October 20, 1999 | Commentary on Foreign Aid and Development

A Clean Slate for Poor Countries

During the late-September meeting of the International Monetary Fund and the World Bank, President Clinton said he would ask Congress to forgive the debt owed by 36 of the world's poorest countries to the United States -- an amount totaling $5.7 billion. Unfortunately, the proposal is only a temporary solution; it does nothing to repeal the cycle of lend-forgive-lend-forgive that keeps poor countries indentured to the developed world.

The president's proposal follows an earlier agreement by the wealthy G-7 nations to forgive most of the bilateral, or country-to-country, debt owed by poor nations. His proposal commits the United States to forgive the remaining debt these nations owe the U.S. Treasury after the G-7 agreement is implemented. While both these plans are better than the IMF and World Bank's proposal to "restructure" poor-country debt, they fall short of the best solution: Forgiving poor-country debt completely in exchange for an agreement not to seek new loans.

Debt forgiveness for the developing world is imperative. For many poor countries, external debt is already more than twice their gross domestic product. As this burden increases, they must allocate greater portions of their budgets to debt repayment, resulting in higher taxes, more borrowing or debt default.

The president's proposal won't solve the debt problem for several reasons. For one, it does nothing to repair the IMF and World Bank's flawed debt-restructuring program, called the Heavily Indebted Poor Countries (HIPC) initiative. Even if poor countries are forgiven the debt they owe to other countries, they still owe substantial amounts to these international lending institutions. And the IMF and the World Bank refuse to cancel foreign debt outright because that would "diminish assurances of repayment on new lending and, in some cases, hurt their credit ratings," according to the General Accounting Office. In other words, they won't accept responsibility for past lending errors because doing so would harm their ability to commit new lending errors.

From 1996 until February of 1999, roughly the time the HIPC initiative has been in place, the amount poor countries owe to the IMF and World Bank has actually increased from $43.9 billion to $48.6 billion -- a 10.6 percent jump. As for the HIPC initiative's debt restructuring, the international development committee of the British House of Commons calls it little more than a "rearrangement of accounts."

Of course, "rearranging accounts" is what the World Bank and IMF have been doing for years. Countries unable to service current debt receive new loans, which spares the World Bank and IMF the embarrassment of explaining a "technical" default even though the countries have, in fact, defaulted. Such practices would rightly land private lenders in trouble with regulators, but for the World Bank and IMF it's business as usual.

Another problem with the president's proposal is that in exchange for having their debts cancelled, poor countries would have to spend the money they save on "development" projects in areas such as health and education. But the president forgets that money is fungible. Poor countries might use the savings to replace -- not add to -- the money they currently spend on health and education. Countries could take the funds they otherwise would have budgeted for development programs and spend it on anything they like. There's no guarantee a single debt-relief dollar will go toward the programs the president favors.

Most serious, however, is the failure of the president's proposal to prevent poor countries from accumulating more unsustainable debt in the future. Wiping out current debt is only part of the solution. A successful relief program must keep poor countries from falling back into the debt cycle. The only way to do that is to insist that countries receiving debt forgiveness refuse to accept future loans.

Such a requirement may appear harsh, but a fresh infusion of credit would only perpetuate the problems caused by past loans and deny poor countries the incentive they need to adopt free-market reforms such as reducing government regulation and enforcing business contracts. Only functioning free markets allow domestic entrepreneurs to flourish and attract increased foreign investment and private-sector capital -- precisely the kinds of dollars poor countries need from the developed world.

However well intentioned, the president's proposal merely gives poor countries a reprieve. To create sustainable growth in poor countries, two elements -- a ban on future loans and an embrace of free-market reforms -- must be added. Only then will poor countries begin to achieve lasting freedom from debt.

Brett Schaefer is the Jay Kingham fellow in international regulatory affairs and Denise Froning is a former policy analyst at The Heritage Foundation, a Washington-based public policy research institute.

About the Author

Brett D. Schaefer Jay Kingham Senior Research Fellow in International Regulatory Affairs
The Margaret Thatcher Center for Freedom

Related Issues: Foreign Aid and Development

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