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With the best of intentions: Debt forgiveness or how to build a perpetual motion machine…

How we got where we are;

Take a small developing country somewhere in the depths of Asia, Africa or Latin America which continues to enjoy the attention of the donor community and in particular of the multilateral development banks. It is not particularly well run, nor badly run, things just muddle along. There is a measure of democratic government but ethnic social and religious stresses and strains constrain the room for manoeuvre in government particularly as regards economic management and the development of social policy. Nonetheless there is a will to get things right……

Indeed many sections of the society including those in government wish to develop faster and wish to enjoy higher rates of economic growth and higher real incomes, all within an equitable framework that assures fair shares for all. However, given a low rate of growth, feeble exports and a strong appetite for sophisticated imports, the country cannot generate sufficient savings and taxes to finance the investment and public expenditure required for faster development. Hence the need to turn elsewhere…..

Clearly our country is a promising destination for the loans from the multilateral development banks, eager like all banks to lend to the right customers, and so borrowing takes place at a relatively substantial rate and, over the years, the amount owing begins to accumulate.

The borrowing is both to support the more traditional forms of development spending (roads, railways, better irrigation, ports etc.) and allows for more recent preoccupations as regards the needs of development, for example schools, hospitals and rural health schemes etc. As a consequence many of the loans go directly into supporting and enhancing public expenditure.

The thinking behind these loans is that the resources made available will raise all aspects of productivity, will enable the country to enjoy a faster rate of economic growth, will strengthen exports, will support a greater inflow of goods, will increase the welfare of everybody, and should (!!) generate the resources to service and repay the debt.

Enter debt forgiveness

Unfortunately things do not go as planned. The government, whilst well intentioned, looses its grip on spending due to a mass of internal forces and pressures and much of the money borrowed is used inefficiently or simply disappears. The expected benefits, increased productivity, faster economic growth, greater incomes, an increase in well-being, fail to materialise, or do so only to a limited extent. Repayment becomes a strain and impoverishes the very programmes the loans were designed to support. A downward spiral of debt repayment and weakening economic performance sets in.

A suitable candidate indeed for a debt forgiveness scheme and so a deal is made. The multilateral development institutions and the authorities in our country agree that in return for better policies and policy implementation, better control of public expenditure, social reforms and more resources for education and health, debt reductions or debt forgiveness will be allowed. All this is set out in a strategy to which the authorities subscribe. This is serious stuff and an important part of the deal is that vague promises and assurances by the country's authorities are not enough. Reform and good management must be seen to be happening…a long term programme….

However our chosen country, whilst economically small and weak does not lack audacity and courage and so the reform programme and the strategy is implemented and shows a measure of success. After a time, some of it painful, officials from the multilaterals concerned with implementing debt relief and debt forgiveness schemes register satisfaction, and our country begins to climb the ladder towards solvency and towards a much needed reputation for probity, good management and economic sense. However the ladder is long and a great deal needs to be done.

Nonetheless the lending parts of the multilaterals have noticed all this and, always on the look out for a good home for the banks' loans, and keen to avoid lending to no-hopers, are asking whether our country, as its economic and social health improves, is not a suitable case for further loans. And so the lending teams arrive and are persuaded that fresh loans are a good deal, both for the lender and the borrower (a little difficult at first but these negotiations gain a life of their own). Eventually, after some heart searching the loans are made, with more on education and health, less on infrastructure, the thinking being that better education and health really is the key to higher productivity, faster growth and increased welfare.

And so our country again finds itself loaded with the largesse from the multilaterals and even the bilaterals as well, who do not wish to miss out on a good thing.

Unfortunately things do not go quite according to plan. The weight of such fresh resources again sets up stresses and strains within government and mistakes are made and the money is not used as wisely it should have been; productivity and growth do not advance as expected, and the downward spiral of excessive debt and default looms upon the horizon. And so on…..

Plausible? Then how do you get this country off this perpetual motion machine?…….

Michael Green is former Head of Unit, Economic Analysis, DG RELEX (External Relations).