International Debt Crisis and Development Economics

Introduction

The international debt crisis refers to the inability of developing nations to repay sovereign debts borrowed from international market, development institutions and sovereign governments (Gall 17). Traditionally, the crisis has been associated with developing nations, most of which are in Africa, Pacific and Latin America. Those being the debtors, their creditor counterparts happen to be the developed countries and the international banking industry. Though the height of international debt crisis was experienced in 1980s, the topic has been popular in the international circles because the repercussions are sill being felt in many countries.

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Indeed, the crisis forever changed the way developing countries in the aforementioned regions run their economies. This matter will be discussed in detail. Subsequent sections of this report will deal with specific issues relating to international debt crisis. The first section will deal with the factors that led to debt crisis, which was first experienced in 1980s; the second section will address the nature of these cases in individual countries and collectively as a group. This second section shall also report on the effects of the crisis on international banking industry that had huge contribution in creating enabling conditions. The third section shall elaborate on short and long-term measures that were applied at that time and the ones being applied today. A conclusion stipulating on several important points shall follow.

Causes of Debt Crisis

As described in the introduction, debt crisis occurs as a result of nations’ failure to meet their international loan obligations. Owing to fact that members of sovereign debts are huge, any failure by nations to keep paying annual premiums leads to an increase in interest payments payable to the point of exceeding principal amounts (Wachtel 77). Politicians in these countries are therefore quick to not that their countries are being exploited by foreigners and therefore resort to defaulting on loans owed to other nations and international agencies. Poor countries also benefit from well-wishers at international circles who aid in the process of helping nations defaulting on loans.

The seed for international debt crisis is said to have been plated in the 1973 OPEC oil embargoes (Wentraub 23) that resulted to sudden rise in cost of living worldwide. As it happed, increase in oil prices was resulting to higher production costs around the world. Developing countries had to therefore start borrowing loans to enable them overcome financial challenges posed upon them by the increase in energy prices (Weitraub 23). Most of the loans were provided to developing nations whose economies could absorb effects of higher oil prices. It has to be considered that most of developing nations were newly independent countries in Africa, Asia and Latin America that had not accumulated enough capital to caution their economies from such tough times. In addition, the same countries had been colonies on western countries and therefore had strong ties. This means that developed world was obliged to help their former colonies. Fact that developed nations had ruled over developing nations for decades and even centuries means that there were economic interests that had to be protected. As a result, corporations from developed nations could have coerced their governments to provide assistance to the developed world.

Unfortunately, most of the monies advanced to the developing nations were directed to the construction of capital infrastructure that was to be used in these countries’ production processes. Colossal amounts of finance were advanced for this matter. Problem was that most, if not all developing nations did not have the capacity to adsorb or use the monies on the right purposes; the money was redirected to consumption rather than investment (this will be discussed late). In addition, some of the projects that were established were not in line with the countries’ comparative advantages, which meant that funds had been used in the right purpose but on projects that could not bear income for these countries. For instance, George Ayittey (Ayittey 217) observes that in African countries like Kenya, there were loans advanced for the purpose of constructing fish processing factories around a certain lake.

The monies were well utilized on the project, but there was one problem: communities living around that lake were pastoralists who cared little about fishing. This meant that the fish factory was to become a shell in the countryside yet the country had to pay back the loan to its creditors. Ayittey gives another example in Ivory Coast. The country had been advanced loans to construct a mango processing factory only for the government to realize that the factory the factory’s capacity was ten times Ivory Coast’s annual mango production (Ayittey 211). The country was still expected to repay those loans. When it comes to the construction of roads and other transportation infrastructure, some governments had embarked on constructing the intended roads but they lacked funds for maintenance and upgrading. The roads later became impassable, which means that efficiency in transport systems was not achieved. This subsequently meant that countries would later face problems of meeting their loan obligations that became to be referred to as debt crisis.

In addition, fact that developed nations were feeling the need to help the newly independent nations to develop their infrastructure led to the failure of performing cost-benefit analysis on projects being funded (Schatan 120). As just indicated, officials from developed and developing nations were just singling on the project to be financed and immediately embark on providing money for that purpose. This mistake thus led to financing infrastructural development without care on future monetary needs to upgrade and maintain facilities. In addition, it was little considered that the receiving nations did not have enough skilled individuals to manage facilitate decent and profitable management of those projects.

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Some development economies like Deepak Lal (Lal 85) notes that economic ideologies of the day were key foundations for the debt crisis. Lal singles out import substitution, which led to beliefs that only through self-reliance that developing countries could overcome their economic challenges. In the attempt to help these countries to produce enough goods and services in their own localities, their counterparts in the west were ready to shower them with all amounts of cash to establish industries and infrastructures. This became the case of rushed development that was to be regretted later through the hardship of repaying what had been advanced.

After all these loans for development were made and the resulting infrastructure and factories were performing as expected, nations in the west started expecting to be paid back loans they had advanced to developing countries. However, the projects were making some contribution to the national economies. Developing countries were caught in the dilemma of whether to repay the loans or improve and maintain the infrastructure. As one would have expected, most nations chose the latter, reason being that it had a high propensity to benefit local populace; repaying the loans would have just reduced the lot of capital in these countries let alone increase fears that the countries were being exploited by foreign powers.

Another source of capital that led to debt crisis in 1980s was international banking institutions, which happed with some contribution from oil-producing countries (Watkins 120). The 1973 oil embargoes by OPEC led to the increase of oil prices worldwide. As a result, oil-producing countries found themselves with lots of petrodollars that could not be absorbed by respective local economies. As a result, countries embarked on depositing the money to foreign commercial banks, most of them in the west. Economic challenges that the west was facing because on increased energy prices meant that banks had to look for other debtors that could use the money being deposited by oil-producing countries. In addition, banks had unexpectedly found themselves with sudden increase in deposits, and had to subsequently look for areas to invest the money. At the same time, developing nations, most of which had just become independent in 1950s and 60s were in need of financial capital to establish their economies. All these meant that the newly independent countries were the prime places that banks would have invested their rising deposits. Commercial banks in the west thus started to provide capital to governments in these countries.

Unfortunately, commercial banks also performed similar mistakes with their governments: they never bothered to undertake a cost benefit analysis to understand whether projects would be in a position to repay principal amounts. This was partially contributed by increasing deposits in the banks from oil producing banks. Increase in bank deposits, shrinking local demand for loans, and heightened competition in the developed country’s banking sector blinded players against seeing risk of lending to developing nations. On the other hand, governments in developing nations were taking advantage of decrease in interest rates in the west. This meant that costs of borrowing had been reduced in western countries.

The combination of the above factors continued until late 1970s, when developed countries started getting into recessions and prices of oil were starting to normalize. As a result, banking sector in the west was starting to see drop in deposits from oil-producing countries. This reduction in deposits meant that banks in the west were to start reducing collecting what was owed to them by the developing nations, only to realize that these countries did not have anything to pay back. The developing countries were at the same time suffering from decreased commodity prices that had made their economies shine in mid-1970s. Some commodities like coffee had seen their prices soar to a point that coffee was referred to as the black gold (Wachtel 77).

Owing to fact that most countries that had been provided with monies by western governments and banks were agricultural, the decrease in world market for agricultural commodities was complete bad news for them. This did not make it easier to meet loan repayment obligations to developed countries. As a result, countries started seriously considering defaulting on the loans that had been blindly advanced to them by the developed countries’ governments and banks. Fact that these countries were relying on their agricultural products to pay for the loans also contributed to failure in meeting their loan obligations. In addition, governments in these countries had taken the center stage for economic development. In matters pertaining to agriculture, governments had through its agencies been involved with farming and marketing of the produce (Watkins 120). This means that reduction of international prices for the product led the state to lack enough resources to support the industry.

Increased participation of government in the production process led to increased corruption in developing nations, which led to some funds being directed to personal use instead of the intended public investment. Government officials that were responsible in paying national debts therefore saw paying debts as crowning stealing of public resources. Failure to pay back the loans was further necessitated by fact that most developing nations were suffering under brutal dictatorship. There was therefore no legal redress on those who abused public offices through corrupt needs. Despite this situation, governments and banks in western countries still advanced loans to the developing countries suffering from dictatorial leadership.

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Another reason that resulted to defaulting to debt crisis was too much reliance on external help in solving local problems. As it has been reported earlier, developed countries’ governments had been providing help to those in the developing countries in the name of making them more self-reliant in their economic pursuits. Since this had been happening immediately after 1960s independence, through 1970s, the developing countries governments had little incentive to improve their tax collection systems. As a result, these countries did not have enough money to maintain infrastructures that had been developed nor pay back loans advanced to them. The loans from developed countries thus became moral hazards that led to the crisis.

After considering all the above causes of debt crisis, it can be concluded that governments in both developed and developing countries together with western banking sectors contributed greatly to the debt crisis that characterized global economies in 1980s. It was especially due to the failure of stakeholders performing cost-benefit analysis of projects that were to be deve3loped using loan monies that led to failure of repayment. Indeed, countries that were being helped could not results of the said projects, reason being that the money could be invested in non-income generating activities or taken by corrupt politicians and bureaucrats.

Nature of Debt Crisis and Resolutions

Increased pressure from western banks to get developing countries to pay back loans that had been advanced to them was becoming common among countries. Some of them had done their best to pay back on the loans. However, government officials were feeling the pain of paying loans that had been squandered by counterparts before them. In addition some of the political leaders responsible in the facilitation of debt repayment were quick to get money into their own pockets. Threats from private banks in the west were not something that could deter them. Indeed, they were not taken seriously; because there is no way sovereign property could have been attached by the bankers. Indeed, banks could not have dared to attach sovereign property because of the international uproar that would have developed from such actions.

The first country to default on international debt was Mexico in August 12, 1982 (Meissner 225). The country’s proximity to the international banks in New York led had made it a key beneficiary of the loans that had been provided to developing nations. Mexico’s move was indeed bold because no other developing country had dared make the move. The central bank in Mexico had decided that the loans owned to banks in New York and foreign countries had to either be canceled or rescheduled. Debtors who refused to have their debts rescheduled were threatened with total default, which meant that the principle and payable interest would remain in Mexican government’s hands.

Brazil was quick to follow Mexico’s example of defaulting on their international loans. This country’s failure to pay international loan obligation was also explained as that the country had not benefited as there was nothing to show in investments that had been done. As if to borrow queue from Mexico and Brazil, 27 countries had refused to meet their international loans obligations by June 1983, barely a year after Mexico’s lead. This unanimous action by developing nations against banks, governments and development organizations in the west became the first time ever that the world experienced massive default in history. Fact that lots of money had been provided for the development of developing nations exposed the entire world, especially banking sector to the crisis.

The stakeholders in this crisis had to develop long-lasting solutions, which happened to forever change financial relations between developing nations and their debtors in the west. In a quick measure to prevent the occurrence again, governments in developing nations were requested to change the way they conducted business. For instance, they were asked to embark on privatizing national companies that had been established through loans from other banks. This was initially not taken well by developing countries’ governments, because they thought that banks wanted to take those assets. However, the managerial difficulties and inefficiencies that had characterized operations in those companies were forced.

The debt crisis also served as opportunities for developing countries to adopt market economy as opposed to economic planning that had characterized these nations. This factor was especially emphasized on the fall on USSR in the later years of 1980s. Through the fall, international organizations together with western governments gained more courage to approach developing nations with market economy as the main prevention of another debt crisis in the future. The failure of developing nations to take care of their loan obligations with western banks also led to the end of greater cooperation between the two. This is because banks would not have agreed to undergo the same process again. However, it did not mean that banks would not provide loans to the affected countries; loans were however to be provided to the private sector of the countries privatizing their national resources, and especially those that had adopted market economy. In addition, the establishment of stock markets in many nations that had been affected by the crisis led to the influx of private investors from rich countries. Banks too and other financial organizations were quick to embark on re-financing projects in developing countries. Most developing countries have therefore embarked on developing market mechanism that helps in prohibiting the much-needed investment capital for local entrepreneurs.

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Works Cited

Ayittey, George. Africa Unchained. New York, Palgrave/Macmillan Gall, Normal, “Money Games Played by Bankers,” Forbes, December 15, 1984, pp. 17

Lal, Deepak. Development Economics. London, IEA.

Meissner, Charles. “Reforming Sovereign Debts,” Foreign Policy, 59, Fall 1986.

Schatan, Jacobo. World Debt Crisis. Zed, Mexico City, 1987.

Wachtel, Howard, Economic Order and Money Mandarins, Pantheon, New York. 1989.

Watkins, Alfred. International Debt Crisis, New York, University Press, 1986.

Wentraub, Robert. “Crisis and Challenges of International Debt.” Cato Journal. 4 (1984): 21-61.

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