40th Session Issues
Impact of External Debt
A HISTORICAL PERSPECTIVE
International debt has developed from a normal and necessary pact to an international problem to a global crisis since 1970. Had the debtor nations experienced the same rate of development in that time, the crisis would probably never have occurred. In the early seventies, the less developed countries were in need of capital in order to continue funding of the internal development strategies begun with the foreign investment dominant in the 1960's. At that same time, Western banks were flush with petrodollars. This seemingly happy marriage deteriorated through the 1970's and 1980's because of repayment problems. The reasons for those repayment problems are many.
In the sixties, multinational corporations (MNCs) were drawn to the less developed countries (LDCs) because they offered cheap labor, and indigenous raw materials. From 1960 to 1965, for example, 20 percent of all money going into the LDCs was the result of direct foreign investment. This investment by the MNCs had grown to such importance by the early 1970's that they began to be criticized for having too much impact on the internal affairs of the LDC's. Foreign investment spurred the economies of the LDCs so that they soon needed further funds to develop to a point of self-sufficiency that would allow them to shed the perceived excess influence of the MNCs. Circumstances elsewhere in the world seemed to fill that need perfectly.
At the same time that LDCs were hungering for more investment, western banks were busting at the seams with petrodollars. The oil rich OPEC countries instituted an oil embargo on western nations driving up the price of oil and bringing incredible wealth. This money was deposited, in large measure, in western banks. This set of circumstances put pressure on the banks to lend at the same time that the LDCs found themselves in need of capital. In 1970, western bank lending amounted to approximately three billion dollars. Because of petrodollars and the ensuing pressure on banks to lend, that amount grew to twelve billion by 1975. This seemingly appropriate arrangement was born of the very circumstances that led to the international debt problem of the 1970's. Higher oil prices had provided the banks with money to lend, and thereby had provided much needed capital to developing nations. Those same high prices created higher energy bills for the LDCs. These bills proved so daunting that development was impossible. All income in the debtor nations was spent paying for energy and loans. The effect was like that of giving a hungry man a fish but not teaching him how to fish.
The LDCs seem to have thought of this situation as a temporary setback, however, because they continued to borrow throughout the 1970's. By 1983, total foreign lending was up to thirty six billion dollars, and a cycle had been established. It is understandable that this took place when one considers that capital investment has historically been the primary funding source for development, which the LDCs desperately needed and still need today, and that the banks were primed with lendable dollars.
Another factor that contributed to the borrowing cycle was the number of crises which the debtor nations experienced in a short period of time. In all, it could be said that LDCs were the victims of four horrendous setbacks in the 1980's. The oil crisis of the early 1980's hindered their trade; monetary policies which led to high interests in the United States, where most lending originated, had adverse effects; the fact that most of the debt was denominated in dollars increased those effects; and OECD retaliation to U.S. policies dealt a final blow.
Just as the LDCs might have been finding some relief from the problems that plagued them in the 1970's, they were hit by the oil crisis of 1978. This began the scenario of high energy bills, low or non-existent development, and borrowing all over again. The higher energy prices once again created such a great need for capital in the LDCs and such great pressure on banks to lend, that one hundred and fifteen billion dollars was infused into the debtor nations between 1980 and 1983.
The United States was affected by the oil crisis as well; it over took Brazil as the largest debtor nation in 1986. In response to the inflation following the 1980's oil crisis, the United States Federal Reserve embarked on a path to tighten the money supply, raise interest rates, and create a recession. While these policies did allow the United States to recover from the crisis, they wreaked havoc with the repayment capabilities of nations indebted to them. Interest rates to LDCs, which were as low as 6.2% in 1970, rose to 10.0% by 1984. Loans with flexible rates became virtually the standard at this time increasing from 16.2% of all loans made in 1974 to 42.7% in 1983.
Higher interest rates, a result of the tight money policies of the United States, had the effect of strengthening the dollar. This meant that the currency of the debtor nations was worth less compared to the currency borrowed. Seventy-five percent of the international debt was held in U.S. dollars. Every point of increase in the value of the dollar meant one more point needed to be repaid by the debtor nations. This left them in the inevitable position of increasing their debt without ever having seen more capital.
The problem became a full-blown crisis when OECD countries retaliated against the U.S. monetary policies. Until then, exports allowed the LDCs to at least service their debt. The steps taken to combat the U.S. policies, however, created a global recession which dried up the export markets of the debtor nations. Debt service ratios in the LDCs shrank, leaving them with no choice but to borrow more funds in an attempt to stay out of national bankruptcy.
The result of these setbacks was that the debtor nations found themselves near bankruptcy. Growing debt coupled with economic production that could, at best, be called unprofitable led the debtor nations to look for relief. This was most often found in the form of debt rescheduling, a complicated business of consolidating and rescheduling payments in ways that allow the debtor nation to fulfill its internal obligations as well as service the external debt.
The Paris Club, established in 1956, is a group of creditors who meet occasionally for the purpose of working out debt rescheduling plans for loans given or guaranteed by official governments. Private sector loans are handled under the auspices of the London Club, an advisory committee of the Paris Club comprised of creditor bank's representatives. The Paris and London Clubs work in much the same manner. The economy of the nation in question is studied for ways to allow it to address internal problems and obligations while paying the external debt as well as possible.
Both clubs worked with the International Monetary Fund (IMF), affiliated with the World Bank, which tied rescheduling and emergency loans to austerity measures. These austerity programs, while usually economically sound, were often politically unwise. In tightening the economies of the debtor nations, social programs were usually the first cuts made. Implementation of the austerity measures has thus led to political unrest, protest, and rioting, called "IMF riots".
This political unrest grew through the 1980's. As with the MNC's in the 1970's, debtor countries began to criticize the actions of the IMF. Peru went so far as to suggest that a debtor cartel be formed to use the threat of default as leverage against creditors. Larger debtors such as Brazil and Mexico, fearing the future cessation of lending, would not go along with the plan. Such political and economic fencing continued until 1985 when the Peruvian president announced that his country would devote only 10% of export revenues to repaying debts. In 1986, Mexico followed this lead declaring that its debt repayment would henceforth be on an ability-to-pay basis. The United States intervened in this case by creating a repayment plan tied to Mexican economic growth, but when Brazil demanded the same treatment in 1987, private banks were less willing to negotiate. Citicorp, who had outstanding Brazilian loans totaling five billion dollars in 1987, stood to lose $340 million in annual income if default occurred. Other banks had put up to 32% of their annual profits in jeopardy.
A united approach has not emerged in dealing with the problems of external debt. Lender countries are concerned that defaults by LDCs could damage the banking industry to a point where only large-scale government intervention could save it. Debtors are worried that inconsistent export revenues have not allowed them to develop internally while fulfilling their debt obligations. The major point of agreement is that economic interdependence demands some form of cooperation. New loans are tied to the London Inter-Bank Offered Rate (LIBOR) or the U.S. prime rate thereby necessitating the careful monitoring of these rates to preclude another escalation of the repayment crisis.
THE SOCIAL COSTS OF DEBT
The debt has another darker side: the cost in human life. UNICEF recently released a report entitled, "The State of the World's Children 1989." In it, a startling fact is reported; of the 14 million children under the age of five that died in DCs in 1987, 500,000 deaths can be directly attributed to the slowdown in growth brought on by the debt crisis. Several million more die from diseases that would be easily cured in the developed nations.
In an attempt to pay back international loans, developing countries are cutting their budgets. The part of their budget allocated to social programs is hardest hit. On the average, education has been cut by 25% and social welfare programs by 50%.
If the United States were dependent upon the IMF, it might well be told by foreign economic experts to slash government expenditures on social programs such as unemployment benefits, social security, food stamps, aid to education and medicare, as well as severely curtailing military spending. A tax increase dollar devaluation and tightened money supply would likely be requisite. The havoc brought to key sectors of the U.S. domestic economy, such as automobile and home construction would be seen as unfortunate, but necessary. The human costs and domestic political unrest accompanying such foreign imposed decisions might lead to protests, rioting and dissatisfaction with the international economic and political system.
UNITED NATIONS ACTION
From 9 to 13 January 1984, government leaders and their representatives met at the Latin American Economic Conference in Quito, Ecuador. The Quito Declaration and Plan of Action were adopted, establishing "basic criteria" for renegotiating external debts.
Also in 1984, the United Nations Institute for Training and Research (UNITAR) submitted an analytical study to the General Assembly on the progressive development of the principles and norms of international law relating to the establishment of a new international economic order. The new international economic order is an effort of the Group of 77. (Please see the chapter on Trade and Development for further discussion of these topics.)
Resolution A/41/144 established the question of external debt as a separate issue in 1986. The proposal was made by the Group of 77 Chairman.
In resolution 41/202, the General Assembly agreed on a number of factors that should be considered when addressing the problem of external debt. These included improved international cooperation, relating the issue to finance, currency, resource and trade questions, and encouraging stronger growth and development in the LDC's.
SUGGESTIONS FOR FURTHER RESEARCH
To gain a more complete understanding of the external debt problem, delegates should consult the chapters in this book on The Criticial Economic Situation in Africa and Trade and Development. In this way, other topics of research might be found.
Delegates should also become familiar with the following terms: Debt Service, Ration, IMF, Debtor Cartel, Creditor Nation, Debtor Nation, Debt Rescheduling, Paris Club, London Club, Capital Flight, Foreign Investment, LIBOR, U.S. Prime Lending Rate, G-77, OECD, Austerity Programs, NIEO, Balance of Payments, Balance of Trade, Debt Forgiveness, UNCTAD, GATT.
SOURCES
- Blake, David H., Walters, Robert S., The Politics of Global Economic Relations, Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1987.
- Annual Review of United Nations Affairs 1984, 1985, & 1986. United Nations Publications.
- Pirages, Dennis, Global Technopolitics: the International Politics of Technology and Resources, Pacific Grove, California: Brooks/Cole Publishing Company, 1989.
- Resolution 43/198, "External Debt Crisis and Development: Towards a Durable Solution of the Debt Problems"
- "Children Bear the Debt Burden," San Diego Tribune, Dec 21, 1988