Peter Lilley considers the morality and the practical politics of Third World debt
THE AIM OF THE JUBILEE 2000 campaign to encourage leaders to cancel the backlog of unpayable debts by the most impoverished nations is wholly admirable.
The idea of cancelling debts for a Jubilee is directly inspired by scripture which makes it an appropriate way to celebrate the millennium of Christs birth. Certainly it is a much more fitting memorial than many of the soulless edifices which will be left behind in the wake of the year 2000.
The campaign to resolve the debt problem needs to be international since the issue spans the world. The Churches are uniquely well placed to lead such a campaign.
But it is particularly appropriate that the British Churches have played a central role and that the campaign came to a head at the G8 conference held in this country. After all, Britain has an outstanding record on this issue and has consistently taken the lead since the early 80s in a series of initiatives to lift the debt burden.
The first major agreement to help relieve the debt of the poorest countries, the Toronto agreement of 1988, was the result of Nigel Lawsons initiative. This was taken further by the then Chancellor, John Major, in the 1990 Trinidad terms (which were progressively enhanced under the labels London terms and Naples terms).
To give a lead Britain converted virtually all official aid loans to the poorest countries into gifts. In total, the last government wrote off £1.2 billion of British debt from these countries.
Unfortunately, it has not been easy to persuade other creditor countries of the compelling moral and practical case for accelerating debt reduction of the poorest countries as Tony Blair discovered when he tried to build on previous British initiatives at the G8 meeting. Nonetheless, he has the support of the Opposition in pursuing that difficult task.
Given the scale of suffering in the poorest and most indebted countries, it is natural to seek out who is to blame for this tragedy. Is it the lenders or the borrowers, civil war or crop failure, corrupt bureaucrats or the capitalist system?
One thing is clear. It is not the people who are suffering who are to blame. The peasant farmers of Rwanda and Mozambique who have to pay taxes out of a meagre harvest did not incur the original debts. The sick who have to go without medicine, the children who receive no education, the villagers who lack clean water - did not choose to incur the debts which mean they have to forego these basic needs.
That is why there is such a strong moral case for cancelling the backlog of unpayable debts of the most impoverished countries. There is a practical case too. There is no possibility of repaying those debts in full. Beyond a certain point attempts to secure repayment will become counterproductive. And the pretence that they are repayable gets in the way of arranging those countries future financial needs.
However, it is important to understand the origins of the debt problem both to help plan a solution and to prevent a recurrence. Unfortunately, there has been a great deal of obfuscation about the causes by those who want to use the debt issue as a stick to beat the free market.
For example, it is frequently asserted that the debt problems of the poorest countries were caused by commercial bankers pushing loans onto third world governments.
There was indeed a problem of commercial lending to middle income developing countries. It erupted in 1982 when Mexico could not service its debts. The banks eventually had to agree to re-schedule the debts of Mexico and other mainly Latin American and Eastern European countries and large amounts of debt had to be written off. The cost was met by the shareholders of the commercial banks. And by the early 1990s that crisis was formally declared to be over.
But the real problem lies with the highly indebted poorer countries. The vast bulk (85 per cent) of their debt is owed to western governments and government agencies - not to commercial lenders. Far from pushing loans down their throats the banks were very reluctant to lend to most of these countries. So these countries debts arose either from government or multilateral aid being given in the form of a loan or from western governments guaranteeing trade credit.
Despite, or perhaps because of, being channelled via governments these loans were not used productively. Either they were invested in projects which failed to produce a return, or not invested but used to finance government expenditure, or syphoned off by corrupt ministers and officials, or used to finance civil conflicts. Far from being a failure of the free market, they represent a tragic failure of statism.
The net result was that the countries concerned could not repay their debts. In many cases they could not even pay the interest. So unpaid debts were building up at a compound rate. Merely giving countries longer to pay would be little help. The creditor nations needed to acknowledge that they were never going to get back all the money they had unwisely lent.
Nigel Lawson recognised this simple fact in the mid-eighties. But he also recognised that unilateral action by Britain would be of little help to the underdeveloped countries. It would just mean other creditor countries would reserve a slightly higher proportion of the amount due to them.
For example, suppose a poor country owes an equal amount to five creditor nations; it is due to pay $100 million a year in servicing their loans; in practice it can only pay out $50 million so each country gets back $10 million. If Britain then cancels our debt the other creditor nations will still insist that the poor country pays out the $10 million it can just manage (of which each will get £12.5 million).
So Lawson tried to achieve international agreement on reducing the debt burdens of the poorest countries - those in Sub-Saharan Africa. This resulted in the Toronto agreement in 1988 which allowed eligible countries to receive a reduction of a third in their debt payments. In 1990 John Major carried this forward proposing the Trinidad terms which would allow for a reduction of debt by two thirds. Final agreement on this was reached in Naples in 1994. And in 1996 the creditor countries agreed on the Heavily Indebted Poor Countries (HIPCS) initiative which can result in writing down debt by 80 per cent.
In the course of these initiatives, Britain set an example by converting virtually all our aid loans to the poorest countries into grants. A total of £1.2 billion of British loans was written off - the biggest single contribution to easing the debt crisis. Our only remaining loans to these countries are therefore the result of guaranteeing trade finance. We stood ready to remit those debts subject to conditions (which the Jubilee Campaign rightly recognises is sensible).
It is sometimes asserted that the West takes back in debt repayments from the poorest more than it gives in aid. That is certainly not the case for the UK. In 1996/ 97, the last year for which figures are available, our aid (all in the form of grants) to the HIPCs was more than six times the loan repayments and interest received on outstanding debt.
It is also sometimes suggested that the trade debts which the British government guaranteed are largely to finance the arms trade. In fact the government has recently stated that only a tiny proportion of debts owed to the UK arise from ECGD supporting sales to defence ministries of HIPCs - some £40 million, nearly all of it to Kenya. To 37 of the 41 HIPCs there were no arms debts at all.
Since most debt of the poor countries is owed by governments to governments, it is clear that capitalism is not the cause of the problem. Indeed far from being the cause it could be the cure - or better still the prevention that is better than cure.
When a bank or other commercial lender makes a loan to a company or project in a developing country both lender and borrower are responsible for seeing that the loan is repayable. The lender needs to assess whether the company is credit worthy or the project viable. The borrower needs to invest the money productively to make a return sufficient to repay his debt. Sometimes, through incompetence, misfortune or lack of foresight, the loan will go bad - the company will prove uncreditworthy, the investment will fail. If the free market is allowed to operate the borrwmg company will be declared bankrupt. The companys assets - be it a factory, a dam,, a power station - will remain. A new owner and management will acquire those assets and try to use them more efficiently. But its debts will be wiped out. They will not be a burden on the local taxpayer.
The loser is the lender. That is tough but fair. The lender will profit from other more successful ventures. He misjudged this one and will have an incentive (and more experience) to invest more wisely in future.
Alas when loans are made via governments this does not happen. Bad debts are not automatically wiped out. No-one has a strong incentive to ensure the project is viable and wellmanaged in the first place. Nor does the management change if it fails. Worst of all the cost of paying off the bad debt falls on the local taxpayers in the poor country not on the banks shareholders in developed countries.
In short, the free market system requires lenders as well as borrowers to accept responsibility for and be realistic about bad loans. The approach of British Chancellors from Nigel Lawson onwards has been to encourage creditor governments to show similar realism and responsibility in dealing with the backlog of unpayable debt owed by the poorest countries.
The clear lesson for the future is to ensure that investment into developing countries is channelled directly through free enterprise so that these problems do not occur in future. Humanitarian aid whenever possible should be channelled (as grants not loans) via the voluntary agencies.
Peter Lilley, MP is Shadow Chancellor.
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