Developing countries are being blamed for having borrowed and spent irresponsibly. But they have only been doing what foreign powers and financial interests have urged them to do.
Since the 2008 global financial crisis, developing nations have been told to borrow massively from private finance, even at exorbitant interest rates, to scale funding up 'from billions to trillions'.
With progress towards sustainable development often in reverse, servicing external debt now blocks progress. Many governments have cut back spending in line with conditions or advice from powerful foreign economic agencies.
Current account tales
Many still believe all national economies should have trade or current account surpluses with others - typically citing Germany's and Japan's post-war booms. But of course, not all countries can have surpluses simultaneously.
If a country's trade and current account balances remain in deficit for long, its currency's purchasing power will often be under pressure to fall. Such is the case for developing countries, at least. The situation differs for countries such as the US, UK and Japan.
The 1944 Bretton Woods agreement created an 'exorbitant privilege' for the US by making the dollar the world reserve currency. This privilege survived the US refusal from August 1971 to honour its Bretton Woods obligations.
The US sells Treasury dollar bonds to the world but does not face the pressures others face to repay debts denominated in other currencies. Dollar liquidity thus meets international demand for USD. Federal government expenditure supplements private spending, with both eventually finding their way into private bank accounts.
Central banks of creditor nations have long bought low-risk US Treasury bonds. Indeed, current account surpluses make them net exporters of capital: they pay off external liabilities and make other payments abroad without incurring foreign debt.
By contrast, developing nations with chronic current account deficits are often obliged to go into debt, bearing the higher costs of accessing foreign-denominated finance.
Hence, developing countries are seen as 'creditors of safe assets' (US Treasury bonds) offering low returns but 'debtors of risky assets' promising higher returns.
Foreign capital's Pandora's box
Foreign capital is usually seen as necessary to supplement inadequate domestic investments. For example, much higher interest rates in developing countries may encourage borrowing and investment from abroad. However, heavy reliance on foreign finance is more problematic.
Servicing external debt drains foreign exchange resources, eventually causing national currencies to depreciate. Meeting foreign liabilities - including returns to foreign investments and external debt servicing - may require more foreign borrowings.
Reducing external debt by selling domestic assets to foreigners further denationalises post-colonial economies and diminishes national wealth. External liabilities over the medium-to-long term are likely to increase, with the repatriation of returns to foreign investments, both direct and portfolio.
If exchange rates are undervalued but stable - which is rarely the case - they can discourage imports and promote exports if rapid economic transformation is feasible. But some imports - e.g., food and medicines - are necessities, not easily replaced by domestically-made substitutes.
Macroeconomic stabiliser?
Credit to households and government deficits increase purchasing power, enabling spending, at least temporarily. When domestic productive capacities respond to such demand, national economic output grows.
When private credit and spending fell during the 2008 global financial crisis, government deficits revived many rich economies - averting more rapid economic contraction and allowing output to recover. Thus, more government and private spending and investment - using debt and earnings - spur growth.
Recessions have become less frequent and deep as fiscal deficits have increased in recent decades. Consistently counter-cyclical fiscal policy can thus reduce business cycles and stabilise growth and employment in rich nations.
With public debt and expenditure, economies would flourish more often. Government debt is less of an issue in rich countries: unlike developing economies, government debt is typically in the national currency, while interest rates are under central bank control.
Interest rate yoyo
Interest rates for government securities issued by prosperous economies were lowered after 2008. 'Unconventional monetary policies' - especially 'quantitative easing' - were widely adopted, defying orthodox monetary theory.
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Such rates remained low until early 2022, when the Fed acted against the tight US labour market after three consecutive presidents - Obama, Trump, and Biden - sustained full employment after the 2008 global financial crisis and the ensuing Great Recession.
For two years, the US Fed and the European Central Bank have pushed up interest rates, fully aware that developing country governments have to borrow heavily on much more onerous terms.
While the US Fed has stopped raising interest rates, it refuses to lower them, while the ECB remains adamant about not doing so. Meanwhile, developing countries' central banks maintain high rates, fearing further haemorrhage abroad.
Fiscal austerity is increasingly demanded by developing countries close to government debt distress. Yet, fiscal austerity cannot possibly address external liabilities, debt, or otherwise. In other words, there is no analytical basis for the typical policy prescriptions for developing country governments facing external debt stress.
Dr Ndongo Samba Sylla is Africa Research and Policy Director for IDEAS, which organised an international conference on the African debt crisis in Accra, Ghana, on 27-29 March 2024.
