Foreign Relations of the United States, 1961–1963, Volume IX, Foreign Economic Policy

146. Telegram From the Embassy in India to the Department of State⁰

New Delhi, July 9, 1962, 7 p.m.

91. Department pass White House. Eyes only to Kaysen for the President. The President’s letter and accompanying documents were delayed en route.¹ Accordingly I am using telegram to expedite response.

In recent years I have not believed that we could defend the aid program politically were it “both” a large budget charge and a substantial drain on payments balance. Since aid is an essential offset to our foreign policy we must minimize its impact on payments balance by every feasible means. (As I think you know, this is not a new conviction. I repeatedly blocked proposed democratic-liberal attacks on the Eisenhower administration for tying the DLF outlays.) Every step to minimize dollar loss will have some effect on the convenience, efficiency or effectiveness with which aid program is conducted in the particular country. Some damage to objectives of the aid program cannot thus be an objection per se. It is only an objection if the damage frustrates goals.

This leads me to comment on three other points in your memorandum before I get on to the main business of what we do, to wit:

(1) The test of a conserving measure is not as you say on page 3 paragraph 5 of your memorandum that it will fail “in itself (to) change the current balance payments deficit into a surplus.” (Indeed I doubt that you meant this should be taken literally. We would both obviously settle for a healthy improvement.) The goal is to make aid as nearly neutral as possible in balance of payments effect. This increases our ability to use this valuable instrument without balance of payment calculation.

(2) I am distressed by your cautionary references about impairing the principle of multilateralism for an essentially short-run remedy. As we both agree, one of the profound tendencies of the American establishment is to commit itself to fashionable principles per se and not examine their effect and the effect of change on their effect. Multilateralism has worked well in these last years because we have paid for it. It has not worked in this century unless someone was financing it with large capital exports like ours in the twenties and again in the fifties. Germany, France and Italy can now be multilateral as hell (though not as multilateral as we are) because our deficit eases all the strain and more. But as the establishment has yet to realize no country is multilateral if it has payments problems and no country, not even Switzerland, would be. These are questions to be decided not on high principle but at the low level of national policy.

(3) I agree with your perspective pertaining point about liquidity arrangements and I too yearn to keep my card as a professional economist on these subtleties. But the fundamental problem is still what we earn abroad as against what we spend abroad. And that is properly the subject of our present concern.

However, as usual, I mostly approve your analysis and I now turn to affirmative action. This requires three broadly related steps as follows:

(1) Recognition that flat purchase of local currency for dollars is, on the whole, a most wasteful form of aid justifiable only in emergency circumstances.

Special cases like Vietnam apart, we buy local currency in countries that have not reached the stage of development where they can use capital imports from the United States or where we must bribe the government into domestic reforms. Local currency generated by dollars accomplishes nothing in the first instance that straightforward credits from the central bank would not accomplish. (Some of these programs trace to the time when Randalls² of the world were uniting in defense of prehistoric view of currency management.) At a later stage the local currency does expand demand including demand for imports. In the absence of internal planning, in the presence of large differences in incomes and in the absence of exchange control, these reserves will ultimately finance imports of consumers goods or services (including travel) mostly for the comparatively well-to-do or the minority with American-European consumption standards. There is a nice question whether we should finance such imports even from United States. But, as you properly note, from Africa this demand will flow naturally to Europe. And even South Americans long ago learned that Parisian brothels are safer, cheaper, more conveniently located and possibly even more imaginative than those of New York.

(2) The first part of the remedy is to accord a highly unpreferred rating to this form of aid. (For schools which you mention our main thrust should be provision of help with books, equipment and teacher training rather than local budget support. Local currency should come where at all possible from local taxes. We should adhere where possible to the old rule that we supply the foreign exchange component.) However, I concede the need for bribing virtue in some cases. And even though we persuade countries to create currency this has the well-recognized effect of expanding demand including demand for imports. We should be willing, perhaps as a fairly common course, to establish reserves against local currency expansion that is issued for approved purposes. However, we must establish firm rules. These reserves should under all circumstances be held in New York. And it should be part of the bargain that they may be drawn upon only for approved categories of procurement in the United States. At one step this policy reduces the supply of dollars floating around outside and gives partial control over both the place and object of use. To work out these arrangements will be time-consuming and inconvenient and there will, accordingly, be strong arguments against them from men who, naturally, want to get on with the job. Such objections call for sympathy without concessions.

(3) There remains, however, the third problem which is that dollars from trade can be easily substituted for dollars from aid. Except where trade earnings are negligible, to tie aid will lead only to a redirection of trade earnings if these customarily go elsewhere. Accruals from the provision of dollar-backing for the currency in the cases just cited can be spending for austere objects that would be required in any case from the United States while releasing other hard currency earnings for the Place Pigalle or for that matter Schneider-Creusot.

Here, however, the problem is no longer peculiar to aid in the form of local currency purchases. It exists wherever aid is combined with other sources of dollars, the possibilities depending on geography and the amount of other convertible currency available for switching to non-dollar procurement. And we must think of this indirect leakage at several levels. A South American country uses tied dollars for essentials in the US and has its untied dollars for elsewhere. India gets aid to cover most of its needed dollar procurement and uses its trade-earned dollars in Germany. Then there is a deeper leakage when India or Pakistan get non-project aid on PL-480 wheat or cotton and thus do not have to curtail purchases in Germany to div up the necessary dollars for these resolute essentials procurable only in the US.

The only answer here is a measure of mild bilateralism. Aid being a substitute for American purchases, we must begin to put into all our significant aid agreement provisions against such substitution. The Nigeria formula is in the right direction. I do note the highly unmilitant determination in the aid memorandum—“would appear to require an effective system of exchange control…not always desirable…experiment will be (carefully) observed with a view to (possibly) extending.” And the Nigerian case does not deal at all with what I have called the deeper leakage, i.e., the fact that aid or PL-480 gets free what would otherwise have [to] be bought in the US leaving earned dollars for Europe. Here, and this is most important, we must keep solidly in mind that the colonial world which we have inherited has trade channels, specifications, consumer habits, financial arrangements, and a dozen other ties which automatically guide trade to the erstwhile European Motherlands. (In India and Pakistan it is infinitely easier to buy from England than elsewhere and where else can you get one where you pull the chair.) To combat and overcome this continuing bilateralism, which it is, we must have responses of our own and the aid leakages make them urgent.

First we must formulate a rule. It is broadly that major recipients of our aid—we can safely ignore the de minimus countries and should—should have expenditures in the US as compared with the total in the other industrialized countries that are about in the same proportion that their combined aid and trade accruals in dollars are to the combined accruals from the other advanced countries.

This effort should initially be hortatory but no less vigorous for that reason. We can say that, if our costs prove to be seriously higher as the result, we will consider this in the aid allocation. We can afford to spend more for a reduced dollar drain. Note also that at any significant level of development, import controls to stop frivolous overseas use of scarce resources are essential and especially for countries receiving scarce dollar aid. Even in the most primitive country foreign trade is subject to some guidance and we can help.

You are wrong, I am sure, in suggesting that such action will invite retaliation. The major European countries cannot apply this rule because they are away ahead of it and for them the use of similar measures is not a matter of abstract principle but of need. On the other hand such pressure by us will encourage the European countries to extend more credits because they will not be financing their trade to the underdeveloped world out of our dollars. You will be interested to know that I broached this line of thinking to both Desai and Jha³ before they left on their current hunting trip. Both concede that we are financing their Western European imports, both were deeply depressed at the thought of redirecting their trade and both immediately asked if they could say in their discussions of aid with the Germans and other Western Europeans that the Americans were thinking along these lines.

If hortatory efforts do not suffice, the next step would be gentlemen’s agreements in negotiation of aid arrangements. Only then something stronger.

In communicating these ideas to the President you should not minimize the horror that they will arouse in the more theological of his followers. Nor should you fail to remind him that on these matters I am usually right though at that stage in time just before the need for action becomes generally evident and when as a result sensible proposals invariably arouse the maximum of righteous indignation.⁴

Galbraith

0. Source: Department of State, S/S Eyes Only Microfilm. Confidential; Priority. Relayed to the White House.
1. Documents 142 and 143.
2. An apparent reference to Clarence B. Randall, Chairman of the Council on Foreign Economic Policy during the Eisenhower administration.
3. Morarji Desai, Indian Finance Minister, and Bibodanan Jha, Chief Minister of the Indian State of Bihar.
4. For reactions to Galbraith’s views as set forth in this telegram, see the memorandum from Dick Cooper, Council of Economic Advisers staff member, to Kaysen, July 13; Kaysen’s memorandum to the President, July 13; and Dillon’s memorandum to the President, July 17; all in the Supplement.