I will begin this essay with the debt issue. But because of this opportunity to bring other participants into the follow-up discussion, I will broaden and deepen the questions on economic development, including: Why do economic formulas work so well in some parts of the world and not in others? What money help is better for poor countries: grants, loans, or investments? Will globalization destroy us all or will it build a better global community? But first the debt question.
Jubilee and HIPC (Heavily Indebted Poor Countries)
The Jubilee 2000 Coalition believes that the start of the new millennium should be a time to give hope to the impoverished people of the world and calls for cancellation of the unpayable debt of the world’s poorest countries. A general call for write-offs of debts began as early as 1990 when the All Africa Conference of Churches called for cancellation of unpayable debt. No one really paid attention until 1995 when a coalition of Non-Governmental Organizations (NGOs) in the United Kingdom such as Christian Aid, OXFAM and others, took up the cause. The call for action soon gained a momentum that surprised even Ms. Ann Pettifor who has led the Jubilee coalition for several years. Similar action groups were formed in other European countries and North America, as well as in many less developed countries. These national groups created awareness among their legislators of a pending debt crisis. And real international attention was given the issue when Gordon Brown, UK’s Chancellor of the Exchequer, kept bringing it up at G7 (later G8) meetings in ’98 and ’99. These heads of state asked the World Bank and the IMF to look into the matter and come up with recommendations.
There was much less chagrin among Bank and IMF staff to tackle this assignment than presumed by the outside world. For some twenty years these institutions had tried to solve the structural puzzle for reducing poverty in the poorest countries. The dramatic successes of poverty reduction in Latin America and Asia in the late ’80s and early ’90s were not seen in Africa. It was hoped that lending in support of export promotion and balanced budgets — touted under the structural adjustment formula — would see a surge in economic growth among the poorest, especially in Africa. It didn’t happen. Official debts (debts owed by governments) even at highly concessionary interest rates were piling up. Too much program lending — in support of vague import lists — was, in fact, returned to lenders as service payments on earlier loans. This was not leading to sustainable development.
So staff came up with a list of guidelines which, when met, would qualify a poor country for some debt forgiveness. These
qualifications for debt relief for the Heavily Indebted Poor Countries (HIPC) included low GNP per capita — under $700, a very high aggregate debt of at least twice the value of annual GNP (US debt is half the annual GNP), and other ratios. But the key goal was that no poor country would need to use more than 25% of annual export earnings to service external debt. This was and remains the key answer of the international financial institutions (the IFIs) for future lending relationships with the poorest countries: sustainable debt for sustainable development. But there was another change implied in the fine print. Henceforth the IFIs would become more involved in internal matters of sovereign states. Why the high expenditures for the military? Why all the dollar deposits in private accounts abroad? What level of democratic participation is practiced in the country? And each country receiving cancellation of some debt would need first to prepare a Poverty Reduction Strategy Paper (PRSP). How would the poor benefit from reduction of government external debt? Governments seeking debt relief would need first to prepare and share with their own people some clear social development targets. Political leaders needed to become more accountable.
By mid ’99 these criteria for cancellation of debt were generally accepted by the G8 and other donor countries. Some debtor countries and their advocates in the NGO community wanted total debt forgiveness. The donor countries said they’d first try the 25% debt service threshhold and see whether it brought help to the poor in the slums and the villages. So, while demonstrations were increasing on the streets of Washington and Okinawa calling for total debt forgiveness, discussions inside the halls were moving in the other direction — toward more caution. For two practical reasons: 1) If the UN-related financial institutions declared these poor countries bankrupt these countries would have no credit and would be unable to operate in the international market and, 2) who would pay for the massive write-offs so that the financial institutions themselves would not weaken their assistance to the poorest countries?
While the finance ministers of the G8 mulled the questions of how to pay for the write-offs World Bank staff began the detailed work of splitting these various and several sovereign debts into three categories: 1) money borrowed from multilateral development banks, such as the IMF, the World Bank and regional development banks like the Inter-American Development Bank (IDB), the Asian Development Bank (AsDB) and the African Development Bank (AfDB) and other smaller banks with concessional (cheap) money, 2) money borrowed directly from other governments and their export banks known as bilateral debts and, 3) money borrowed from large commercial banks like Chase Manhattan, Dresdner Bank, BNP, Mitsubishi and others, the latter money being the most expensive but quickest to get for short-term needs. In all, a country might owe various amounts to thirty or forty institutions falling into these three categories. None were willing to cancel a part of their exposure if the other banks didn’t equally participate. Someone was needed to lead the negotiations. So, the G8 asked the World Bank to chair the debt-forgiveness meetings with all creditors even though the World Bank might not be the creditor with the largest exposure. So, how did the Bank do it?
But first, we need to interrupt the debt story to sketch the role of a few of the international institutions and why they were created.
The UN-related Institutions
Towards the end of WW2 the allies met in several settings to set up specialized institutions in addition to the UN General Assembly and the Security Council. WHO (health), the ILO (labor) and GATT/WTO (trade) were set up in Geneva. UNESCO (education) in Paris. FAO (food) Rome. The Maritime Institute in London, etc. And at a 1944 meeting in Bretton Woods, a ski resort in New Hampshire, the allies created the International Monetary Fund (IMF) to help stabilize the value of national currencies, and set up the World Bank to help finance the reconstruction of Europe and Japan as well as to facilitate development of other countries. In fact, development was an afterthought to help perhaps a few independent Brazils and Argentinas. Many Asian colonies and most of Africa were not even independent states at the time, of no concern to the emerging UN system. The two Bretton Woods institutions were headquartered in Washington because at the time the US was the only country with the money to get them started.
Unlike the UN General Assembly, where each member country has one vote, in the financial institutions the voting shares are in proportion to their financial responsibilities. In the early years the US had nearly 25% of the shares (and votes) but that has decreased over the years to 18% today. UK, France, Germany, Japan each have about 6%, Canada 3% and so on giving Europe, North America and Japan about 60% of the shares. All member countries, however, rich and poor, have some shares and are represented on the Board which meets weekly to approve loans.
The World Bank had a slow start. It had to borrow money in order to lend but had no credit of its own. With the guarantees of key shareholders, especially of the US, its first bonds were successfully launched and the first loans were made to France and Japan for reconstruction of their war-shattered infrastructure. That reconstruction phase lasted only fifteen years. By 1960 the economies of Europe and Japan were humming and no longer qualified for World Bank assistance. By its statutes the World Bank was to help only when other financial sources proved inadequate for a country’s reconstruction and development. By 1960 north and central Europe and Japan had graduated as borrowers but remained active in the Bank as buyers of World Bank bonds and as suppliers of goods and services to developing countries.
In the 60s many newly independent countries were knocking on the Bank’s door as colonies from Asia to Africa were launching their sovereign identity and qualifying for help. The cost of Bank money was lower to these new nations than from commercial sources. In the early years the interest rate markup was one to two percent above the cost of the Bank’s bonds. Later, and currently, the Bank’s margin between the cost of borrowing money and the lending charge fell to less than one percent. In the mid 60s the interest rate on Bank loans was at seven and eight percent and the repayment terms ran from 12 to 18 years depending on the nature of the project. That was concessional money for Asian and Latin American countries. But still too expensive for the newly emerging African countries.
Robert McNamara, after seven years as Secretary of Defense under Kennedy and Johnson, came to head the Bank in 1968 and saw quickly that cheaper money was needed to finance the development of the world’s poorest countries in Central America, Africa and the Indian subcontinent. He set up a special branch of the World Bank known as the International Development Association (IDA). He was able to convince the by then flourishing countries of North America, Europe and Japan to give (not lend) money to IDA which it would onlend to the poorest countries without interest for repayment over 40 to 50 years. Through a series of three-year replenishments he was able to receive major sums from donor countries which saw IDA as a major source of the cheapest way to finance development of the poorest countries without actually calling them grants. The borrowing country would have to repay the initial capital and a modest administrative fee over a long term. It would be a transitional fund to move a country to eventually assume regular Bank loans and then graduate to full independence in the commercial world. I joined the Bank in 1970, shortly after the IDA fund was established, and for twenty years worked on projects financed with this highly concessional money. Yet, cheap money was mixed with expensive money as leaders in the emerging countries also borrowed from commercial banks to promote their personal ambitions and elite tastes.
Now, back to reducing the debt. When the Bank was called in to supervise debt reduction they had to deal with these many creditors. Dealing with the bilateral and other multilateral creditors was quite straightforward since they were all politically established entities. Governments can always finesse their generosity on political and moral grounds. And they can take a bit of next year’s foreign aid budget to pay themselves and the debt-forgiveness trust funds. The private and commercial creditors are usually paid first by dictators because they ask fewer questions on the purposes of the loan. Yet, they too came to the table when their short-term loans were threatened.
The creditors looked not so much at the total initial amount of a loan as the net present value (NPV) of a loan and, more specifically, the debt servicing burden of each loan. When, after tedious calculations and negotiations, it was shown that, say, a 50% reduction of all loans would bring the country’s debt service to 25% of annual export earnings, then all creditors — multilateral, bilateral and commercial — would reduce their loans by 50%.
But how were the write-offs to be absorbed? The commercial banks would take their lumps and draw down their debt provisioning funds. Governments of industrialized countries could write off loans to developing countries and pay their own export banks through their foreign aid budgets. Maintaining credit ratings of the World Bank and other multilateral banks was trickier. If they had to write off all debts of the HIPC it would seriously deplete the no-interest fund reserved for the poorest countries, the very clients the fund was created to serve. In the end the G8 decided the multilateral banks would absorb about half of the debts forgiven and the other half would be paid by the rich donor countries. That’s where matters now stand — and are stalled. When the orginal promises of generosity faced the reality of actually having to come up with more money to pay the debts of other countries congressional resistance stiffened. In due course, some debts will be forgiven but not as quickly nor as completely as the Jubilee 2000 Coalition had hoped because debt forgiveness is not a benign act, it costs somebody money. In the case of the pool of no-interest funds it would reduce these resources available for future assistance to the poorest countries and would require another outlay from donor countries.
An interim assessment of the debt-forgiveness exercise
Much good will come out of the Jubilee exercise. Here are some of the benefits:
- Of the $90 billion official debt owed by African countries some $20 billion could eventually be dropped. Already Mozambique, Tanzania and Uganda are having their debt burdens cut by 50%. Others could qualify soon. But I just don’t see the taxpayers of Europe, Japan and North America coming up with much more than $20 billion over the next few years. South Africa, Botswana and Namibia don’t have debt servicing problems. Ghana has opted not to seek debt forgiveness because it prefers a strong line of credit for trade. Bangladesh, India, Nepal don’t qualify for relief because they earn so much hard currency in trade and tourism and remittances back home of their citizens working abroad that their debt service levels are less than 20% of export earnings. And the many countries at war in Africa will have to wait for peace to be even considered for debt relief.
- The new guideline that no poor country should have a debt servicing burden of more than 25% of foreign exchange earnings will be a useful benchmark for future official debt. Borrowing countries will seek the cheapest money possible and limit their demands for loans. The lending Banks - multilateral, bilateral and commercial — will limit their lending to stay under the debt-servicing threshold
- There will be increased pressure on the poorest countries to come up with policy decisions and transparent governance which lead to trade and economic revival instead of hindering the economic energies of their own people.
The downside of Jubilee includes:
- A major depletion of low-interest funds for the poor countries. These IDA and other similar initiatives which were set up as revolving funds to help poor countries will see those funds reduced for on-lending because repayments are canceled.
- There will be major calls for more grant money from the have-nations to help the poor countries. Grants will continue to come for emergency relief, but the day of bilateral grants for building the physical and social infrastructure needed for economic development will not be forthcoming. A generation of corrupt oligarchs has squandered the goodwill of the donor world.
- By taking the side of corrupt leaders in the name of helping poor people improve their educational and medical services the NGOs became suspect of naivete at best. The foreign debt in dollars has almost nothing to do with domestic budgets for health and education which are 90% expenditures in local currency which these governments print freely. Did the NGOs really think the dictators at war care one whit about the welfare of their own people, that debt relief would build a rural clinic instead buying another machine gun? I was greatly disappointed by the lack of reflection by our own Mennonite students and academics. Surely, after all these years of serving abroad our community could see beyond the hype. We should have carried placards like:
No debt relief to the dictators.
No debt relief to countries at war.
First free the political prisoners.We squandered a great opportunity to make real progress for the poor.
Much useful restructuring of borrower/lender relationships will come out of the debt exercise, but little help will come to the mothers and children in the village. That will come when governments become more accountable to their own citizens.
What works, what doesn’t work in economic development?
Though debt was the upfront issue for Jubilee, four other matters of long-term consequence to economic development were on the agenda of the demonstrators.
- growth via trade vs. redistribution of wealth;
- globalization vs. national sovereignty;
- fair labor practices;
- environmental protection.
Again, let’s interrupt the immediate and look at the larger story of the human economic venture. Ever since Adam and Eve left the Garden their descendants have labored by the sweat of their brows to make a living. Thanks to unequal interests and talents they learned early on that by specializing and trading they could all improve their lot. And when improved means of transportation and communications were added they could enlarge the circle of traders and broaden the spectrum of benefits. Instead of limiting themselves to trading by barter — a cow for a plow, a goat for a boat — they began using precious metals as a medium of exchange and the temporary storing of wealth. Nothing much has changed in the terms of economic development over the six thousand years of recorded history: specialization and trade create wealth which can improve the standard of living for the participants.
For thousands of years the economic cycle of life revolved around crops, livestock, religion and war. The known world was the Middle East, Europe and China via India. And some trade developed overland. But the rush of economic change happened after sea routes opened up new lands to exchange new goods for basic commodities. The Magna Carta, the Bible in the vernacular, the Reformation, the Renaissance, democracy were all trends of social change that empowered the individual. In tradition-bound times the lords, bishops and feudal elite set the pattern of economic activity. The peasants were locked into servile service without choices. But the Enlightenment filtered new ideas even to the peasants.
The industrial revolution created opportunities for inventors and investors. But also for the peasants. Their children could work in the sweat shops under horrible conditions but the revolution broke the back of feudalism and elitism. And it opened a whole new sector of the world’s economy. Manufacturing was not dependent on land to create wealth. By harnessing energy and transmitting power to drive machines in assembly lines doing repetitive tasks, goods could be produced cheaply for mass markets. Henry Ford’s dream that even the assembly line worker should be able to have a car for himself was an economic revolution.
But if the 18th and 19th centuries started the move to the factories and created the concentrations known as industrial cities it was the 20th century that brought these possibilities to all corners of the world. At the turn of the century America was a debtor country owing massive debts to European creditors who financed construction of the railways and the factories. Borrowed money opened the West and built a national transportation system which delivered the machines and brought wheat to the cities. And the obligations were honored. Debts were paid. By the mid 1920s the US became a creditor country. By the time of Pearl Harbor and the US entry into the Second World War the American economic structure was solid enough to not only build the war machine but also to finance the allied cause. The allies floated bond after bond which their citizens bought, and governments honored every dollar with interest. Governments could have asked their citizens to forgive official obligations in the name of patriotism but they did not. Citizens needed to cash in their savings to rebuild the peacetime economy. Governments needed to retain credibility and creditworthiness.
It is in this postwar setting that the institutions of international development were created at mid century. The renewed dream was to build a United Nations family, free of war, free of poverty.
However, the Cold War took its toll of resources and formed strange alliances. And the economic war on poverty took two very different paths. In their extremes we called them capitalist and socialist, private enterprisers and government-controlled economies. Both systems had merits and flaws and generated heated debates among academics and policy makers.
The first round went to the government-controlled camp and started with Jawaharlal Nehru and his National Planning Committee of the Congress Party even before independence of India. Indeed, it completed most of its work prior to Nehru’s arrest in 1940 by the colonial government. And when India was granted independence in 1946 the government was ready to roll with its state-controlled plan: heavy industries, large scale manufacturing, electric power and scientific research were deemed essential to national economic independence. The social goals of the economy were to insure an adequate standard of living for the masses. To achieve these goals the national income had to be greatly increased and there had to be a more equitable distribution of wealth. The committee even spelled out nutritional goals of 2400 to 2800 calories per day per working adult, doubling clothing consumption to 30 yards of cloth per capita, increasing life expectancy by improved medical services, abolition of illiteracy.... And the state would have ownership and/or closely regulate the industrial, agricultural and financial sectors.
An even more radical form of state-control directed the economies of the Soviet Union and other communist countries. India and other countries nonaligned in the Cold War confrontation grouped themselves in the Group of 77 most of whom followed the Indian example of state-controlled production and services. Both the communist economic models and the Indian socialist models served their people rather well for thirty years after WW2. The energies of reconstruction carried them through the 60s and the high commodity prices of the 70s seemed to confirm their premise that government control could best serve all the people. But the drastic decline of agricultural and energy prices in the 80s and 90s collapsed their only export incomes. No one but nationals were buying manufactured goods produced under policies of import-substitution. This policy saved foreign currency but it earned no foreign currency to finance imports. To their chagrin their economies stumbled as they saw their neighbors in East Asia soar in exports.
Immediately after the war Japan implemented an export model which targeted the markets of North America and Europe. In contrast to their exports of the 30s which were shabby imitations, the Japanese insisted on quality products at a competitive price. By the mid 70s they had beat Detroit at its own game in automobile production and became the standard for the new electronic gadgets from television sets to the new world of computers. Taiwan and South Korea learned the same lesson. Import-substitution limited the producers to a small national market. Export targets forced a better product at lower cost but offered the world as a market. Hong Kong and Singapore followed quickly to make up the four tigers. Then Thailand, Malaysia and Indonesia offered their cheap labor to investors from Japan, Europe and America who were seeking cheaper assembly sites.
And when the tragic years of China’s cultural revolution ended in 1978 that country changed its economic model and joined the export promoting world by offering its massive labor force to the manufacturing sector. Finally, after another financial crisis in 1991, the Indian government encouraged the private sector to do its thing. Now at end of the decade the Indian economy is growing at 6 percent while its neighbor, China, is cruising at 5 percent. This does not mean India’s goal of reducing poverty is on hold. Rather, seeing government could not do it alone they decided to let the people do more of it themselves.
What then is the role of government in an effective development model? There are things government must do, things government can do, and things government should not do.
- Provide security for people and property. Development cannot happen when people are molested on the streets and in their homes, when property is stolen or confiscated — even by government — with impunity.
- Through clear and simple legislation define the economic system and contract procedures that government and the private sector will follow in a transparent system of laws and regulations.
- Provide an efficient administration of these laws through a small and well-paid civil service which does not need bribes to feed their families.
- Establish an independent, well paid, judicial system that arbitrates disputes fairly.
- Encourage a free investigative press.
- Issue and maintain a stable currency regulated by an independent central bank or tied to a stable foreign currency.
- Encourage the creation and stabilization of financial institutions which attract the people’s savings and use these funds for national development.
Governments enhance development if they can also:
- Provide for a national education system which promotes universal literacy and training in simple skills.
- Offer health maintenance education and basic clinical care for all its people.
- Build or facilitate the construction of an infrastructure of roads, ports and communications that serve all regions of the land.
Governments should not:
- Pick private and corporate winners and give them preferential treatment. That is dangerous ground. The current financial malaise in Japan, South Korea and Indonesia is due precisely to this policy of picking winners. Concerted favoritism between government and a few corporations in the private sector leads to cronyism with public money layered over bad decisions. Remember the Resolution Trust of the late 70s? The US government had relaxed investment controls on savings and loans associations resulting in massive risky real estate schemes. The government, rightly, rescued the depositors (not the S&Ls) at a cost of $50 billion and let the shaky S&Ls go bankrupt or be bought up by more stable banks. Japan’s banks will need a government rescue package of $500 billion to erase bad loans, but the cozy arrangements of the past continue to delay an effective solution. Governments and their economies are at their best when they enhance the opportunities for all their citizens, not just a few.
- Nor should governments be in manufacturing and distribution of consumer goods. The communist economies of Russia and China tried and succeeded to supply consumer needs up to a point but were eventually overwhelmed by the innovations, better quality and lower prices of the private sector. The inefficiencies, nepotism and corruption of government-owned factories is not worth the dubious merits of controlled lower prices subsidized by the national treasury.
The 20th century has shown us some clear policies for governments to effect economic development. This century also saw the almost universal rise of democracy as a foundation of legitimate government. Dictatorships are very efficient in waging war and targeting their economies in support of personal objectives. Totalitarian governments led Japan, Germany, Italy, Russia, China and most of Latin America during WW2. Most now have turned to democratic forms of government liberating not only their citizens for political participation in shaping society but also freeing individual energies to build national economies. Half of Africa is still run by dictators and warlords who tie up the economies for personal gain and power. Poverty will be eased in Africa when the people are freed to work for the welfare of their families and communities.
We know what governments need to do. And we know what policies of international intervention are helpful. Grant money is needed for temporary relief, official loans can help build a national infrastructure to serve all economic players, private investment money is the real trigger that launches economic takeoff. But we must address a few of the other issues that haunt our way toward a more equitable world.
Economic growth through trade is the best way to alleviate poverty say the IFIs and the WTO. Not so, say the social workers: a redistribution of existing and new wealth would immediately solve poverty and ease tension among economic classes. Both views are right. But not concurrently. They work best in sequence. Growth and trade create jobs and wealth. As demand for labor increases the price of labor increases. At that point government needs to set new levels of minimum wage which resist income declines during an economic slowdown. Likewise, the indirect noncash benefits of health care, maternal leaves, education and retraining need to be consolidated through legislation during the good times in order to ease insecurities in bad times. Growth and redistribution of wealth are not opposites, they are highly complementary when handled in rhythm.
Globalization implies a lessening of national sovereignty. The more we join international organizations the more we join a global community with diverse values and agendas. And when we sign up for freer trade the benefits go in both directions. The European Union has gone the farthest in allowing not only free trade of goods among member states but free movement of labor. The member states of Europe have given up large chunks of sovereignty to enjoy larger markets and choices. NAFTA is moving towards free movement of goods among Canada, US and Mexico. The newly elected president of Mexico will push for a European style free flow of labor across our borders.
De facto we are moving towards three major currencies in the world: the US dollar, the Euro, and now the East Asians are rallying behind the idea of one currency stabilized by the yen. Every time a nation joins a regional association it loses some independence, a bit of its sovereignty. When lovers marry they give up some freedoms in exchange for other benefits. We do so by choice. Nations join trade associations because they facilitate trade. Some people object to the trend, others see this as part of building a worldwide community. In the meantime we all enjoy multinational airlines, global communications and shopping at Wal-mart.
The Jubilee demonstrators for debt relief were joined by labor leaders and environmentalists who had their own agendas quite unrelated to debt forgiveness. Labor unions of Europe and North America want WTO to enforce developed labor standards abroad, thus lessening the advantages of building factories abroad. Yet, the developing countries want to continue to create more jobs for their low-cost labor and thus lessen poverty in their midst. They’re even eager to apply lower environmental standards in order to lure the large multinational corporations. The volume of private investments to the developing world is now four times all bilateral grants and multilateral lending combined. And those investments are in factories and services. They create jobs. And jobs alleviate poverty.
- The current exercise in debt forgiveness promoted by Jubilee will help define future levels of sustainable national debt. This will lessen the role of the lending institutions and sharpen awareness of fiscal responsibility among poor countries. Both effects are salutary. But debt relief will see almost no benefits trickle down to the mothers and children in the villages and the slums. Corrupt dictators and the oligarchic elite of poor countries have little concern for their own people.
- Government has a modest but essential role in the economic development of its citizens. When governments offer a secure setting with honest administration of laws which promote transparent opportunities for all and stands aside to let the people work then economic development happens. Always. Anywhere.
- Globalization is a mixed blessing. It lessens cultural distinctions and cherished values due to the global media which spread Hollywood movies and the Pokemon phenomenon. Global trade, however, enhances the prospects of job creation in the remotest parts of the planet and will bring more people out of poverty than high walls of tariff protection and the exclusion of foreign investments. Just ask 10KV (Ten Thousand Villages).