Development Studies

Development Studies                                                                           

topic:  

 ‘Identify the main cause of the debt crisis and examine its effects on one LDC of your choice’.  

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Key words: Debt  and underdevelopment                    .

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  ...”The onset of the debt crisis is usually dated from August 1982, when Mexico announced a moratorium on repayments and asked leading banks to form an advisory committee. But confidence in Latin America generally had been seriously eroded already..; and by the end of 1982 some 20 countries had suspended payments, and the number rose to over 30 by the end of 1983.  Their number included all the Latin American countries except Colombia, Paraguay, El Salvador and Nicaragua (which had already rescheduled); in Asia and Africa, the Philippines, Nigeria and Morocco were the only substantial debtor countries in a similar position, though many small African countries also fell into arrears; in Eastern Europe, Romania joined Poland and Yugoslavia; and another COMECON member, Cuba was soon among the Latin American problem countries.”1

Yet it was hot summer weekend in August 1982 when Mexican officials notified The United States Government that their country did not have enough money to make upcoming foreign debt payments.  The news shook Washington and Wall Street: a Mexican default would threaten the US baking system and have serious world-wide repercussion.  Washington officials hastily arranged a bail-out for Mexico, but the incident was a dramatic signal to many around the world of a new international problem,—the “debt crisis”.

But how and where did it all begin? so that it led into the present mess?

There are two questions to answer in untangling the roots of the crisis.  How did Third World countries accumulate a trillion-dollar debt? And how did this debt lead to crisis?

Like most problem, the current debt crisis has building for some time.  Its root causes lie deep within the structure of the modern world economy, marked by dependent and unequal economic relationship between nations and regions.

Yet, the more immediate seeds were not sown until the 1970s, when developing countries quintupled their long-term borrowing abroad.  Governments needed large sums of money to finance development projects, such as building roads, dams, and water systems; boosting agricultural production; developing local manufacturing capacity; and trying to ameliorate poverty by expanding health services, education and public transportation.

The conception of the crisis is often traced to the oil price rises of the early 1970s.  They supplied rich countries with both the wherewithal and the reason for the massive lending spree.  Arab oil wealth was deposited in Western bank vaults.  These ‘petrodollars’ provided much of the cash lent to Third World borrowers.  Western leaders feared the impact of rising oil prices.  If the oil producers could not spend all the money, some one else should, they argued ‘Recycling’ oil money to the Third World mean that it could keep buying Western exports, despite bigger oil bills.  Rich-country governments hoped this would keep factories in Europe and America open and stave  off a further descent into recession.  But equally important in bringing on the debt disaster was the way in which money was lent: “ the mal-development model”.2   For this we have briefly go further back to examine the so called “Bretton Woods system”.

Since its held at the New Hampshire resort of Bretton Woods in 1944 created the International Monetary Fund to supervise and maintain global financial relations and the International Bank for Reconstruction and Development, popularly called the World Bank. Western governments and international government institutions like the World Bank had been the principal lenders to the Third World.  “During the 1970s private commercial banks began to eclipse these official lenders. Armed with oil money, the banks moved into the market in a big way.  At the height of the lending in 1982, bank were lending $63 billion a year to the Third World, nearly twice the amount lent by official government sources”.3

The banks were propelled into this new prominence by the changes which swept the global financial system in the 1970s.  With the rise of the West German and Japanese economies, the United States’ top position was threatened.  The dollar-centred, post-war global financial consensus (the Bretton Woods system) was faltering.  “In the early 1970s managed international exchange rates based around the dollar were dropped in favour of floating exchange rates.  Suddenly a lot of money could be made by buying and selling currencies as they fluctuated in value.  A new expansion of international banking took off outside the financially restrictive United States.  The ‘Eurocurrency’ markets were born and grew rapidly from the market worth $300 billion 1973 to over $2,000 billion in 1983”.4

Arab fear that the hostile US government may freeze their assets if they put them into US banks ensured that the oil wealth found its way into headstrong Euro-market.  The search for new ways of making money out of the oil windfall took banks to the distant shores of rising Third World hopefuls, mainly in more industrialized Latin America, but also in oil-rich countries in Africa, like Nigeria and the Ivory Coast.

Big banks bought money on the burgeoning Eurocurrency market and resold it as loan to the Third World.  In the increasingly footloose and competitive environment of international finance, bankers began to see overseas lending as a key to the future.  Soon, even the smallest banks got in on the act through syndicated loans organized by the large lead bank, sometimes involving hundreds of other banks. As the Third World lending gathered pace, more and more banks began to lend more and more money to more and more countries.

Loan scouts toured the world in their search for ‘under-borrowed’ countries, trying to make deals to use up the ‘loan quotas’ their banks told them to fill.  One bank economist recall:— “The international side looked glamorous...Bankers like travel and exotic locations.  It was certainly more exciting than Cleveland or Pittsburgh, and an easier way to make money than nursing along a $100,000 loan to some scraps-metal smelter”.5

The old rules of prudent banking were cast aside in the rush to lend.  Banks over-extended themselves to a greater extent than ever before.  “By 1982 the nine biggest US banks had lent nearly three times their total capital to the Third World”.6  Bankers were convinced that because loans were to governments (or were guaranteed by them), they were secure. “countries do not fail to exist”, reassured the chairman of the biggest US bank, Citicorp, in 1983.7 Banks believed, Third World countries, unlike companies could not go bankrupt.

The business was also very profitable for banks.  Third World countries were still marked as relatively high-risk and therefore loans carried a higher rate of interest.  For banks putting deals together, there was a commission averaging about 1 per cent of the loan; big money when the loans were so large.  On a hundred-million-dollar loan a bank could pick up a million dollar fee.

Thanks to the protection of their governments, many Western banks continue to do very well out of their outstanding Third World loans.  “Since the debt crisis broke in 1982, Britain’s four main banks (Lloyd’s, Midland, National Westminster and Barclays) have amassed a total profit of £15 billion, sustained by an estimated transfer (payments minus new lending) of some £8.5 billion from the major debtors between 1983 and 1987 alone”.8 Clearly the crisis has not been all bad for the banks.

Meanwhile, Governments in developed countries were not expanding their foreign assistance enough to meet the developing nations’ needs, making it difficult for the later to obtain grants and other concessional financing.  So Governments increasingly turned to commercial banks—which they presumed would be least intructive source of funds, compared to transnational corporations or multilateral institutions, such as the World Bank and International Monetary Fund (IMF), which frequently attach restrictions or policy conditions to their loans. (Today, the most highly indebted countries owe more than half of their total long-term debt to private creditors.  For all developing debtors, the ratio is roughly one third).

As has now become so apparent, financing development through commercial bank debt carried some drawbacks.  Interest rates are generally higher than on loans from official sources (Governments or multilateral institutions) and maturity period are shorter.  While not at first, commercial bank loans increasingly have come to carry floating interest rates which add risk and instability to debtors budgets, since debtors cannot plan their payments when interest rates fluctuate.

“...The debt problems of 1980s have been caused by very high real interest rates ”.9  As the international cost from borrowing turned from rock-bottom to sky-high, countries’ payments on debt went through the roof.  Raising interest rates was the policy adopted by the Us administration under President Reagan in 1981.  Rates went still higher as US tax cuts conspired with massive government spending - notably on a major rearmament programme - to send the US heavily into deficit.  “High interest rates in other Western countries rose to keep up.  With every 1 per cent rise in the interest rate an estimated $2 billion was added to poor countries’ annual interest bill ”.10

While Organisation of Petroleum Exporting Countries (OPEC)’s price hikes in 1973-74 and again in 1979-80 helped oil-exporting nations, the consequences were devastating to most of the developing world.  Many countries rely heavily on imported oil, and this takes a tremendous chunk of precious foreign exchange.  In order to avoid throttling their economies, many nations took out loans to pay for their now more expensive oil imports.  Later, sharp declines in the price of oil and the demand for it wrecked havoc on a number of oil-exporting nations that had themselves borrowed heavily, such as Trinidad and Tobago, Mexico, Algeria, Indonesia and Nigeria.

Besides, not only was the Third World paying out more for oil, but the value of their non-oil export was falling.  Countries reliant on exporting commodities like copper or tea were being paid less and less for them by rich countries.  “The heart of the debt crisis”, says Zambian President Kenneth Kaunda, “is the prices paid to us for what we produce”.11   The poorest debtors - many of them in Africa - were the most dependent on commodity exports and were hardest hit by the decline.

“Zambia is an extreme case, in one sense at least, because of its subordination to a single export, copper.  Such dependency is unwise in any circumstances, and downright catastrophic when copper is less in demand, as is the case today.  Fully 90-95 per cent of the country’s foreign exchange has traditionally been derived from this single metal”.12   As one observer puts it, “The bad news is that the price of copper is down.  The good news is that Zambia is running out of copper anyway”.13 This is a sick-joke way of noting that the bottom dropped out of the copper market in 1975.  The country’s leadership continued, however, to hope for the best and went on importing food and capital goods, while subsidizing social services through borrowing.  Everyone, including the Bank and the IMF, not to mention Zambia’s own authorities, miscalled copper trends. ‘I was in the mining division in 1975’, a former World Bank employee told a reporter, ‘and nobody got it right. A lot of decisions were based on [copper] price expectations which turned out not to be true.

Although responsibility for misjudgement was shared, its costs were not.  Zambia alone must pay for everyone’s mistakes and can no longer service its debts of over $4 billion represents $600 owned by each Zambian, with no prospect of ever working its way out of the hole.  Zambian GNP per capita, by contrast, is $470.  If the country were servicing its debt fully, which it isn’t, it would have to devote 195 per cent of export earnings to this purpose alone — one of the highest debt-service ratios of any developing country.14

Zambia has obtained several reschedulings of its debts from Western government creditors and from the IMF.  Each time it has failed to meet the new agreement’s repayment terms.  The IMF has now suspended credit, thus turning off the tap on all foreign loans.  It has also imposed its usual package of reforms, making life appreciably worse for Zambians, whose incomes had already declined, on average, by 44 per cent since 1974.  In later 1985 the price of the staple food, ‘mealie meal’(corn meal), suddenly went up 50 percent, while bread increased by 100 per cent.  Zambia is landlocked.  When gasoline prices doubled, anything dependent on transport (virtually everything) was also hit, including bus fares(up to 70 per cent).  It’s no longer even possible to die affordably in Zambia, since the price of a coffin has escalated by 90 per cent. 14a

A country that has no foreign exchange cannot earn foreign exchange. Nor can it feed and care for its people for very long or very well. Farmers can’t get credit to invest in seeds or fertilizer, and they can’t count on sales either. ‘Maize sales, after an impressive year in 1980-81 when there were no [IMF] adjustments specifically in place, fell by one-third in the 1981-82 season. The decline was widely ascribed to inadequate rainfall, but was undoubtedly exacerbated by IMF restriction.

A downturn in the rural economy naturally hit the majority of the population. Bill Rau, an American who has lived for long periods in Zambia has report that: “Although stocks might have appeared narrow, basic consumer products such as cloth, candles, soap, etc., were readily available...between 1976 and 1981, at least haft of all rural shops closed as the distribution system broke down. The squeeze on imports...enforced by IMF pressures and devaluation after 1978, effectively cut off many rural areas from consumer supplies. Beyond district towns it is now unusual to find any shops able to meet rural needs. In turn, that means that many rural people must travel to towns for purchases (an expensive and time-consuming process) or pay greatly inflated prices to traders who charge two to five times more than prevailing urban prices for basic commodities.[This] is just one indicator of increasing rural improverishment.15

Again according to Rau:

“Agricultural extension staff sit by idly during the planting season for they lack vehicles or fuel to visit farmers...the rural poor have become poorer during the past decade, a trend accelerated by IMF conditionally.”

Rural health centres dependent on imported drugs and equipment ‘now turn away the seriously ill for lack of the means to provide treatment’. Urban people are not much better of in this regard: “An American doctor working in Zambia’s leading hospital told a reporter it was chronically short of surgical gloves and scalpel blades: most surgery patients bring their own, and non-emergency operations are postponed until they do”.16

It comes as no surprise that chronic malnutrition is also on the rise, especially among children and pregnant and nursing mothers. The cost of food is major factor. Even in 1980 (when the cost of maize meal had already gone up by 70 per cent compared with the previous year) a government study noted that low-income urban people would have to spend 80 per cent of their incomes on food just to ensure a bare minimum diet. Conditions have considerably worsened since then.

In a burst of sincerity the odd international lender may admit that the lenders too are to blame for the mess Africa finds itself in. As an IMF official told Washington Post reporter Blaine Harden, “What happened in Zambia could have been avoided. It has taken special effort to run this country in to the ground.”17

Out side Africa, more industrialized Latin America found its manufactured exports to rich countries faced rising trade barriers, as Western countries pinned the blame for industrial decline on ‘cheap import from the Third World’.

As a result, headline-catching food riots are the symptoms of an agonizing economic disease afflicting the Third World. Latin Americans have seen their standard of living (or more accurately, their chance of survival) fall by at least 10 per cent since the debt crisis began; African by over 20 per cent.18 The UN Children’s Fund(UNICEF) has calculated the human suffering ignored in financial reports:— “As least half a million children a year die as a result of the debt and recession burdening Third World economies”.19  Despite the horrific human toll, debt only appears on newspapers’ financial pages, not front pages.  Unlike famine or drought, this crisis cannot easily captured by TV cameras. Nor, says UNICEF, is it happening because of “any one visible cause, but because of an unfolding economic drama in which the industrialized countries play a leading role”.20

Finance ministers in developing countries did not adequately foresee the new trend towards low commodity prices in the 1980s.  The rise of synthetic substitutes (for natural fibers, agricultural goods, metals) and protectionism in Northern markets depressed prices, as did the economic recession and sluggish growth in the industrialized nations.— “Africa’s export earnings, for example, grew 22 per cent a year between 1970 and 1979 (although the volume was shrinking 0,2 per cent a year), and then fell 9,0 per cent a year in 1980-84, with sizeable drops since (-0,7 per cent in 1985, -26,0 per cent in 1986, -6 per cent in 1987).  The  picture is similar if oil exports are excluded ”.21

Developing countries likewise saw a worsening of their terms of trade—the purchasing power of their exports in relation to the cost of imports, specially manufactured goods.  Over the long run it has become relatively more expensive for them to import needed products for development and harder to earn foreign exchange needed to service debts.  For example, now it may take seven tons of sugar to buy a tractor where it used to two tons.  Overall terms of trade for primary products are at their lowest values since the Great Depression of 1930s.

In an effort to make up for falling prices and to obtain foreign exchange to service their debts, debtors have tried to boots export volumes.  But this has only tended to push prices down further.

As the global economy slowed and developing country debtors began to have real troubles servicing their debts, they found commercial bankers no longer eager to make new loans.  The global financial industry has entered a period of major restructuring and banks have shifted to new markets closer to home.  debtors found themselves paying back more money than they received in new commercial loans.

The slowdown in external financing, combined with the heavy debt servicing burden that most developing nations must shoulder, brought about a reverse flow of resources by 1983.  Every year since then the developing world has transferred to the North more financial resources than it receives.  According to United Nations data drawing on all major sources of financial flows (loans, foreign investment, aid, etc.), a sample of 98 developing nations shipped a net $115 billion to the developed world in the period 1983-1988.  The World Bank, looking only at banking transactions, estimates that the debtor countries transferred to foreign creditors more than $50 billion in 1988 alone, followed by another estimated $50 billion in 1989.22

It is now clear that an economically disastrous decade of debt for the Third World  has made its people poorer, hungrier, sicker, less likely to learn to read and write. In many part of Africa and Latin America - not just in disaster arrears - malnutrition is again on the increase. People are hungrier, not because there is not enough food to go around, but because debt and austerity have made them poorer and food more expensive. Rising malnutrition is, in turn rising more poverty and pushing up the numbers of children dying in many countries, after decades of improvement.— “In Brazil, for example, the child mortality rate rose a staggering 12 per cent between 1982(when the debt crisis broke) and 1984.”22a

As debt payments increase, governments slash already meagrer health and education budgets. “In the thirty-seven poorest countries, health spending per head has been cut by half and education spending by a quarter in the last few years.” 22b 

The result is that victims of debt are the poor. And within their ranks, women and children suffer most. As debt and austerity programmes bite deeper, the economic pressure on women increases. In a desperate attempt to make ends meet, they are forced into working in unstable and badly paid jobs, including ‘illicit’ activities such as beer brewing, smuggling and prostitution. Yet at the same time they are expected to fill the gap as carers after health and social cuts. As Maria de Pilar Trujillo Uribe, Director of the Colombian Centre for labour Studies(CESTRA), told an audience on her speech of 15 February 1988, in Council of Europe Public Campaign on North-South Interdependence and Solidarity: —”... It is our nations that are suffering and dying through hunger, cold, deprivation, a lack of housing, a lack of education, of health care and of employment. It is on the shoulders of the Latin American women that the worst effects of the crisis are falling, thanks to external debt, just as they are borne by the frail shoulders of our children, millions of whom are living, or hardly surviving even, in the streets of our great cities.” 22c

Since that fateful summer weekend in 1982, when the proportions of the debt crisis could no longer be ignored, the developing countries have seen their obligations rise by an additional $500 billion.  At the end of 1989 they collectively owed some $1.3 trillion.  Rather than diminishing, the crisis has grown.

These dry figures do not do justice to the cost in human terms. As Davison Budhoo, an IMF economist who resigned in disgust in 1988, has started: “IMF-World Bank structural adjustment programmes(SAPs) are signed to reduce consumption in developing countries and to redirect resources to manufacturing exports for the repayment of debt...the greatest failure of these programmes is to be seen on their impact on the people...it has been estimated that at least six million children under five years of age have died each year since 1982 in Africa, Asia, Latin America because of the anti-people, even genocide, focus of IMF-World Bank/SAPs. And that is just the tip of the iceberg...some 1,2 billion people in the Third World now live in absolute poverty (almost twice the number 10 years ago)...On the environmental side, million of indigenous people have been driven out of their ancestral homelands by large commercial ranchers and timber loggers...It is now generally recognized that the environmental impact of the IMF-World Bank on the South has been as devastating as the social and economic impact on people and societies.”23

It has affected public conceptions of the nature of the problem.  It was first characterized as a financial crisis—a temporary cash-flow squeeze that could be dealt with by short-term loans to bridge the funds gap.  Then, when balance of payments problems persisted for several years, it became an economic crisis—one that could be cured by a major revamping of debtors’ economies. Long-term “Structural Adjustment Programmes” the so called ‘SAPs’ lending began to dominate the landscape.  As many developing countries’ economies remained stagnant and as the debt burden grew virtually unabated, the problem has begun to be viewed as a political crisis—one threatening political and social stability in a large number of countries and requiring concerted, comprehensive action by the international community as a whole.

“...Political stability is directly threatened;”—UN Secretary-General Javier Pérez de Cuéllar started in a 27 April 1989 speech on the debt. ”...The struggle for a better standard of living has now moved into the streets. Many deaths have occurred in the developing countries.”24

In the light of these results the question arises: What sort of future now faces the developing world as we come to the end of the present millennium and approach the drawn of new age, and, how might the solution be found?

The answer to these questions is clearly linked to the experience of the past 50 years and to the failed efforts of the developing countries to achieve meaningful economic growth and the accompanying economic transformation.  This experience largely in relation to the role of the international economic system and the determined bid by these countries to bring about favourable changes in that system.

“In present circumstances, where the North is so firmly in control and there is simply no outside pressure to force their hand, what are the chances of shift to policies more favourable to development? Such a shift could only come about if it appeared to the North in their own cool judgement, that it was in their best interest to do so”25

The collapse in the real prices of commodities (as mentioned in the case of Zambia and Latin America, as well as in other developing countries) inhibit the growth of a manufacturing base since the beginning of 1980s has been disastrous for the poorer developing countries which rely overwhelmingly on commodities for their export earning.  Falling prices have had severe impact, contributing substantially to the increase in Third World poverty and to widening gap between rich and poor countries.  Perhaps, while the debt burden has been extensively discussed, and solutions sought, comparable attention has not been paid by the international community to the underlying long-term decline in commodity prices that faces many developing countries.

The future development of these commodity-dependent Third World countries depends crucially on their ability to generate resources.  To do this they need a substantial improvement in their export earning, -which can achieved only if commodity prices increase and their economies are diversified.

Developing countries should reduce their dependence on primary commodities, because a number of structural factors make a continuing deterioration in their buying power very likely.  One way to overcome the structural problems of declining terms of trade would be to develop a manufacturing base.

The top priority is to call-out our action for fairer trade.  Today’s overriding concern is to reduce poverty and suffering. The nature and causes of poverty vary significantly from one country to another.  Yet the impact of the debt crisis and the inter-linked problem of heavy dependence on commodities and declining terms of trade are shared by many of the developing countries.

Finally, as students of world-development-studies it is necessary for us to realize that we can make an important contribution to the development debate, and that

— “ being among the world’s privileged, you and I have a special obligation to think and act as a global citizen, to be steward of what ever power we hold, to contribute to the transforming forces that are reshaping the world. The future, of human society, of our children, depends on each of us ”; 26

Notes and References: