Debt Relief in Theory and Practice

A Ugandan uses the experience of his own country to illustrate why those arguing for debt relief ought to take sceptics a lot more seriously than they currently are doing. If one can read this article and still not understand the concept of "moral hazard", one never will understand it.

British Prime Minster Tony Blair and his colleagues on the Commission for Africa (CFA) are calling for total debt cancellation for Africa as part of a strategy to "help" the continent out of its poverty and misery.

Although this argument is convincing, it is deceptive. Experience shows that debt relief (or cancellation) generates unintended outcomes often at odds with the otherwise noble intentions of its architects.

The argument for debt cancellation is built on humanitarian appeals devoid of pragmatic considerations of the effect of debt forgiveness on the political behaviour of governments in Africa.

To understand the pitfalls of debt relief, we need to look at the Highly Indebted Poor Countries (HIPC) debt relief initiative sponsored by the International Monetary Fund (IMF) and the World Bank in the late 1990s.

The first country to benefit from HIPC, both original (1998) and enhanced (2000), was Uganda. The justification for HIPC was a duo-dimensional contradiction: on the one hand it was because the government had carried out "successful economic reforms" and as a result, its economy was growing consistently and impressively.

Then the flip side: the country's debt was big and increasingly becoming unsustainable. As a result, the debt was not only going to undermine future economic growth, it was also likely to put the reforms themselves in jeopardy.

When Uganda qualified for HIPC in 1998, its total debt was $3 billion. In both the original and enhanced HIPC, Uganda got debt relief to the tune of $2 billion. It is important to note that Uganda did not accumulate this huge debt burden as a result of "bad governance" under the brutal regime of Idi Amin.

On the contrary, more than 85 percent of the country's total debt by 1998 had actually been accumulated in implementation and application of structural adjustment reforms sponsored these donors under Milton Obote (between 1981-85), and now the Yoweri Museveni government (since 1987). In both periods, donors have hailed Uganda's economic reforms and economic growth rates.

Question: if these policy reforms work and Uganda's economic recovery was worth the claims donors were making, why couldn't this "African success story" pay itself out of debt? Assume Uganda were a company: how can it borrow, then report "successful restructuring" leading to "sustained expansion of the business" but be unable to pay its debts?

An excellent question, and one that agitators for debt-relief never bother to ask themselves. But now let us get to the heart of the piece:

Debt forgiveness creates a problem of moral hazard: a country borrows and invests the loan wisely and repays; another borrows and squanders the loan, is unable to pay back and is forgiven.

Such a scheme rewards incompetence and penalises good performance, and therefore creates a disincentive to better loan management. This argument is often dismissed as "neo-liberal" theorising. But as the experience of Uganda demonstrates, debt relief became an incentive for fiscal imprudence.

In Uganda's case, the law of unintended consequences applied: having gotten debt relief, the government went not only on a renewed borrowing spree, but also indulged itself into profligate public expenditure. It launched military adventures at home and abroad and rapidly expanded its patronage networks. As a result, the military budget grew from $88 million in 1998 to $200 million in 2004. Expenditure on public administration (i.e. on political patronage) grew at an annual rate of 16 percent consistently from $100 million in 1998 to $200 million in 2004.

By 2004, Uganda's debts had grown to $4.8 billion in spite of, but also because of HIPC and the IMF and World Bank "Debt Sustainability Analysis" for the country said the debt was "unsustainable".

In fact, this deterioration took place at a time when international donors had moved away from loans to grants so that Uganda was getting 60 percent of her total foreign aid as grants - the remaining 40 percent was itself on highly concessionary terms.

Amazing, isn't it? Keep in mind that Uganda is actually supposed to have been a star performer in governance terms, at least by comparison with other African countries. But at least the reckless spending bought some benefits in terms of improved living conditions for Ugandans, right?

Here is how debt relief is actually a futile exercise: donors insisted that money saved under HIPC should be put into a Poverty Action Fund to finance "poverty reducing expenditure areas" like infrastructure, health and education. However, although Uganda had managed to reduce poverty from 56 percent in 1992 to 35 percent in 2000, after debt relief, poverty increased to 38 percent in 2003.

Oops ... ahem ... guess not! And now for the section where Mr. Mweni starts to sound like a clone of yours truly:

This experience is not unique to Uganda, as many governments in Africa have behaved in similar ways. Countries should not be "forgiven" their debts. If a country cannot afford to pay its debts, let it default and pay the price i.e. be blacklisted by the international financial markets. Debt relief creates fiscal indiscipline, with a hope that a country will get away with its corrupt and profligate ways through forgiveness.

Western kindness and generosity out of humanitarian concern will not save Africa from its corrupt elites; tough and pragmatic action will. It is time donors stopped subsidising corrupt dictators in the naïve fear that by insisting on loan repayment, they will hurt the poor.

On the contrary, debt forgiveness tends to save incompetent regimes from collapse, and therefore sustain thieving elites in power. The poor cannot be helped that way.

No doubt Mr. Mweni's just another brainwashed native like myself, unthinkingly spouting the white capitalist devil's heartless "neoliberal" rhetoric: yup, that definitely has to be it, for as every sensible person knows, incentive problems can always be wished away by sufficient largesse; just forgive those debts, pile on new aid, and this time you'll succeed in monitoring every single bit of government expenditure so well that those helpful bankers from the Cayman Islands will be reduced to misery for lack of work ...

By the way, a good example of the kind of weak-minded thinking Mweni's warning against can be found on this page, being made by a gentleman called Neville Gabriel; Mr. Gabriel takes it as evidence of the efficacy of debt relief that HIPC spending on health care and education rose substantially between 1998 and 2002, but Mr. Gabriel neither bothers to look into whether this was actually a break with the past or merely a continuation of previous spending trajectories, nor does he care to ask whether all that spending has translated into real improvements on the ground; it takes no great talent to spend large amounts of money on "education" or some other lofty goal by marking up the prices of the required inputs by astronomical sums, and rewarding the contracts for them to suitable cronies. This is no mere theoretical possibility, but a recurring problem in pretty much all of the world's poorest countries, and the thorny question of how to prevent such thievery from occurring is one few debt-relief campaigners seem much interested in seeking answers to.

Comments

[Jim]

"it takes no great talent to spend large amounts of money on "education" or some other lofty goal by marking up the prices of the required inputs by astronomical sums, and rewarding the contracts for them to suitable cronies."

You have just identified the payoff that motivates all this lending and debt relief that enables continued lending. Pimps routinely get theier prostitutes addicted to something they can provide more easily than anyone else, and then they can get down to extracting their profits.

[Nicholas Weininger]

I know this is a newbie question, but: why aren't countries that receive debt cancellation/relief/whatever blacklisted by financial markets just as if they'd defaulted? If I'm a holder of a Ugandan bond, what does it matter to me whether Uganda is "forgiven" its debts or defaults on them? Do I get compensation in the former case from the "forgiving" country or agency, or what?

[dsquared]

Uganda has basically no private sector creditors, apart from short-term self-liquidating trade credits. Its external debts are almost entirely government-to-government or multilateral.

Museweni's article is highly misleading and self-serving; I noticed the following points.

1. The reason why Uganda qualified for HIPC a second time in 2004 is that "sustainability" for the purposes of HIPC is measured by the debt to exports ratio. Uganda is mainly an exporter of basic commodities, and although they rose rapidly in 2004, commodity prices are still much lower than they were in 2000. In debt-to-GDP terms, Uganda is much better off than it was.

2. It is unbelievably misleading to call Uganda's operations against the Lord's Resistance Army bases in Sudan "military adventures". The LRA are an incredibly nasty terrorist group, quite as bad as the Janjaweed.

3. It is also similarly misleading to talk about the change in the poverty rate between 2000 and 2003 without noting that the actual increase in poverty is located in the north of the country, in the region bordering Sudan, where there was a war on in 2003. The population of Uganda is 21 million, and there were 1.4 million people displaced by the 2002-3 conflict in northern Uganda. Presumably all of these people became poor.

and so on ... I find the assertion that "agitators for debt reform never trouble to ask themselves" whether the structural adjustment programmes of the 1990s worked to be absolutely bizarre; it is a cornerstone of the debt relief community that they didn't.

Africa is not short of locals who can be relied upon to tell American rightwingers that everything is the fault of corrupt blacks (and by the way, I note that Museweni, probably because he realises what the readers of allafrica would know to be ridiculous, doesn't make Abiola's perennial crack about offshore banking). They're not poor deluded natives, but that doesn't mean that we should let them get away with meretricious crap like this. Talk about the soft bigotry of low expectations.

[Abiola Lapite]

"Museweni's article is highly misleading and self-serving"

It's one thing to say it's "misleading", but how exactly is it "self-serving?" It's not as if he's defending himself against charges, is it?

"I find the assertion that "agitators for debt reform never trouble to ask themselves" whether the structural adjustment programmes of the 1990s worked to be absolutely bizarre; it is a cornerstone of the debt relief community that they didn't."

But that isn't the question I said they never ask themselves. To repeat:

"Assume Uganda were a company: how can it borrow, then report "successful restructuring" leading to "sustained expansion of the business" but be unable to pay its debts?"

If an economy is growing robustly, and the interest rates on the government's loans are low, then it ought to be more than possible to finance its debts while meeting other needs; this is simple arithmetic.

"Africa is not short of locals who can be relied upon to tell American rightwingers that everything is the fault of corrupt blacks"

Europe is not short of locals who can be relied upon to insinuate that Africans who disagree with their leftwing views must be shills for American rightwingers. What a ridiculous ad hominem; are you going to start calling us all "sellouts" and "Uncle Toms" next? Are you trying to imply that corruption is NOT one of the biggest problems facing Africa, and that corrupt, incompetent leaders are NOT to blame for fuckups everywhere from Ghana to Nigeria to Angola to Tanzania? I suppose all the Africans at home and abroad cursing their leaders must be shills in the pay of AEI, right? Your statements are as stupid as they are insulting.

"and by the way, I note that Museweni, probably because he realises what the readers of allafrica would know to be ridiculous, doesn't make Abiola's perennial crack about offshore banking"

If it's so ridiculous, tell us where exactly the funds of people like Salinas, Marcos, Mobutu, Suharto and Abacha were traced to. The only one being ridiculous here is YOU, for denying the blindingly obvious; big-time money laundering for criminals and despots is concentrated in havens like Andorra, the Caymans, Guernsey, Liechtenstein, Monaco, Switzerland and so on. How can you claim to be in the financial sector and not know something so transparently true?

"They're not poor deluded natives, but that doesn't mean that we should let them get away with meretricious crap like this. Talk about the soft bigotry of low expectations."

This is simply hilarious coming from you. It takes real cojones to presume to know local conditions better than most of the locals themselves, and the fact is that pretty much all the Ugandans I know paint a picture of domestic affairs in their country far closer to Mweni's than your rosy projections. It's easy to hold up Museveni as some sort of saint being hard done by in the writings of shills for "American rightwingers", but to do so against the criticisms of locals who have to live under the man is the height of hubris; to then accuse such critics of being shills for foreigners shows you up as an arrogant ideologue.

[Abiola Lapite]

By the way, as for your attempt to dismiss Mweni's criticism of Museveni's military spending out of hand, try dismissing the following, courtesy of the BBC:

http://news.bbc.co.uk/1/hi/world/africa/3526275.stm

["President Museveni acknowledges some corruption - with senior officials now under investigation for allegedly pocketing the wages of thousands of non-existent "ghost soldiers".

But he denies it has affected the army's performance.

His critics are less confident.

They claim the corruption has, at the very least, seriously undermined morale among the troops, and point to the army's recent failure to protect civilians from a massacre 10 days ago just north of the town of Lira - a failure blamed on a series of basic tactical errors by the military.

Which is why, last week, thousands of civilians marched through Lira to show their anger with the Ugandan military."]

Boy, these American rightwingers sure do get around, don't they? They not only recruit a guy writing for a Kampala based newspaper to write what they want to hear (who knew Grover Norquist religiously read "The Monitor"?), but then up their dirty tricks by roping thousands of Ugandan civilians out onto the streets against Museveni's sainted army: what a diabolical lot! Next thing you know, some UN shills for the American rightwing might even suggest that the Ugandan army's presence was a - gasp! - looting adventure

http://news.bbc.co.uk/hi/english/world/africa/newsid_1303000/1303351.stm

while BBC shills might even start saying that Museveni was still extricating his troops from his Congo adventure as late as 2002 ...

http://news.bbc.co.uk/1/hi/world/africa/2222051.stm

Cheeky, aren't they, all these shills? Ubiquitous too.

[dsquared]

[What a ridiculous ad hominem; are you going to start calling us all "sellouts" and "Uncle Toms" next?]

Depends. Are you all going to try to get away with reporting poverty figures without mentioning wars?

[If it's so ridiculous, tell us where exactly the funds of people like Salinas, Marcos, Mobutu, Suharto and Abacha were traced to]

Don't know. I'm pretty sure, however, that it wasn't Uganda.

[By the way, as for your attempt to dismiss Mweni's criticism of Museveni's military spending out of hand]

... never made one, mate. My criticism was of the description of the attacks on LRA camps in southern Sudan as an "adventure", which they weren't. I have no particular opinion on whether this non-adventure self-defence operation was conducted competently, let alone about more general questions of the Ugandan army. For someone who demands to be read with the utmost of interpretative charity himself, you aren't half keen on putting words in people's mouths.

[This is simply hilarious coming from you]

How much do you know about me, Abiola? Specifically, how much do you know about me and East Africa? You know, East Africa - you can't miss it, it's just on the other side of Africa from Nigeria.

[than your rosy projections]

what projections? As far as I can see, the only "projections" here are your projections of the image in your head of a leftwing strawman , onto me.

[Timothy Burke]

Just on the military adventures point: Mweni is surely referring here not to operations against the LRA, but to fairly extensive involvement by the Ugandan military in the Congo civil war between 1998 and 2003, and the expansion of the Ugandan military that involvement required.

[dsquared]

But these don't match up at all well on a timeline to HIPC?

[Timothy Burke]

Huh? It matches perfectly: the original HIPC was 1998, enhanced 2000. Direct Ugandan involvement in the Congo civil war began in a serious way in 1999, and ramped up again big time in 2000-01. Withdrawal came in 2003. I'll go off and look to make sure I'm right about this, but that's my sense of it.

[dsquared]

I have HIPC agreed in 1998 (thus starting to contribute in 1999) and DRC involvement starting in the same year. If you're right then fair enough; though I still regard the point about poverty rates as very dodgy.

[erin]

this is it.

[erin]

this is a good article for the project.