International Borrowing and Institutions (Edexcel A-Level Economics A): Revision Notes

International Borrowing and Institutions

Introduction

Developing countries require external funding to support their economic growth and development. One important strategy for obtaining these funds is through international borrowing. This borrowing can come from multilateral institutions like the World Bank and the International Monetary Fund (IMF), or from commercial sources in international financial markets. However, this approach has historically presented challenges, particularly regarding loan conditions and debt sustainability.

International borrowing and the debt crisis

Borrowing options for developing countries

Developing countries have several options when seeking to borrow funds for development purposes:

• World Bank loans: These are typically provided on concessional terms (favourable conditions with lower interest rates)
• International Monetary Fund (IMF) loans: Short-term financing to address balance of payments difficulties
• Commercial borrowing: Loans from international financial markets at market interest rates

Each of these sources has different characteristics, terms, and implications for borrowing countries.

Loan conditionality

When countries borrow from the World Bank or IMF, they don't simply receive money without obligations. These institutions attach strings to their loans, known as loan conditionality. This means that borrowing countries must agree to implement specific economic policies as a condition of receiving the funds.

The conditions typically relate to the types of economic policies that countries should adopt. These policy programmes, which will be examined in more detail later in this note, usually involve:

• Restrictive monetary policies
• Fiscal discipline and constraint
• Market-oriented reforms

The beginnings of the debt crisis

The international debt crisis first emerged in the early 1980s. The trigger point came when Mexico announced that it could not meet its debt repayment commitments. This revelation exposed a problem that affected many developing countries, particularly those in sub-Saharan Africa.

The stock of outstanding debt became a major burden for numerous developing countries. By 1990, the situation had become severe for many nations. For example, Uganda was spending more than 80% of the value of its exports of goods and services just to service its outstanding debt. This left very little surplus available for promoting development or investing in the country's future.

The role of oil price crises

Two major oil price shocks contributed significantly to the debt crisis:

1. 1973-74 oil crisis: Oil prices quadrupled, creating sudden payment deficits for countries that were not oil producers
2. 1979-80 oil crisis: Prices tripled, deepening the financial difficulties

For developing countries that imported oil, these price increases created serious problems. They suddenly faced much larger deficits on their current accounts (the balance of payments record of trade in goods and services). The demand for oil in the short run was highly inelastic, meaning countries couldn't easily reduce their consumption even as prices soared.

Why countries avoided the IMF

Developing countries were reluctant to approach the IMF for loans because they knew the IMF would impose onerous (burdensome) conditions. They would be forced to accept restrictive monetary and fiscal policies that could be politically and economically painful.

Meanwhile, oil-producing countries were enjoying windfall gains from the higher prices. Their surpluses were deposited with banks, which were then eager to lend these funds. This created an attractive alternative for developing countries: they could borrow from commercial banks at variable interest rates, avoiding the IMF's strict conditions.

The threat of default

The situation deteriorated further when the second oil price crisis occurred in 1979-80. Many countries were now carrying a legacy of past debts while needing to borrow even more. To make matters worse, countries like the USA and UK adopted macroeconomic policies that pushed interest rates to very high levels. This made it increasingly difficult for developing countries to meet their existing debt commitments.

The result was the debt crisis of the 1980s. Several countries were threatening to default on their debts (fail to make required payments). While various plans were introduced to safeguard the international financial system—such as the Baker and Brady Plans—these solutions primarily involved rescheduling existing debt. In other words, countries were given longer to pay, but this meant that debt levels continued to grow rather than decrease.

Unwise use of funds

The debt problems were compounded by another issue: in some countries, the borrowed funds were not used wisely. Sustainable borrowing requires that funds be invested in ways that enable exports to grow. When export earnings increase, countries can generate the revenue needed to repay their debts.

However, when borrowed funds are not used to boost export capacity or are mismanaged, repayment problems inevitably arise. Without increased export earnings, countries lack the means to service their debts, creating a vicious cycle of increasing debt burdens.

Improvements over time

Encouragingly, for most countries that experienced serious debt problems, the situation has considerably improved since 1990. By 2019, many countries had dramatically reduced their debt servicing burdens. For instance, Uganda's debt servicing as a percentage of exports fell from over 80% in 1990 to around 5% in 2019.

The Bretton Woods institutions

Background and establishment

At the end of the Second World War in 1945, an important conference was held at Bretton Woods, New Hampshire, USA. The influential economist John Maynard Keynes was a key delegate at this conference. The Bretton Woods conference established the foundation of the post-war international financial system.

In addition to creating the exchange rate system that operated until the early 1970s, the conference set up three key multilateral institutions with prescribed roles to support the international financial system:

1. International Monetary Fund (IMF)
2. World Bank
3. General Agreement on Tariffs and Trade (GATT), which later became the World Trade Organization (WTO)

These institutions continue to play crucial roles in the global economy today.

International Monetary Fund (IMF)

Definition: The International Monetary Fund (IMF) is a multilateral institution that provides short-term financing for countries experiencing balance of payments problems.

The IMF was established with a specific brief: to offer short-term assistance to countries facing difficulties with their balance of payments. Here's how it works:

If a country is running a deficit on its current account (importing more than it exports), it can borrow from the IMF to finance this deficit. However, the IMF doesn't simply provide funds without conditions. As a requirement for granting the loan, the IMF insists that the borrowing country implements specific policies to address the underlying problems causing the deficit.

IMF conditionality typically includes:

• Restrictive monetary policies (controlling money supply and credit)
• Fiscal policies to reduce government spending or increase taxation
• Structural reforms to improve economic efficiency

World Bank

Definition: The World Bank is a multilateral organisation that provides financing for long-term development projects.

The International Bank for Reconstruction and Development was the second institution established under the Bretton Woods agreement. It quickly became known simply as the World Bank.

The World Bank's role: The World Bank's primary function is to provide longer-term funding for projects that will promote economic development. Much of this funding is provided at commercial interest rates, reflecting the bank's role as a channelling mechanism for finance to projects that normal commercial banks might view as too risky.

However, the World Bank also engages in concessional lending (loans at below-market interest rates) through the International Development Association (IDA), which is part of the World Bank group. This concessional lending is particularly important for the poorest countries that cannot afford commercial rates.

Key characteristics:

• Focus on long-term development rather than short-term balance of payments support
• Finances specific projects like infrastructure, education, and health
• Provides both commercial and concessional loans depending on the country's circumstances
• Acts as an intermediary, channelling funds to projects that might otherwise struggle to attract financing

World Trade Organization (WTO)

Definition: The World Trade Organization (WTO) is a multilateral body responsible for overseeing the conduct of international trade.

Initially, the Bretton Woods conference established the General Agreement on Tariffs and Trade (GATT). GATT was the precursor to the WTO and organised a series of 'rounds' of tariff reductions aimed at encouraging countries to reduce trade barriers.

In addition to facilitating tariff reductions, GATT provided a forum for:

• Trade negotiations between countries
• Settling disputes between nations over trade matters
• Establishing rules and norms for international trade

In 1995, GATT was replaced by the World Trade Organization (WTO). Since its establishment, the WTO has presided over a significant reduction in barriers to trade between countries. These barriers include not only tariffs but also other forms of protectionism such as quotas, subsidies, and non-tariff barriers.

The WTO's impact: The work of these organisations has contributed to the expansion of international trade and the reduction of protectionist policies that once hindered global commerce.

Heavily Indebted Poor Countries (HIPC) Initiative

Background and rationale

By the late 1990s, it had become clear that many countries' international debt burdens had become unsustainable. These nations simply could not repay their debts without severely compromising their development prospects. In response, pressure mounted on the World Bank and the United Nations to offer debt forgiveness to developing countries, particularly to herald the new millennium.

The moral hazard problem

The World Bank was initially reluctant to pursue this route. One of the main concerns was the concept of moral hazard. The argument goes as follows:

• If a country expects to be forgiven its debt, it will have no incentive to behave responsibly in the future
• Furthermore, if one country has its debt forgiven, other countries may also expect the same treatment, reducing their incentive to repay their debts
• This could undermine the entire international lending system

Despite these concerns, the mounting evidence of unsustainable debt and the advocacy of pressure groups eventually led to action.

The HIPC Initiative framework

Definition: The HIPC Initiative is an initiative launched in 1995 to provide debt relief for heavily indebted poor countries.

The response to the debt crisis was the Heavily Indebted Poor Countries (HIPC) Initiative, which allows for debt forgiveness under specific conditions. The key requirement is that countries must demonstrate a commitment to implementing 'good' policies over an extended period of time.

The HIPC Initiative was first launched in 1995, but initially, the conditions were so restrictive that very few countries could qualify to benefit. Pressure groups, including the Jubilee 2000 campaign, lobbied the World Bank to make the initiative more accessible. As a result, the initiative was revised to allow more countries to benefit.

The original HIPC framework required countries to follow the prescribed policy package for a period of six years before they would qualify for any debt relief. This lengthy timeframe was intended to ensure genuine commitment to reform.

The four main steps

The HIPC policy package incorporated four main steps that countries needed to implement:

1. Successful implementation of policies to enhance economic growth: Countries needed to demonstrate they were taking effective measures to stimulate economic development

2. Development of a Poverty Reduction Strategy Paper (PRSP): Countries had to create a comprehensive plan outlining how they would reduce poverty within their population

3. Encouragement of private enterprise: Governments needed to create an environment conducive to private sector development and entrepreneurship

4. Diversification of the export base: Countries needed to work towards diversifying their exports rather than relying on a narrow range of products

G8 debt cancellation and expansion

In July 2005, government leaders from the G8 countries (the world's major industrialised nations) met at a summit in Gleneagles, Scotland. At this meeting, the countries present pledged to cancel the debt of the world's most indebted countries. This effectively meant cancelling the debts of those countries that had qualified under the HIPC Initiative.

Limitations and exclusions

However, the Jubilee 2000 campaign continued to argue that the HIPC Initiative remained overly restrictive. They pointed out that some countries facing heavy debt burdens were excluded from the programme and were therefore also excluded from the Gleneagles debt cancellation statement.

Countries excluded from HIPC debt relief included:

• Bangladesh
• Cambodia
• The Philippines
• Nigeria
• Peru

Effectiveness of HIPC

What remains unclear is the extent to which improvements in debt service levels can be directly attributed to the HIPC Initiative. Some commentators have noted that not only HIPC countries witnessed reductions in their debt servicing burdens during this period. This suggests that other factors, such as:

• Global economic conditions
• Improved economic management
• Rising commodity prices
• Overall development progress

may have also contributed to the improved debt situation across many developing countries.

The Washington Consensus

Origins and core policies

The Bretton Woods institutions, particularly the World Bank and IMF, have had considerable influence on economic growth and development in developing countries. These institutions have tended to impose conditions on countries seeking loans or debt forgiveness. These conditions were based on prevailing economic theories about how economies should respond to policy changes.

In 1989, economist John Williamson articulated a set of ideas about economic policy that he believed represented accepted mainstream views. These ideas became known as the Washington Consensus. The name reflects the fact that these views were widely held among policymakers in Washington, D.C., where both the World Bank and IMF are headquartered.

The ten core policies of the Washington Consensus were:

1. Fiscal discipline: Governments should maintain balanced budgets or small deficits
2. Reordering public expenditure priorities: Shifting spending away from politically popular but economically less productive areas
3. Tax reform: Broadening the tax base and lowering marginal tax rates
4. Liberalising interest rates: Allowing market forces to determine interest rates rather than government control
5. A competitive exchange rate: Maintaining an exchange rate that supports export competitiveness
6. Trade liberalisation: Reducing tariffs and other barriers to international trade
7. Liberalising inward foreign direct investment: Removing restrictions on foreign investment
8. Privatisation: Transferring state-owned enterprises to private ownership
9. Deregulation: Removing unnecessary government regulations that hinder business
10. Secure property rights: Establishing strong legal protection for property ownership

Market-oriented approach

These measures clearly reflect a market-oriented view of how economies should operate. The emphasis is on:

• Reducing government intervention in the economy
• Allowing market forces to allocate resources
• Encouraging private sector activity
• Opening economies to international trade and investment
• Establishing clear rules and property rights

The underlying assumption was that countries adopting these measures would be able to initiate a process of economic development. The Washington Consensus formed the basis of conditions imposed on countries seeking support from the World Bank and IMF.

Criticisms and limitations

While many countries did adopt some or all of these policies, it became increasingly clear that the Washington Consensus was not a complete solution to development challenges.

Alternative development models

The experience of China provided a stark counterexample. China offered an alternative development model, successfully blending market reforms with continued state control. This demonstrated that the Washington Consensus approach was not the only path to development.

Neglect of governance and institutions

Critics argued that the Washington Consensus measures neglected several crucial issues:

• Governance: The importance of good governance and accountable institutions
• Institutional development: The need to establish reliable and robust institutions to underpin the economy
• Rule of law: The necessity of strong legal frameworks and enforcement

Successful development requires not only market-oriented policies but also effective institutions that can implement and enforce those policies.

Labour market and social concerns

Additional criticisms focused on:

• Flexible labour markets: The measures didn't adequately address the need for labour market flexibility and the challenges of creating employment
• Poverty reduction: Insufficient emphasis on targeted poverty reduction strategies
• Social safety nets: Lack of attention to protecting vulnerable populations during economic transitions
• Inclusive growth: The need to ensure that growth benefits the entire population, not just elites

The inclusive growth approach

These critiques led to the development of initiatives centred on the notion of inclusive growth. Under this approach, it becomes essential to ensure that economic growth provides genuine benefits for the entire population. Development policies need to consider both macroeconomic stability and microeconomic aspects, bringing together the large-scale structural reforms with targeted interventions at the local level.

The Washington Consensus, while influential, proved to be an oversimplification of the complex challenges facing developing countries. Modern development thinking recognises that successful economic development requires a more nuanced approach that combines market-oriented reforms with strong institutions, good governance, and specific attention to poverty reduction and social welfare.

Non-governmental organisations (NGOs)

Role and definition

Definition: Non-governmental organisations (NGOs) are non-profit, voluntary citizens' groups (including charities) organised on a local, national or international level.

In addition to governments and multilateral institutions, another important group of actors promotes and supports development in developing countries: non-governmental organisations.

Examples of NGOs active in development:

• Oxfam
• Médecins sans Frontières (Doctors Without Borders)
• Various other charities and voluntary citizens' groups

These organisations operate at different scales:

• Local level (community-based organisations)
• National level (country-wide charities)
• International level (global organisations)

How NGOs support development

NGOs impact development in several important ways:

Direct project funding: NGOs raise funds through public donations and use these resources to finance development projects in developing countries. This provides an alternative source of funding beyond official government aid and multilateral institution loans.

Advocacy and pressure: Beyond direct donations, NGOs also work to influence policy by applying pressure on:

• National governments (both in developed and developing countries)
• Multilateral organisations like the World Bank and IMF

This advocacy role helps ensure that development policies consider the needs of local populations and the poorest communities.

NGO approach and impact

Local-level focus: NGOs have been particularly active in supporting projects that operate at a local level. They are often tailored to the specific needs of local communities, which makes them highly relevant and effective. This grassroots approach allows NGOs to:

• Understand local contexts and challenges
• Engage directly with affected communities
• Design interventions that fit specific local circumstances

Self-help and sustainability: A key characteristic of many NGO projects is their emphasis on:

• Encouraging self-help among communities
• Building local capacity and skills
• Promoting long-term sustainability rather than creating dependence

Institutional influence: While NGOs lack the financial resources of governments or the Bretton Woods institutions, they have demonstrated that focused, well-designed projects can have a genuine impact on people's lives. Their success has encouraged larger institutions to recognise important principles:

• The importance of inclusivity in growth: ensuring that development benefits reach all segments of society
• The limitation of one-size-fits-all solutions: recognising that different countries and communities face different challenges and need tailored approaches
• The value of community participation in development projects

NGOs have played a crucial role in shifting development thinking towards more inclusive, participatory, and locally appropriate approaches. They complement the work of larger institutions by focusing on the human dimension of development and ensuring that the voices of the poorest and most vulnerable are heard in development policy discussions.

Remember!