The role of international debt

Introduction

This page focuses on the problems created by indebtedness within LEDCs and firstly asks the question, how did third world debt became so unmanageable?  This page also looks at the impact this has had on development.  Under the old syllabus this page was covered under unit 4.7.

Enquiry question

How do changes in the long term terms of trade result in a global redistribution of income, through deteriorations in many LEDCs who have specialised in primary commodities.

Lesson time: 90 minutes

Lesson objectives:

Outline the meaning of foreign debt and explain why countries borrow from foreign creditors.

Explain why the servicing of international debt causes balance of payments problems and has an opportunity cost in terms of foregone spending on development objectives.

Explain that the burden of debt has led to pressure to cancel the debt of heavily indebted countries.

Teacher notes:

1. Beginning activity - begin with the opening activity and then discuss this as a class.  (Allow 5 minutes in total)

2. Processes - technical vocabulary - the students can learn the background information from the videos, reading activities and the list of key terms.  (15 minutes)

3. Group presentation - activity 3 on part of the enquiry question, should wealthy nations simply right off the debt of Developing nations?  (20 minutes)

4. Developing the theory - activities 5, 6 and 7 focus on the issue of capital flight.  To what extent does this act as a burden on development and does this strengthen or weaken the case that much of the debt burden should be written off?  (30 minutes)

5. Applying the theory to Developed nations - activity 8 provides another discussion point. (10 minutes)

6. Link to the assessment - activity 9 consists of a final unit summary project.  (10 minutes)

Key terms:

Capital flight - occurs when assets or money rapidly flow out of a country, for example from the political and economic elites in LEDCs to safe havens in Developed nations.

Debt burden - the size of a nation's total debt as a % of its GDP.

Debt service ratio - the ratio of a nation's debt service payments to its export earnings.

The activities on this page are available as a PDF at: Third world debt

Beginning activity

Which nation is the world's most indebted, Zimbabwe?, Nicaragua?  The response might surprise you.  Find out at:

Most indebted nations

Activity 1

Start by investigating the level of debt, owed by the worlds 60 poorest nations in 1970 and then the level of debt 40 years later.

In 1970, the world’s 60 poorest countries (as classified by the World Bank), owed $25 billion in debt.  By 2002, this figure had grown to $523 billion, despite $550 billion being paid in both principal and interest during this period.  Approximately $ 153 of which was owed to multilateral institutions such as the IMF and the World Bank and $ 70 billion is still owed to multilateral institutions.

Activity 2: Reading activity

Watch the following short video, made by two high school students and then read the short extract. 

A short history of international debt

Prior to the 1970s the level of LEDC debt was relatively low and the repayments largely manageable.  As the short video highlights, this all changed in 1973, when the League of Arab nations (OPEC), angered by the West's support for Israel, doubled oil prices in a move designed to punish America and her Western allies.  The group then doubled oil prices again shortly afterwards.

This caused recession in many other parts of the world but meant that a small number of middle eastern nations became awash with petro dollars.  Not knowing what to do with their new found wealth many wealthy middle east individuals placed their savings into American and European banks.

The Western banks, now awash with cash, looked for new customers to lend their new found wealth to.  Western markets were saturated while many governments in Africa and the rest of the developing world were keen to borrow those funds.  Unlike earlier loans which were 'soft' in nature, these development loans were made at market interest rates and repayable in US$.  While some of this development money was well spent on infrastructure and other development projects, much of it was squandered by corrupt officials. 

Throughout the 1970s the debt crisis was largely manageable as real interest rates remained low and many LEDCs were gaining profits from exporting their natural resources at relatively high prices. 

This all changed in the early 1980s when Ronald Reagan came to power and borrowed large sums of money to finance tax cuts and increase military spending.  With America on the world market, borrowing large sums of money world interest rates rose, as did the American $ as investment funds poured into the country.  This situation was made worse by a collapse in world commodity prices as a result of a world recession.

With the LEDC government loans, repayable in US $ and at floating exchange rates, many nations were then suddenly saddled with higher repayment costs and lower export revenues from the sale of commodities.  Many LEDCs responded by borrowing more to make the earlier repayments and their problems escalated.  Mexico was the first LEDC to default on its loans in 1982.  In refusing to service their debt, the whole international credit system was threatened - if one country could get away with non repayment then what would prevent others from doing so?  Other LEDCs did follow Mexico in defaulting on their loans, forcing the IMF to take steps to manage the 'Third world debt crisis'.  

After this point the IMF would still lend development funds to Developing nations, but would only do so on the condition that they adopted certain policies designed to impose fiscal discipline on the nation.  These came to be known as Structural adjustment policies.

Activity 3: Group presentation

Divide the class into groups and then have each present their views to the class on the question of:

Should the wealthy nations simply right off the debt of Developing nations?

Factors to consider:

  1. The social / economic cost of the debt burden on LEDCs, e.g. in 1997, Zambia spent 40% of their total budget in debt repayments and just 7% on basic services such as vaccines for children.
  2. LEDCs currently spend $1.3 on debt repayment for every $1 that it receives in grants.
  3. Cancelling the debts of the 52 poorest nations would cost just one Euro cent a day for each person within OECD countries for the next 20 years.
  4. Would the money gained from cancelling the debt really go into improving living standards in LEDCs or would it simply encourage nations to purchase more debt - how can Western governments prevent this if they decide to write off the world's debts?
  5. Is there a third option, perhaps the answer could be to make debt cancellation conditional on genuine improvements to the nation's infrastructure, health and education sectors?

Activity 4: Debt relief under the heavily indebted poor countries (HIPC) initiative

The HIPC Initiative was launched in 1996 by the IMF and World Bank, with the aim of reducing the debt burden for the most indebted of nations.  This involved a two step process.  In the first, LEDCs wishing to qualify for debt relief must meet certain criteria, including a commitment to reduce poverty and the demonstration of a good track record over time. The Fund provides initial debt relief in stage one and then in stage two, full debt relief, once the nation meets its commitments.

By November 3, 2017 the IMF and World Bank had approved debt relief for 36 countries, 30 of them in Africa, providing $76 billion in debt-service relief over time. 

A list of nations is included below:

Post-Completion-Point Countries (36)

Afghanistan

Ethiopia
Mauritania
Benin
The Gambia
Mozambique
Bolivia
Ghana
Nicaragua
Burkina Faso
Guinea
Niger
Burundi
Guinea-Bissau
Rwanda
Cameroon
Guyana
São Tomé & Príncipe
Central African Republic
Haiti
Senegal
Chad
Honduras
Sierra Leone
Comoros
Liberia
Tanzania
Republic of Congo
Madagascar
Togo
Democratic Republic of Congo
Malawi
Uganda
Côte d’Ivoire
Mali
Zambia

Discussion:

Is the debt relief programme the sensible way forward for managing debt relief and if so, are there any amendments that need to be made to the agreement e.g. the conditions attached to qualify for debt relief, the number of nations that qualify - could this be extended?

Activity 5: What is capital flight and how has this added to the debt burden?

Does the level of capital add to the argument that debts run up by LEDCs should be cancelled or not? Watch the following short video and then decide whether you believe that many of the debts, owed by LEDCs should be paid or not?

Activity 6: A focus on capital flight

According to estimates, every year US$ 1.26 trillion - 1.44 trillion disappears without a trace from developing countries, ending up in tax havens or rich countries. In many cases this is perfectly legal, with individuals changing their local currency savings into a hard currency. Other forms of capital flight, however, are less legitimate, for example through multinational companies seeking to evade tax where they operate.  Even more cynically, capital flight also  includes corrupt heads of state illicitly moving state funds, very often received from developed nations, international development organisations or NGOs, into their private accounts to enrich themselves. The stories of Sese Seko of Zair, who is believed to have amassed more than $4 billion, or General Sani Abacha of Nigieria, who looted the Nigerian central bank stealing nearly $2 billion, are just the tip of the iceberg.

Taken from Capital-flight

1. Investigate which nations are most affected by capital flight?

Forum Syd has calculated that 15 of the countries with the highest cumulative illicit outflows are in Africa. They are Angola, Cameroon, Republic of Congo, Côte d’Ivoire, Ethiopia, Gabon, Ghana, Madagascar, Mozambique, Nigeria, South Africa, Sudan, Tanzania, Zambia, and Zimbabwe.  These fifteen nations plus China are the worst affected.

2. What impact does this have on development within LEDCs?

This biggest loss is through the potential tax revenue, that could otherwise contribute considerably to economic growth and development, in the regions and make a major difference in the fight to combat poverty.  Illicit capital flight restricts domestic investment, reduces tax collection, undermines trade and drains currency reserves.

If reinvested this capital would contribute to jobs and growth in those countries as well as supporting the value of the local currency.

3. What role have developed nations played in encouraging capital flight?

Western governments have been very reluctant to improve the transparency of commodity trading, which is one of the main channels of capital flight.  Such an initiative would not only help to curb the amount of capital which leaves Africa, but could also stimulate the reduction in corruption and tax evasion by improving transparency of the economic system. 

Specifically countries which receive exorbitant cash flows from Africa could report it, much as the African countries have to adhere to the rule of law and accountable governance.  The issue is unlikely to be addressed effectively unless there is a world-wide consensus about tackling the problem of capital flight.

Countries such as Switzerland, one of the world’s leading commodity trading hubs, refuse to implement payment disclosure regulations. These countries appear to profit from this lack of transparency: for example, in all the oil-rich countries apart from Angola, Swiss traders were the buyers in at least 30% of identified national oil companies’ (NOCs) sales.

Activity 7: A focus on capital flight in China

Watch the following short video and then summarise how many Chinese people are able to transfer their money out of the country despite the best efforts of the government to prevent them from doing so.  How does this illustrate the difficulty that many LEDCs have in preventing capital from leaving their nations?

Activity 8: How debt affect the wealthy nations too

Watch the following video and then summarise how the world's wealthiest nations too, are impacted by the debt burden placed on many LEDCs.

Hint:

The assumption in the video is that the debt burden is a significant contributor or perhaps the sole contributor to the lack of opportunity in many LEDCs, forcing many to seek refuge in the West

This also presumes that provided with greater opportunities in their own nations many people currently fleeing their own regimes would instead opt to stay where they are - another debatable assumption.

Activity 9: Final reflection project

Consider the following points from recent lessons and then present your findings to the class:

The impact of the following as a barrier to development in LEDCs

Barrier to developmentRanking order (1-5)Explanation

Debt burden

Poor governance
The role of the IMF / World Bank, including SAPs
Limited access to world markets through trade
Over reliance on a narrow range of primary products
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