2 - 1999
The Debts of poor Countries
General Debt Cancellation?
Economic and ethical considerations
by Hans Tietmeyer
Amongst the critics of the Campaign’s demands is the outgoing President of Germany’s Federal Reserve Bank, Hans Tietmeyer. While he acknowledges that a bolder approach to the debt problem than hitherto is necessary, Tietmeyer rejects proposals for a total and unconditional debt cancellation on both economic and ethical grounds. He suggests instead that a more generous debt reduction be given on a case-by-case basis and under stringent conditions for economic reform in the countries that benefit.
Public opinion has recently begun once again to pay greater attention to the foreign debt of developing countries. Demands have again been raised, particularly by the churches, for the debts of the poorest countries to be forgiven. In contrast to many advanced developing countries, whose economic environment has improved, in some cases significantly, during the 1990s as a result of internal adjustment measures, debt rescheduling and support operations by creditors, the debt problems of many of the poorest countries have continued to grow ever more acute right up to the present. In the public debate, stagnation, poverty, hunger and crass income differentials have, at times, been linked directly to the burdens imposed by excessive debt and heavy debt-service payments.
Against this background, it is now generally recognised that continued support for the heavily indebted poor countries is necessary. In the following I will examine with reference to both ethical and economic considerations, whether debt forgiveness can make an effective contribution to improving the difficult situation in the poorest countries, and, if so, what form it should take.
There can be no doubt that the high level of foreign debt, in conjunction with the difficult economic and social situation in the poorest developing countries, constitutes a major ethical challenge. The advocates of general debt forgiveness point, rightly, to the in many cases heavy burden of interest payments and principal repayments required to service past loans, which, it is argued, prevents the indigenous population from being adequately supplied with food, housing, education and employment, that is, deprives it of a life fit for human beings. Although in principle debts should be repaid, repayment cannot be demanded if that entails unacceptable sacrifices.
However, from an ethical perspective, too, debt forgiveness raises questions. For instance, it is far from certain that such a step primarily benefits those in real need in the developing countries. Indeed, even some of the advocates themselves fear - and probably not without reason - that debt forgiveness would chiefly benefit those whose economic mismanagement, abuse and exploitation, and failure to reform were major factors behind the given critical situation. A general debt reduction or a reduced level of debt servicing could be exploited by such groups to enrich themselves, to indulge in economic prestige projects, or to step up military spending, without the envisaged development-policy objectives been achieved. At the end of the day, the cancelling of foreign debt - as is forecast in many cases - would in a sense provide an ex post justification of capital flight from the poorest countries, or might even foster it further. Hence, above all from an ethical perspective, debt forgiveness must be embedded in an appropriate overall strategy if it is to result in a sustained improvement for the poor.
In addition, it must be determined for which countries, according to which criteria, and to what extent the foreign debt is to be waived. A fair balance must be struck between those countries which have so far been exclusively or primarily recipient countries, but have persistently refused to make the necessary structural adjustments, and those which have combined external help with reform efforts of their own, and which now, albeit not without difficulty, are standing on their own two feet.
A one-sided and undifferentiated approach in this area can hardly be justified in either economic or ethical terms. The same applies with respect to those poor countries with only a low level of foreign debt. Such countries would not benefit from debt forgiveness, although they are likewise grappling with the typical problems of underdevelopment, such as poverty, inadequate health care or poor educational opportunities. Clearly, instruments other than a general reduction in debt are required to help such countries. In this context, concern has been expressed that debt forgiveness could have an adverse effect on the overall provision of development aid. But increasing reluctance to provide aid on the part of the creditor countries would be to the detriment of precisely those poor countries that would not benefit from debt forgiveness, making them the biggest losers, a highly dubious outcome in ethical terms.
Generalised debt forgiveness for the poorest developing countries would subject the willingness of donor countries to provide aid on the basis of solidarity to severe strain in another respect as well. After all, social hardship also exists in some parts of society in the affluent countries, hardship that ties up financial resources. Given that the willingness to help cannot be increased indefinitely, in the final analysis different social objectives compete with one another, and it may not always be easy - indeed, it is often decidedly difficult - to decide in favour of one and against another on the basis of ethical considerations.
High levels of debt in many poor developing countries and the concomitant problems are not merely an ethical challenge that must be met in a differentiated way, they also force economists to face up to the empirical finding that excessive foreign debt is obviously an obstacle to sustained development in the economies affected. Solutions to the debt problem that aim to strengthen the forces for growth and stimulate the development of the private sector would also, in principle, permit greater social justice in the HIPCs.
The link between heavy foreign debt and economic underdevelopment is often explained in terms of the burden of debt-service payments tying up financial resources that would otherwise be available for higher investment. Although at first sight this view appears to be consistent with the usually weak investment activity in the HIPCs, it must be recalled that these countries have been, and still are, net recipients of foreign capital, in spite of their interest and principal payments. Evidently there are additional factors preventing resources from being used for investment.
In this context, the reluctance to implement reforms in many heavily indebted developing countries is emphasised, among other reasons. Yet this, in turn, is frequently interpreted as a consequence of high foreign debt. Market economic reforms, such as the liberalisation of foreign trade, the privatisation of state-owned enterprises and the restructuring of the taxation system in order to promote growth, it is argued, usually entail political and economic costs in the country itself, whereas the expected returns on reforms, in the shape of higher export earnings and greater economic dynamism, largely benefit foreign creditors in the form of higher debt-service payments (to the extent that the foreign debt has so far not been serviced according to the contractual requirements).
By way of such disincentives, an excessive debt burden is claimed to cripple the willingness to reform. Moreover, the heavy dependence of many HIPCs on creditor countries may have an adverse effect on the environment for investment decisions. Repeated rescheduling agreements, the outcomes of which are uncertain, and dependence on transfer payments, the level and timing of which are unknown in advance, may generate an atmosphere of uncertainty and thus promote a wait-and-see attitude on the part of investors, a phenomenon frequently observed. Last but not least, repeated rescheduling negotiations tie up scarce human capital that, particularly in developing countries, might well be deployed more efficiently.
However, to infer from such arguments the necessity of far-reaching, let alone general, debt forgiveness would be jumping to conclusions, all the more so since empirical studies have only partially confirmed the ’debt overhang hypothesis’ outlined above, particularly for the HIPCs. It is far from certain that internal sclerosis, a lack of willingness to undertake reform and economic policy mismanagement can be removed by the stroke of a pen in a debt agreement. Past experience shows that incentives for better economic performance must be complemented by controls that ensure that resources are put to appropriate uses.
Moreover, the unconditional forgiveness of foreign claims on the poorest countries could quite generally reduce the willingness to meet debt-service obligations (moral hazard problem). Other transition and developing countries, whose debt levels in absolute terms are far higher than those of the poorest countries, might also seek to have their foreign liabilities waived or take unilateral measures. This could ultimately pose a threat to the stability of the entire international financial system. But even if things did not go so far, it needs to be carefully considered whether debt forgiveness might deter potential creditors, and thus make it more difficult for developing countries, beyond the group of countries initially benefiting, to gain access to foreign sources of finance.
Any measures to ease the debt problems faced by the poorest developing countries must take due account of the special role played by the multilateral financial institutions. In addition to their advisory activities, they also play an important part as creditors to the poorest countries. The operations of the multilateral development banks, for instance, rely on a return flow of the funds provided, so that they can be passed on to other borrowers. The first-class credit rating of the World Bank and other development banks that is based on this fact enable them to borrow funds in the international capital market on especially favourable terms, which, at the end of the day, benefits developing countries dependent on official loans in the shape of low interest rates. Consequently, any measures that might weaken the capital-market standing and financial strength of these international financial institutions would have serious financial disadvantages for this group of countries, and must therefore be rejected, not least on development-policy grounds.
This means that, at the end of the day, primarily the industrialised countries and a small number of other advanced economies would have to reimburse the multilateral financial institutions for the funds required by debt forgiveness. To this extent, waiving the claims on the poorest countries would impose a strain on the financial resources of the creditor countries. On top of the lack of return flows from bilateral loans, additional contributions would have to be made to the multilateral institutions. In view of the tight budgetary positions and already high taxation levels in many countries, any government would have to examine very carefully how much it can ask of its citizens at the present time, for if the capacities of the industrialised economies were over-stretched, nobody would benefit, not even the HIPCs. To this extent, calls for a general forgiveness of debt for developing countries may easily kindle hopes that, given a realistic evaluation of the financial possibilities, cannot be fulfilled.
A plea for limited, conditional debt forgiveness for the HIPCs
Both the ethical and the economic evidence suggests that the comprehensive and unconditional forgiveness of the foreign debt of the HIPCs is scarcely feasible. Hence, the obligation to practice solidarity with the poorest of the poor, and the belief that scarce resources are being used suboptimally necessitate a search for alternatives.
There is much to support the view that limited (rather than general) conditional debt forgiveness should be considered. Such an approach would be likely to win broader acceptance among the creditor countries, set appropriate incentives for market-consistent behaviour in the debtor countries, and ensure that the international capital markets continue to function. At the same time, social objectives could be pursued as well. In a sense, such a solution could reconcile ethical and economic demands, a task that both sides must face up to in any case. For ethics and compliance with objective economic laws are not in contradiction, but belong together.
Specifically, such an approach means that it must be examined, on a case-by-case basis, whether the debt situation of a country exceeds a sustainable level, and which measures are likely to reduce the burden of debt-service payments to an acceptable level. This would encompass the traditional instruments used to ease the debt burden, such as issuing new, preferential loans to bridge over short-term liquidity difficulties , extending the repayment periods for outstanding loans, subsidised interest rates and, if there is no prospect of such measures achieving lasting success, (partial) forgiveness of foreign liabilities.
To an even greater extent than traditional rescheduling agreements, which are frequently coupled with adjustment programmes that must be implemented by the countries affected, debt forgiveness must be conditional on the fulfilment of reform commitments.
Given that the waiving of claims is a one-off and irreversible act, those benefiting must primarily be expected to make reform efforts. They must provide evidence of their willingness to cooperate and ability to implement reform, and must credibly show, through their behaviour, that (partial) debt forgiveness can be expected to result in favourable developments in the future. In particular, steps must be taken to preclude, as far as this can be judged, a renewed drift into the vicious circle of unsustainable foreign debt and unsatisfactory economic activity.
Professor Dr. Dr. h.c. mult. Hans Tietmeyer is President of the Deutsche Bundesbank (German Federal Reserve Bank) in Frankfurt Main and a member of the Papal Academie of Social Sciences. His text is an abriged version of an article, first published in "Kirche und Gesellschaft", Nr. 256, Köln 1999. Translated by Fremdsprachendienst of the Deutsche Bundesbank.