Economic Development and World Debt

Since the eruption of widespread debt crises in mid-1982, a large number of actions have been taken — by governments (of industrial countries as well as major developing country borrowers), by international financial institutions (such as the IMF) and by private banks — to reschedule debts and to seek adjustment by debtor economies; this adjustment of debtor economies was largely geared to assure that within the current international environment, the debtor countries can continue servicing their (usually rescheduled) debts. As Enrique Inglesias, the Chairman of the Cartagena Group, pointed out clearly:2 ‘In the majority of debtor countries, the debt problem has been administered, but not solved’.

The high growth rate of Japan has been upheld as a model for the more tired economies of Great Britain and the US. While Japan’s GNP grew annually by 4.3 per cent between 1980 and 1985, the average growth rate of other industrial countries was only 2.2 per cent. The US growth rate declined from 6.6 per cent in 1984 to 2.3 per cent in 1985.

This paper attempts to dispel some current misconceptions about the ‘debt crisis’. It does so in order to emphasise the persistent need for development with debt and hence more effective debt management on the part of debtor and creditor countries alike. If the development momentum is to be regained, misconceptions must be removed and fears allayed.

The real Adam Smith, like his contemporary copy, wrote during a period of long economic crisis. He made the two above cited observations, which afford us important historical perspective on the contemporary debt crisis.

The significance of the most recent World Bank Debt Tables is not the figure of 1035 billion dollars indebtedness as such, or the 1080 billion dollars it is expected to grow to by the end of 1987. If short-term trade credit and inter-bank loans are excluded — as they should be for the purposes of most discussion — these two figures would both fall by about a quarter. More significant than the figures themselves are two facts that emerge quite clearly from the tables. The first is that, despite the genuine efforts that most debtor countries have made to implement structural reforms, the share of bank lending to developing countries in total international lending has not revived; it has fallen from 27 per cent in 1982 to 1 per cent in 1986. The second is that the most heavily indebted countries have repaid more in principal and interest than they have received in new loans every year since 1983, In 1986 this ‘reverse transfer’ was estimated at 29 billion dollars, bringing the total of such transfers since 1983 to 82 billion dollars. Despite these transfers, the total indebtedness of developing countries has continued to grow — not because of any voluntary new lending but because of unavoidable reschedulings and the addition of unpaid interest to the principal outstanding. The Third World debtor is verily the Sisyphus of the modern world, but with two differences from the hero of antiquity. Each time his block of marble rolls back to the bottom of the hill, Sisyphus finds that it has become heavier.

In discussion on Southern indebtment the word ‘crisis’ is almost exclusively used to characterise the allegedly risky position of international private banks. In particular and especially the crises of big debtors in the 1980s, and the huge amount of debts accumulated by peripheral countries (PCs) have given rise to the perception that sheer size might have changed international relations in favour of debtors, thus increasing the risks of lenders.

The starting-point is the fact (if we can trust at least the broad message of the macroeconomic statistics) that during the 1970s the developing countries as a group even if we exclude major oil exporters — maintained their rates of economic growth in fece of the slow-down of growth in the industrial countries of the North, the rise in energy prices, balance of payments problems, upheavals in commodity prices, the accumulating debt, inflation.… Summary figures are shown in Table 7.1, and the outcome is not quite in accord with those ‘centre-periphery’ or ‘dependency’ explanations of North-South relationships which allot the role of ‘motor of growth’ in the world economy to the industrialised regions. Was the transmission chain from North to South weakened? Does this short period of history indicate a greater capacity of the South for self-reliance, or for resistance to external misfortunes, than would have been expected a decade or two ago? And if, as many ‘growth pessimists’ hold, the North passed in the 1970s a turning-point in the historical series of Kondratief cycles what conclusions can be drawn for the prospects for economic progress in the South?

There is no denying the fact that the rich world and its supported international financial institutions did not come to the rescue of developing countries and they allowed the debt of these countries to accumulate. The pressure forcing for more commercial borrowing by reducing the flow of aid and concessional lending to these countries, opened the doors of the debt trap for them.

The 1970s and the 1980s have witnessed considerable shifts with respect to growth, innovativeness and trade in core regions of the world economy. The international network of flows in technology, goods and financial assets has been disrupted by high real and monetary dynamics. With high adjustment pressure and low adjustment capacity in core regions of the global economy, regional imbalances in trade and income growth as well as in the mix and time structure of financing have emerged.

Recently R. de Vries, Senior Vice President, Morgan Guaranty Trust Company said:

it has to be accepted that LDC debt problems would not have reached such troubling dimensions had the major industrial powers and official institutions played a more assertive role in the initial period following the second oil shock.

The problem of international debts is, no doubt, the most important issue that the world economy is faced with. It is a hallmark of the deep crisis, that is progressive in character, and generally referred to as ‘the debt crisis’ by many economists and politicians. International debts have reached a level that endangers economic development in the whole world, and nowadays they have hit hard developing countries, especially the poorest ones. They pose a gigantic menace to the development processes of developed and developing countries alike. Since the debt crisis might very quickly create a general crisis all around the globe, a speedy solution to the problem of the world economy is required.

The sharp disinflation from 1979 — 83 forced a series of wrenching changes in the structure of the world economy. This disinflation transition represents the most radical disturbance that has hit the world economy since the Second World War. As a result of human action but not human intention, we did not have Milton Friedman’s well-known monetarist policy of gradualism but the more publicised central bank variety of a series of sharp shocks.

Capitalist finance has come a long way from Ricardo’s era, when its mobility was bounded nationally by high transactions costs and patriotic sentimentality. Financial globalisation has had, however, a mixed press, reflecting not merely nationalistic prejudices, but also dubious results even when judged from a cosmopolitan perspective.

This chapter analyses the prospects of developing-country debt repayment given the current state of the international capital markets. It examines the impact which the structural changes in the international capital markets have had on the sources and uses of the external funds of developing countries since 1981. A set of policy recommendations is proposed to aid global financial stability, within the context of the current risks associated with capital market innovation, the geographic distribution of credit flows, and the industrial and debtor country policy stances.

The origins of the contemporary debt crisis are usually traced to the imprudence both of creditors and borrowers in the years of the petro-dollars recycling feast. The debt ‘bubble’ burst through an ‘external shock’: the 1979–80 shift in the monetary policy stance of the international monetary regime’s hegemonic power. As a result interest (floating) rates bearing on most of the stock of debt shot up; world output and trade declined sharply; prices of primary commodities which account for most of the exports of indebted developing countries suffered a steep and prolonged downfall. The bankers stopped lending — with a lag — and the debtors were forced to adjust severely through demand policies which sank their economies into deep recessions, great monetary, fiscal and price upheavals, and huge capital flights.

Over the course of this decade, the international financial system faced shuddering shocks from the external debt problem of developing countries. According to the World Bank estimate, their external debt amounted to over 1 trillion dollars by the end of 1986. I should mention here that the accumulating process of external debt of developing countries is closely connected with the international banking activities which were carried on in Eurocurrency markets from the late 1970s to the early 1980s, and the debt problem is inseparably interwoven with a structural change of international fund flow in today’s world financial markets. The net external debt position of the US most symbolically indicates a change of international fund flows. The US, whose currency the dollar has been a unique international key currency over the decades after the Second World War, changed its net international investment position to a negative figure of 107 billion dollars during 1985.1 Until recently, the external debt problem has been discussed only as a matter between the lending creditor banking concerns and debtor countries. This attitude was derived from the practical needs of banking business management: how to evade the country risk; how to treat demands of rescheduling from debtor countries; and how to restructure banking balance sheets. Certainly, these practical prescriptions are very urgent and important, but there remains a wider area to be studied on the relation between indebtedness and the system of international financing. In other words, the international financial system is the basic framework where international banks have lent money and the indebtedness of LDCs has overgrown.

Generally, macroeconomic disequilibrium is the cause of foreign borrowing. Foreign borrowing permits a country to maintain domestic investment at levels beyond those that could be financed through domestic saving alone. It is this imbalance of domestic saving and investment that generates the external debt. Like many developing countries, Yugoslavia borrowed abroad to supplement her domestic savings to increase investments and accelerate her growth.

Depending on when we open the financial pages of our newspaper and which economic pundit we pay attention to, the LDC debt problem is variously viewed as insoluble or well in hand. The subject represents one of those rare cases when, among academics and practitioners alike, there is general agreement about the facts, but very little about their interpretation. This leaves the field open to the prophets of doom and gloom predicting the imminent collapse of the international financial and trading system, on one extreme, and Pollyanna-like protestations of faith in our efforts to ‘muddle through’ successfully, on the other. Purple language seems to have become a substitute for analysis and consequently we appear to be continuously lurching between crisis and euphoria — both undoubtedly equally unwarranted. This paper will take a quick look at the agreed-on facts, at varying interpretations, and suggest one possible ‘way out’.

The use of food aid in structural adjustment lending (SAL), developed largely under World Bank/IMF auspices, has attracted recent attention both on the part of those concerned with SAL and with food aid. This is not difficult to understand: SAL needs food aid; and food aid needs SAL. Those administering SAL are increasingly ready to concede that the sacrifices involved in adjustment programmes require more oiling of the wheels in the form of additional external resources, to make adjustment more ‘growth orientated’ and/or to give it a more ‘human face’. Those administering food aid are increasingly aware of a need to link food aid with ‘food strategies’ and efficient macroeconomic policies to avoid disincentive effects — the same objectives as adjustment programmes — and to combine food aid with financial aid to maintain demand for food out of increased incomes, to make up for the leakage of food-aid-generated income transfers into non-food expenditure. It is not surprising that in their search for additional resources the eye of adjustment lenders and of debtor countries should have fallen on food aid; nor that in their search for uses of additional food aid and acceptable policy frameworks the eye of food aid donors should have fallen on SAL. If there is any surprise it is that it should have taken so long for the two sides to get together — in the case of such multilateral sources as the World Bank and the World Food Programme, a tribute to the strength of the bureaucratic separatism of agencies within the UN system.1

Over recent years both the World Bank and the International Monetary Fund have introduced programmes or facilities which, at least in name, address the problem of structural adjustment. The Bank started making Structural Adjustment Loans (SALs) in 1980, and the Fund set up its Structural Adjustment Facility (SAF) in 1986. It is therefore an appropriate time to be asking what contribution the official sector can make towards assisting structural adjustment in indebted developing countries, and whether existing institutional arrangements are adequate as they stand or could be improved.

Since the decade of the 1970s, most developing countries, and in particular Latin American economies, have adopted economic stabilisation programmes geared at the restoration of internal and external equilibrium. The causes and consequences of these disequilibria have varied from country to country and time to time; however, in most cases, the roots of these disadjustments seem to have been originated in an accelerated expansion of the money supply and of domestic credit induced by huge fiscal deficits. In the periods previous to the introduction of stabilisation programmes, in most countries, very high inflation rates, an unsustainable relation of fiscal deficit to output, serious external disequilibria as a consequence of the above, and an appreciation of the real exchange rate have been observed.

This paper develops and analyses a perfect foresight model of economic growth, inflation, and the balance of international indebtedness for a small, fully employed debtor economy operating under a flexible exchange rate system. This model differs from other growth-cum-debt models in that it is a one-sector growth model in which the relative price of installed capital adjusts along the dynamic path in such a way as to preserve international security arbitrage between the home country and the rest of the world.

Postwar experience has indicated a propensity in many developing countries to pursue the policy of overvalued domestic currency. This has been widely recognised as one of the major developmental policy failures which has substantially contributed to distortions in economic structures, balance of payments problems and the debt crisis. Appropriate exchange-rate policies are, therefore, suggested and recognised as a necessary condition for improvements in the balance of payments and the relief of the debt problem. It is also recognised that appropriate exchange-rate policies will differ according to the character of sources and nature of disturbances in particular economies.

In a sense, the title of this paper is a misnomer, since Britain does not have a debt relief programme as such. In common with other developed countries, it has always resisted the idea of generalised debt relief or of incorporating debt cancellation as an integral part of its ongoing aid programmes. Rather, what it does have is a series of ad hoc measures and responses to requests for relief from individual countries. This remains its basic policy on debt relief.

The IMF and the World Bank are currently putting pressure on the low income agrarian economies of Sub-Saharan Africa to make a number of economic adjustments in order to reduce their high debt/GDP and debt/export ratios. Among the probable long-run effects of these adjustments, one is particularly alarming. It is the prospect of the irreversible degradation of arable and grazing land in ways that put the sustainability of agricultural production at risk. This paper considers the impact of the adjustment on the microeconomic decisions of farmers, and discusses the link between these decisions and the degradation of resources. It indicates the crucial importance of the programme’s assumption about the effects of poverty, risk and uncertainty on the supply responses of farmers to change in exchange rates, interest rates, prices and taxes. It argues that these assumptions make the programme blind to the environmental costs of poverty under different incentive systems.

Recently, the

Financial Times

reported that

Brazilian officials have begun intensive discussions with foreign bankers and government on the country’s radical plan to convert half its 68 billion dollars (41 billion pounds) debt into tradeable securities.… Under the Brazilian plan, which officials say is subject to negotiation in order to make it more acceptable to banks, about 30 billion dollars of existing bank debt would be converted dollar for dollar into (fixed interest) bearer securities with a maturity of about 35 years.

1

The chapter aims at offering an integrated treatment of the US foreign and domestic debt. The important common element is that both types of debt are for the most part denominated in US dollars.1 The underlying similarity has been lost sight of because the foreign-held debt has unique implications for the exchange rate.

In August 1982, the Government of Mexico announced that it could no longer honour the country’s foreign debt obligations and would need emergency assistance. Within months, fourteen Latin American countries followed suit. This was the beginning of what has come to be known as the ‘debt crisis’ of developing countries.

The problem of external indebtedness is central to the Latin American discussion on economic policy. The problem is also central to the political discussion in Latin America today. Nevertheless, the problems associated with the external indebtedness of the under-developed countries are poorly perceived. The theoretical development of the problem is insufficient and the necessary theoretical tools have not been found. The statistical data on external indebtedness is rather uncertain.

The developing country’s negotiations of its external debt with creditor countries, and in particular with the international banking system, have been conducted within a context in which several devices have been utilised in order (i) to reschedule the cash flow of the debt service and (ii) to reduce the actual value of the debt. These negotiations have paid much more attention to the cash-flow problem than to the actual value of the debt.

There is basically nothing wrong in borrowing, because this was the pattern common to now advanced, former developing countries. Both Asian and Latin American NICs, intent on industrialisation helped by foreign borrowing, had shown rapid growth through the 1970s. Debt-dependent growth patterns had been more or less common to both, but had not yet posed any serious problem. The world of the 1970s had seen the two oil shocks and the boom of primary products.

In a conference devoted to the growth problems of heavily indebted countries, it would seen ironic to introduce a paper entitled ‘Is India Overborrowed?’. An answer that shades into a possible ‘no’ would sit awkwardly on many borrowing countries that are bemoaning past excesses for which they are now paying a heavy penalty. It would also run counter to the mainstream of Indian policy today which finds reinforcement for its traditionally self-reliant ideology by reference to these problems. Yet it may be possible that India is erring on the side of caution by borrowing too little: that a considered strategy of trade liberalisation financed by increased commercial borrowings could enhance the rate of growth. Given the external and internal conditions now, it could be the opportune time for restructuring of the economy, while utilising other countries’ experience to avoid the serious problems that can arise from improper borrowing.

By 1984 the total external debt of Eastern and Southern Africa was approximately 21.2 billion US dollars. This compares quite favourably with that of Brazil alone which was 107.3 billion US dollars in the same year. Within Africa, the region’s debt is similar to that of Nigeria which was 19.3 billion US dollars in the same year. Perhaps a better way of exposing the real burden would be by using the ratio of interest to export earnings as shown in Table 33.1. The table gives comparative figures for Eastern and Southern Africa’s most indebted countries against the ten most heavily indebted developing countries using the same ratio.