False Promises and Real Relief
On June 12, 2005, the finance ministers of the G8 finance ministers agreed to cancel the debt of eighteen of the world’s most heavily indebted poor countries. It is impossible not to welcome the decision, given that debt payments have been systemically draining resources from urgent social priorities. However, we must not be overly sanguine about the agreement, or deceived that the debt cancellation marks any kind of shift in the economic and social priorities of the G8. We are still a long way from achieving unconditional cancellation of all developing country debt. Nor does the present G8 debt cancellation address the underlying factors that gave rise to the debt crisis in the first place. Far more fundamental changes will be required to open up a broad spectrum of genuine developmental options for the South, and to free poor countries from future subordination to the mandates of the IMF.
What Was Agreed
Under the terms of the G8 agreement, the full value of all debts owed to 18 countries that were deemed to have "qualified" for relief has been written off. All qualifying countries have reached the "completion point" in the HIPC (Highly Indebted Poor Countries) program set up the 1990′s to exchange the promise of future debt relief for country’s agreement to undertake a prolonged and rigorous structural adjustment process. Measures imposed on various HIPC participants have included reductions in tariffs and other border controls; elimination of state supports for domestic industries; privatization and sale of vital infrastructure to foreigners; removal of capital controls to allow for the free flow of money in and out of the country; labor market deregulation to make it easier to fire workers; strict mandates concerning meeting budgetary surpluses; requirements that countries open up service sectors for foreign investors; and the phasing out of preferential government procurements used to support domestic providers.
In short, any promise of debt cancellation was tied to strict conditionality requirements. The IMF and World Bank, acting as the de facto agents of the international financial community, established strict surveillance and transparency requirements, and could unilaterally determine when a country was or was not in compliance with HIPC mandates. While these practices were justified under the rubric of "good governance," the real objective was to impose an even more stringent set of liberalization criteria that would effectively oblige any future government to follow free market mandates once the burden of external debt was removed.
It is by now widely acknowledged that HIPC failed to bring about a significant reduction in debt or achieve a notable reduction in poverty in these countries. Despite this fact, the current proposal of the G8 makes qualification for future relief to poor countries contingent upon completion of HIPC-mandated liberalization policies. In short, more neoliberalism imposed by the rich and powerful on the world’s poorest nations, overseen by the IMF and World Bank, which will unilaterally determine what constitutes compliance and who shall be eligible for any future debt write-off. None of the basic power structures of the present international order are challenged by the G8 agreement. The rich nations will continue to determine the fate of vast regions of the global economy; failure to comply with their mandates brings threat of permanent marginalization and exclusion from participation in the international system on anything approaching equitable terms.
So, while we welcome the cancellation, we have no illusions about the larger interests that are driving the agenda. The question is thus, what way forward from here?
Real Reforms: Cancel All the Debt
There are several proposals that progressives could consider in attempting to move the struggle forward. In the immediate term, we believe recent proposals put forward by Rep. Bernie Sanders and Rep. Jessie Jackson Jr. (the HOPE Initiative) on how to restructure trade and debt are a good place to begin, as these proposals can be used to launch a new set of campaign demands for more thoroughgoing reform of the international financial system. The HOPE initiative calls for full cancellation of all bilateral debt owed by African countries to the US; for US representatives to the international financial institutions to advocate full cancellation of all multilateral sovereign debts owed by African countries; and for funding for purchase at current market prices (generally around 10% of nominal face value), and subsequent cancellation of all private debts of sub-Saharan countries. Both the HOPE initiative and the Sander’s proposal would further cap at 5% the amount of a poor country’s export earnings that could be earmarked for debt servicing. The Sanders bill also calls for an independent and impartial body to be established to determine when a country is insolvent and hence eligible for debt cancellation.
We fully support these initiatives, and further believe that ALL developing countries’ sovereign debt should be cancelled in full without conditionality (sovereign debt is the liabilities of governments). The sovereign debts of developing countries are obligations that have often been incurred either through decisions made by elites who were the overwhelming beneficiaries of loans; or have been acquired through promises to entice private international financers to lend to private domestic entities. When repayment of these loans becomes difficult, cuts in wages, social services, and the like are then imposed on those who have had little say in negotiating these loans, but must now pay the price for the often imprudent investment decisions of the major Western banks over which they have no control. There is nothing just in this situation. The debts should be cancelled in full, for all countries, without conditions, to clear the slate and allow impoverished nations to begin anew.
Changing the Rules of the International Order
The real problem is what to do next. The debt crisis is not due simply to "bad policy" choices of borrowing governments, or the malfeasance of Third World elites, or the maliciousness of international financiers. On the contrary: the crisis, now ongoing for over twenty-five years, is endemic to the basic architecture of the international system itself. Loaning agencies systematically limit the range of projects that are considered as viable investments by favoring those that promise to generate more exports and foreign exchange over those aimed at developing internal markets.
Suppose a developing country wants to finance a project that might require importing goods form abroad for instance, capital goods or technologies not presently available in the country itself. If current foreign exchange reserves are insufficient to cover the projected costs, the only option is to issue debt on the international market. This requires taking out loans which are denominated in dollars, and which must be repaid in such.
So far, so good one might say. There is a catch, however. In borrowing on the international markets, the country is committing to repayment out of its future foreign exchange earnings. The only way to boost foreign exchange earnings is by increasing exports. The only way to insure a higher volume of future exports is to invest in those projects oriented towards the external market. Because imports must be paid for in dollars, and loans must be repaid in dollars, there is an inherent bias imposed by the market itself on the types of projects witch are deemed viable by borrowers. In other words, the fact that the dollar rules the roost, and that repayment must be made in "hard currency," which can only be increased through exports, creates a systemic "selection bias" that eliminates a broad range of otherwise viable and sound investment projects from serious consideration, given the imperative to export. Projects that would prioritize domestic development of internal markets are thereby excluded from consideration.
An Alternative Proposal: How It Would Work
While complex in its detail, the way to restore real choice to project financing and open up a range of development options for poor developing nations is simple in its essentials. For one, it is necessary to replace the current reign of the dollar, which continues to serve as the world’s preeminent international reserve currency with a universally accepted international currency issued by an International Central Bank. All national currencies would be convertible into this international currency at either fixed or floating rates, depending upon the type of currency regime favored by the national government. Further, all international exchanges would be denominated in this currency, so that the deficits and surpluses of countries would be quoted in a single international standard. Countries would have overdraft, or borrowing privileges, set at some agreed upon percentage of their total gross domestic product. Countries experiencing temporary trade deficits could borrow from the ICB at a level of up to 50% of its total annual trade over the previous five-year period. Banks exceeding this overdraft allowance would be charged interest; thereby creating incentive to maintain relatively balanced trade. Similarly, countries running persistent surpluses on their trade accounts of an amount that exceeded 50% of their overdraft allowance would likewise be subject to interest charges levied on the annual surplus. This is known as demurrage, or "negative interest", and would create additional incentives for countries to maintain more or less balanced current accounts.
John Maynard Keynes advanced these policy proposals in 1944 as an alternative to the dollar-denominated, US-centered financial system that was eventually established at Bretton Woods, which gave birth to the IMF and World Bank system. What is needed in addition is a system that would allow borrowers who need to finance international transactions to borrow and repay in their own currencies in order to free countries from the present dependence on exports to service international debt. One way to accomplish this is as follows.
A borrower wishing to finance imports for a capital project issues debt on the international market that is denominated in the international currency (ICU) issued by the International Central Bank. To set the terms of the repayment of the loan, the debt is indexed to the exchange rate prevailing at the time the loan is issued. For instance, if the present dollar-Mexican peso exchange rate is 1:4. (or the price of one IC unit is 4.00 pesos), then this is the rate of repayment of the debt if the currency of Mexican currency undergoes depreciation. So, for instance, every ICU owed on interest or principle due over the course of repayment would be payable at this rate of currency conversion. This means that, if the project was primarily directed towards sale on the domestic market, and the project succeeded, the fall in the value of the peso due to devaluation would not induce additional repayments strains on the borrowing entity. Nor would the project be de-selected on the basis of whether it would generate exports and foreign exchange; projects directed towards either exports or internal market deepening would compete on equal footing.
If the peso appreciates (e.g. increases in value relative to the ICU), then the debt would be repaid at the present market exchange rate, not the rate that obtained at the time the loan was issued. Otherwise, the real value of the loan would rise in domestic terms. For instance, if the value of the peso rises to 1:2.00, then the loan would be repaid at the current rate of exchange, not the prior conversion rate of 1:4.00. This will effect a reverse transfer of resources away from international lenders in favor of borrowing countries by effectively devaluing the real domestic value of international debts
One can immediately hear the outcry from our well-schooled and respectable economists that this interferes with the market mechanisms, and would encourage countries to borrow aboard, spend with scant regard for the principles of financial prudence, and then artificially inflate the value of their currencies to decrease borrowing costs. There are several responses to this. The first is so what? Who really would suffer under an arrangement of real devaluation of the value of international debts held by large multinational financial institutions? Certainly not the poor, certainly not workers in developing countries, certainly not small farmers, or poor impoverished states struggling to meet the basic needs of their populations. No, the real ‘victims’ of this arrangement would be the big Western financiers. Bond traders, in other words, would have to take the hit, as they would now be repaid in dollars that had, on the international market become less valuable.
The second is that there is no reason to believe that countries would all begin to engage in "irresponsible" manipulations of their currencies values, simply because they would still want to export some goods onto the international market. Hence, incentives would remain that would prevent countries from driving up the prices of their currencies, simply because this would reduce the competitiveness of their exports on the international market.
The third response is simply that lenders will be evaluating projects on the basis of their soundness as investments. This will, in itself, impose discipline on borrowers, who will still have to pay back these loans, and on lenders, who will have to properly evaluate their lending decisions, knowing that the IMF is not waiting in the wings, ready to impose a harsh cycle of adjustment to make sure they are paid off.
Beyond allowing a broad range of projects to freely compete on the basis of their economic merits, not just their direct ability to boost export earnings, this type of reform would have several other positive effects. For one, currency depreciation would no longer constitute the same threat to the financial structures of borrowers in the developing world. This would increase the policy latitude of states. Second, the power of the IMF to impose macroeconomic policy reforms on developing countries would be greatly reduced. This is because the incidence of repayments crisis, due to declining export earnings and run down of foreign exchange, would be attenuated under such an arrangement, given that debts could now be effectively repaid in the borrower’s home currency.
To work, such reforms would require the existence of an international lender able to make loans in the event that worthy projects could not find outside sources of finance. The World Bank should therefore be abolished as presently constituted, and replaced with a genuinely multilateral international lending institution that will vet projects according to internationally acceptable standards of evaluation and make loans on this basis. No conditionality criteria will be attached. Further, debts owed to this international bank will not be transferable to sovereign entities states and therefore cannot be converted into public liabilities if loans go bad. No more bailouts of rich, powerful, Western interests. Enough is enough.
Make no mistake the real issue is about power. The economists will tell us that the present world order is the only viable arrangement that could ever actually exist. It may be tweaked here and there, but its basic contours are immutable and founded on sound "economic science". Reality suggests otherwise. The rule of the dollar is not due to the commitment of the US to obey the rules of sound finance. Quite the contrary: the US is the world’s largest debtor state, presently living well beyond its means, and yet can freely borrow on the international market in its own currency. This privilege is not rooted in the willingness of the US to "pay by the rules" and set a good example of fiscal probity and financial restraint. In fact, the US regularly and repeatedly violates all the fundamental norms of good finance, and can do so simply because of the sheer power of the US in the international arena. It is time to change the rules.
Would this proposal eliminate all the problems facing poor developing countries? Certainly not. Is it the ideal longer-run solution? Not at all. But it is a start. We desperately need to develop alternative visions of how to begin to transform the present international financial order. Debt cancellation, absent more fundamental changes, will not alter the situation in which poor developing countries presently find themselves within the international order. We need to think through the question of what a truly just and sound financial system would look like.
We therefore support: full debt cancellation; an end to all conditionality; abolition of the international financial institutions as present constituted; and the creation of new international lending arrangements that restore real choice to development.
KARL BEITEL is Policy Analyst at the Institute for Food and Development Policy, commonly known as Food First, and a specialist in international financial markets.