Causes of the Debt Crisis

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  • by Anup Shah
  • This Page Last Updated Sunday, June 03, 2007

Third world debt has long been recognized as a major obstacle to human development. Many other problems have arisen because of the enormous debt that third world countries owe to rich countries. Debt has impeded sustainable human development, security and political or economic stability. How has this happened?

On this page:

  1. A Continuing Legacy of Colonialism
  2. Odious Debt
  3. Mismanaged Lending
  4. The World’s Poor Are Subsidizing the Rich
  5. Backbone to Globalization
  6. More Information

A Continuing Legacy of Colonialism

The historic causes of third world debt is introduced in a working paper from the development organization, the South Centre. It summarizes how the developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States:

The history of third world debt is the history of a massive siphoning-off by international finance of the resources of the most deprived peoples. This process is designed to perpetuate itself thanks to a diabolical mechanism whereby debt replicates itself on an ever greater scale, a cycle that can be broken only by canceling the debt. According to a new Working Paper on Effects of debt on human rights prepared by Mr. El Hadji Guissé for current UN Sub Commission on Human Rights (E/CN.4/Sub.2/2004/27), the developing countries’ debt is partly the result of the unjust transfer to them of the debts of the colonizing States! A sum of US$ 59 billion external in public debt was imposed on the newly independent States in 1960. With the additional strain of an interest rate unilaterally set at 14 per cent, this debt increased rapidly. Before they had even had time to organize their economies and get them up and running, the new debtors were already saddled with a heavy burden of debt.

Third World Debt a Continuing Legacy of Colonialism1, South Centre, Bulletin 85, August 2004

The working paper continues by questioning the legality of such a system that pushes many developing countries into extreme poverty.

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Odious Debt

Odious debt is unfair debt resulting from illegitimate loans. A useful summary from Jubilee USA:

Odious debt is an established legal principle. Legally, odious debt is debt that resulted from loans to an illegitimate or dictatorial government that used the money to oppress the people or for personal purposes. Moreover, in cases where borrowed money was used in ways contrary to the people’s interest, with the knowledge of the creditors, the creditors may be said to have committed a hostile act against the people. They cannot legitimately expect repayment of such debts.

G-8 Summit 2004; Iraq’s Odious Debt: Rhetoric to Reality 2, Jubilee USA, 2003

Jubilee USA continues on to note that this principle has been used by the US to prevent Spain imposing debts on Cuba in 1898, as the US pointed out to Spain that those loans were imposed on Cuba by force, for Spain’s interest. Great Britain was also denied similar claims against Costa Rica in 1923).

Many poor countries today have started their independent status with heavy debt burdens imposed by the former colonial occupiers. South Africa as another example, has found it now has to pay for its own past repression: the debts incurred during the apartheid era are now to be repaid by the new South Africa.

But it is not just South Africa paying for this; surrounding countries that have been destabilized from this are paying debts incurred to deal with it. The organization Action for Southern Africa summarizes this clearly, albeit in a report from 1998:

This report estimates apartheid-caused debt at £28 billion [about $46 billion at the time the report was written]. That is the £11 billion [$18 billion] that South Africa borrowed to maintain apartheid, and the £17 billion [$28 billion] that the neighbouring states borrowed because of apartheid destabilisation and aggression. This is 74% of the present regional debt of £38 billion [$62.5 billion].

Apartheid wrought vast destruction across the region; now the people of Southern Africa want to rebuild. In a remarkable spirit of reconciliation, the people of Southern Africa want to forgive the horrors of the past and look forward. But the banks, international financial institutions, and individual countries which lent to both sides in the apartheid war are demanding repayment.

... people are dying in Southern Africa so that the debts can be repaid.

... After the Second World War, the United States allowed Britain to repay debt at a very low rate so that it could rebuild. In 1953, the victorious allies met in London to cancel most of Germany's debt, so that it could rebuild. Now the nations of Southern Africa want to rebuild a post-apartheid society, but the creditors of today, are not willing to offer them the space Britain received from the US and the Allies gave to Germany. Instead they are demanding that the states of Southern Africa pay three to five times the level that Britain or Germany paid after World War II.

Paying twice for apartheid3, Action for Southern Africa, May 1998

The report also adds that countries further away, such as Tanzania, also felt the effects and had invested substantial sums (about $800 million for Tanzania) to appose apartheid.

Various other nations have found that they have to pay debts incurred by their previous military dictators (many of which were installed as clients of the rich countries.

As Steve Mandel, of the New Economics Foundation argues, because so much of these loans were knowingly given to unaccountable and corrupt leaders, there should be a shift in discussion from odious debt to odious lending, and thus there should be more of a spotlight on the banks who made large loans to illegal regimes, in effect, sustaining them.

Mandel also notes the scale to which odious debt has been overpaid, and is quoted at length here:

Long after odious debts are technically off the books, subsequent generations are still effectively paying for them. This [New Economics Foundation] research paper examines 13 clear cases that present a picture of the extent and impact of odious lending. These include:

  • Indonesia, where in the region of US$151 billion relating to odious debts has already been ‘overpaid’—twice the level of recorded debt. This means that Indonesia has made a cumulative net transfer to the North of US$138 billion to date—or 90 per cent of Indonesia’s GDP.
  • Argentina, where in the region of US$77 billion relating to odious debts has already been ‘overpaid’—75 per cent of the country’s recorded debt.
  • Nicaragua, where the odious debt is over five times the country’s total GDP.

The net loss to these countries economies’ often exceeds the total outstanding debt. This means that people in these—often desperately poor—countries end up paying three times for loans ostensibly taken out in their name:

  1. first they are oppressed by the regimes propped up and enriched by these loans;
  2. secondly they are impoverished by the cost of servicing the loans; and
  3. thirdly they are oppressed again by the penalties imposed if the odious regimes default.

Also, if debt cancellation only comes through the procedures of the Paris Club and the Heavily Indebted Poor Countries (HIPC) initiative, they pay a fourth time when IMF conditionality imposes the often disastrous policies of trade and capital account liberalisation, privatisation, and restrictions on social expenditure.

Steve Mandel, Odious lending: debt relief as if morals mattered4, New Economics Foundation, September 18, 2006 (Emphasis and numbered formatting added)

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Mismanaged Lending

Further debt resulted from mismanaged spending and lending by the West in the 1960s and 70s. As summarized from Jubilee 2000 (and reposted here5) :

  • 1960s saw the US spend more than it had, resulting in the printing of more dollars.
  • Oil-producing countries, pegged to the dollar were affected as the value of the dollar decreased.
  • In 1973, the oil-producing countries hiked their prices as a result, earning a lot of money, which they put in to western banks.
  • Interest rates started to plummet resulting in more lending by banks to try and prevent a crisis.
  • A lot of the borrowed money went to western-backed dictators, resulting in little benefit for most people.
  • In 1982 Mexico defaulted on its debt payment, threatening the international credit system.
  • The IMF and World Bank stepped in to Mexico and other nations facing similar problems, prescribing their loans and structural adjustment policies to ensure debt repayment.
  • The poor have suffered the most6 as a result of the harsh conditions of structural adjustment.

Most loans to the third world have to be paid back in hard currencies (which do not usually change too much in value, e.g. the Japanese Yen, the American Dollar, etc.)

  • Poor countries have soft currencies (values which can fluctuate).
  • Debt crises can also occur just by the value of the developing country’s money going down, which can be due to a variety of other inter-related factors.
  • Paying off loans implies earning foreign exchange in hard currencies.
  • Combined with falling export prices for many poor countries, debts become even harder to pay off.
  • Refinancing loans implies taking on new debts to service the old ones.
  • Structural adjustment7 advice in the past from the IMF and others, has led to the cut back on important spending such as health, education, in order to help repay loans. This has implied a downward spiral and further poverty.

Economists often refer to a moral hazard of forgiving debts, because it may encourage people to take on new loans and refuse to pay. Yet, as Action for Southern Africa also noted in the above-mentioned report about Southern Africa’s odious debt, the problem is not necessarily with borrowers, but with lenders: repay odious debts is to encourage lending to pariah regimes. If banks could lend to apartheid South Africa in the face of global opposition and global calls for sanctions, and still collect on the loans, then the signal to international banks is that they can lend to any regime, no matter how repugnant. There is a moral hazard here: that we will encourage immoral lending.

Paying twice for apartheid8, Action for Southern Africa, May 1998

It is not just the debt that is an issue for poor countries; it is the harsh conditions that come with it, that for years, have been known to make things worse, not better.

The well-respected Martin Khor, director of the Third World Network9 describes this further in a 3-minute video clip:

Martin Khor, Debt in the Developing World—Part Two10, July 15, 2005, © Big Picture TVTranscript11

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The World’s Poor Are Subsidizing the Rich

Another cause for large scale debt has been the corruption and embezzlement of money by the elite in developing countries (who were often placed in power by the powerful countries themselves). These moneys are often placed in foreign banks (and used to loan back to the developing countries). Many loans also come with conditions, that include preferential exports etc. In effect then, more money comes out of the developing countries than is given in. This depresses wages even further due to the spiraling circle downwards to ensure that enough exports are produced. (See the structural adjustment12 section on this web site for more on that aspect.)

J.W. Smith, from the Institute for Economic Democracy, is worth quoting at length:

Susan George, in her 1992 book, Debt Boomerang: How Third World Debt Harms Us All, calculated a net of $418 billion borrowed funds flowed right back north between 1982 and 1990.

The world’s poor are subsidizing the rich. The net gain to the over-capitalized countries (loss to the under-capitalized ones) of $418 billion between 1982 and 1990 is more than double what was spent to rebuild Europe after World War II. Capital flight from Mexico between 1979 and 1983 alone [was] $90 billion — an amount greater than the entire Mexican debt at that time.

... How this is accomplished is well-known to American bankers,

Their real role has been to take funds that Third World elites have appropriated from their countries and to loan them back, earning a nice spread each way.

... Loans from the U.S. government are almost invariably tied to the purchase from the creditor nations. Over 80 percent of America’s foreign aid returns directly through its exports.