Developing Countries’ Government Debt Crises Loom Larger

By Ndongo Samba Sylla and Jomo Kwame Sundaram

ACCRA, Ghana, Apr 3 2024 (IPS) - 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.

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.

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IMF Urges Non-alignment in Second Cold War

By Jomo Kwame Sundaram

ACCRA, Ghana, Mar 27 2024 (IPS) - The IMF no. 2 recommends non-alignment as the best option for developing countries in the second Cold War as geopolitics threatens already dismal prospects for the world economy and wellbeing.

IMF warning Ominously, International Monetary Fund (IMF) First Deputy Managing Director Gita Gopinath warns, “With the weakest world growth prospects in decades – and…the pandemic and war slowing income convergence between rich and poor nations – we can little afford another Cold War”.

While recognising globalisation is over, she appeals to governments to “preserve economic cooperation amid geoeconomic fragmentation” due to the second Cold War.

Growing US-China tensions, the pandemic and war have changed international relations. The US calls for ‘friend-shoring’ while its European allies claim they want to ‘de-risk’. While still pleading for ‘globalisation’, China realistically stresses ‘self-reliance’.

Multilateral rules were rarely designed to address such international conflicts as ostensible ‘national security’ concerns rewrite big powers’ economic policies. Hence, geoeconomic conflicts have few rules and no referee!

Historical perspective

After the Second World War, the US and USSR soon led rival blocs in a new bipolar world. After Bandung (1955) and Belgrade (1961), non-aligned countries have rejected both camps. This era lasted four decades.

World trade-to-GDP rose with post-war recovery and, later, trade liberalisation. With the first Cold War, geopolitical considerations shaped trade and investment flows as economic relations between the blocs shrank.

According to her, such flows increased after the Cold War, “reaching almost a quarter of world trade” during the “hyper-globalization” of the 1990s and 2000s.

However, globalization has stagnated since 2008. Later, about “3,000 trade restricting measures were imposed” in 2022 – nearly thrice those imposed in 2019!

Cold War economics

Gopinath sees “ideological and economic rivalry between two superpowers” as driving both Cold Wars. Now, China – not the Soviet Union – is the US rival, but things are different in other respects too.

In 1950, the two blocs accounted for 85% of world output. Now, the global North, China and Russia have 70% of world output but only a third of its population.

Economic interdependence grew among countries as they became “much more integrated”. International trade-to-output is now 60% compared to 24% during the Cold War. This inevitably raises the costs of what she terms economic ‘fragmentation’ due to geopolitics.

With the Ukraine war, trade between blocs fell from 3% pre-war to -1.9%! Even trade growth within blocs fell to 1.7% – from 2.2% pre-war. Similarly, FDI proposals “between blocs declined more than those within blocs…while FDI to non-aligned countries sharply increased.”

China is no longer the US’s largest trading partner, as “its share of US imports has fallen” from 22% in 2018 to 13% in early 2023. Trade restrictions since 2018 have cut “Chinese imports of tariffed products” as US FDI in China fell sharply.

However, indirect links are replacing direct ties between the US and China. “Countries that have gained the most in US import shares…have also gained more in China’s export shares” and FDI abroad.

A BIS study found “supply chains have lengthened in the last two years”, especially between “Chinese suppliers and US customers”. Hopefully, Gopinath suggests, “despite efforts by the two biggest economies to cut ties, it is not yet clear how effective they will be”.

For Gopinath, trade restrictions “diminish the efficiency gains from specialisation, limit economies of scale due to smaller markets, and reduce competitive pressures.”

She reports IMF research suggesting “the economic costs of fragmentation… could be significant and weigh disproportionately on developing countries”, with losses around 2.5% of world output.

Losses could be as high as 7% of GDP depending on the economy’s resilience: “losses are especially large for lower income and emerging market economies.”

Much will depend on how things unfold. She warns, “Fragmentation would also inhibit our efforts to address other global challenges that demand international cooperation.”

Policy options

Policymakers face difficult trade-offs between minimising the costs of fragmentation and vulnerabilities, and maximising security and resilience.

Gopinath recognises her ‘first best solution’ – to avoid geoeconomic hostilities – is remote at best, given current geopolitical hostilities and likely future trends. Instead, she urges avoiding “the worst-case scenario” and protecting “economic cooperation” despite polarisation.

She wants adversaries to “target only a narrow set of products and technologies that warrant intervention on economic security grounds”. Otherwise, she advocates a “non-discriminatory plurilateral approach” to “deepen integration, diversify, and mitigate resilience risks”.

Despite the odds, Gopinath appeals for a “multilateral approach…for areas of common interest” to “safeguard the global goals of averting climate change devastation, food insecurity and pandemic-related humanitarian disasters”.

Finally, she wants to restrict “unilateral policy actions – such as industrial policies”. They should only address “market failures while preserving market forces”, which she insists always “allocate resources most efficiently”.

Not recognising the double standards involved, she wants policymakers “to carefully evaluate industrial policies in terms of their effectiveness” But, she is less cautious and uncritical in insisting on neoliberal conventional wisdom despite its dubious track record.

Unsurprisingly, two IMF staffers felt compelled to write in 2019 of ‘The Return of the Policy That Shall Not Be Named’. Despite much earlier extensive European and Japanese use and US President Biden’s recent embrace of industrial policy, the Fund seems caught in an ideological trap and time warp of its own making.

While making excessive claims about gains from globalisation, Gopinath acknowledges “economic integration has not benefited everyone”.

Thankfully, she urges developing countries to remain non-aligned and “deploy their economic and diplomatic heft to keep the world integrated” as the new Cold War sets the world further back.

Pragmatically, Gopinath observes, “If some economies remain non-aligned and continue engaging with all partners, they could benefit from the diversion of trade and investment.”

By 2022, “more than half of global trade involved a non-aligned country…They can benefit directly from trade and investment diversion”, reducing the Cold War’s high costs.

Related IPS Articles

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·                China Debt Traps in the New Cold War

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Industrial policy, East or West, for development or war?

Jomo Kwame Sundaram

NEEMRANA, Rajasthan, India. March 20, 2024 (IPS). Developing countries wanting to pursue industrial policy were severely reprimanded by advocates of the ‘neoliberal’ Washington Consensus. Now, it is being deployed as a weapon in the new Cold War.

Industrial policy vs colonialism

Industrial policy is often seen as pioneered by Friedrich List. But List was inspired by George Washington’s first Treasury Secretary, Alexander Hamilton. He advocated promoting manufacturing as the Industrial Revolution was beginning in England.

For List, post-colonial national development required tariffs. Despite a title deceptively similar to his earlier Principles of the Natural Economy, List’s Principles of the National Economy was quite different, clearly inspired by Hamilton.

The Meiji Restoration started in 1868, after a quarter millennium of Tokugawa shogunate military rule. Meiji emperor rule was no mere palace coup but involved industrial policy to catch up with the already industrialising West.

Meanwhile, public intellectuals like Dadabhai Naoroji and Sayyid Jamaluddin al-Afghani rejected Western imperialism. They criticised how parts of the global South were being transformed – and ruined– by Western imperialism.

Half a century later, Harvard’s Josef Schumpeter rejected the idea that capitalism had become imperialistic. The Austrian economist insisted imperialism was a pre-capitalist atavism that capitalism’s ascendance would wipe out.

Weaponising industrial policy

Today’s geopolitics has seen a renewed Western interest in industrial policy as a weapon in the new Cold War. US President Joe Biden’s National Security Adviser, Jake Sullivan, is widely credited with articulating its use as an economic weapon.

This contrasts significantly with longstanding interest in industrial policy in the global South over several decades. For many, industrial policy has long been associated with post-colonial development efforts.

Meanwhile, strong stagnation tendencies in the West after the 2008 global financial crisis underscored the failure of purported neoliberalism. Advocacy of transformative, including green industrial policies by Mariana Mazzucato and others in Europe, was well received by desperate governments keen to resume growth.

Developmental, industrial policy

However, in developing countries, there has long been interest in developmental industrial policy. Neoliberal economists and the many influential financial institutions they control have long frowned upon this.

Alfred Marshall, Petrus Johannes Verdoorn, Nicholas Kaldor and others urged Europe to industrialise. Selective industrial policy has been even more controversial, with the government favouring some manufacturing activities over others, e.g., due to increasing returns to scale.

Typically facing resource, including fiscal constraints, developing countries have had little choice but to be selective. However, with such powers associated with governments, there was understandable concern about the potential for abuse, arbitrariness and error.

Instead, the market was supposed to decide in the best interests of society without recognising its own inherent biases and ‘failures’, especially in highly unequal post-colonial societies. Neoliberal economists were quick to caricature industrial policy with dismissive metaphors (e.g., picking winners) rather than rigorous analysis.

Asian miracles?

The East Asian Miracle was simplistically caricatured due to the abandonment of import-substituting industrialisation in favour of export-orientation. A more nuanced alternative narrative of ‘effective protection conditional on export promotion’ in Northeast Asia was thus ignored.

Industrial policy is much more than trade policy, involving a range of policy instruments. Recognising the variegated aspects, dimensions and tools of industrial policy is essential. Besides investment, finance, and technology, human resource development is also significant.

For instance, the Indian Institutes of Technology (IITs) were an important initiative to support its industry. However, with India’s gradual neglect of industrial policy, IITs have probably contributed more to the development of US hi-tech.

Evaluating industrial policy

For years, economists working on India have criticised industrial policy, usually referring to the Nehruvian experience. But rushing to such a conclusion solely referencing that experience requires cherry-picking evidence.

India’s pharmaceutical policy has been crucial to the health and well-being of its population. Affordable, often generic medicines in India have been central to its improved public health outcomes. However, unlike Western pharmaceutical transnational corporations, Indian companies have not been accused of price-gouging.

Bangladesh has since utilised its special dispensation as a least developed country (LDC) to export affordable generic medicines to many other poor countries. However, the West blocked the Indian-South African initiative to suspend patent royalties to address the COVID-19 pandemic for its duration.

Effectively, the West was reneging on its 2001 agreement to the Public Health Exception to Trade-Related Industrial Property Rights (TRIPS). This compromise was needed to restart WTO processes after the African walkout from the 1999 Seattle World Trade Organization (WTO) ministerial meeting.

If not for India and Bangladesh, the costs of medicines would have been much higher, and there would be more ill health in the world today. Defining industrial policy success solely in terms of the financial profitability of investments ignores such gains.

It is, therefore, crucial to build coalitions to create the conditions for sustained and appropriate but adaptive industrial policies. These are needed to accelerate growth and structural transformation to achieve sustainable development in the face of stagnation and regression in much of the world, especially the global South.

Selected IPS readings

Stop Blaming Industrial Policy. Oct 06, 2020.

http://www.ipsnews.net/2020/10/stop-blaming-industrial-policy/

Exchange Rate Undervaluation for Export-Led Growth Promotion. Jan 28, 2020.

http://ipsnews.net/2020/01/exchange-rate-undervaluation-export-led-growth-promotion

Industrial Policy Still Relevant. Oct 29, 2019.

http://www.ipsnews.net/2019/10/industrial-policy-still-relevant/

Industrial Policy Finally Legitimate? July 9, 2019.

http://www.ipsnews.net/2019/07/industrial-policy-finally-legitimate/