Among some government officials and certain members of the financial press, the idea of debt forgiveness is in vogue. Many specious arguments have been made by an assortment of different groups who believe debt forgiveness is the financial panacea that will begin an age of economic growth and prosperity for lesser-developed nations.
Even rock musicians are getting in on the act. Most notably rock star Bono of U2 has been demanding that Western government forgive the debts of third world countries (and like many of his fellow “humanitarians” he has yet to volunteer his treasure chest of millions to aid the third world).
The rationale for proponents of debt-forgiveness is based on bad economics and a narrow understanding of international capital markets. The sad reality is that if developing nations were granted total or partial debt-forgiveness, the poverty-stricken masses of most third world countries would not experience any appreciable difference in their living standards. Moreover, debt-forgiveness would only help perpetuate financial unaccountability within inefficient bureaucratic governments, and could ultimately compound the problems of the developing world.
Most developing nations lack the investment capital and economic freedom necessary to fuel economic growth and development. There are many poor nations with an industrious and well-educated work force but which have never experienced economic prosperity. This is because the wealthy individuals of poor countries send their capital abroad to offshore accounts in order to avoid the financial volatility and political instability endemic in their homelands. Therefore, developing nations have had to rely on the the looting and mooching of foreign taxpayers by the governments of developed nations and the international capital markets for their financing needs.
In the mid to late 1980’s, there was an ideological shift in many developing nations toward market economics, and this in turn spawned immense interest on the part of rich countries searching for strong investment returns. The result was that capital transfers to emerging markets surged in the early 1990’s, and the local equity markets reflected foreign investors’ newfound optimism.
The real problem that arose was that many developing nations lacked the financial framework necessary to accommodate the massive infusions of investment capital, causing malinvestments to be made on a grand scale. The shift to market economics in these developing nations was only superficial window dressing.
Corruption and cronyism didn’t help the situation either, as many sweetheart deals were struck with government insiders eager to bilk the coffers of state-controlled financial institutions.
The result: many developing nations today are left with non-performing loans and punishing interest payments.
The Paris Club, a consortium of official lenders who convene in Paris, have rescheduled the debt payments for many of the poorest borrowers, but with every new government that comes to power, there is a demand for new terms. In fact, many poor countries argue that current leaders should not be held responsible for the corruption and profligate spending of previous administrations.
The problems facing the poorest nations of the world are the same today as they were fifty years ago. The lack of a market-based economy, capitalist political institutions, rule of law, and an uncorrupted judiciary have tended to diminish developing nations’ ability to attract foreign investment.
Forgiving the existing debt of poorer nations is really a cosmetic quick fix that serves to perpetuate the transfer of wealth into unaccountable government hands, postpone structural reform of the financial sector, and sully the already negative impression the international capital markets have of the worlds poorest nations.
Hypothetically, if all the debt of developing nations were forgiven today, those nations would still need to borrow tomorrow. Proponents of third-world debt forgiveness must ask themselves how the inability of developing countries to service their obligations will affect the cost of borrowing in the future. With a proper understanding of capital markets, the answer is truly enlightening.
Copyright IAAC.COM. All rights reserved. Reprinted by permission.
