Unchecked Governments

WHEN GOVERNMENTS WEREN’T borrowing on behalf of their state enterprises or their military, or to compensate for monies draining the country through corruption and capital flight, they were borrowing on their own account.

Soaring oil bills after the OPEC oil crisis come in for the most blame in indebting Third World governments. Yet, of the ten most indebted developing countries, three export oil and only three — Brazil, India, and South Korea — depended heavily on imported oil. Of those three, only Brazil could not manage its debt. Among the next 25 most heavily indebted countries, only four more — the Philippines, Pakistan, the Sudan, and Uruguay — suffered seriously. Uruguay, for example, spent 44 per cent of its export earnings on imported oil in 1975.

Others — Argentina, Peru, and Chile among them — depended far less on imported oil. Despite a threefold increase in oil prices by 1975, these countries spent only about 15 per cent of their export earnings on imported oil.

In fact, the oil crisis most crushed those that it enriched — Mexico and Venezuela, two of the world’s biggest oil producers. Being rich in oil, and hungry for funds to develop their oil reserves, Mexico and Venezuela borrowed heavily against their natural assets.

The oil crisis disproved Pearson’s dire warnings that Third World nations would soon run out of credit. Awash with petrodollars, the private banks — until then minor lenders — stepped in to fill the financial breach, allowing Third World countries to blissfully borrow more to pay off old debts. But Pearson’s prediction had only been postponed: the Ponzi game continued on inexorably toward a conclusion one decade later.

The borrowers’ luck finally ran out. Worldwide interest rates, but especially those in the United States to which most Third World loans were tied, went sky high, forcing Third World countries to pay more. At the same time, commodity prices fell through the floor, giving them less with which to do so. Meanwhile, like Mr. Ponzi, Third World governments had failed to put their money in income-generating investments, squandering it instead on ill-considered megaplans and more.

Contributing to the spending deficits of oil exporting and importing nations alike were all manner of subsidies. For the oil exporting countries, subsidized domestic fuel encouraged wastefulness and — since less was left to sell — represented foreign exchange forgone. For all countries, energy subsidies encouraged consumption at the expense of the environment and the economy.

Next to energy subsidies were food and agricultural subsidies, which especially wreaked havoc on Third World economies by undermining local agriculture.

African governments have provided cheap food to the politically important urban populations by forcing state grain boards to sell their stocks below market prices. As a result, most governments have run up large deficits for decades. In Zambia, corn subsidies for the urban population alone accounted for 16 per cent of the government’s 1986 budget deficit.

To help pay for the low consumer prices, farmers have in turn been expected to hand over their crops for a pittance, driving them out of business or into the black market, out of the marketing board’s reach. For export crops, says the Heritage Foundation, a conservative think-tank based in Washington, the marketing board’s “rule has been: buy low, sell high and pocket the difference.” Farmers in Ghana, Nigeria and Tanzania — among Africa’s main coffee-, cocoa- and cotton-exporting countries — received only about 50 per cent of the export price of their crops in 1984. Cameroon’s coffee farmers received 29 per cent for their Arabica beans in 1986 — $1,400 a ton against a world market price of $4,800 a ton.

“Price-conscious African farmers,” reports the Heritage Foundation, “responded by selling their production in black markets, smuggling it across the border, shifting into livestock, reverting to subsistence agriculture or leaving the land entirely to join the urban swell.” By so grossly underpaying their farmers in an attempt to squeeze the maximum profit for the state, African governments eventually drove an important source of revenue away.

Mismanaging agriculture has generally been very costly for governments and farmers alike. In El Salvador, the Coffee Growers’ Association railed against the state monopoly marketing board for costing the nation $400 million from blundered speculations and inexperience, for paying coffee growers less than their own costs of production, and for delaying payment, thereby adding to the growers’ own debts on production loans.

State-subsidized agriculture has also drained many Third World treasuries of scarce resources. In Mexico and Brazil, government-subsidized credits had low, if not negative, interest rates, with the well connected borrowing state money at low interest rates, only to invest it in government bonds that were indexed to the much higher inflation rate. In 1975, Brazil lent farmers more than the net value of their crops, as the loans became too cheap to refuse. Depending on the loan’s use, interest ranged from 13 per cent to 21 per cent, much less than inflation. Farmers could put their borrowed money in banks and earn three or four times as much. According to The Economist: “That is the only way to explain how the acreage receiving credit for favored crops like wheat and soybeans regularly exceeded the acreage harvested — depending on the crop — by between 30 per cent and 100 per cent in 1976.”

The biggest farmers were the quickest to take advantage of the credit windfall. In 1976, 4 per cent of the loans accounted for 52 per cent of all the money, widening the already cavernous gap between rich and poor farmers: 10 per cent of the farmers control three-quarters of the country’s farmland. Brazilians called this form of arbitrage ciranda financeira, or “financial ring around the rosy.” One Brazilian economist called it “perverted,” explaining that the government was issuing credit that was being used to finance not development but speculation.

Bloated state payrolls have also drained Third World treasuries.

Brazilian governments at all levels kept an estimated seven million people “paid, and sometimes employed,” according to the financial magazine, Euromoney, with payroll padding rife throughout the system: the agrarian reform agency had 600 doormen on the payroll, but occupied buildings with only 10 entrances.

In his six years in office, President Sarney increased real spending on personnel by 71 per cent with over 50,000 hirings. By the time he passed on the presidential sash to Collor de Mello in 1990, federal and state government payrolls exceeded the federal government’s entire tax revenues. The new Brazilian president decided to fire between 20 and 25 per cent of the federal payroll, including several dead civil servants. Eleven thousand federal employees holding two or more government jobs were told to quit their extra employment.

To meet an IMF budget-cutting requirement in 1983, Zaire fired a third of its teachers and civil servants, including several thousand fictitious people on the state payrolls. Some school headmasters kept the fictitious staff on the payroll to appropriate the salaries, while dismissing their real staff.

The Third World governments’ reaction to their highly vulnerable position only made matters worse. Zambia’s President Kaunda, seeing his country’s export earnings slashed in half upon the collapse of copper, its main export, decided to “carry on as before, namely to keep importing and hope for the best.”

The borrowers’ luck got worse. The major banks, questioning the credit-worthiness of their clients, began to bail out, raising interest rates on new loans, avoiding the jumbo syndicated loans, and shortening the length of their loans.

Needing new loans to pay back older debts, Third World nations took the shorter-term, much more expensive loans, but found the foreign exchange relief short-lived: these loans were expensive and had to be paid back in very short order, with interest. Latin American debt, especially, began to snowball. Short-term debt as a proportion of all external debts almost tripled, rising from 15 per cent in 1973, when the OPEC oil crisis occurred, to 43 per cent in 1981.

Zaire’s debt servicing payments shot up from 10 per cent of the national budget in 1982 to 44 per cent in 1985. By the last year of the Marcos reign in the Philippines, the country’s interest payments had climbed to almost half of the government’s annual budget, making it the single largest budget component, larger than education and defense combined.

Government deficits accumulated into national debts so large that they sometimes exceeded the value of all the things the country could produce in a year. The more a government borrowed, and the more its interest payments climbed, the more it needed to borrow to keep the country functioning and its creditors at bay.

Third World countries borrowed from their own citizens too. Mexico nationalized the banking system a few weeks after its August 1982 bankruptcy announcement, then installed its own hand-picked bank executives who raided the bank reserves to finance the public sector deficit, leaving virtually no bank credit available to the private sector. Prospective homebuyers couldn’t even secure modest mortgages.

To pay back their citizens, many governments simply printed money, effectively repudiating their domestic debt by repaying with near-worthless paper. Early in 1990 the Brazilian rate of inflation reached 19,000 per cent a year, unimaginable to most Westerners. Brazilian economist Carlos Langoni described the uncertainty that comes from living with rapidly rising prices: “Hyperinflation,” he said, “is when you discover that it’s a better deal to pay for lunch before the first course than after dessert.”

To pay off foreigners, Third World governments can’t repudiate their debts by printing money: debts must be repaid in what are called “hard currencies” — dollars, marks, yen, and francs. Pesos, cruzados, and nairas will not do.

The more anxious Third World debtors were to borrow from foreign bankers, the more anxious these bankers became about lending to the Third World. New lending began to slump. By 1981 new loans to Latin America barely covered the interest payments flowing back to the lenders. By 1983, what the Pearson Commission had predicted more than a decade earlier finally happened: the Third World was paying more to the First World than it was receiving in new loans and foreign aid. The Ponzi scheme had collapsed. But unlike Mr. Ponzi, Third World governments couldn’t be thrown in jail. So they — or, more to the point, their people — had to come up with the foreign currency to pay off their creditors.

Sources and Further Commentary

For an analysis of the contribution of the oil crisis to the Third World’s debt, see International Debt: Systemic Risk and Policy Response by William R. Cline, Institute for International Economics, Washington, D.C., 1984; The Debt Squads: The U.S., the Banks and Latin America by Sue Branford and Bernardo Kucinski, Zed Books, London, 1988.

For an excellent description of how increasing interest rates and declining commodity prices squeezed Third World countries see Latin American Debt by Pedro-Pablo Kuczynski, The Johns Hopkins University Press, Baltimore, 1988. See Kuczynski also for the contribution of state subsidies to government deficits.

On the subject of state subsidies to agriculture see Mexico Service, A Publication of International Reports, vol. 10, no. 9, New York, April 25, 1990; “Government role in farming is big issue in Salvador, too” by Virginia Prewett, in The Wall Street Journal, March 8, 1985; “Survey: The Third World” in The Economist, U.K., September 23, 1989; “World Bank sows bad advice in Africa” by Melanie S. Tammen, in The Wall Street Journal, April 13, 1988; “Tanzania: Again Squandering Foreign Aid” by Melanie Tammen, Backgrounder, The Heritage Foundation, Washington, D.C, no. 62, 1/7/88; “Grain Marketing Policies and Institutions in Africa” by Peter Hopcraft, in Finance & Development, Washington, D.C., March 1987.

For the details on the diversion of agricultural credit to other investments in Brazil see especially “National Business, Debt-Led Growth and Political Transition in Latin America” by Sylvia Maxfield, in Debt and Democracy in Latin America, edited by Barbara Stallings and Robert Kaufman, Westview Press, Boulder, 1989; “Too Big, Too Bad” in The Economist, U.K., March 12, 1983.

Regarding state payrolls in Brazil, see “Losses Grow As Payrolls Blossom” from A Supplement to Euromoney, U.K., September 1989; “Deficit-cutting wage curb blocked by Brazil’s army” in The Globe and Mail, Toronto, March 7, 1988; “Brazil may lay off 400,000 to curb government costs” in The Globe and Mail, Toronto, May 10, 1990. For public sector layoffs in Zaire, see The African Debt Crisis, by Trevor W. Parfitt and Stephen P. Riley, Routledge, London, 1989.

Sources describing the growth in budget deficits and the increasing difficulty of maintaining them come from “Last days of an African survivor?” by Hugh McCullum, in The Globe and Mail, Toronto, July 26, 1990. See Latin American Debt by Kuczynski for an excellent description of the commercial banks’ retreat to short-term loans.

The crushing cost of servicing the debt is described ably in the publications and communiques of the Swiss Aid Agencies Coalition, including the various publications of its coordinator Richard Gertser; “Debt Crisis — Where Now?” by Sue Branford in Friends of the Earth — Tropical Rainforest Times, Spring, 1989; “World Bank looking for more belt-tightening” by James Rusk, in The Globe and Mail, Toronto, September 1, 1989; Philippine Debt To Foreign Banks by John E. Lind, Northern California Interfaith Committee on Corporate Responsibility, November 1984; the regular publications of PAID! People Against Immoral Debt, Official Newsletter of the Freedom From Debt Coalition, Philippines.

Much has been written about the contribution of government budget deficits to the Third World’s debt crisis. Here is a sample of the sources I have used: “China’s budget deficit yawns wider,” from The Globe and Mail, Toronto, August 21, 1990; “A no-growth future for Zimbabwe” by Dan Griswold, in The Wall Street Journal, September 26, 1985; Nigeria and the IMF, by T.A. Oyejide, A. Soyode, M.O. Kayode, Heinemann Educational Books (Nigeria), 1985; “Angola, an economic ostrich” by Julian Ozanne, The Financial Post, Toronto, May 10, 1991; “The Federal Deficit” in Brazil Service, A Publication of International Reports, vol. 10, no. 9, New York, May 2, 1990; “Can Salinas Avoid Mistakes of the Past?” in Mexico Service, A Publication of International Reports, New York, October 3, 1990; “Aid, the Public Sector and the Market in Less Developed Countries” by Paul Mosley, John Hudson and Sara Horrell, in The Economic Journal, 97, September, 1987; “Reviving Growth in Latin America” by S. Shahid Husain, in Finance & Development, Washington, D.C., June 1989; “Why Asia boomed and Africa busted,” by Keith Marsden, in The Wall Street Journal. An article about Bolivia’s attempts to curtail its budget deficit explained the difficulty for leaders: “The danger is that the government may end up shying away from unpopular measures. Fernando Illanas de Rivas, former minister of hydrocarbons and ambassador to the U.S. who was responsible for implementing the buy-back of the Bolivian debt, asserts: `The budget was a typical example. The President said we must make the government more efficient and shrink its spending, but then a budget was produced increasing spending by 50 per cent, in the search for popularity. The President also feels the need to be loved.'” See “Bolivia: Holding Steady But Growth Proves Elusive” by Kevin Rafferty, in Annual Meeting News, IDB Annual Meeting, Montreal, April 3, 1990.

The effect of Mexican budget deficits is described in “Mexican crisis shocks financial community” by Alan Freidman, in The Globe and Mail, Toronto, August 24, 1982; “Mexico’s president breaks the banking taboo” by Sergio Sarmiento, in The Wall Street Journal, May 4, 1990.

Sources of analysis and data on the extent and effect of inflation in the Third World are from The Debt Threat by Tim Congdon, Basil Blackwell, London, 1988; “Daily inflation struggle obsesses Brazil” by Thomas Kamm, in The Wall Street Journal, January 29, 1990; “Brazil’s moves to curb its inflation also curb U.S. concerns’ profits” by Robert L. Rose in The Wall Street Journal, July 25, 1990; “Bolivia’s inflation triumph holds perils” by Jonathan Kandell, in The Wall Street Journal, September 11, 1989.