International Debt

Nations have rarely defaulted on their loan payments, because they fear that they would face political retribution from lending countries and experience difficulty in obtaining future loans. The slow acceptance that many of these countries will never be able to repay these debts has led the international community to assist some highly indebted nations by partially or completely forgiving their debts. Thus international debt has become not only an issue of economics and development policy, but also an issue of ethical relations between the world’s wealthest and poorest nations.

International Financial Institutions
The Creation of Debt
Many organizations (e.g., private banks, other national governments, and international financial institutions) lend money to national governments, which borrow money to keep their currency at a steady value and to invest additional money in government programs. The sale of bonds to individual investors and banks is one way governments borrow money to pay for specific projects. There are a variety of other ways that governments can borrow money. Governments and regional associations of governments lend money to allied nations to help them maintain social and economic stability. International financial institutions also receive donations from wealthier countries in order to coordinate additional lending to developing countries. The two leading international financial institutions, the International Monetary Fund (IMF) and the World Bank, actively attempt to create economic growth and maintain stable trading relationships in countries throughout the world.

To maintain stable trading relationships, the values of currencies must remain fairly constant. Currency values fluctuate when importing companies buy products abroad to sell to their customers, they must buy foreign currency in order to pay for those products. Traded products include not only consumer goods but also necessities that often cannot be produced by the importing nation, such as machinery and parts for factories, water systems, and power plants. When a nation's companies buy foreign currency, the value of that currency rises, and the value of that nation's currency falls, making the same products more expensive to import in the future. Countries strive to export as much as they import so their currencies maintain steady values. This is known as maintaining steady “terms of trade.” When currencies change in value, trade patterns change, leading to increases in business failure and unemployment.

A major reason governments incur debt is that they are attempting to stabilize the value of their currencies. A government borrows an amount of another, more stable currency ("hard currency"), then sells that currency to its own domestic companies in order to keep the price of foreign currency from rising, which would make the value of the nation's own currency fall.

The International Monetary Fund
The International Monetary Fund (IMF) exists to advise national governments on maintaining their terms of trade in order to ensure increased import and export growth. More specifically, the IMF seeks to aid individual countries in identifying industries in which it has a “competitive advantage”—industries in which a particular country could position itself as a global competitor.

Economists disagree on which sets of national policy decisions lead to increased economic development. These disagreements lead to controversies about the policies recommended by the IMF. For example, should exploiting its natural resources be a major component of a developing country’s economic strategy? In many developing countries, natural resource extraction industries are globally competitive, especially when environmental and labor protections are set lower than in other countries, yet these industries tend toward massive environmental degradation, which could also negatively impact the country’s future competitiveness.

Another controversial issue is an increased focus on exports in order to create economic growth. Several countries, most notably the “Four Tigers”—Hong Kong, Singapore, South Korea, and Taiwan—converted from low-income to high-income societies in just a few decades by strongly emphasizing exports of consumer goods. Other developing countries have pursued opportunities to export raw materials, yet this increased production of minerals, timber, and other natural resources has lowered global market prices for many of these commodities. Many developing countries have seen very little profit from their exporting strategies. Meanwhile, prices have been low for multinational corporations and their customers, who mostly live in developed countries.¹

French economist Susan George suggests that export industries promoted by the World Bank and IMF are not creating the economic growth necessary for developing countries to repay their loans. Noting the economic interests that multinational corporations have in free trade, George suggests that the World Bank and IMF are consciously prioritizing free trade over debt relief and poverty reduction. George argues, “[d]ebt has relatively little to do with economics and finance and can only be understood as a political phenomenon.”²

Conditionality
Countries cannot continue to borrow money indefinitely. Lenders utilize Moody’s Investors Service (a company that studies the financial situation of various countries in order to issue credit ratings of those countries) to calculate the probability of loan repayment. Countries with poor credit ratings have more difficulty borrowing from private banks and other individual governments. For these countries, the IMF plays a role economists call the “lender of last resort.”

As part of the loan initiation process, the IMF requires countries to make changes that will ensure loan repayment. This “conditionality” typically includes reforming economic policy, loosening labor and environmental regulations, eliminating set prices for producers and consumers, increasing exports, and cutting government expenditures. For example, on December 5, 2001, the IMF indefinitely suspended any further loans to Argentina because the country had failed to follow its own law against incurring further budget deficits. Argentina had signed an agreement with the IMF earlier that year that included a promise to follow the zero-deficit budget policy in order to save enough money to keep paying on previous loans.³ Without continued support from the IMF, Argentina’s government placed further restrictions on withdrawals from private bank accounts to keep funds invested in Argentina. These events led to public rioting and the resignation of Argentina’s president on December 20, 2001.

Massive protests against the IMF’s conditionality policies are common in developing countries. The aggrieved groups range from supporters of social programs to investors and businesspeople affected by government fiscal decisions. Protesting organizations argue that the loan restrictions of the IMF overshadow the constitutional authority of their own governments. Even the IMF recognizes the power of its role in describing its work as “oversight of member countries’ economic policies.”⁴

In some cases there are direct links between IMF conditions and environmental destruction. For example, the devastating smoke pollution in Southeast Asia in 1997 was partially caused by the widespread burning of forests to plant oil palm trees for the Indonesian palm oil export industry. Suparb Pas-ong and Louis Lebel note that even in 1998, the IMF was still successfully pressuring Indonesia to allow further foreign investment in oil palm plantations.⁵ Thus IMF policies relating to competitive industries essentially funded Indonesian environmental degradation.

The World Bank
The World Bank Group includes five financial institutions working collaboratively to support poverty reduction. The two oldest institutions are the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Together these two institutions are known as the World Bank. The World Bank currently provides "adjustment loans" for economic stability, makes "investment loans" for long-term human development projects, and is implementing certain forms of forgiveness for unpaid debts. Similar regional organizations, such as the African Development Bank Group, the Asian Development Bank, and the Inter-American Development Bank (IADB), also lend for poverty-reduction projects. For adjustment loans, the World Bank, like the IMF, employs conditionality by requiring policy changes within the borrowing countries.

After they were criticized by international environmental organizations for prioritizing dams and electricity generation in the 1980s, the World Bank and Inter-American Development Bank “have moved from [the] construction of physical capital to [the] construction of the social institutions necessary to conserve natural resources and environmental quality.”⁶ These changes often include the funding of environmental ministries. For example, the World Bank has joined with the United Nations Environment Programme (UNEP) and the United Nations Development Programme (UNDP) to fund and operate the Global Environment Facility (GEF), which awards small grants and loans to developing nations for environmentally related projects. The World Bank also increasingly studies whether its projects are helping or hurting social development and environmental protection.

The World Bank’s activities have become so diverse that some analysts claim its effectiveness in promoting long-term development and economic stability is decreasing. Jessica Einhorn, the Bank’s former Managing Director, notes that in recent years the World Bank “has been called on for emergency lending in the wake of the Asian financial crisis, for economic management as part of Middle East peacekeeping efforts, for postwar Balkan reconstruction, and for loans to combat the AIDS tragedy in Africa.”⁷ Einhorn says the Bank has “mission creep” and is “unmanageable.”⁸

Other economists are concerned that without higher educational levels, better health-care systems, and a healthy environment, economic growth will not occur. From this perspective, developing nations need additional international aid, greater environmental regulations, higher minimum wages, and higher tax rates on corporate profits or personal income. With the exception of receiving international aid, all of these strategies can slow foreign investment. Attracting investors for long-term economic development is in direct conflict with the implementation of taxation and regulation that are necessary for human development. This conflict lies at the heart of political debate in developing countries. Governments have borrowed money to invest in human and industrial development without raising taxes, but in many cases the debts have become so large that they cannot be repaid without devastating national budgets.

In the late 1970s and early 1980s when credit was plentiful, many developing countries amassed enormous debts. A large number of economists believed that certain investments could trigger tremendous growth, but the forecasted growth failed to materialize. Since then, the annual interest on previous loans has exceeded the amount of annual new loan moneys these countries are receiving. As a result, there has been a net flow of money out of the very countries in greatest need of assistance. In the 1980s some Latin American countries chose to default on their loans rather than enact the further spending cuts or tax increases that would have been necessary to make the large loan payments.

Relatively wealthy developing countries (e.g., Brazil, Mexico) have been able to recover from this debt cycle, but many of the world’s poorest countries (e.g., Nigeria, Vietnam) have taken funds from various social and environmental programs in order to make interest payments on their loans. In the 1990s speculative trading of currencies by investors has exacerbated near-default situations in Mexico and East Asia.

Foreign Development Assistance
Private banks and many governments have realized the loans they have made to the poorest countries are unlikely to be paid in full and thus they have written off most of these loan amounts as losses. This circumstance has made banks increasingly unwilling to lend more money to the governments of these nations and has precipitated changes in the way they deal with these countries. In order to avoid future defaults, developed countries are beginning to replace loans to developing countries with smaller grants.

Countries with few assets and few prospects receive relatively few loans. So it is the lack of economic growth and development assistance, not a lack of credit itself, that truly determines the poverty of developing countries. In 1970 the United Nations General Assembly proposed that all developed nations donate 0.7 percent of their gross national product to foreign development assistance. Only four countries—Denmark, the Netherlands, Norway, and Sweden—have ever met this target.⁹ Thus the two core issues underlying the international debt crisis are the ability of nations to escape poverty through wise investments and the generosity of wealthier nations. This situation forces developing nations to ask:

1. Which economic, social, and environmental investments and policies will lead to a wealthier, healthier future?
   
   
2. Will wealthy nations give the poorest peoples of the world more grants to alleviate poverty and attract private investment?

Loan Forgiveness
Since 1996, the IMF and World Bank have considered partial forgiveness of their previous loans to forty-three nations through the Initiative for the Heavily Indebted Poor Countries (HIPCs).¹⁰ Responding to a growing public movement, many European governments have also begun to waive portions of debt payments for some of the poorest countries in the world.¹¹

Debt forgiveness implementation methods remain controversial. Columbia University economist Jeffrey Sachs finds that loan forgiveness is often targeted toward specific programs chosen by the donors. This type of loan forgiveness does not assist governments in raising the necessary funds for basic human services such as health care. In an effort to pay off huge loan debts, governments often cut these important human services.¹²

One example of externally directed debt relief is the “debt-for-environment swaps,” in which national governments forgive debts in developing countries in exchange for environmental initiatives in those countries. These initiatives are usually administered either by the borrowing country’s government or by an established international nongovernmental organization that is usually based in a developed country.¹³ Sachs argues that this kind of external priority setting further weakens national governmental institutions.¹⁴

Diversion of loan funds by dictators to their own private accounts has plagued lending institutions, which have sought to prevent repeat occurrences in the future. The most notorious example of such corruption was the continued IMF loans to Zaire’s dictator, Mobutu Sese Seko, in the 1980s and 1990s, when there was ample evidence that he was stealing much of the loan money. Even after these dictatorships have been replaced with elected governments, as happened in Zaire (now called the Democratic Republic of the Congo) in 1997, the IMF still requires that these countries pay back prior loans before obtaining additional credit.

Additional Information
For additional information on political organization, check the resources in our International Debt Links section.

Endnotes
1 Corporations are government-chartered entities granted similar legal rights as human beings. Large corporations are legally owned by shareholders who typically know little about, and take little responsibility for, the actions of the corporation. Shareholders are granted “limited liability,” so in case the corporation goes bankrupt, they can never lose more than their original investment. A “multinational” (or “transnational”) corporation is a corporation that produces goods, sells goods, and/or has employees in more than one nation.
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2 Susan George, “Rethinking Debt,” Contribution to the North South Roundtable on Moving Africa into the 21st Century: An Agenda for Renewal, updated n.d., http://www.tni.org (cited 21 December 2001).
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3 Barry Eichengreen, “Argentina After the IMF,” updated 2001, http://elsa.berkeley.edu/users/eichengr/argentina.pdf (cited 18 February 2002).
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4 International Monetary Fund, “What Is the International Monetary Fund?” updated 2001, http://www.imf.org/external/pubs/ft/exrp/what.htm (cited 21 December 2001).
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5 Suparb Pas-ong and Louis Lebel, “Political Transformation and the Environment in Southeast Asia,” Environment 42 (October 2000): 8–19.
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6 George D. Santopietro, “International Conservation Assistance in an Era of Structural Change,” Journal of Economic Issues 32 (1 June 1998): 365–73.
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7 Jessica Einhorn, “The World Bank’s Mission Creep,” Foreign Affairs 80 (1 September 2001): 22–31, http://lnweb18.worldbank.org/eap/eap.nsf/Attachments/
083101WB+Mission's+Creep/$File/The+World+Bank+mission.pdf (cited 21 December 2001).
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8 Ibid.
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9 Jean-Phillipe Therien, and Carolyn Lloyd, “Development Assistance on the Brink,” Third World Quarterly 21 (February 2000): 21–38.
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10 The IMF and World Bank have arranged partial loan forgiveness, or are considering such forgiveness, with the forty-two nations it currently classifies as Heavily Indebted Poor Countries (HIPCs). These nations, in order of their year 2000 population, are Vietnam, Ethiopia, Democratic Republic of the Congo, Myanmar, Tanzania, Sudan, Kenya, Uganda, Ghana, Mozambique, Yemen, Côte d’Ivoire, Madagascar, Cameroon, Burkina Faso, Mali, Malawi, Angola, Niger, Senegal, Zambia, Chad, Bolivia, Guinea, Somalia, Rwanda, Benin, Honduras, Burundi, Laos, Sierra Leone, Togo, Nicaragua, Central African Republic, Liberia, Republic of the Congo, Mauritania, the Gambia, Guinea-Bissau, Guyana, Comoros, and Sao Tome and Principe.
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12 Jeffrey Sachs, Kwesi Botchwey, Maciej Cuchra, and Sara Sievers, “Implementing Debt Relief for the HIPCs,” Center for International Development, Harvard University, Policy Paper (August 1999), http://www2.cid.harvard.edu/cidsocialpolicy/hipc5.pdf (cited 22 February 2002) 2.
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13 United Nations Development Programme Office to Combat Desertification and Drought (UNSO), “Debt-for-Environment Swaps for National Desertification Funds,” updated n.d., http://www.undp.org/seed/unso/pub-htm/swap-eng1.htm (cited 22 February 2002).
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14 Sachs et al., 2.
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