Debt and Development

BY ALEJANDRO REUSS | December, 2015

This article is from Dollars & Sense: Real World Economics, available at

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We used to hear all the time about the “Third World” debt crisis—and how it was keeping Latin America and Africa poor. But now I hear that those economies have actually been growing pretty fast. Was all that talk about debt overblown?

For both regions, the return to economic growth was far removed from the severe debt crises in the 1980s and 1990s. In Latin America, the entire 1980s came to be known as the “lost decade.” Per capita gross domestic product (GDP) for the region as a whole was actually lower in 1990 than it was in 1980. For sub-Saharan Africa, the story was even worse. In 1974, the region’s per capita GDP was just over $950, according to World Bank data. Over the next two decades, it would plunge by more than 20%, and would not regain its 1974 level until 2008. Per capita GDP has indeed grown again in Latin America since the 1990s (and more rapidly since the early 2000s). In sub-Saharan Africa, per capita GDP bottomed out in the early 1990s, and growth through the rest of the decade was so modest as to be practically nonexistent. GDP growth for the region, as for Latin America, has been faster in the 2000s. Economies in both regions have grown, in part, due to the boom in agricultural and mineral commodities prices. In Latin America, center-left governments in several countries have adopted policies to reduce income inequality, which has also boosted economic growth. In both regions, too, burdens of external debt have declined in recent years—in Africa, partially due to debt-cancellation campaigns—and this has also played a role.

None of this is to say that external debt—that is, debt owed to foreign financial institutions or governments—was the sole cause for economic crisis and stagnation in either region. However, debt has certainly played a large negative role, in the recent history of much of the “developing world,” by thwarting economic development.

If debt is bad for economic development, shouldn’t developing countries just avoid getting into debt in the first place?

Well, debt isn’t always bad from the standpoint of economic growth or development. A developing country may borrow to finance an infrastructural or industrial project—for example, to pay for imports of machinery, materials, energy, or other needed inputs that are not produced domestically—expecting that it will more than pay for itself. That is, the resulting revenues will be large enough that the loan can be paid back with interest, plus leave some revenue left over.

We don’t usually think of the United States as a “developing country,” but in the mid-to-late 19th century, it was going through a period of rapid industrialization, financed in large measure by external debt. As economist Jayati Ghosh put it in a recent interview: “If you think about it, the United States would not be a developed economy if throughout the 19th century it had not been able to borrow vast sums, mostly from England. ... So in fact the United States ran current account deficits between 5–7% of GDP for nearly 70 years. And this is what really enabled it to become the industrial power that we saw before the First World War.”

Note that the experience of the United States was unusual, especially in that it enjoyed such large and steady flows of credit for so long. Other countries were not so fortunate. Ghosh has pointed out that other countries in Britain’s informal commercial empire during the mid-to-late 19th century—like Argentina—also received very large credit flows, but these were subject to sudden interruptions. A sudden interruption of credit can be very damaging—forcing the borrower to suddenly come up with payment for the full principal, causing the discontinuation of long-term projects for want of further credit, and so on. In the 1890s, for example, a major British bank went bankrupt after many of its loans in Argentina went bad, triggering a much broader shut-off of credit to Argentina and playing a major role in the “reversal” of the country’s economic development.

In a way, that suggests a loss of access to credit can be a big problem. Are there ways that debt itself can impede economic development?

One way is that the burden of debt repayment (or “debt service”) is so great that it leaves little left over for high-priority domestic spending, including basics like nutrition, health housing, and education, as well as investments on infrasctructure or industy to promote economic growth.

Economists James K. Boyce and Léonce Ndikumana estimated, in their recent book Africa’s Odious Debts, that each dollar in external debt service is associated with a decrease of about $0.29 in public health spending. Just one consequence of this reduction, in turn, is increased infant mortality—seven more infant deaths per year for every $290,000 reduction in health spending. In other words, every additional $1 million in debt service results in seven more infant deaths. Boyce and Ndikumana estimate that there are 77,000 more infant deaths per year, for Africa as a whole, from just the portion of debt service (about 60% of the total) that has fueled capital flight.

High debt service on past loans can also impede domestic “capital formation”—new investment in assets like machinery, factories, infrastructure, etc.—and therefore economic growth. Slow growth, in turn, can make it difficult to repay even the principal on past debts, so the country could go on making interest payments indefinitely. There are many cases where countries have, in effect, repaid international debts many times over for exactly this reason. Sub-Saharan Africa in the 1980s and 1990s illustrates this vicious circle. In 1981, the region’s debt service (payments of principal and interest) was less than 4% of GDP. It would drop again below that threshold in 2010. In the 28 years between, it would average over 7% of GDP, twice hitting a full 10% of GDP. Another common way to look at the debt service burden is as a percent of the region’s exports. Exports mean a flow of goods out of the country, and a flow of payments back in. These payments can be used to pay back principal and interest on previous debt, so this ratio is sometimes used as a measure of a country’s ability to pay its debt. Here, we’re more interested in it as showing the diversion to debt repayment of resources that could otherwise have been used for domestic development. Again, we find much the same story. For sub-Saharan Africa, debt service goes from about 15% of exports in the early 1980s to an average of over 30% for the 20 years between 1982 and 2001. In other words, the region’s debt crisis meant that it was paying up to one-tenth of its total income, or nearly one-third of its revenue from exports, just to service its debts. Domestic capital formation, meanwhile, was substantially lower than it had been since the late 1960s.

So how do countries actually get into debt trouble? It seems that what we usually hear about is a country having big trade deficits—or “living beyond their means”—and having to borrow heavily to finance them.

That’s a misleading story, for several reasons. First, the phrase “living beyond their means” suggests that the borrowing is being done to finance consumption beyond the country’s own capacity for production. Developing countries, however, often run trade deficits (or the slightly broader concept of current account deficits) because they import large quantities of production goods, rather than consumption goods. The “import substitution industrialization” policies adopted by many Latin America countries in the 1950s and 1960s, for example, were designed to reduce reliance on imports of manufactured consumer goods. Tariffs and other “barriers” were put in place to protect budding domestic industries from import competition. And yet trade deficits increased, largely due to rising imports of machinery and other production goods needed for domestic industrialization.

Second, there are other factors in trade balances besides the physical quantities of imports and exports. Changes in the relative prices of a country’s imports and exports may have a big effect on its trade balance. This is especially true for countries that are exporters of “primary” goods—raw materials like agricultural products and minerals—whose prices tend to be highly volatile. A petroleum-exporting country, for example, might run large trade surpluses when oil prices are high, but trade deficits when oil prices are low. (By the same token, the reverse might be true for a petroleum importing country.) A country might not start running trade deficits because it is importing larger quantities of goods—or because its people are enjoying higher consumption—but because its exports are suddenly worth less, or its imports suddenly cost more.

Third, the actual cause-effect relationship often runs not from trade deficits to debt, but the other way around. The story can start with large capital flows into a country—when individuals, companies, or governments of other countries buy tangible assets, buy stocks or other securities, or make loans in that country. This can cause the currency of the country experiencing the financial inflows to increase in value relative to other currencies. A “stronger” (higher valued) currency makes the country’s imports cheaper and its exports more expensive. Rising imports and declining exports, in turn, push the trade balance in a negative direction (from surplus towards deficit).

Finally, a country’s debt burden depends not just on the amount borrowed, but also on the interest rates the country faces. Those rates depend on the risk that lenders assign to different borrowers. As a country becomes heavily indebted, lenders are likely to see it as a bigger credit risk, and it may have to pay higher interest rates to get further loans—if it can get them at all. The yield on long-term Greek government bonds (the IOUs that a government or other borrower issues for the money it borrows), for example, went from less than 6% as late as 2009 to as high as 36% in 2012. Lenders’ calculations of how risky it is to lend to a particular country, however, may not be based solely on economic conditions within that country. During the Latin American debt crisis of the 1980s, for example, some countries’ default on debt led to a tightening of credit throughout the region. (In effect, lenders were treating the entire region as a single unit, for the purpose of evaluating risk.)

The interest rates that one borrower faces, meanwhile, also depend on the interest rates that lenders can get elsewhere. This, too, was a big factor in the 1980s debt crisis. In the late 1970s, the United States government adopted policies to deliberately drive up interest rates, mainly to rein in domestic demand and reduce upward pressure on wages. Lenders prefer to make loans to borrowers who will pay higher interest rates, keeping in mind differences in risk. With interest rates on the rise in the United States, the country became a more attractive place for lenders to make loans. Borrowers in developing countries, therefore, suddenly had to pay higher rates to keep attracting credit.

Are countries better off, if they start getting into debt trouble, tightening their belts to repay it as soon as they can, rather than getting deeper and deeper into the hole?

A country’s external debt may be public (owed by the government) or private (owed by private individuals and companies), but for now let’s think about a large public debt. The pro-austerity reasoning is that the best way to bring down the debt fast is to cut spending and/or raise taxes. The resulting “primary surplus” (current revenues minus current expenditures, excluding payments on past debts) will then make it possible to pay down debt and bring down the country’s debt-to-GDP ratio.

This argument for austerity seems to make sense if we’re thinking about a single household—if it gets too deep in debt, it can cut back on its spending and maybe find more paid work or other income opportunities, and over time whittle down what it owes. Reasoning by analogy with an individual household, however, is not a good way to approach public policy. When we think about a household “tightening its belt” and cutting back on spending, we usually don’t think of this as getting in the way of its income opportunities. The austerity policies described above, however, may have the effect of reducing demand, output, and incomes for the society as a whole.

Think about it this way: Governments often adopt fiscal “stimulus” programs when the economy goes into a downturn. By increasing spending and reducing taxes, they increase demand for goods and services. That causes businesses to increase their planned output, to increase their orders for inputs, and to hire more workers. The workers and suppliers, in turn, spend their new incomes, further boosting demand. Austerity programs, however, do just the opposite—reducing demand in the economy. If the idea is to bring down debt relative to GDP, this kind of policy can backfire—since it may bring down GDP. (It may also fail to bring about the sought-after primary surpluses, since recession conditions will usually reduce tax revenue and may actually increase some kinds of spending, such as unemployment insurance and other government social-welfare payments.) A big reason that Latin America’s debt crisis turned into a “lost decade” was not the loss of access to credit itself, but that austerity policies—pushed, in many countries, by the International Monetary Fund—depressed these economies.

Austerity policies can also be aimed at pushing a country’s trade balance in a positive direction (from deficit toward surplus). The reduction of demand reduces output and employment. The resulting unemployment, in turn, puts downward pressure on wages. Lower wages tend to make the country’s goods cheaper relative to those of other countries, and therefore reduce its imports and increase its exports. Of all ways to accomplish this change in relative prices, however, austerity is just about the worst—coming at a high cost in lost output of goods and services and an even higher human cost, especially in the form of mass unemployment. An alternative way to accomplish this is through “devaluation”—making the country’s currency weaker, and so its exports cheaper and imports more expensive. There may be impediments to such a policy for countries, however, that are in a fixed exchange-rate system or that share a currency with other countries.

Finally, no matter what policy is used to pay back debt—including devaluation or other policies that reduce imports and boost exports—we have to ask whose belts it is that are getting tightened. The burdens of debt are never borne equally by all—and are not necessarily even borne by those who took out the debt in the first place, or who benefited from taking it out. In many developing countries, external debt has not been used to develop infrastructure, promote industrialization, or reduce poverty—but to enrich the already rich and powerful. Economists Boyce and Ndikumana have shown that external debt is strongly associated with “capital flight.” In some cases, autocratic rulers have stolen billions of dollars in loans, transferring the money to their own bank accounts overseas. Why should the people of these countries be responsible for repaying loans they neither took out nor benefited from? If the banks knew—or should have known—that the loans might be stolen, why should they not bear the cost if the loans are not paid back?

More generally, austerity policies tend to fall hardest on workers and poor people. This was certainly the case, for example, in the Latin American debt crisis of the 1980s. Austerity policies included cuts to public subsidies on basic goods like food and fuel, reductions in social welfare spending, reductions or elimination of minimum wages, cutbacks in public employment, and so on—all of which quite transparently targeted lower-income people. These policies transferred income not from the debtor countries to the creditor countries in general, but specifically from workers and the poor in the debtor countries to the wealthy bondholders in the creditor countries.

OK, so if austerity policies aren’t the solution, how are poor countries that get into debt trouble supposed to get out?

If one is determined to make sure highly indebted low-income countries be able to repay their debts, then austerity is surely not the solution, because it is a recipe for “lost decades.” An alternative would be policies that 1) include debt restructuring—that is, reduction or postponement of debt repayment—and 2) promote growth—so that debt can be repaid out of growing income. Many of today’s high-income countries have benefited from debt restructuring in the past, or from “growing their way out of debt” over time, without demands for immediate payment when they could ill-afford it.

If one is not determined that debtor countries repay their debts—put another way, if one is not determined that, above all else, the banks should be repaid—then debt repudiation is an option. Many countries have repudiated (refused to pay) past debts. One argument in favor of repudiation is that of “odious debt”—sovereign debt that did not benefit the people of a country. This idea has been frequently invoked, in recent years, in regard to debt incurred by dictators—and largely used to enrich the dictators, their families, and their cronies. Advocates of repudiation argue that the people have no moral obligation to pay such debts. With the possible move of debt repudiation up their sleeve, indebted countries need not knuckle under to creditors’ demands for payment in full (whatever the suffering this may mean for their people). Rather, they can negotiate more favorable terms. One recent example is Argentina, which defaulted on its external debt in 2001, and then managed to negotiate a restructuring of its debts with the vast majority of its creditors. Getting some relief from debt repayments and avoiding austerity policies that would have undermined growth, Argentina enjoyed a surprising economic rebound. (Since then, the debt-restructuring deal has been endangered by the so-called “vulture funds.” These are speculators who did not lend to Argentina at all, but bought Argentinean bonds after the default for a fraction of their face value. Now they’re fighting in the courts to be paid the full value of the bonds, and standing in the way of the restructuring deal that most creditors had already accepted.)

One reason people give for thinking a country shouldn’t default on its debts—that the country will cut itself off from future credit—turns out not to be generally true. This raises the question of why heavily indebted countries do not do this more often. There’s no one simple answer, but the example of the Latin American debt crisis of the 1980s is instructive. As multiple Latin American countries had become heavily indebted, serious discussion emerged about forming a “debtors’ cartel.” If they all threatened to default, many argued, they would be able to get better terms from the banks. In the end, however, the proposed debtors’ cartel did not materialize, and the various countries ended up accepting quite onerous debt-repayment conditions. One reason was that there were significant divisions between more-indebted and less-indebted countries, with policymakers in the latter thinking that they could negotiate better terms going it alone than if they threw in their lot with the worse-off. More importantly, elites in debtor countries faced a choice—either confront a creditors’ alliance including the giant international banks, the U.S. government, and international institutions or push the burdens of repayment onto the workers and poor of their own societies. Not surprisingly, they chose not to confront the high and mighty, but the poor and downtrodden.

Is there no way for lower-income countries to increase standards of living for their people without recourse to external debt?

Raising future consumption requires that some current resources not be used to produce goods for consumption today, but rather goods that will make it possible to produce and consume more tomorrow. For example, rather than consumer goods like food, clothing, televisions, and houses, some resources are used instead to produce industrial machinery, factory buildings, and so on. If the alternative is to ferociously restrict consumption now, in order to finance such investments domestically, external debt may seem like the lesser evil.

There are ways, however, that countries that countries can promote economic development without having to “bite the bullet” and choose one of these two options. First, many developing countries could greatly reduce their need for credit or other inflows of capital, in order to finance investments in future production, if they did not suffer from enormous financial outflows. As economists Boyce and Ndikumana have documented, as of 2010, capital flight from the 33 countries of sub-Saharan Africa had resulted in total ownership, by citizens of those countries, of over $1 trillion in assets abroad. Basically, this is what the region is lending to the rest of the world. At the same time, the region’s total external liabilities—basically, what is owes to the rest of the world—added up to less than $200 billion. In effect, Boyce and Ndikumana conclude, “making the region a net creditor to the rest of the world.” Think about that. Heavily indebted sub-Saharan Africa is not actually borrowing from the rest of the world, on balance, but lending! Capital flight is draining many countries of resources that could be used for domestic development. International credit is not only failing to fill the resulting void, but as Boyce and Ndikumana argue, is actually fueling much of this capital flight (as the wealthy and powerful divert loans, including public loans, for their own enrichment).

Second, economic development and economic growth are not the same thing. If we define economic development, following economist and philosopher Amartya Sen, as the expansion of substantive human freedoms (or “capabilities”), then we can ask whether economic growth is either necessary or sufficient to achieve development. Sen emphasizes universal access to basic capabilities, like long life, good health, education, and the ability to participate in community life. Many countries have achieved substantial economic growth without achieving economic development in this sense. If the fruits of growth are mainly appropriated by the already well-off (and well-housed, well-fed, well-clothed, and well-educated), it’s not surprising that growth would not bring about much improvement in the general level of these “capabilities.” So economic growth is not sufficient for economic development. Neither, however, is substantial economic growth (raising per capita incomes) necessary for dramatic progress in “human development.” High levels of human development can be (and have been) achieved, even at very low per capita incomes, in countries or sub-national regions where income is distributed quite equally and there is a strong public commitment to universal provision of basic goods (e.g., adequate nutrition, public health, elementary education, etc.).

On some level, we can imagine “unilateral” changes in the political and economic institutions of a lower-income country dramatically altering these two factors. More democratic and egalitarian societies are likely to be more successful both in avoiding the theft of resources by elites and in deploying the available resources to meet fundamental human needs. However, individual countries are also embedded in the capitalist world economy. The basic way capitalist economies operate is no different on the world scale than it is at the level of the individual enterprise—those who own resources only make them available to those who don’t if the owners expect to profit by doing so. That is why so much discussion of development policy is about how lower-income countries can make themselves attractive for foreign investment. The only apparent way to get access to needed resources—by means of credit, foreign direct investment, etc.—is to convince the global banks or other global corporations that they will profit from it.

An alternative would be a world system in which there were large transfers from high- to low-income countries, without expectation of repayment or profit. These resources could be deployed, given sufficiently democratic and egalitarian institutions in the recipient countries, to spur development—including investments to increase future productive capacity and standards of living, but especially focusing on universal achievement of the basic capabilities that define “human development.” Global mechanisms for wealth redistribution may seem like an unrealizable and utopian fantasy. In fact, they have existed in recent history—only operating in the reverse direction.

Colonialism, among other things, was a giant engine for transferring wealth from the “periphery” of the capitalist world economy (Africa, Asia, and Latin America) to the “core” (Western Europe and North America). Indeed, that system helped to create the division of the capitalist world into its “developed” and “underdeveloped” regions, producing development at one pole along with underdevelopment (subordinate, dependent development) at the other. In short, it created the world we know—not only one in which there are rich and poor countries, but in which the peripheral-subordinate-poor are used for the further enrichment of the core-dominant-rich.

A system that did the opposite is not unimaginable, but it does require that we imagine a very different world.

is co-editor of Dollars & Sense and teaches labor studies at UMass-Amherst and Umass-Boston.

Jayati Ghosh, “Who Benefits from Sovereign Debt Crises?” The Real News Network, Oct. 26, 2015; World Bank, Data, GDP per capita (constant 2005 US$) (; International Monetary Fund, Data and Statistics, External debt, total debt service (; James K. Boyce and Léonce Ndikumana, “Capital Flight from Sub-Saharan African Countries: Updated Estimates, 1970-2010,” Political Economy Research Institute, University of Massachusetts-Amherst (October 2012); Léonce Ndikumana and James K. Boyce, Africa’s Odious Debts: How Foreign Loans and Capital Flight Bled a Continent (Zed Books, 2011).

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