Global Policy Forum

Aid and the Cycle of Debt


By Michael Camarda*

September 7, 2007

How many countries worldwide need debt cancellation? What would be the economic ramifications of debt relief on both the Global North and the Global South?

According to the UK, 67 countries are in need of immediate debt cancellation in order to meet basic development targets such as the Millennium Development Goals. Aside from these countries, which are the most impoverished on the planet, illegitimate debts, such as those given to dictators like Marcos in the Philippines, Mobutu in the Democratic Republic of the Congo, and Suharto in Indonesia must be cancelled. All told, this may mean debt cancellation for about 100 countries. The economic impact on the North would not be that significant, as the actual amounts of money relative to the economies of the developed world are small. For countries in the Global South, however, this is a question of life and death. Why should countries that have no social infrastructure and therefore that are in desperate need of money for hospitals, schools, and roads spend up to 60 percent of their national budgets repaying loans? Debt cancellation gives the flexibility necessary to prioritize real development over taking another lap on the debt-impoverishment treadmill.

For what and to whom are these countries in debt?

Most of the debt we are talking about began as a result of the 1970s oil crisis. When oil prices rose, commodity prices rose with them, and countries that had to import oil found themselves with huge debts, often owed to countries with which they had prior colonial relationships. In the late 70s and early 80s, some powerful countries, especially the U.S., expressed their displeasure with the situation and asked the International Monetary Fund to take on the task of restructuring economies to prioritize paying off these debts. This was the advent of what we now call "structural adjustment policies" or the "Washington Consensus." Namely, the IMF and the World Bank would lend to countries at low interest rates, and the money being borrowed would be used to pay back to rich countries those debts acquired during the oil crisis. In return for the money, poor countries had to take dramatic steps to prioritize short-term cash over a long-term development strategy. So we have policies like privatization, which means that the government sells what it can to make as much money in the short term as it can. Or budget austerity measures, which mean that government budgets have to be very tightly controlled. In practice this means no money for social services such as healthcare and education, though military budgets tend to stay stable. As a result of these policies, the debts are now primarily held by the IMF and the World Bank and other similar institutions and no longer by rich governments. There are a few bilateral debts in many of these countries, and sometimes that can be significant, but usually is it the multilateral deb "to the IMF, World Bank, or one of the Regional Development Banks" that is important.

You claim that the 2005 Gleneagles Debt Relief Agreement presented in Scotland by the G-8 nations is far from perfect. Why is that?

The 2005 agreement is important in that it sets a precedent -100 percent debt cancellation with no new conditions - that for years had been derided as "a letter to Santa Claus." That precedent needs to be expanded upon in two ways. First, it needs to be applied to the 70 or so countries in need of immediate debt cancellation instead of the 20 or so countries that currently qualify. Second, it needs to be de-linked from the program of economic conditions - the IMF's Heavily Indebted Poor Country program - that the World Bank itself has acknowledged to be a failure. Once these two criteria have been met, the next step is to talk about reparations owed indebted countries because of the failures of the economic paradigm that the North has been pushing on the South since at least 1980.

You also make the claim that increased aid is not a panacea for global poverty.

After World War II, it was the hope that more and more aid would flow into Europe and that this would help take Europe out of the poverty that it was then suffering. Aid, or rather a dependence upon aid, is a symptom of poverty, not a way out. Meaningful development strategies may look to build up industries in countries, as in Europe and Japan did following World War II, in order that national budgets come primarily from progressive taxation, as they do in every industrial country, and not from aid flows, as they do in most countries in Africa. IMF and World Bank policies have prevented these developments from taking place, preferring policies of deindustrialization "as a result of liberalization and budget austerity policies" to meaningful development strategies.

How does a "vulture fund" work?

Vulture funds by definition invest in failing economies, whether a private company or a sovereign nation. In the Zambia case that has recently received much attention, a vulture fund bought up heavily discounted debt owed by Zambia to Hungary and then sued the government of Zambia for the entire amount, for a profit of about 1,000 percent. Such things are able to happen because there is a hierarchy of creditors, with the IMF at the top, followed by Multilateral Development Banks, governments next, and private banks at the bottom. Because of the debt cancellation deal, private banks like Donegal can move to the front of the line and demand repayment for heavily discounted debt bonds.

What is the current debt situation in Zambia? What would Donegal International's successful collection of debt mean for Zambia?

If Donegal were to collect, Zambia would effectively see none of the benefits of debt cancellation until 2009, as the money that it used to pay other creditors would go to a private bank.

What kind of strings does the North attach to the aid money it doles out?

Aside from budget austerity and privatization, the other major condition is liberalization. Liberalization can be fiscal - meaning that a government's currency must be allowed to float in the free market, not attached to the dollar, the Euro, or any other currency -or trade-related, meaning that subsidies and tariffs must be done away with. The effect of fiscal privatization is that currency values are left to the whims of international speculators who can run a currency up or down at a moment's notice. The prime example of this is the Asian financial crisis of 1997, when the actions of a single shareholder caused a run on the Thai baht, and the repercussions of that action led to one of the worst financial crises the world has seen. Countries that followed the IMF advice - which was basically to continue the liberalization policies -in the aftermath of the crisis, such as Indonesia and the Philippines, are still struggling to recover; those that ignored the IMF suggestions, such as Malaysia, are doing better than they were before the crisis. Trade liberalization is the idea that countries should neither subsidize their exports nor place tariffs on their imports. The idea, which probably made a lot of sense in some economics textbook somewhere, is that this integrates the country into a global capitalist market and that the goods for which the country has the most competitive advantage -usually agricultural commodities such as coffee, tea, sugar, flowers - will find their way onto the world market. The problem with this theory is two-fold: in the real world, the biggest economies in the world - the U.S., Europe, and Japan - rely heavily on subsidies, especially in the agricultural sector. Rice, for example, is so unprofitable for us here in the U.S. that 40 percent of the profit a farmer makes growing rice comes from subsidies. The second problem with this is that -outside of economics textbooks - no country has industrialized without heavy reliance on subsidies and tariffs. The best documentation of this is Ha-Joon Chang's Kicking Away the Ladder, a 2003 book which documents in vivid detail the development of every major industrial power and the market distortions that made development possible. While Chang's work is revolutionary, the basic premise has been understood for years: if the U.S. had developed using the theory of "comparative advantage," we would be a sparsely populated nation of fisher people and fur traders and not the highly industrialized economy that we are.

When countries cannot pay up debts to vulture funds, how are those debts collected?

It varies. Often companies will find assets to seize in the country where the court ruling takes place; occasionally the company will be awarded a lucrative privatization contract at a heavily discounted rate. In the case of Donegal and Zambia, the funds to pay Donegal are likely to come from the payments owed to Zambia by its former corrupt dictator, who is likely to be found guilty of corruption charges in the UK.

Which courts often rule in favor of vulture funds?

I believe it's the UK, the U.S., and France that have the most business-friendly laws and are therefore where such cases are usually pursued, though the companies in question are often headquartered in the Cayman Islands or some other tax haven.

What are the alternatives or the solutions to create a more humane situation? What changes can be made so that less money goes to already wealthy private investors and more money goes to development in indebted nations?

The relationships we're describing are based on theft and the exploitation of weakness to set up policies to ensure more theft. How about some compensation for all that theft, for a start? In the long term, the basic stuff we can do in the North is to keep our governments accountable, to ensure that they do not continue to use our resources for the profit of elites in the private sector. If we're talking about development strategies for Africa, that can only be decided by Africans through processes of democracy and accountability. Our duty is to get our governments and the institutions whose strings it pulls out of the way so that civil society in these places can begin to have a more meaningful discussion about what real development looks like. Unless we're talking about political and economic democracy, we are merely playing the part of the doctor who prescribes a bandage after needlessly cutting someone's arm off.

About the Author:Sameer Dossani is director of 50 Years Is Enough: U.S. Network for Global Economic Justice, a coalition of organizations advocating for changes in World Bank and International Monetary Fund practices.



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