G-7 Should Have Cancelled Poor Countries' Debt

By Mark Weisbrot

October 4, 2004, Knight-Ridder/Tribune Information Services

The failure of the G-7 governments this past week to reach an agreement on debt cancellation for the poorest countries of the world shows remarkable callousness on their part. These are countries -- mostly in Africa -- where thousands of people are dying each day from AIDS and other even more treatable and preventable diseases, children are being orphaned and economies wrecked.

Why should the richest countries of the world -- or the International Monetary Fund (IMF) and World Bank -- continue to take debt service payments from them?

This time it was the Europeans that scuttled a reasonable proposal from the U.S. Treasury Department to cancel 100 percent of these countries' debt, and to switch to a system of grants for poor countries, rather than loans, from now on. The Europeans appeared to side with the World Bank, whose director Jim Wolfensohn argued that such a proposal would hurt the Bank "in 10 years because we are expecting 40 percent repayment from those loans."

But Washington has veto power in both the IMF and World Bank and has used it for 60 years on matters that are of importance to it. So the blame must fall upon all of the rich country governments for failing to cancel this debt.

Economist Jeffrey Sachs of Columbia University, a special advisor to UN Secretary-General Kofi Annan, has argued that poor countries should unilaterally cancel this debt themselves if the G-7 countries fail to act.

"Africa should say: 'thank you very much but we need this money to meet the needs of children who are dying right now . . .' " Sachs said last July.

Sachs is right, and there is nothing radical or impractical about the idea of poor countries taking matters into their own hands. The idea that poor countries might ruin their credit rating for future borrowing is implausible. Their credit rating has already been ruined. And fears that other debtor countries might press similar demands are also misguided.

In fact, default can sometimes be an option worth considering even for middle-income countries. This has certainly been the case in Argentina, whose economy has grown by 8.8 percent last year and a projected 7 percent this year, while failing to reach an agreement with holders of about $100 billion of defaulted foreign debt. The country's defiance of the IMF, with its credible threat to default to the Fund, has also freed it from having to accept the IMF's economic advice. This advice, which has often proved disastrous in the past, could easily have cut short the country's economic recovery.

According to standard economic theory, international lending can benefit the borrowing country by allowing it to invest more and increase productive capacity. In this scenario the country has a net benefit even after paying interest and repaying the loans. But many developing countries are stuck in a situation in which their debt service payments exceed new borrowing, with no obvious reversal in sight.

These countries are therefore sacrificing present consumption and investment just to pay off debt. In such a situation default can be the most practical option, rather than to continue to reduce living standards and growth simply to make debt payments. This is even more likely if, as is often the case, the IMF and financial markets enforce conditions on borrowing -- such as excessively high domestic interest rates -- which further reduce growth.

Wolfensohn's worry that the Bank might have less influence in the future is also misplaced. The IMF and World Bank, which formulate policy for developing countries jointly -- with the Bank subordinate to the Fund -- have a losing track record for the last 25 years. Not only the poorest countries, but also the vast majority of low and middle-income countries have suffered a sharp slowdown in economic growth while implementing reforms promoted by these institutions.

The HIPC (Highly Indebted Poor Countries) initiative of the IMF and World Bank promised debt relief for poor countries eight years ago, but progress has been slow and inadequate. Debt cancellation for these countries is long overdue. Any spillover effects that lead other countries to re-evaluate the costs -- including economic conditions attached to borrowing -- and benefits of servicing their debt burdens need not be feared.