Q.7) Discuss the causes of Third World debt, and evaluate the success of the solutions offered.

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In this essay I will highlight my understanding to the Third World debt. The call for debt repudiation for least developed countries have echoed the sentiments of various sectors. Popular politicians, celebrities, the church and ordinary people all agreed that debt cancellation for the poorest countries in the world is justified. But are they right in that assumption? While it is true that countries with wealthier economies extended the credit line to these southern countries, how the money was spent in the respective third world countries was beyond their jurisdiction. Whatever the proponents of debt repudiation would say regarding the culpability of these lenders, it should be recognized that structurally, the lending systems at that time were also deficient.

When the Mexican government in 1982 declared that it would default on its obligations, it started the ball rolling for a global debt crisis to occur. Other countries followed suit like Argentina and Brazil. Creditors were up in arms and calling for sanctions for the recalcitrant countries. Aside from debt relief or reduction, defaulting is one way of resolving the burgeoning problem of external debt.

When these countries announced that they were no longer interested in paying their external debts that had grown into huge amounts and these compounded amounts have become extremely difficult to pay, several questions come to mind. How did these countries amass such debts that it could not pay? Why did the creditors allow the situation to balloon to such proportions? How would these unpaid debts affect the world economy in general? Despite the loan amounts being substantial, why had these countries remained destitute, if not poorer?

The aim of this essay is in the ensuing sections, the discussion will focus firstly on the root causes of the third world debt. Secondly, there were several solutions proposed to reduce third world debt. Whether they were effective or not remains to be seen.

        Several factors were attributed to third world indebtedness. Towards the end of 1990, third world debts combined ballooned to $1.3 trillion. The three countries, “Brazil ($116 billion), Mexico ($97 billion), and Argentina ($61 billion) had the most troublesome numbers” (Rogoff 1991). What the least developed countries owed to industrialized nations was staggering. Most of the creditors were privately owned commercial banks.

The third world debt was a remnant of colonialism. Shah (2005) wrote that colonialism allowed colonizing countries to transfer what they owed to their colonies. When some third world countries broke away from their colonizers to form newly independent states, the debts incurred during their colonialism periods were automatically transferred to them. This created a huge fiscal imbalance especially when these newly independent countries were starting with nothing. Before they could even jumpstart a plundered economy, these third world countries already bore the burden of external debt.

One could also trace the source of the problem to the lending practices that prevailed in the early 1960’s. The more affluent nations had excess cash as a consequence of economic windfall derived from currency float and favourable returns from oil. The developing countries began borrowing to finance their trade deficit. They also borrowed money to pay back interest rates occurred by incurred debts and maturing debts. The need to access more funds to finance their projects also added to the debt burden. On the other hand, the lenders themselves were at fault when they failed to consider the risks involved. The third world countries were also borrowing investment money due to empty or inadequate national reserves. The ineffective borrowing strategy extended to include consumption. “Borrowing becomes imprudent if it was used to finance consumption and government budget deficits” (Dornbusch and Fischer 1986,p.837). Moreover, the lenders believed that they were dealing with the sovereign and therefore the risk of defaulting or misuse was given little emphasis.

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Many of the countries that availed of funds provided by lenders were also used to finance capital flight. For example, the country sells cheap green backs to their citizens. The citizens, instead of reinvesting into the domestic market removed their money from the local system and took it elsewhere. The extent of debt build-up had grown to enormous proportions that made the third world borrowers unable to repay them. The commercial bank lenders, recognizing the risks, continued to increase lending rates. Even though debtor countries kept piling up their debts the commercial banks continued extending their lending facilities thinking that ...

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