STANFORD, Calif.--(Business Wire)--July 6, 2005-[off the wire, no link]- In June finance ministers of the Group of 8, the world's wealthiest industrialized nations, agreed to cancel at least $40 billion in debt owed by the world's poorest nations, many of them in Africa. The move certainly sounds generous, but researchers caution it is unlikely to result in large benefits for the struggling countries.
"The good news is that the G8 announcement focuses attention on the economic problems of the highly indebted poor countries, but you have to understand the tradeoffs," says Peter Henry, associate professor of economics. "Debt forgiveness isn't free." In research funded by the National Science Foundation and the Stanford Institute for Economic Policy Research, Henry and economist Serkan Arslanalp of the International Monetary Fund analyze the tradeoffs and demonstrate that debt relief may not be the most efficient way to help these very poor nations. The researchers say their work shows that these poorest countries would realize greater benefit from receiving foreign aid than they will from the debt forgiveness.
[...]The first problem with the agreement, say the researchers, is that $1 billion to $2 billion per year is a tiny number relative to the resources that have been expended.
Furthermore, the debt relief agreement may divert attention from the central issue: Poor countries need an enormous amount of help that the G8 nations have been unwilling to provide. "Time and again, the G8 has pledged to provide 0.7 percent of their annual gross domestic product for aid to underdeveloped nations. For the United States alone, honoring this pledge would provide roughly $70 billion dollars per year--70 to 35 times the quantity of resources on the table in Gleneagles (Scotland)," where the G8 talks are scheduled, Henry says.
Currently, the actual U.S. contribution is closer to 0.1 percent of GDP per year.
"The second problem is that the debt relief debate is so emotionally charged that participants seem to have lost sight of the most fundamental question: Is debt relief efficient?"
[...]"For obvious reasons, debt relief will not stimulate investment and growth in the 18 countries under consideration for G8 debt relief in July 2005," says Henry. Unlike their Brady counterparts, these countries lack the institutions that provide the foundation for profitable economic activity--not only roads, schools, hospitals, and clean water, but also well-defined property rights and a well-functioning judicial system, he says. To compare the infrastructure of the typical Brady and highly indebted poor countries, Henry used a measure constructed by Stanford economist Robert Hall and University of California, Berkeley, economist Charles Jones. According to their ranking of 127 countries, the United States has the best social infrastructure. The median Brady country ranks 63rd while the median highly indebted poor country ranks a lowly 102nd.
"In the absence of basic institutions, debt relief is like forgiving debt owed by a firm that makes losses on every unit it sells--a temporary band-aid when radical surgery is required. When a country's principal problem is inadequate institutions, there is no reason to believe that debt relief will stimulate a rush of foreign capital, generating higher investment and growth.
"But this is not an argument for leaving such countries to whither on the vine," says Henry. The efficient way to help these countries is to provide direct aid (as called for by the Millennium Challenge Goals)--aid that must be used to help build the institutions that will eventually make them attractive places for both domestic and foreign investment.
Disputing the argument that debt relief is equivalent to aid, Henry argues the two are not equivalent because debt relief is fungible.
"There is simply no reason to believe that writing down a government's debt by a billion dollars will translate into a billion dollars' worth of institution building. Having said that, aid is no panacea either, and we need to make sure that it is not wasted. But the issue is not whether we should give aid, but rather how to design aid programs that work.
"Just as bankruptcy protection can help a fundamentally sound business, debt relief can work for relatively developed but highly indebted emerging economies. Aid is the more promising way of helping poor countries build the institutions they so critically need," he says. |
