The Political Economy of Third World Debt

International Debt: An Overview• International (Third World) debt is among the most

contentious problems facing the present international economy.

• It highlights the disparity between North and South within the international system.

• At the same time, it ties the two inextricably together by challenging the stability of the present system.

• As of 2002, the total amount of debt in the international financial system amounts to US$ 2,484,838 million

• This is approximately 57% of the debtors’ collective GDP.

17%

34% 30%

12%

8%

Sub-Saharan AfricaNorth Africa and the Middle EastLatin America and the CarribeanAsia and OceaniaEurope

Figure 1: Outstanding International Debt by Region

Where Does the Money Go?

14%

10%

33%

18%

19%

6%

Least Developed CountriesOther Low-Income CountriesLower-Middle Income CountriesUpper-Middle income CountriesCEECS/NIS in transitionOther High Income Countries

Figure 2: Outstanding International Debt by Type of Country

Where Does the Money Go?

Where is the Money From?

10%

22%

24%15%

9%

21%

Multilateral CreditorsOfficial Bilateral CreditorsExport CreditsBank Loans and DepositsDebt SecuritiesOthers

Figure 2: Outstanding International Debt by Type of Country

A History of Recurrent Crisis

1950-60s• Period of decolonization resulting in a growing Third World

consciousness.

• Owing to nationalist movements, economic growth and development figured prominently on the government agenda of these countries.

• General trend favoring government-led development (such as import-substituting industrialization).

• Development finance was sourced through FDI (to a greater extent) and loans (to a lesser extent).

1970s• A maturing international financial system gave rise to the

phenomenon of eurodollars and petrodollars.

• Eurodollars: Basically, currencies that are held off-shore.

• Petrodollars: As the name suggests, funds arising from the oil industry.

• 1973: OPEC Quadruples Oil Prices

• This occurred during a time when the international economy was booming.

• International financial markets expanded, and banks ended up with more money than they knew what to do with.

A History of Recurrent Crisis

1970s• Third World countries became attractive borrowers for

these surplus funds.

• They needed the money to finance their export and manufacturing sectors.

• The economies in these countries were apparently on the rise, backed by seemingly coherent development plans.

• In borrowing, these countries offered in exchange for favorable terms a sovereign guarantee of repayment.

• Thus, development finance shifted to a greater amount of commercial bank loans (at variable interest rates).

A History of Recurrent Crisis

1970s• 1979: Second Oil Price Shock

• Debtor nations throughout the intervening period generally kept their currencies overvalued, resulting in capital flight as the years progressed.

• US reaction this time was to contract the money supply in order to combat inflation, causing interest rates to rise.

• Northern economies responded by becoming more protectionist in order to keep their own economies (and constituents) secure.

• Debtor nations resorted to debt refinancing.

A History of Recurrent Crisis

1980s

A History of Recurrent Crisis• 1982: Mexico announces a moratorium on the payments of

interest for its sovereign debts.

• Concern of creditor countries: what if other nations do the same thing?

• US Government steps in to provide short term financing to the Mexican government.

• The IMF steps in to provide needed funds (subject to strict conditionalities) and to broker deals with other lending institutions using moral suasion.

• 1989: Brady Plan is put forward.

• Attempt at debt alleviation by debt swaps via “Brady Bonds”.

1990s

A History of Recurrent Crisis• 1994: Financial crisis in Mexico (a.k.a. Tequila Crisis)

• Following successful economic reforms, large amounts of capital began flowing into Mexico.

• However, these funds did not lead to economic growth but were used to finance the country’s large trade deficit.

• 1996: Creditors adopt the Highly Indebted Poor Countries Initiative.

• Structural adjustment and policy reforms in exchange for debt write-offs.

• June 2, 1997: Thailand devalues the Bhat, marking the beginning of the Asian Financial Crisis.

2000s

A History of Recurrent Crisis

• 2000: There is a renewed push for debt cancellation under the Jubilee 2000 Initiative.

• December 24, 2001: Argentina defaults on more than $130 billion in external debt.

Analysis• Third World Debt presents a problem on many fronts:

• The amount of funds used by debtor nations to finance their debts could be put to other good uses.

• The possibility of default by a large debtor nation can throw the entire financial system into disarray.

• Owing to the large amounts of debt accruing to Third World countries, the phenomenon presents a significant challenge to the integrity and legitimacy of the entire system.

• Although debtor countries should bear much of the responsibility for the problem, this does not preclude creditors’ themselves taking some initiative to resolve it.

Sidebar: Potential Solutions

Debt refinancing.

Debt restructuring.

Debt swaps.

Debt moratorium.

Debt forgiveness.

Debt cancellation.

Analysis (continued)• The persistence of the problem demonstrates the leverage

of creditor countries in the international economy.

• Creditors’ worries revolve around the prospect of en masse default.

• Debtors’ worries revolve around the impact that default may have on their future access to finances.

• As not all debtors are created equal, smaller debtors have more to gain from defaulting than larger ones.

• Facing the prospect of collective default, creditors can (and have) play(ed) debtors against each other to prevent such an occurrence.

Analysis (still continuing)

• The nature of the problem is changing.

• Whereas before, the problem largely revolved around the inability of countries to service their debts, this is now made all the more volatile in the face of short-term, rapid flows of capital in and out of economies.

• It is becoming clear that the sheer amount of debt facing the South may amount to a perennial “debt trap” they cannot get out of (it it is not already the case).

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