Debt Crisis in the Third World

CONTENTS

Introduction

1. Causes of The Debt Crisis
1.1. External Economic Conditions
1.1.1. Oil Crisis in 1973-74 and 1979-80
1.1.2. Global Recession in 1981-82
1.1.3. U.S. Monetary and Fiscal Policies
1.1.4. The Stabilization Program of the IMF
1.1.5. Over-lending
1.2. Internal Economic Constraints
1.2.1. Fiscal Irresponsibility
1.2.2. Corruption and Abuse of Power

2. Consequences of the Third World Debt Crisis
2.1. Consequences in the Developing Countries
2.1.1. Remaining of Poverty
2.1.2. High Social Costs
2.2. Consequences for the Developed Countries

3. Solutions and Recommendations
3.1. Liberal Reforms of the IMF and The World Bank
3.2. Debt Swaps
3.3. Debt Cancellation, Reduction and Rescheduling

4. Conclusion

5. Reference
Table 1 The Third World Debt and Refunds (1980-1999)
Table 2 Impact of Exogenous and Endogenous Shocks on External Debt of Developing Countries

INTRODUCTION

A remarkable historical phenomenon in the latter half of the 20th century was the process of decolonisation, which has resulted a tide of new states seeking independence in Sub-Saharan Africa, South Asia and Latin America (Fieldhouse, 1999). In the 1970s, the world trade framework provided possibilities and opportunities for poor economies to grow. However, the harsh reality of poverty in those new independent nations was the main obstacle for any development. Their economic conditions suggested that borrowing money and gaining foreign aids were reasonable courses in the 1970s. In the meantime, the ex-colonial powers began rising awareness of remaining their influence over their past conquests. Considering of remaining economic dependency, western countries showed great willingness of lending money to poor nations. The result was an unprecedented flow of sources from the developed countries to the developing world. A large proportion of sources were in form of loans and international aids from commercial banks and western governments. Many developing countries had very large debts, and the amount of money they owed was quickly increasing. In 1982, Mexico came finally to the brink of default on its foreign debt. The critical situation marked the beginning of the “Third World Debt Crisis”. In 1970, the fifteen heavily indebted nations (using the World Bank classification of 1989) had an external public debt of $17.923 billion – which amounted to 9.8% for their GNP. By 1987, these same nations owed $402.171 billion, or 47.5% of their GNP. Interest payments owed by these countries went from $2.789 billion in 1970 to $36.251 billion in 1987. In 1991, the developing world as a whole owed a total external debt of $1.362 trillion, or 126.5% of their total exports of goods and services that year (Ferraro, V. & Rosser, M., 1994). Trying to pay off the debt became a serious problem for these countries. The nature and terms as well as the political conditions with them caused great hardship for their people.

The debt crisis in the third world is highly linked to the issues of western policies, interest rates, export values and confidence in the international banking system. The crisis is thus an international phenomenon and to understand it fully needs a global perspective.

This paper will examine the origins of the debt crisis in the third world in the first part and the consequences in the second part. The third part will give solutions and recommendations followed by conclusion in the fourth part.

1. CAUSES OF THE DEBT CRISIS

1.1 External economic conditions

1.1.1 Oil crisis in 1973-74 and 1979-80

During the period of 1973-1974 and 1979-1980, the member of the Organisation of Petroleum Exporting Countries (OPEC: e.g. Saudi Arabia, Kuwait) with the oligopoly position interrupted the supply of oil and raised the prices. Thus those countries amassed great wealth and caused the global oil crisis. After the two oil crises, large amount of extra “petrodollars” was deposited in international and commercial banks. Those banks were left a huge excess of capital and were anxious to put it in productive use. Governments of many developing countries including some less developed OPEC countries such as Columbia, Ecuador, Mexico, Nigeria and Venezuela were keen to borrow funds, since it was generally assumed that countries wouldn’t default on their repayments. Consequently, loans were flowing into the developing countries at an unprecedented level.

1.1.2 Global recession in 1981-82

At the beginning of the 1980s, almost all the industrialized countries were deeply influenced by the oil crises and were suffering from the rising energy costs. In order to pay for petroleum, developed countries had to cut down their budget and reduce consumption spending. Hence, the global demand for exports from developing countries declined dramatically. In the meantime, developed countries set up high tariffs and quotas for the imported products to protect their domestic industries from foreign competition and gain extra revenue to reduce payment deficits. The global recession and trade protection of the western countries made developing nations more difficult to gain from the export products and generate income for their investment with borrowed loans, or even provide adequate infrastructure for their citizens (Fieldhouse, 1999).

1.1.3 U.S. monetary and fiscal policies

At the beginning of the 1980s, the United States experienced its own serious debt crisis. The massive government debt and the balance of trade deficit forced the country to implement an economic contraction strategy. Interest rates were risen by the Reagan Administration to attract foreign investments and finance the extraordinary U.S. budget deficits. However, the high interest rates inflated the value of dollars, and were also forced directly upon the developing countries by paying back their loans. This is a reason why the foreign debt kept growing so fast.

Contrasting with the developed countries, developing nations usually have soft currencies, which easily go down and up in value. However, most of the loans to the third world have to be paid back in hard currencies like the Japanese yen, the American dollar or the Swiss franc. As a matter of fact, if the currency of a developing country is devaluated - as it is in the most cases - the cost of the debt rises logically, that means it takes more of the country’s money to pay back the same amount of debt in hard currency. The devaluated currency makes the exported commodities cheaper and more attractive in other countries. But it may also have adverse effect. In Latin America for example, the losses of real export income grew faster than earnings from the increased exports! (Gilpin, 1987)

Table 1: The Third World Debt and refunds (1980-1999)

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Table 1 underlines the following facts: Merely within 2 decades, the debts in the third world has increased 4 times; and by the end of the 1990s, the third world has refunded as much as 6 times of its initial debts!

1.1.4 The stabilization program of the IMF

The IMF stabilization program emphasizes mainly on the internal economic policies of heavily indebted countries. The 4 basic components include (1) abolition or liberalization of foreign exchange and import controls; (2) devaluation of the official exchange rate; (3) stringent domestic anti-inflation program and (4) greater hospitality to foreign investment and a general opening up of the economy to international commerce (Todaro & Smith, 2003). This program was tested in 28 of 32 nations of Latin America and the Caribbean. But it seemed not to work. Argentina for example, still has defaulted on its $160.2 billion debts in 2002. The liberalization of the economy enriched only overseas investors and undermined the local economy: Privatised and denationalised enterprises and banks extracted and repatriated huge profits and enormous interest payments; deregulation led to financial swindles, massive capital flight and increased debt payments, but no productive expansion (Petra, 2002). Even worse, some of the investors are thus able to get their money out before the inevitable collapse, or to make a fortune by speculating against the domestic currency (Bertini, 2002). Other countries financed their repayment only with enormous high social costs of economic stagnation, unemployment and decline of income (World Bank, 2002).

Other critics of the IMF’s stabilization program are that the program has “failed to encourage the very type of economic growth that might have helped the developing countries to grow out of their indebtedness. In fact, these programs have had exactly the opposite effect: they have further impoverished many of the heavily indebted countries to a point where their future economic growth must be seriously doubted. The sobering point is that programs of this sort have been adopted repeatedly, and have failed repeatedly” (Ferraro, V. & Rosser, M. 1994)

1.1.5 Over-lending

While the action of debtor governments was essential, many creditors continued to make loans for their own benefits. For example, western governments and international institutions such as the World Banks and IMF secretly lent $ 8.5 billion to Mobutu during the 1980s despite their own investigation that the loans were corruptly brought into Swiss banks. This irresponsible lending contributed significantly to the debt crisis (Begg, 2001).

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