The Economics of
International Debt Relief
By Keith Swartzendruber
Fall 2001
The anti globalization and anti debt movements have become
the largest citizen
action groups since the anti nuclear protests in the 19805.
Debt relief is hip, with
everyone from Bono to Pope John Paul" and even Jesse
Helms jumping on the Jubilee
bandwagon. At the center of this movement is a desire to
free the developing world of
crushing poverty. Debt forgiveness is seen as essential part
of this. But while the
motives may be good, is the tool a good one? It is easy to
get swept up in the euphoria
of a cause but then at the same time lose focus on the
facts. The debt problem is
complex and requires more than just slogans. What role can
debt relief play in poverty
alleviation? Will debt relief spur economic growth and
finally lift least developed
countries out of poverty for good?
Debt Cancellation and Poverty Alleviation
As with many things, economists disagree on the merits of
debt relief for
development. Most radical of the proposals by activists is
the cancellation of 100% of
all the debt of the heavily indebted poor countries (HIPC).
The primary argument for
this is that the savings from not having to make
debt-servicing payments could be
invested in social infrastructure. This step could however
threaten the existence of
global financial institutions and result in huge losses for
commercial lenders in the
developed world, affecting their ability to lend and ultimately having a global ripple effect. As an example, the International Bank for Reconstruction and Development
(IBRD) has a capital leverage of 5:1, meaning they can lend $5 for every $1 of capital
they have. Debt cancellation would result in a $5 reduction in its capacity to lend for
every dollar of debt cancelled, which would come out of capital.1 This would have a
profoundly negative effect on programs for poor countries that may not fall into the HIPC
category.
The role of debt relief in poverty alleviation is questionable as well. While in
theory, debt cancellation would free up resources for additional social spending, in
reality savings from debt cancellation could end up anywhere. Despite the best efforts
of NGOs within HIPCs, governments are rarely responsive to their efforts. Money could
be spent just as easily on guns and grenade launchers as it could hospitals and
education. This would serve to further entrench poverty rather than reduce it.2
The World Bank HIPC Program
The HIPC program is the most recent initiative to reduce debt service payments
and reduce overall debt burdens. It does this through policy reforms, debt relief, and
additional inflows of aid.3 Immediately it is easy to see that this program is a partial one.
By enabling additional borrowing to pay reduced debt service payments, the HIPC
program merely replaces old debt with new debt. This credit trap perpetuates the debt
problem rather than lessening it. This is merely another way to reschedule debt. This
also continues the credit trap that has impoverished so many countries. In order for HIPCs to be able to make their payments, their economies must grow. In order to grow,
they need capital, leading to more loans. The only way out of this cycle is some form of
debt cancellation.4
One of the most controversial parts of the HIPC initiative is the Poverty
Reduction Strategy Paper (PRSP) required for countries that wish to participate in the
program. This is a program of macroeconomic policy changes with a focus on poverty
reduction over a three year time period.5 Because of this condition, many of the world's
HIPC are not included in this program and have not received any relief, despite the
severity of poverty that may exist.6 While perhaps important to encourage economic
reform to ensure proper use of funds and the establishment of economic growth, the
radical nature of the PRSP makes it counter productive to establishing consistent
growth, full employment, and low inflation. The time period alone suggests the HIPC
initiative serves as a shock to the system rather than fuel for growth. Radical change
can lead to wide variances of currency value, prices, and reduction of real wages and
buying power for society. Indeed, this would not be a very attractive market to invest
venture capital into indigenous industry for outside financiers.
GDP Analysis of Development
In analyzing the focus of current debt relief programs, it is helpful to put it in
terms of what effects these programs hope to have on GDP. The primary focus of
many programs is on increasing the export portion of the equation. Debt relief and aid is seen as a way of developing an industry that a country may have a short-term
comparative advantage in and then encourage industrial countries to open their markets
to these products.7 Industrial countries however often make opening their markets
conditional on HIPCs opening their markets as well. This can in turn have the effect of
crowding out infant industries in the HIPC, stunting further growth and perhaps even
creating a trade deficit that can reduce GDP .
Another problem with the trade focus is that focusing on an industry with short-
term comparative advantage is unsustainable in some cases. This is especially true
when the comparative advantage is in a particular natural resource. Countries with
large rainforests as a unique resource strip them bare to reap as many economic
benefits as possible, inevitably using up the source our their economic growth over time
and creating negative externalities such as global warming.
The main GDP channels for international loans are governments, who control
how such funds are spent. While consumption, investment, and exports can be
controlled more by economic factors and less by political factors, government spending
is the most susceptible to manipulation and misuse. Debt relief intended for
development can just as easily go to by arms, as indicated earlier. In many cases it is
misappropriation of funds that has gotten countries into debt trouble. This has put many
new democracies in recent years behind as they try to recover from past abuses.
What is the Source of the Crisis?
In the end, some argue that the debt crisis is not an economic one but a political
one instead.8 At its core, it may go beyond politics as well. What is in conflict is the
model of western economics being pushed by western financial institutions and the
traditional societies that have their own rich histories of prosperity as well. Even the
World Bank's and IMF's HIPC initiative that puts an emphasis on civil society
contributions to the PRSP is still based on a western model of market economics.
Perhaps a solution lies outside the realm of competitive markets in the short term. After
time, HIPCs may be able to compete in the global market place. Organizations such as
the Grameen Bank are already trying to do this by building up the base of economies
through micro credit programs. Political will, however, will ultimately decide what will
work and what won't.
Despite substantial debt cancellation in recent years, it remains one of the
primary barriers to development. The income gap continues to widen between the rich
and the poor. Unfortunately, the only ideas currently be used are the same old
programs with different names. What is required of the international community is a
new comprehensive commitment to development that includes lessening conflict,
ending the arms trade (freeing resources for development), large amounts of aid (not
loans) to have an impact on developing economies, accountability for HIPCs, and
political will. The current movements for debt forgiveness have contributed a new
perspective on this issue. Going forward, it is dialogue between them and international
financial institutions that could lead to new approaches to alleviate international debt
and promote poverty alleviation.
ENDNOTES
Bibliography
Arruda, Marcos. External Debt:
Easterly, William. "Think Again: Debt Relief." Foreign Policy. November-December
2001, 20-26.
George, Susan. A Fate
Worse Than Debt. Grove Weidenfeld:
International Monetary Fund. "The Logic of Debt Relief for the Poorest Countries." IMF Issue Briefs, September 2000.
International Monetary Fund and World Bank. Debt Relief and Poverty Reduction: The
Role
of the Enhanced HIPC Initiative. IMF and World Bank:
International Monetary Fund and World Bank. "100% Debt Cancellation? A Response
from the IMF and the World Bank." IMF Issue Briefs, July 2001.
Jubilee 2000
Nafziger,
Sonko,
Stiglitz, Joseph E. Economics.
2nd Edition. Norton: