Once a truth is universally acknowledged, some economists feel a duty to shoot it down. Many of those who have wrestled longest with the plight of the world's poorest believe that debt cancellation is often bad for those receiving it. They have strong reasons to dispute the consensus on debt relief set to be crowned at the G8 meeting in Gleneagles this July.
The economist Jeffrey Sachs has been a key inspiration behind the $51bn debt cancellation plan that will write off all the multilateral debt of, eventually, 27 mostly African countries. Debt relief is a major component of Sachs's plan to achieve the end of poverty by 2025, and was a springboard for his biggest "shock therapy" success stories: Poland and Bolivia. The one big failure he admits to, Russia before its oil boom, is ascribed to the unrelieved weight of Soviet-era debt. Sachs's friendship with Kofi Annan and his authorship of the UN's millennium development goals has made him "probably the most important economist in the world," according to the New York Times, even before his association with Bono and Bob Geldof. But other economists don't just envy Sachs's exposure; many view his prescriptions as dangerously wrong. What is the argument, and what is the evidence against him?
If countries have already stopped making payments on debt—a frequent occurrence in war-hit places like Liberia and Sudan—"relief" brings no new funds; it merely affirms the loss of creditworthiness. If cancellation is partial, recipients can end up paying more, as they resume full service of the remaining debt. Financial markets rarely distinguish between cancellation by creditors and repudiation by debtors: both represent default, and so obstruct new borrowing for development. To regain lender trust, defaulters may need to submit to austerity policies every bit as severe as those imposed by debt.
Today's 42 "heavily indebted poor countries" (HIPC)—mainly countries in Africa such as Mozambique and Zambia—got that way after relief of previous, smaller debts. Their share of developing-world foreign direct investment halved during the 1990s, to 2.5 per cent. So the earlier debt relief does not seem to have helped. Former World Bank economist William Easterly concludes from the HIPC record that "Debt relief has brought little of the benefits promised." He identifies a strong "moral hazard," with governments borrowing more and reforming less because they expect to be relieved again. Anti-poverty campaigner Susan George foresaw this in A Fate Worse Than Debt almost 20 years ago.
Campaigners complain that the biggest debts are run up by corrupt dictators and and then inherited by their democratic successors. But private banks have acknowledged this faster than official creditors. The Latin American and east European countries that resisted default were allowed to scrap part of their commercial debt and repackage the rest into tradable bonds, whose cost quickly fell as activity and liquidity recovered. But IMF proposals for a similar "orderly workout" for today's problem debtors were blocked, by the same G8 governments now championing debt relief.
Cancelling the debts of countries still repaying them amounts to a transfer of resources akin to foreign aid. The new G8 enthusiasm for increased aid owes much to 1990s World Bank research by economists Craig Burnside, Paul Collier and David Dollar, suggesting a clear link between aid and growth and poverty reduction when "sound policies" are put in place. But Easterly's work also contests this, driving him to the conclusion that "spending $2.3 trillion (measured in today's dollars) in aid over the past five decades has left the most aid-intensive regions, like Africa, wallowing in continued stagnation." The World Bank's "strong" connection between aid and policy actually disappears, he argues, with small changes in dates, definitions or data. The Asian tigers that escaped stagnation—many of which were poorer 40 years ago than most of Africa—did so by avoiding prolonged dependence on aid and keeping policies and industries in their own hands.
While excessive debt immobilises countries, manageable debt can transform their fortunes. Showing an ability and willingness to meet creditor conditions attracts equity investment, and encourages good economic and business management. So-called micro-loans, pioneered by the Grameen Bank of Bangladesh, impose high interest rates and short payback periods on some of the world's poorest borrowers, with a low default rate and generally positive outcomes for lender and borrower.
The western world's productivity and profit gains in the 1990s were linked, in part, to the enabling and constraining effects of tradable corporate debt. Debt underpins almost all corporate expansion and innovation, and governments have equally good reasons to incur it: to spread to future generations the cost of investments and social provision from which they will benefit.
Nations with a low savings rate and big appetite for credit have long been among the world's fastest growing. Lenders' belief in US expansion has maintained the low interest rates that help fulfil that expectation, as Americans consume more than they produce and invest more than they save. The debt-averse eurozone has, at times, grown only half as fast.
Most rich nations comfortably run up debts equivalent to 60 per cent of GDP, and often exceeded this in earlier phases of industrialisation. They don't have to ask for relief, because they don't expect to repay; these national debts have been "rolled over" for a century or more, for good reasons. If not excessive to start with, debt remains sustainable as long as output and exports grow in line with it. When they don't, the usual escape is to let higher world inflation cut the debt's real value back down to size.
The protesters of Seattle were right to complain at the double standard that forced poor nations to trade freely while the rich clung to protectionism. The protesters of Gleneagles should be wary of adopting a double standard themselves—condemning the poorest to default, while basking in the rich world's very different approach to running up the national debt.
