any large-scale transfer of resources or whether, instead, governments will have to provide the great bulk of the money. And if it is governments that will be left with this prodigious task, how will they get the money to do it? Will taxpayers in the U.S. and other industrial countries pay the bill?

In absolute terms, the impending global demands for capital are unprecedented, but we should not be overawed by the numbers themselves. After all, virtually every decade has produced record capital demands, well above what was predicted beforehand. The reason is clear: Healthy rates of capital formation are an integral part of the economic growth process. So, it is not solely the prospective size of the demand for capital in the 1990s but the distinctive financial market setting and the political context that make this such a complicated subject. Admittedly, the prospective demand for capital is far in excess of the likely supply. But I would remind you that it is virtually an iron law of economics and finance that a share of the total demand for capital will always be denied.

Conventional Wisdom

In reviewing the current discussions on capital scarcity and capital allocation, I find that three substantive policy conclusions stand out.

The first conclusion we often hear is that, because the private capital markets are not presently capable of funneling financial resources to the areas where the prospective investment yields are highest, the governments of the industrial countries must ensure that the necessary resource transfers take place. I would go so far as to say that this prescription has become conventional wisdom: more money and most of it from official sources. The U.S. and the other major industrial countries have already committed to a sizeable financial support program for the Russians. While the International Monetary Fund (IMF) is playing primarily a coordinating role for this program, at some point substantial sums of IMF and World Bank money may be brought in, along with resources from the new European Development Bank. The leadership of those agencies are all of a view that financial needs are more like $45 billion at the time of this writing - a magnitude beyond the capacity of the multilateral lending agencies and their government shareholders to mobilize.

The second conclusion we occasionally hear is that to the extent that financial resources do manage to be attracted to such places as Eastern Europe, the former Soviet Union, or Latin America, the real rate of interest will, in the process, be lifted for everyone. The newcomers will gain access to...

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