Third World Debt


[This paper was originally published in the Proceedings of the 15th Anniversary Third World Conference Foundation (Chicago: Third World Conference Foundation, Inc., 1991): 27-38.  An earlier version of this article, titled “Global Debt: Causes and Consequences,” was published in the Review of Radical Political Economics, Vol. 20, Nos. 2 & 3 (Summer-Fall 1988): 223-234; reprinted in The United States in the World Economy, edited by Theodore Reutter, McGraw-Hill, 1994.]



While there is now a consensus that there must be a debt relief for the debtor nations of the Third World, there is no agreement over the degree of and the measures for such a relief. This study is an attempt at establishing measures that would serve as the basis for the much-needed debt relief. Since the establishment of such criteria requires identifying the causes for the debt problem, our study therefore includes a brief survey of the major factors that contributed to the proliferation and accumulation of the debt. This survey showed that (contrary to popular perception) the oil price shocks of the 1970s were not the major source of the developing countries’ external debt crisis, although they greatly accelerated that crisis. To the extent that petrodollars contributed to the debt crisis, the blame lies not with those dollars as such, but with the policy responses to them (i.e., policies of “recycling” those dollars). This included policy responses of the advanced capitalist countries, of the lending institutions, and of the borrowing governments. The survey further showed that the major bulk of the immense Third World debt has snowballed as a result of factors exogenous to their economies. These factors included excessive interest charges by the commercial banks, capital flight from these countries, rise in the value of the dollar and the loss of their export earnings due to the depressed prices of and demand for their exports. Debtor nations are not responsible for this portion of the debt, i.e., the portion that can reasonably be attributed to factors exogenous to their economies, and it should therefore be repudiated as “illegitimate.”



A. The Role of Oil Price Shocks

The structure of the developing countries’ external financial receipts in the post-war period has undergone considerable change. Whereas in the earlier part of this period the major bulk of those receipts consisted of official capital flows from industrial countries and international agencies, in the later part, especially after the late 1960s and early 1970s, commercial bank lending became the dominant source of those receipts. For example, in the 1960-78 period the official development assistance (ODA) to developing countries decreased from 58 percent of their total external financial receipts to 30 percent, while private bank lending rose from about two percent to about 33 percent. Contrary to private bank loans, the official capital flows consisted largely of grants, concessional loans, and other official loans that were based on long-term, low-interest, or project-related financing. This shift away from official to private bank lending played a major role in the development of the present crisis of the Third World debt.

No doubt the oil price shocks of the 1970s greatly accelerated the process of private bank lending and the accumulation of Third World debt. But to view this accelerating (or contributory) effect as the cause for commercial bank lending, hence for the debt problem, is challenging the reality of those developments. Evidence shows that the shift away from official financing to private commercial lending–the major culprit in the debt crisis, in our opinion–took place prior to the oil price shocks. That is, the expansion of bank lending as a result of these oil shocks took place within the general context of the expansion of bank lending.

For example, Kristin Hallberg, using the official data of the Federal Reserve Board of Governors, shows that “real private bank lending grew 144%” between the years 1970-1973. Citing Charles Kindleberger’s private correspondence (a renowned authority on international finance), she further shows that the expansion of commercial lending “coincided with the  ‘cheap money’  push of 1971, when bankers looked to developing countries for riskier investments to maintain their income.”

Neither the expansion of commercial loans nor the crisis of the Third World debt were inherent in the oil price hikes of the 1970s. To the extent that the resulting petrodollars from those price hikes contributed to the debt crisis, the blame lies not with those dollars per se, but with the policy responses to them, the so-called “recycling” policies of petrodollars. In fact, with policies concerned with the health of global economy those massive petrodollars could be viewed as a blessing in disguise: the tens of billions of dollars that were generated as a result of the oil price hikes of the 1970s constituted the potential for the largest primitive accumulation of capital to date which could be used for the industrialization and development of developing countries. That potential could be realized through a combination of measures: (a) direct equity investment from “surplus” countries in “deficit” countries–industrialized countries could provide the necessary technology for this strategy and thus make it a truly trilateral cooperation; (b) development grants from “surplus” countries to “deficit” countries, and (c) recycling the surplus not through the commercial banks but through independent international agencies that would grant long-term, low-interest, development-related loans to nonoil developing countries.

Instead, the massive amounts of petrodollars (along with Eurodollars and the so-called “cheap money” of the early 1970s) found their way into the coffers of the big commercial banks and the pockets of corrupt “leaders” of the borrowing countries, which triggered their external debt problem.

Several factors prompted the switch away from multilateral, official lending to commercial bank lending. Most significant among these factors was what might be called a weakening of Bretton Woods objectives. The essence of these objectives was to redress and expand the world capitalist system which was badly shaken by the war and threatened by the spread of national liberation and other social movements in many parts of the world. To this end, the historic conference that convened in Bretton Woods, New Hampshire, in 1944, instituted the International Monetary Fund (IMF), the International Bank for Reconstruction and Development (World Bank), and a fixed exchange rate based on gold or the United States dollar. Although the original goal of establishing the IMF and the World Bank was to reconstruct war-torn Europe and Japan, the United States soon began to divert the resources of these institutions to the Third World.

To understand this interest of the United States in the Third world, we need to step back in time and put things into perspective. In the immediate aftermath of the war, the United States was not only challenging the expanding influence of the Soviet Union in the Third World, it was also trying to fend off or preempt independent national liberation and social movements in these countries, i.e., movements that had nothing or very little to do with the U.S.S.R. Furthermore, the United States was competing with its European allies over Third World markets and raw materials. Although these allies were weakened by the war and in need of the U.S. aid, they still controlled most of their colonial territories of the past and, in effect, kept U.S. capital out of those territories and markets.

Under these circumstances, where the Third World seemed at a cross-roads between capitalism and socialism (or something other than capitalism), the United States set out to block the latter road and coax, coerce, or force these countries to move along the former road. [Of course, this does not mean that the U.S. has now abandoned this policy, but that the policy was more urgent at that time.] Thus its financial assistance to the Third World during this period was primarily based on geo-political and long-term  economic considerations rather than short-term, cost-benefit calculations. And this is why the financial flows to these countries at that time were largely in the form of grants, concessionary loans, and other forms of “soft” or development-related loans. The fate of Third World economies at this stage was too precarious to be entrusted to commercial banks:

Generally speaking, it was thought that the official support should play a large role in the financing of developing countries….Multilateral finance came mainly from the World Bank group, with the money being devoted largely to projects, mainly of an infrastructure nature….Export credit was a consistent source of finance for developing countries, particularly that insured by export credit and export guarantee organizations of the OECD countries.

 By the late 1960s and early 1970s, this pattern of Third World financing changed as private banks began to lend to these countries on a commercial basis. A number of factors precipitated this switch: (a) the Cold war atmosphere and the fierce “East-West” rivalry in the Third World had subsided by this time, (b) most of the socio-political upheavals in the former colonies and other less developed countries had also ebbed by the late 1960s, and (c) most of the developing countries had by now adopted a capitalist path of development. Whereas prior to this time private banks were reluctant to lend to developing countries because their economies were considered too volatile and their financial markets too unstructured, and thus unworthy of credit, these banks now began to lend as most of these countries emerged as sovereign nations whose economies and financial markets appeared capable of absorbing substantial debt on a commercial basis. These favorable economic conditions for private bank lending were further reinforced by favorable political and legislative conditions as OECD countries relaxed barriers that previously hampered commercial lending to developing countries. “Bank lending could [now] be expanded fairly rapidly, without the need to go through the legislative and budgetary processes of national governments.”

Commercial bank lending was further accelerated by a “natural” or “evolutionary” process of the accumulation of huge sums of finance capital in the coffers of Western big banks during the three decades of economic expansion and stability since WW II. This accumulation of bank capital was a culmination of several developments: the post-war expansionary cycle of the advanced capitalist economies; the Korean and Vietnam wars, which led to the flow of huge sums of dollars and/or Eurodollars into the hands of banks; the U.S. inflationary monetary policy that began under President Johnson, which led to the emergence of the so-called “cheap money” in the early 1970s; and, finally, the petrodollars of the 1970s. Part of the massive finance capital that resulted from these developments was bound to find its way to foreign lending, especially from the United States, where the Glass-Stegal Act prevented commercial banks from underwriting and selling corporate securities at home. (This also explains why commercial banks there have expanded into all kinds of consumer loans, be they mortgages or credit card.)

As these developments led to bank loan officers roaming the Third World pressing their wares, they also created favorable conditions and big appetites for borrowing in the non-oil developing countries. For the inflationary/expansionary cycle and the accompanying “cheap money,” mentioned above, positively affected the economies of these countries: On the one hand, it raised the volume and the price of their exports, on the other, it reduced the cost of their borrowing. “Dollars borrowed today could be paid back tomorrow in cheaper dollars, as inflation ate away their value.”

This brief overview refutes the claim that the oil price shocks of the 1970s were the major cause for the global debt problem–although it does not deny their contributory or accelerating impact–as it shows that the process of commercial bank lending and the proliferation of Third World debt started before those shocks took place.

Principles of scientific research tell us not to look for a single, isolated factor in the study of the origins of any major crisis or change. Although major crises are usually triggered by a single factor, they are generally the results of processes and the culmination of developments. The present global debt crisis is no exception to this universal law: it is a product of the increasing expansion of finance/bank capital, its internationalization, i.e., accumulation of capital on a world scale, and the emergence of multinational banks looking for external outlets for investment. The petrodollars of the 1970s merely accelerated this process and expedited the outbreak of the debt crisis.


B. Policies and Responsibilities of the OECD Countries and the Lending Institutions

Although the oil price shocks contained the potential for an immense international financial imbalance, and hence the debt crisis, this crisis was not inevitable. The policy responses to the oil price hikes contributed more to the crisis than did the price hikes as such.

As far as the policies of the OECD countries are concerned, the flip-flop character of those policies was more responsible for the crisis than the policies themselves. Policy responses of these countries to the first oil shock (1973-74) were diametrically opposed to their reactions to the second oil shock (1979-80).

The first major concern of these countries in the face of the 1973-74 oil shock was to maintain economic expansion “through joint expansionary policies which would maintain growth….This argument reached its peak in the Bonn summit of July 1978 when the summit countries decided to adopt a locomotive theory of growth, with the major OECD countries agreeing to take action to help stimulate demand.”

The second major concern was that the surplus resulting from the oil price hikes should be recycled toward the “deficit countries” so that their growth, started since the late 1960’s, could also be maintained.

Unfortunately, these countries (in compliance with the wishes of the big private banks) also decided to expand the role of commercial banks in the projected recycling effort. As a supplementary step, they also decided to expand Eurocurrency markets, since Eurocurrency was the universal form of the surplus, and the surplus had therefore been converted into mainly Eurocurrency deposits.

To be sure, there was some opposition to the involvement of private banks on the grounds that these banks were not trustworthy in the matters of international trade and finance, and that therefore the recycling of the surplus ought to be accomplished through official, multilateral financing. But the views that favored the involvement of commercial banks prevailed. These included the views of most OECD countries and the international organizations under their control, as expressed through the voices of their finance ministers or central bank officials. For example, the May 1974 issue of the IMF Survey stated:

Private markets have a basic role to play here, and it is to them that we must look for the main contribution in financing prospective balance of payment disequilibria. In the first instance, the Eurocurrency markets may be expected to be the main channel. These markets are well equipped to handle large volumes of funds, and they offer the flexibility and the anonymity that the lenders desire.

Denis Healey, the British Chanceller of the Exchequer, commended the role played by the commercial banks in recycling the surplus and strongly recommended the continuation of that role in his speech to the IMF in September 1977: “The commercial banking system has rightly played the main role in financing these deficits until now and has shown immense resourcefulness and flexibility in doing so.”

Similar assessments and prescriptions were heard on the side of the United States. For example, William Miller, the United States Secretary of Treasury at the time, made the following recommendation in his speech at the 1979 IMF/IBRD annual meeting:

We all recognize that the private markets will, in future as in the past, have to play by far the major role in channeling financing from surplus to deficit nations. Official institutions, including the IMF, play a vital role in this process, but it is essentially catalytic in the nature.

Not surprisingly, the decision to expand the role of private banks and Eurocurrency markets led to an immediate and rapid expansion of both the share of commercial bank lending and of the Eurocurrency markets. Eurocurrency markets expanded in the 1973-82 period by almost six times, from $295 billion in 1973 to 1,689 in 1982.

And by 1984, “commercial banks’ share of the total guaranteed medium-and long-term debt owed by non-oil developing countries to private creditors had risen to 86 percent.” [The remaining 14 percent consisted of the traditional private debt sources such as bonds and supplier’s credits.]

As a result of this easy monetary policy and vigorous expansion effort, the expansionary cycle that had started before the 1973-74 oil shock continued unhampered despite the recessionary or hindering effects exerted by the oil price shocks. The expansionary monetary policies (based on the locomotive theory) in the OECD countries, especially in the United States, positively affected the economies of the developing countries, even the non-oil ones. On the one hand, it kept the real interest rate very low, hence their borrowing cost very low, on the other, it raised their export earnings, both in terms of volume and prices. True, their debt was gradually building up, but there was no danger of a default as the steady growth in income, exports, and higher prices of primary goods during this period were reducing the external debt burden on these countries. Indeed, because of low real interest rates and healthy export growth their debt service ratio (the ratio of interest and amortization payments to export earnings) showed only a moderate rise, from 16% in 1973 to 23% in 1980.

Thus, the 1973-79 period, the period between the two oil shocks, witnessed a healthy annual growth rate in the OECD countries, ranging on the average from 3.6 to 6.1 percent; in the non-oil developing countries, from 5 to 6.1 percent; and in international trade, an annual average growth of 5.5 percent.

As noted earlier, the policy response of the OECD countries to the 1979-80 oil price hikes was diametrically opposed to their response in 1973-74. Instead of maintaining expansionary monetary policy in order to maintain the level of growth, of income and of world trade, these countries now resorted to tight monetary policy to control inflation. The pronounced, or even dramatic, expression of this new policy was Paul Volker’s departure from the 1979 Belgrade IMF/IBRD conference before it was officially over in order to prepare the new monetary policy in October. The new policy created a ripple effect in the opposite direction of the previous period: interest rates shot up, growth slowed down and the recessionary cycle (of 1980-82) set in, and the export earnings of deficit countries began to drop.

Interest rates were further increased by (a) the larger U.S. budget deficits, and (b) the introduction of so-called floating rates of interest for commercial lending. The effects of the new policy on international interest rates and world economic growth are shown in Table 1. It is obvious from this Table that while this contractionary policy more than doubled the international average interest rate, it reduced the world economic growth to less than a quarter by the end of 1982.


Table1.  Prime Rate, World Growth and Price Inflation in World Trade (average annual percentage rate)

Period              prime rate        inflation rate in world trade    world growth

1970-73           6.7                   12.4                                         4.7

1979-82           15.5                 4.4                                           1.1

Sources: International Financial Statistics (International Monetary Fund) and Council of Economic Advisors, Economic Report of the President (Washington, D.C.: Government Printing Office, 1984).


The trade deficit of the developing countries was further aggravated by the shortening of the maturity period of their debt, on the one hand, and the protectionist policies of the OECD countries (prompted by high unemployment rates), on the other. There has been no alleviation of these factors that negatively affect Third World debt: the OECD countries’ protectionist policies continues, the U.S. budget and trade deficits continue, and the demand for and price of debtor nations’ primary goods also continues to be very low.

The cumulative effect of these factors was a jump in the debt service ratio of these countries from 20% in 1979 to 33% percent in 1982. The absolute amount of their foreign debt rose from $220 billion at the end of 1979 to 326 at the end of 1982 and 343 in 1983. Despite all the talk about solutions to the debt problem, this snowballing process of debt has continued unabated, and it now stands at about $1.3 trillion.


C.  Policies and Responsibilities of the Debtor Countries

Only a small portion of the massive Third World debt has actually been received by (and spent in ) these countries. The rest  has accumulated due to factors exogenous to the economies of these countries. These factors include the rise in the international rate of interest, the rise in the value of the dollar, the decline in foreign demand for their exports, the fall of the price of their primary goods, and, perhaps most importantly, the flight of huge sums of capital from these countries.

According to Jacobo Schatan’s calculations, about two-thirds of the entire Latin American debt in 1985–roughly $450 billion–could be attributed to these exogenous factors, which he appropriately calls the “illegitimate” part of the debt.

The remaining, “legitimate,” part of the debt includes what has actually been borrowed (but not fled back overseas), plus the concomitant interest based on the pre-1976 fixed rate of 6 percent. (As pointed out earlier, after 1976 the lending institutions abandoned the previously-agreed-upon fixed rate in favor of floating rates, which ushered in the double-digit interest rates of the early1980s.)

Peter Nunnenkamp’s estimates of the effects of external factors on the Third World debt are equally shocking. According to his calculations, the combined effects of external factors on Third World debt in the 1974-81 period amounted to $570 billion, of which interest rate effects accounted for $133.49 billion, lost revenues due to depressed demand for their exports constituted $104.41 billion, and the terms of trade effect accounted for the remaining $297.45 billion–Nunnenkamp attributes about half of the terms of trade effect, i.e., half of the $297.45 billion, to the effects of oil price hikes.

A number of other studies have come to similar conclusions regarding the snowballing effects of exogenous factors on the Third World debt.

A big chunk of the loan money was sent back out of the debtor countries to be deposited, invested, or used to acquire real estate abroad. This has been done by both government and military officials, as well as by private middlemen and businesspersons who usually gain access to foreign currency (through government channels) in the name of project investment. According to an IMF estimate, some $200 billion may have flown out of debtor counties by the end of 1985.

Time Magazine estimated that the amount of capital that flew out of three Latin American countries between 1979 and 1984 was about $63 billion (28 billion from Mexico, 23 billion from Venezuela, and 12 billion from Argentina).

Data from the U.S. Federal Reserve Board show that “more than one-third of the combined debt increment of Argentina, Brazil, Chile, Mexico and Venezuela between 1974 and 1982, i.e. about $85 billion, was devoted to purchases of real estate and to banking deposits abroad.”

There is evidence of instances where the lending banks collaborated with corrupt officials of the debtor countries in the plunder of the loan money. The banks involved would lend money to these officials with one hand, and take it back with the other in the form of deposits that carried different titles and lower interest rates, thereby making profits out of the differential interest rates.

But even excluding the part of the debt that is due to external factors, the remaining part, the part that was actually borrowed and somehow spent domestically, was quite substantial, amounting to tens of billions of dollars. What happened to it? How was it spent? What are its impacts on the economic development of these countries?

A major part of this money has been spent on consumption, often wasteful consumption of the military and luxury or unessential type, rather than investment and/or production. Borrowing from abroad is not good or bad per se; it all depends on how it is spent. If it is invested in development projects that will yield a rate of return higher than the rate of interest paid for the borrowed capital, then borrowing can play the positive role of initial capital formation for productive investment, without the problem of repayment. This is a pivotal point in understanding the present crisis of the Third World debt: the borrowed funds were viewed not as capital to be invested productively, but as income to be used for consumption, or for financing the government’s operating deficits. To the extent that some of these funds were formally invested in development projects, investment priorities and development policies were often perverse: building huge stadiums and sports complexes, buying synfuel plants to supply depressed oil markets, buying national airlines where citizens travel on the back of animals or ox-driven carts, and so on. Some of these pompous, grandiose, show-case projects–often undertaken in the name of building economic infrastructure, or as symbols of “national pride”–went as far as building whole new cities from scratch, such as Brasilia in Brazil and Abuja in Nigeria. “Nigeria is building itself a capital, Abuja, from scratch. The cost, by some estimates exceeds the nation’s total sovereign debt of about $20 billion. Yet Nigeria has trouble making interest payments.”

A substantial amount of these countries’ resources, borrowed or otherwise, is devoted to subsidizing “national” industries and enterprises, largely in the state sector but also occasionally in the private sector. While this policy is pursued in the name of promoting “national” industries, import-substitution, and economic self-reliance, in practice it falls short of achieving these objectives. Instead, by providing easy credit and windfall finances for inefficient and unprofitable enterprises, it aggravates the pattern of inefficiency and perpetuates the lack of competitiveness. It spoils the mismanaged “national” enterprises and their corrupt and inefficient managers by financial crutches. Import tariffs, credit controls, exchange controls and similar restrictions are also often justified by this misguided (or, perhaps, hypocritical) nationalism.

Extensive nationalizations in a number of these countries can also be understood in this light. “The Mexican government owns some 60 percent of the country’s industrial base. Notoriously ill-managed, these nationalized industries require heavy subsidies to stay alive.”

While the purported goal of these nationalizations is that the state sector will play a pioneering role in bringing about a speedy industrialization program, experience shows that other objectives can be detected behind the nationalization thrust: to couple or supplement the political and military power of the state with economic power, to broaden the social base of the state by vesting the interests of broad social layers in the state (through consumer subsidies as well as through employment in the state sector), to provide the state bureaucracy with the opportunity of accumulating their personal fortunes and becoming capitalists in the shadow of the public sector and state capitalism.

Curtailment of foreign equity investment in a number of debtor counties–Mexico, Brazil, Nigeria, Ghana, and few others–and the turn to borrowing for financing investment projects has greatly contributed to both the external debt problem and the problem of inefficiency and slow growth. While this policy is celebrated as fighting against imperialism and “dependency,” it is in fact a policy of self-defeat and self-delusion. For in the case of equity investment, investors provide not only funds, technology, and skills, they also take part of the risk of investment proportionate with their invested capital. Whereas in the case of investment through borrowing, the entire risk is shouldered by the borrower. True, foreign equity investment carries a foreign claim of ownership on part of the return to investment, but that is conditional on the success of investment, i.e. if there is a return over and above the cost of production. By contrast, debt carries no ownership claim, but the interest on the loan must be paid whether the investment is profitable or not.



Third World debt has frequently been compared with the Sword of Damocles hanging over the world economy, or a time bomb ticking out there. But even excluding such cataclysmic episodes (triggered off, for example, by a bank collapse), the prevailing contractionay cycle that the global debt has imposed on the world economy, especially that of the debtor countries, is extremely costly. The world financial system, and hence the world economy is in a sense hostage to the developing countries’ external debt. In a sound-the-alarm type report on the global debt, the World Bank recently warned “serious risk” of a “sustained setback to development in many debtor countries, of a growing breakdown in formal debtor-creditor relations, and of consequent lasting damage to the international financial system and world economy.”

Interest payments are devouring a big chunk of the debtors’ national income, leaving very little for growth and development. In Mexico, for example, interest payments consumed 46.23% of the government’s entire expenditure in 1986 and 56.20% in 1987.

The Other Side of Mexico estimated that the “current debt-service burden would cover the costs of constructing 3.2 million dwellings in a year, directly helping 18 million homeless Mexicans.”

Debtor countries facing interest payments and balance of payments problems often turn to the IMF for funds–if not for its own funds, then for its mediation to obtain money from other sources, usually from commercial banks. To obtain favorable response to their request for funds, these countries pay the price of allowing their socio-economic objectives to be shaped to meet the policy objectives of the IMF: reducing the size and the role of the public sector in these economies and shifting productive resources from industries that serve the domestic needs to those that serve the needs for foreign exchange to make interest payments. To achieve these objectives, severe austerity programs are usually put into effect in debtor countries: while government subsidies, real wages, and consumer imports are reduced, income taxes and prices are raised. Other IMF-sponsored measures include dismantling of controls that inhibit the export of foreign exchange, especially the payment abroad of interest and dividends to foreign capital, and devaluation of the currency to raise the cost of imports and reduce the price of exports.

Instead of alleviating the developing countries’ debt burden and other economic problems, the IMF-initiated policies have more often than not aggravated these problems. Efforts to gear national resources to meet the debt obligations have eroded both the standard of living of the majority of population of debtor nations and the industrialization aspirations and development plans of these nations. While many of the burgeoning industries of the 1960s and early 1970s are stalled because of the curtailment of the import of the necessary technology and inputs, a new emphasis is placed on the traditional export industries whose output is largely raw materials and primary goods. This policy, designed to earn maximum foreign exchange in the shortest possible time, is reviving and reinforcing the old pattern of monoculture and rapidly eating away at the natural resources of the debtor nations. Public-sector cutbacks, far from freeing space for private initiative, as the IMF argues they would, has hampered business investment by forcing governments to cut down on essential infrastructure: roads, schools for training a skilled labor force, investment in public health, and so on. Those cutbacks help generate waves of social and political unrest that encourage yet more capital flight.

Debtor countries’ inability to import not only hurts the overwhelming majority of their citizens and paralyzes their industries, it also costs the advanced industrial economies part of their markets abroad and employment at home. Trade figures since the early 1980s clearly demonstrate this. For example, the combined imports of non-oil developing countries declined by $48 billion in 1982 and $75 billion in 1983, compared to 1981 figures.

The loss of markets abroad and of jobs at home, could prompt more protectionist measures in industrial countries that would further aggravate the already depressed economies of debtor nations, and throttle world trade through a regressive chain reaction.



Although there is now a consensus that there must be a Third World debt relief, the degree of and the measures necessary for the proposed relief are far from clear. We believe that a just solution to the debt problem must take into account questions of responsibility for and “legitimacy” of the debt.

Our study showed that the developing countries’ debt has been greatly inflated by exogenous factors like excessive interest rates, loss of export earnings, and capital flight. This inflated part of the debt cannot be considered the responsibility of the debtor nations, and should therefore be repudiated as “illegitimate.” It is the responsibility and the business of the commercial banks and the corrupt “leaders” of the debtor nations–it is their baby, so to speak. Let them take care of it. Debtor nations should not pay for the sins of those who artificially inflated their debt. Nor should the taxpayers in the commercial banks’ home countries pay for it. Thus, recent suggestions that imply transferring banks’ debt risk to governments, and ultimately to tax payers, through tax incentives for discounted debt or government bond for debt-bond swaps, must be opposed. This will not only be fair and just, it will also serve as an example and a lesson for the future: those in charge of nations’ economic resources and in control of political power will think twice when tempted by excessive greed.

As anticipated, our suggestion that issues of responsibility and “legitimacy” should be included in the criteria for the debt relief, drew criticism from both the right and the left during a recent conference on Third World debt in which we presented an earlier draft of this paper. On the right, the critics argued that no one but the international market mechanism is responsible for the debt problem, and that therefore the debtor nations should play by the rules of the market game and try to dispose of their debt obligations, brought about by the mechanism of this game. On the left, the critics argued that the advanced capitalist countries have for decades been robbing the less developed countries of economic resources, and that therefore the entire debt must be repudiated. We challenge both of these arguments.

The argument that the Third World debt is simply the product of a neutral market mechanism does not hold much water in the face of actual developments that led to the accumulation of the debt. Our brief survey of these developments showed that the proliferation of the Third World debt was more a result of the policies of the OECD countries, of the big multinational banks, and of the IMF than of some “neutral” international financial/credit markets. Under the present economic structures and circumstances, whether national or international, the claim that there operates some pure market mechanism, or some innocent “invisible hand,” seems to embody more of nostalgia than reality. Even the most advanced and the best established markets (e.g., in the U.S. economy) are nowadays heavily influenced by government policies and the policies of giant corporations and banks. The mutual influence between market forces and economic policies is a reality of almost all present-day market economies. This is clearly reflected in the tens of regulatory agencies and antitrust laws that prevail in these economies.

Most of the conduct and many of the deals of multinational banks with debtor nations (e.g., the unilateral suspension of fixed interest rates and their substitution by floating rates) would be found in violation of their own countries’ antitrust laws and banking regulation. Thus, to invoke the market mechanism and “invisible hand” in support of commercial banks’ claims against debtor nations is tantamount to a whitewashing of foul players.

As noted, there are individuals and groups on the left who also disagree with the idea of responsibility and “legitimacy” as measures for debt relief, though for a different reason. Their reason is that the “peripheral” countries have for a long time been exploited by the “core” countries of the world capitalist market, and that therefore the entire debt must be repudiated. Our answer to this reasoning is that although the argument of “core-periphery” exploitation is a powerful argument for total repudiation of Third World debt under radically-changed world circumstances, it is not a good one under the present world circumstances (i.e., under the rules of world capitalist market and of the court of bourgeois justice). Under these circumstances, advocates of debtor nations need to show precisely how the debt was generated and accumulated. That is, they need to analyze the debt, to dissect it and break it down into its component parts and identify exactly the source of proliferation of each of these parts. Only in this way can they show the bourgeois judges the illegitimate parts of the debt even by their own standards (i.e., by the standards of their banking regulations and antitrust laws.

While the “core-periphery” exploitation argument correctly points out the transfer of economic surplus and resources from the “periphery” to the “core” of the world capitalist market, it suffers from a number of theoretical and empirical problems. To begin with, it is a class obfuscationist argument. Second (and for this reason) it also obfuscates the question of responsibility and accountability, and thus easily plays into the hands of demagogic national bourgeoisie who frequently point to foreign/external factors to justify their own blunders and mismanagement of the economies under their control (e.g., in the case of the debt it has provided a protective shield for the corrupt “leaders” of a number of debtor countries who are accomplices in the debt crisis). Third, this argument often fails to explain the industrialization and technological impact of the “core” on the “periphery” that takes place under the whip of capitalist accumulation on a world scale–proponents of this argument, largely associated with the Dependency School, either dismiss any such an impact altogether, or trivialize it as simply the development of underdevelopment.

Based on the notions of responsibility and “Legitimacy,” deflation of the debt to its “legitimate” size can be accomplished through the following measures.

(a) Writing off of that part of the debt that can reasonably be attributed to excessive interest charges over and above the originally-agreed-upon fixed rates of interest that prevailed before 1976. According to Schatan’s calculations, an average differential rate of interest of four percent (ten minus six percent) resulted in $105-110 billion difference in Latin America’s outstanding debt in the 1976-85 period. If we extend his calculations to the present time, we will obviously come to a much higher figure.

(b) Repatriating all the capital that left since 1976. Again, according to Schatan’s estimates, the flight of capital from Latin America in the 1976-85 period was in the range of $130-150 billion.

Obviously, had this capital not flown out of the debtor nations, their need for borrowing would have been decreased accordingly. Since the capital to be repatriated will be spent/invested in domestic currency, the foreign currency thus recovered can be used for the repayment of the “legitimate” part of the debt.

(c) Compensating for the loss of debtor nations’ export earnings as a result of the drop in the price of their raw materials, which has drastically turned the terms of trade in favor industrialized countries. Schatan estimates that if “prices of raw materials had stayed at their 1980 level, export earnings for the 1976-85 period would have been some $25-30 billion higher than they actually were ; had this been the case, Latin America’s borrowing needs would have declined by the same amount.”

Repayment of the rest of the debt (i.e., of the “legitimate” part of the debt), can be brought about by imposing a ceiling on the annual payments relative to the debtors’ export earnings, e.g. 20% of their annual export earnings. Alternatively, it can be brought about through the measures delineated by Schatan: (i) transformation of the monetary value of the debt into its equivalent in raw materials and/or manufactured products–reasonable unit prices can be used for this purpose; (ii) a maximum yearly rate of interest of six percent; (iii) a 25-year period for repayment of the principal; (iv) stability of commodity unit prices throughout the whole repayment period.



Although the steps thus laid out will help reduce and eventually remove the developing countries’ debt burden, these steps will not in and of themselves bring about a recovery of their depressed economies. Supplementary steps are needed to bring about such a recovery. This requires a futuristic vision and a globalist perspective of the international economy, a view that transcends the mercantilist type of economic nationalism, and appreciates the increasing integration and interdependence of the world economy. Based on such a view, we propose the following measures for the revival of the depressed developing economies.

(a) An International, Marshall Plan-Type Package of Development. Once the external debt is taken care of via the steps outlined above, the resources pulled together through this package will no longer have to go to the coffers of commercial banks, but to economic development via long-term, low-interest, project-related loans. Allocation and supervision of the funds thus created should be the responsibility of independent multilateral institutions. Needless to say countries like Japan and West Germany with trade surpluses can contribute more to this international pool of development funds. The considerable purchasing power thus to be created will not only have a take-off effect on the revival of the developing economies, it will also give a boost to international trade and the world economy as a whole, and will help reduce trade deficits of industrial countries like the United States. Such a “reflation” and revival of the world economy “is an easy thing to do,” as Juliet Schor recently put it, “made difficult only by the opposition of wealth holders fearful of inflation, and companies wary of the effects of sustained growth on labor and other costs.”

(b) Exclusion of Commercial Banks. Just as in the United States the Glass-Steagall Act prevents commercial banks from getting involved in the manufacturing sector of the economy, so should a similar regulation prevent these banks from tampering with the developing economies. It may be argued that it is economic suicide to shun the immense resources these banks possess. The answer to such an argument is simple: if the commercial banks want to help, they are welcome; let them join the international development pact suggested above and accept its rules and regulations. Or, alternatively, let them accept a ceiling on their interest charges established by the return to investments financed by their loans.

(c) Changes in the Financing and Investment policies of the Developing Countries. As noted earlier, most of these countries have either banned foreign investment altogether or have reduced it to a bare minimum. Instead, they have resorted to financing via borrowing. While this policy has been carried out under populistic posturings such as national independence, economic self-sufficiency, or curtailing the “exploitation of the periphery by the core,” insidious motives can often be detected beneath such posturings: protection of the interests of the state bureaucracy and the class it represents, the so-called “national” bourgeoisie. By curtailing the powerful and efficient foreign competitors, not only will the “national” bourgeoisie enjoy the monopoly of domestic markets, hence higher profits, but also the state bureaucracy can continue its inefficiency and mismanagement of state enterprises.

Motivations and self-interest aside, the policy of curtailing foreign investment (equity or direct investment) and resorting to borrowing has not helped these economies. It must therefore be changed, and a degree of foreign investment capital (in non-strategic industries) must be combined with investment via borrowing. Although this will give foreign investors a title of ownership of a part of the return to investment, they will, in return, share the risk of investment and bring funds, technology, and know-how. More importantly, it will force the inefficient domestic capitalists and public sector managers to be more competitive, and hence, more efficient.



Cardoso, E. A. 1987. “Latin America’s Debt: Which Way Now?”  Challenge (May-June).

Cavanagh, John et al. 1986. From Debt to Development: Alternatives to the International Debt Crisis (Washington D.C.: Institute for Foreign Policy).

Dornbusch, Rudiger. 1984. External Debt, Budget Deficits and Disequilibrium Exchange Rates. National Bureau of Economic Research Working paper No. 1336 (Cambridge, Massachusetts: NBER).

“Economic Crisis and Reconstruction.” The Other Side of Mexico (April-June 1987).

Hallberg, Kristin. 1986. “International Debt, 1985: Origins and Issues for Future,” in World Debt Crisis: International Lending on Trial, edited by M. P. Claudon (Cambridge, Massachusetts: Ballinger Publishing Co.): 3-42.

Khan, Mohsin S. and Malcolm Knight. 1983. “Sources of Payment Problems in LDCs,” Finance and Development  (December).

Lochhead Carolyn. 1987. “Western Money and Holes in the Third World’s Pockets” Insight (31 August).

Lomax, David F. 1988. The Developing Country Debt Crisis (New York: St. Martin’s Press).

Nunnenkamp, Peter. 1986. The International Debt Crisis of the Third World (New York: St. Martin’s Press).

Russell Dean F. 1987. “Measures and Mexico: A Critique of the Mexican Debt Crisis,” unpublished paper, National Collegiate Honors Program (The United Nations Semester), Long Island University, the Brooklyn Campus).

Schatan, Jacobo. 1987. World Debt: Who Is To Pay?  (London and New Jersey:  Zed        Books).

Schor, Juliet. 1988.  “The Great Trade Debate,” Zeta Magazine (March).

United Nations, UNCTC Current Studies. 1986.  Foreign Direct Investment in Latin America: Recent Trends, Prospects, and Policy Issues (New York).