An Overview of the Ongoing Debt Crisis and Lessons Learnt

The concept of a debt crisis revolves around the condition where a government is unable to pay back operational debt. Furthermore, in a situation where a government’s expenditures exceed its tax revenues for an extended period, such a government is said to have entered a debt crisis.

Governments, countries, and organizations generally express inability to service debt in two main ways, i.e. Insolvency: where the borrower is unable to pay a debt now or in the future. Waiting or adjusting pay periods do not improve the situation and lenders may have to consider the reality that some or all the debt will not be paid back. Illiquidity: is another condition where the borrower may be able to service debts at a later time with expected future incomes and receipts. In this case, lenders have the option of delaying or rescheduling debt payment.

Admittedly, the above statements are simply theoretical distinctions and are rarely reflected in reality. When a country goes into a debt crisis, it is quite difficult for analysts and economists to determine whether the debt issue is that of insolvency or illiquidity. This problem can be attributed to the dynamic nature of government activities in conjunction with the political and socio-economic factors of each society.

An article by Christina D. Romer for the Quarterly Journal of Economics, argues that the stock market crash in 1929 generated uncertainty about future investment/income values, leading to a chain of events – reduced investment, lowered consumer spending, declined industrial output etc. – that culminated in the economic downturn referred to as the Great Depression. The Great Depression is noted as lasting from 1929 to 1939 and was characterized by high unemployment rates (15 million people), millions of invested shares considered as worthless, mass worker layoffs and a drastic reduction in purchasing power.

Programs that assisted in economic recovery from the Great Depression include but are not limited to the; Tennessee Valley Authority (TVA), which funded projects to control flooding and provide electricity to the Tennessee Valley and the Works Progress Administration (WPA) which was a jobs program that employed over 8 million people from 1935 to 1943.

The 1980s and 90s were a period during which the debt crisis had a massive effect on the so-called developing world. Many economies of the global south defaulted on their debts, with Mexico being the first domino piece to request repayment assistance. The IMF and the World Bank practically oversaw the financial rescue policies that were necessary to address the mass debt crisis that erupted in 1982. Policies centered on ‘structural adjustment’ (mostly privatization) and ‘macroeconomic tightening’ (austerity measures) were suggested and applied as measures to deal with the debt crisis.

Conversely, the debt crisis of the 90s was not a mass fallout of simultaneous defaults like in the 80s, the crisis was sequential, with multiple countries across the world having economic failures from 1994 (Mexican Crisis) right up to 2002 (Argentine Crisis). The main culprits here were elements of the private sector, with major banks and corporations over-borrowing, as private investors, and foreign banks over-lent without checking ability to honor debt. These actions led to capital flight and massive currency speculation which contributed to the economic failures of the 90s.

The World Hunger Education Service (WHES) argues that the debt crisis (especially in Africa and South America) was caused by unregulated private sector lending and policies administered by international financial institutions. A major node in the crisis onset according to WHCS, is the oil crisis of 1973, where members of the Organization of Petroleum Exporting Countries (OPEC) placed an embargo on oil prices as a geopolitical strategy to disrupt the economies of countries that supported Israel in the Yom Kippur War. Banks that benefited from the new OPEC investments began making loans to developing countries, mostly with improper evaluation as per the loan requests and usage thereafter. The oil crisis led to decline in the exports from developing countries, domestic cost of production kept climbing and many countries saw the interest on their debt rise dramatically.

As a matter of focus, African economies were greatly affected by the oil shocks of 1973/78, and research by Alemayehu Geda Fole, shows that the current debt problems are related to the structure of African economies, which are highly influenced by their colonial histories. These problems only evolved during the post-independence period. Furthermore, his research goes on to show that the majority of African debt is owed to bilateral creditors followed by multilateral creditors at 35% and 14.4% respectively as at 2000. The debt conditions are largely based on stagnant borrowing terms and greater importance on interest than serviceability. Additionally, it has been proven that based on current performance of African economies and the mounting debt, these countries are unable to service debt and pursue economic growth simultaneously.

In looking at solutions to the debt crisis, structural adjustment programs (SAPs) have had the positive effect of opening foreign investment markets and reducing inflation. On the other hand, SAPs have consistently aggravated unemployment levels due to high rates of privatization and civil service reductions. SAPs also lead to environmental neglect and declined quality in health, education, and infrastructure industries. Many countries of the African continent depend on resource extraction as a source of exports, these countries need foreign exchange to service debt and when structural adjustment programs are introduced to the mix, many operations are deregulated and resources are exploited with destructive impact to the land and the people who live off it. This is observed readily across Africa today.

It is understood that the African debt crisis is more a facet of a general crisis that an issue in and of itself. Large arrears and century-old debt-overhangs will always negate GDP measurements and ‘cash flow’ and currency liquidity issues will always negate the debtor’s ability to keep up with interest rates let alone the actual debt. Debt rescheduling has not had any satisfactory effects because many countries are still unable to catch up with repayment schedules, leading only to more negotiations on rescheduling or interest rates. Paris Club agreements are equally inept because countries seeking solutions usually need to first agree to stabilization programs of the IMF.

A vicious cycle is established where “developing” economies are heavily devalued by adopting adjustment programs which makes them less competitive and incapable of generating real value, leading to the inability to service existing debt/interest and as a result, such countries have to seek external funding options starting the cycle of borrowing all over.

Piece-meal solutions have consistently fallen short because suggestions of tax collection do not work in countries that barely have a taxable base, because of extensive capital flight. Large populations are seen as tax potential, while disregarding massive unemployment levels and decaying internal industries. The Overseas Development Institute (ODI) still proposes vague solutions like “boosting alternatives to borrowing” which couching the taxation argument within. The writer, Mark Twain, is quoted as saying “History doesn’t repeat itself, but it does rhyme”. In the context of African debt crisis, leaders, analysts, and economists et al. must be privy to the fact that blanket economic-adjustment policies did not address the crisis at the tail-end of the 20th century and do not serve positively today.

Concrete discussions around debt relief must be conducted, because only if new perspectives are considered can the current ‘debt-lock’ be defeated. Internal industries should be properly nurtured to initiate the process of building a self-reliant population. Research groups with young and fresh-minded individuals should be tasked and trusted to come up with innovative frameworks geared towards sustainable economic paradigms. As the debt crisis is only part of a larger issue, bad governance, illiteracy, corruption, and other root problems should be tackled decisively. Unless the economic regions of the global south take concerted actions to renegotiate or re-establish economic relations, that are not relics of the colonial era, the debt crisis will remain as it is.

 

The African Debt Crisis

Research reports and literature over the years have shown that the crisis of debt in Africa is multifaceted. Debtors and creditors rely on band-aid measures that still do not address core issues related to international debt. The African debt crisis has certainly become central to the issues plaguing relations between the global south and north.

Causes

In considering causes of the African debt crisis, researchers and analysts generally have multiple assessments in this regard. Some reports lay the blame at the structure of the international financial system and isolate the problem to the operations of debtor countries, private lenders, or creditor countries. Others strictly consider only the inefficiencies, miscommunications and misrepresentations that may occur during financial interactions between these countries. There are observers who draw focus to the 1970s -the oil crisis – as the point of ‘run-away’ debt. This is because of the massive surplus in liquidity as a result of the geopolitical machinations between the U.S. government and OPEC countries, vis a vis oil prices and interest rates.

The deeper issues are usually traced to colonial economic interactions and the introduction of western-style capitalism in developing countries. There were concerted efforts to build and maintain economic relations, in which the colonies were made into permanent producers of raw materials to satisfy requirements of metropolitan countries. The established links between the producers and the colonial metropoles meant that colonies became dependent on other countries to purchase and dictate prices of products. Colonies as a result, were left without infrastructure to process the raw materials and only purchased ready-made goods from the associated colonial power. The result was that colonies produced what they did not consume and consumed what they did not produce.

Furthermore, writers like Pradip Ghosh have argued that the Bretton Woods Agreement, signed after World War II, had the direct effect of making African economies less competitive on the so-called international market. Established trace structures allowed developed countries to increase tariffs on processed African products and African exports to the European Economic Community among others, were subject to quotas and stringent price rules. Policies like the 1947 General Agreement on Tariffs and Trade (GATT) served to sustain the domination of developed countries over young economies, particularly in Africa. African economies could not take advantage of tariffs from developed countries because of their small economies, and industrialization was discouraged because African nations could not raise tariffs to protect internal industries, retaliation from larger economies would have devastating effects. The GATT and the International Monetary Fund had the indirect effect of discouraging African economies from diversification, creating a situation where Africa continues exporting primary commodities but keeps borrowing to fund an already sabotaged cycle of development; a lose-lose scenario.

Governments interacting with the World Bank and the IMF especially in the 90s are told to increase volumes of export to get new credit even though the prices of the raw material exports keep crashing on the international market. This can be observed with the crash of global oil prices in the 1st quarter of 2020. Russia and Saudi Arabia disagreed on cooperation to reduce oil production and manage oil prices, the effect was a 65% drop in the quarterly price of oil. The run-off result was the complete disruption in the budget planning abilities of many countries whose economies depended heavily on oil exports. The desire to invest in infrastructure and internal industries, the plans to provide basic amenities for populations means African governments have no choice but to resort to borrowing.

Lessons & Next Steps

As stated above, the causes of Africa’s debt crisis are multifaceted. Austerity measures now have the effect of attempting to squeeze water from stone, the socio-political conditions in African debtor nations are quickly becoming intolerable and the political leadership is not demonstrating any conviction. Leaders, research organizations and academia are understanding that developing countries have sustained the prosperity of developed countries and will always be exploited by imperialist nations. As far as lessons are concerned, unless African political leadership presses for structural changes in the international economic and financial system, economies of debtor countries will continue to buckle under the yoke of debt.

N/B: The above section is a review of the following: Danso, A. The causes and impact of the African debt crisis. Rev Black Polit Econ 19, 5-21 (1990). https://doi.org/10.1007/BF02899929

 

Asian Debt Crisis

The Asia crisis revolves around the 1997 economic collapse in Thailand, Malaysia, Indonesia, and South Korea. The currencies of these countries lost between 30%~50% of their value, many banks became insolvent, and central banks were unable to generate foreign exchange needed to deal with international debts. Similar to countries of Africa and Latin America, the aforementioned Asian countries had economies based on natural resource extraction which had started losing value as of mid to late 1980s. Thailand and Indonesia adopted IMF structural adjustment programs as a means of avoiding debt defaults. Privatization and deregulation of economic activities initially led to increased foreign investment, exports, and loan renewals.

Southeast Asian countries benefited greatly from Japanese Foreign Direct Investment (FDI), this enabled them to temporarily overcome IMF SAP policies and become major exporters of manufactured products to the United States in particular. The underlying problem was the fact that, majority of the production of exports were under foreign control, for instance, over 90% of machinery and electrical appliances exported were from foreign controlled companies (mainly Japanese). As at 1994, the Matshushita company accounted for 4%~5% of Malaysian GDP.

The result of these trade methods were high current account deficits meaning, the Southeast Asian governments were under constant pressure to generate foreign exchange. Even though goods were being manufactured locally and exported competitively, resource exploitation continued apace, and migrant workers were brought in to keep wages low, as the governments searched for more drastic ways to generate foreign exchange. A grim example of the search for foreign exchange is when the Thai government heavily promoted a sex industry that ended up causing an AIDS crisis. With the reduction of Japanese FDI in the early 90s, Thailand, Malaysia, Indonesia, and the Philippines sought to attract investors by dropping foreign exchange controls, raising interest rates, and pegging their currencies to the US$.

With improved FDI, the Thai government increased borrowing and its foreign debt increased from 21$bn in 1989 to 89$bn in 1996. The problem was that the finances never went to productive investments, the majority went to property developers and by 1997, about half of all loans made to property developers were non-performing. Similar events took place in Malaysia, Indonesia, and the Philippines and the respective financial institutions started defaulting on their foreign loans. This led to a chain-reaction where foreign investors started removing their stocks and investments causing the inevitable crash of multiple economies. Thailand and Indonesia sought IMF assistance again and were put back on structural adjustment policies.

Lessons Learnt & Next Steps

Lessons learnt in this context were found in the fact that, the dependent nature of their export industries and the consumption desires of the wealthy class led to desperate measures to build foreign exchange. The financial technologies (i.e. deregulation, incentives etc.) had short term benefits but next to no long-term sustainable advantages. The Malaysian Prime Minister at the time, Mahathir Mohamad, blamed Euro-American speculators and sought tighter capital controls. Cronyism and corruption are obvious problems, the flip-side of the coin is that government-backed deregulation in many industries encouraged cronyism and corruption. History has shown that neoliberal policies for economic recovery as proposed by the IMF and the World Bank consistently and subtly defend capitalist interests. This is usually followed with the calls for lowered private control of the major/central industries, and increased support for responsible growth models which leads to political deadlocks. Alternatives must be continuously sought after. State-capitalism and Export resource-based growth strategies are not the only options, and debates on the debt issues must be encouraged and supported.

N/B: The Asian debt crisis was a review of Causes and Consequences: Inside The Asian Crisis – Martin Hart-Landsberg https://againstthecurrent.org/atc073/p1837/

Africa’s debt crisis was/is centered around stagnant development, while the Asian Crisis was more a result of financial speculation and failed currency protection policies.

 

A Global View

Global debt crisis became apparent following the financial crisis of 2007~2009 which was a fallout of real estate speculation in the US. As at 2015, total debt outside of the financial sector had reached $152trillion and global debt as at 2016 was 225% of global GDP according to the IMF’s Fiscal Monitor publication.

An article by independent researcher Anup Shah argues that causes of the ongoing debt crisis include but are not limited to; a continuing legacy of colonialism, odious debt, mismanaged lending, the world’s poor subsidizing the rich and the economic policies that structurally favor richer countries over poorer countries.

CNN Business reports that the global debt-to-GDP ratio as at 3rd quarter of 2019 was 332% with global debt approaching $253trillion. Over 50% of this debt is accumulated in developed economies like the US and Europe. Household debt levels in Australia, New Zealand, and Switzerland are all rising while so-called emerging markets account for a total of 72$trillion. Although the US Federal Reserve lowered interest rates three times to around 1.5%~1.7% and the European Central Bank dropped to negative interest rates at -0.5%, loans and bonds of over $19trillion maturing in 2020 may not be able to be refinanced or repaid.

A debt crisis report by the World Bank states that the global economy has had four waves of rapid debt accumulation in the past five decades, with each one being larger and more broad-based than the previous. Low interest rates mitigate some risks associated with high debt rates, but they are not sustainable when looking at low growth prospects in low income economies or mounting global economic risks.

Next Steps

Sound debt management, debt transparency, strong fiscal policy frameworks, robust financial sector regulation and effective public finance management are suggestions put forward by the World Bank. These policy suggestions can theoretically address global debt crisis issues but in reality, do not resolve the structural problems that favor some economies at the expense of others. Diligent adherence to such policies will have the contradicting effect of disrupting the advantages of entities that benefit from the status quo. Stark policies may sooth the pressing symptoms of the debt crisis, but do not attack structural issues like bad governance, corruption, and cronyism as well as predatory economic practices.

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