Debt and Development

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Debt and Development
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GNP Per Capita by Region
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Origins of Third World Debt (1)

• In the first decades after decolonisation,
  official lenders were main source for Third World
  credit.
• 1973 Oil Crisis gt flows of money from oil
  consumers to producers.
• Oil producers place deposit money in offshore
  international banks.
• Oil crisis provokes stagflation (inflation and
  stagnant growth) in the core countries.

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Origins of Third World Debt (2)

• Consequences of stagflation
• 1) Decline in aid flows from core to Third World.
  
• 2) Declining demand in the core for Third World
  exports
• 3) Non oil producing nations also had to import
  the more expensive oil.
• 4) Recession, stagnation, and huge bank deposits
  meant money was cheap! Real interest rates were
  negative. But, this was nonconcessional lending
  (variable rates).

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Domestic Causes of the Debt Crisis

• Loans were used to finance middle class
  consumption.
• Corruption led to waste and ill-conceived
  projects, inappropriate technology.
• Capital flight. Funds ended back overseas, often
  in the same banks that had lend it in the first
  place.
• Military spending.

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International Causes of the Crisis

• Huge size of US budget deficit, caused by high
  military spending. This forces up interest rates
  (to attract credit to cover the deficit). This
  pushes up world interest rates.
• Second oil crisis, 1979. US tries to control
  inflation through raising interest rates gt
  disaster for the Third World debtors.

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The Mexican Crisis, 1982.

• Mexico displays all the symptoms of an impending
  crisis.
• Capital flight makes it impossible for the
  Mexican government to service its debts.
• Mexicos default causes an international debt
  crisis as banks recognise their exposure to bad
  loans. Private flows to the Third World halted.

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The International Monetary Fund

• Third World debtors have no choice but to ask IMF
  for a bailout.
• However, IMF bailouts have conditionalities.
• Structural adjustments involves macroeconomic
  reform and structural reform.

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Structural Adjustment (Macroeconomic Reform).

• Exchange rate reforms devaluation of currency
  brings unemployment and welfare cuts.
• Decrease in wages and flexiblisation of labour.
• Central bank independence government can no
  longer use monetary policy.
• Budget deficit reductions
• An end to state investment.

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Structural Adjustment (2) (Structural Reform)

• Trade liberalisation decline in customs
  revenues, thus an impact on states finances.
• Privatisation of state enterprises
• Deregulation of the banking system government
  loses ability to target credit towards local
  producers.
• Liberalisation of the capital movement foreign
  exchange is allowed to move freely in and out of
  the country.

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The South Korean Exception

• In 1983, South Korea (43 billion), Brazil (98
  billion), Mexico (93 billion), Argentina (45
  billion).
• Korea did not become subject to IMF
  restructuring. Why the difference?
• Bailout of Korea by Japan, not IMF.
• Why? 1) Strategic importance of Korea to Japan
  2) Korea was indebted to Japanese banks
• Thus, Korea did not have to undergo structural
  adjustment.

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Debt Forgiveness?

• Against
• - the problem of moral hazard.
• For
• 1) Why should governments inherit debt?
• 2) Failure of indebted governments to provide
  essential services due to debt.
• 3) Disparity between personal debt and sovereign
  debt.

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Attempts at dealing with debt crisis

• 1980s, Baker and Brady Plans.
• The Paris Club Arrangements.
• Debt-for-equity swaps.
• Heavily Indebted Poor Countries Initiative (HIPC)
  still has strict conditionalities.
• Multilateral Debt Relief Initiative aimed at
  cancelling more debt, but only for countries that
  have been through the HIPC.