Enquiry question

How do changes in the long term terms of trade result in a global redistribution of income, through deteriorations in many LEDCs who have specialised in primary commodities.

Lesson time: 90 minutes

Lesson objectives:

Outline the meaning of foreign debt and explain why countries borrow from foreign creditors.

Explain why the servicing of international debt causes balance of payments problems and has an opportunity cost in terms of foregone spending on development objectives.

Explain that the burden of debt has led to pressure to cancel the debt of heavily indebted countries.

Teacher notes:

Activity 2: Reading activity

Watch the following short video, made by two high school students and then read the short extract. 

A short history of international debt

Prior to the 1970s the level of LEDC debt was relatively low and the repayments largely manageable.  As the short video highlights, this all changed in 1973, when the League of Arab nations (OPEC), angered by the West's support for Israel, doubled oil prices in a move designed to punish America and her Western allies.  The group then doubled oil prices again shortly afterwards.

This caused recession in many other parts of the world but meant that a small number of middle eastern nations became awash with petro dollars.  Not knowing what to do with their new found wealth many wealthy middle east individuals placed their savings into American and European banks.

The Western banks, now awash with cash, looked for new customers to lend their new found wealth to.  Western markets were saturated while many governments in Africa and the rest of the developing world were keen to borrow those funds.  Unlike earlier loans which were 'soft' in nature, these development loans were made at market interest rates and repayable in US$.  While some of this development money was well spent on infrastructure and other development projects, much of it was squandered by corrupt officials. 

Throughout the 1970s the debt crisis was largely manageable as real interest rates remained low and many LEDCs were gaining profits from exporting their natural resources at relatively high prices. 

This all changed in the early 1980s when Ronald Reagan came to power and borrowed large sums of money to finance tax cuts and increase military spending.  With America on the world market, borrowing large sums of money world interest rates rose, as did the American $ as investment funds poured into the country.  This situation was made worse by a collapse in world commodity prices as a result of a world recession.

With the LEDC government loans, repayable in US $ and at floating exchange rates, many nations were then suddenly saddled with higher repayment costs and lower export revenues from the sale of commodities.  Many LEDCs responded by borrowing more to make the earlier repayments and their problems escalated.  Mexico was the first LEDC to default on its loans in 1982.  In refusing to service their debt, the whole international credit system was threatened - if one country could get away with non repayment then what would prevent others from doing so?  Other LEDCs did follow Mexico in defaulting on their loans, forcing the IMF to take steps to manage the 'Third world debt crisis'.  

After this point the IMF would still lend development funds to Developing nations, but would only do so on the condition that they adopted certain policies designed to impose fiscal discipline on the nation.  These came to be known as Structural adjustment policies.

Activity 4: Debt relief under the heavily indebted poor countries (HIPC) initiative

The HIPC Initiative was launched in 1996 by the IMF and World Bank, with the aim of reducing the debt burden for the most indebted of nations.  This involved a two step process.  In the first, LEDCs wishing to qualify for debt relief must meet certain criteria, including a commitment to reduce poverty and the demonstration of a good track record over time. The Fund provides initial debt relief in stage one and then in stage two, full debt relief, once the nation meets its commitments.

By November 3, 2017 the IMF and World Bank had approved debt relief for 36 countries, 30 of them in Africa, providing $76 billion in debt-service relief over time. 

A list of nations is included below:

Discussion:

Is the debt relief programme the sensible way forward for managing debt relief and if so, are there any amendments that need to be made to the agreement e.g. the conditions attached to qualify for debt relief, the number of nations that qualify - could this be extended?