The Third World debt crisis and structural adjustment

How did other people's money flow into Latin America and Eastern Europe in the 1970s? {mexico} {brazil} {argentina}

In the 1960s and 1970s Latin American countries such as Brazil, Argentina and Mexico borrowed heavily abroad to industrialise, above all to build infrastructure such as roads and power stations. Their economies were growing fast, so lenders were happy to oblige. At first public lenders such as the World Bank dominated, but the oil price explosion of 1973 changed that. Oil exporters deposited their enormous dollar earnings, the so-called petrodollars, with large Western banks, and the banks lent much of that money on to Latin American governments. This was called petrodollar recycling, and the US government encouraged the banks to act as intermediaries. 1 2 3

Most of the money went out as syndicated loans, in which a group of banks lend a large sum to one government together. The interest rate was not fixed but tied to the London Interbank Offered Rate (LIBOR) and reset roughly every six months; about two thirds of developing-country debt carried such floating rates. Borrowing might be cheap at the start, but when US interest rates rose the interest bill rose with them. Latin America's external debt was $29 billion at the end of 1970, $159 billion at the end of 1978 and $327 billion by 1982. In 1982 the Latin American loans of the nine largest US banks amounted to 176 percent of their capital. 4 3

Parts of the socialist bloc borrowed from Western banks in the same years. Under Edward Gierek, Poland planned to modernise its factories with Western credits and pay the debt back by exporting their products to the West. After the 1973 oil crisis the plan faltered, and the share of export earnings going to debt service rose from 12 percent in 1971 to 75 percent in 1979. Yugoslavia's foreign debt grew by 20 percent a year and passed $20 billion in the early 1980s, and Romania ran up large foreign debts after failed oil ventures in the 1970s. These countries are covered separately in the entries on the Polish economic crisis of 1980–1981 and on Romanian debt repayment and austerity. 5 6 7

Why did higher US interest rates make the debts unpayable?

By the late 1970s the industrial countries' first priority was to bring down inflation. In October 1979 the Federal Reserve chairman Paul Volcker announced new measures to rein in inflation, and interest rates in the United States and Europe soared together (that policy is covered under the Volcker shock). The LIBOR rate on Latin American loans rose from an average of 10.2 percent in 1980 to an average of 15.8 percent in 1981 and 1982. Because the loans carried floating rates, debtors had to pay far more interest on debt they already owed, without borrowing anything new. Latin America's debt service grew from $12 billion in 1975 to $66 billion in 1982. 8 4 1

It was not only interest rates. World trade contracted in 1981, and the prices of primary commodities, Latin America's main exports, fell. The debts were in dollars, so as the dollar strengthened and local currencies weakened, it took far more local money to pay the same dollar debt. Mexico had borrowed dollars against future oil revenue, and when world oil prices fell in the summer of 1981 its capacity to pay collapsed rapidly. An analysis by the US Federal Deposit Insurance Corporation (FDIC) sums up that what specifically triggered the Mexican crisis was the combination of high interest rates and the sharp fall in oil prices in 1982. 1 9 4

Some saw the danger coming. In a 1977 speech the then Fed chairman Arthur Burns criticised commercial banks for taking on excessive risk in their Third World lending. But in the early 1970s real interest rates were close to zero and the world economy was expanding, so banks and debtors alike assumed the loans could always be rolled over. Much of the debt was short-term, so the moment banks refused to refinance, large sums fell due all at once. When rates rose in the late 1970s, the banks instead shortened repayment periods and raised their charges. 3 1

What happened in Mexico in August 1982?

Mexico devalued the peso in February 1982, but capital flight did not stop. On 12 August Finance Minister Jesús Silva Herzog informed the US Federal Reserve chairman, the Treasury secretary and the managing director of the International Monetary Fund (IMF) that Mexico could not meet its debt payment due on 16 August. Its foreign debt stood at $80 billion, mostly in dollars. Mexico announced a unilateral 90-day moratorium on payments and asked for rescheduling and for new loans to pay its existing obligations. That moment, when the international capital markets realised that Latin America could not repay, is where the debt crisis began. 4 1 9

On 1 September, in his last annual address to Congress, President José López Portillo condemned the businessmen and bankers behind the capital flight and nationalised the banks: "They have looted us, but Mexico is not finished, they won't loot us again!" Meanwhile, in August the US Federal Reserve called an emergency meeting of central bankers from around the world to provide Mexico with a bridge loan, and encouraged US banks to join in rescheduling Mexico's loans. President Miguel de la Madrid, who took office on 1 December, turned to deep cuts in public spending and opening the economy to the market. 9 3 10

After the Mexican moratorium the commercial banks sharply reduced or halted new lending to Latin America. Since much of the debt was short-term, refusals to refinance meant that billions of dollars that would earlier have been rolled over fell due at once. By October 1983, 27 countries owing $239 billion had rescheduled their debts with banks or were doing so. Sixteen were in Latin America, and the four largest, Mexico, Brazil, Venezuela and Argentina, owed commercial banks $176 billion, about 74 percent of all developing-country debt. Their debt to the eight largest US banks equalled 147 percent of those banks' capital and reserves, so several of the world's largest banks faced the prospect of failure. 1 4

The crisis soon reached South America's two big economies. In Argentina, under the military regime of 1976–83, debt ballooned while Economy Minister José Alfredo Martínez de Hoz attempted neoliberal policies, and inflation reached 344 percent in 1983. In Brazil, José Sarney, who became president with the return to civilian rule in 1985, inherited an enormous foreign debt and rampant inflation. The Cruzado Plan of 28 February 1986 froze prices and replaced the currency and was at first hugely popular, but the frozen, overvalued exchange rate favoured imports and harmed exports, and the reserves collapsed. A plan meant to stop inflation worsened the balance of payments until the country could no longer honour its external commitments. 11 12 13

What did the IMF ask for in return for its money? {usa}

As the crisis spread beyond Mexico, the United States organised an "international lender of last resort" in which commercial banks, central banks and the IMF acted together. The banks rescheduled the debts, and the IMF and other official lenders lent the debtors enough to pay the interest, though not the principal, on their loans. In return the debtors had to undertake structural reforms and eliminate budget deficits. The reasoning was that reform would raise exports and earn the trade surpluses and dollars needed to pay down the debt. In practice most of the new money did not go into the debtor economies but went back to the banks as interest. 3 1 14

This bargain is called conditionality: the IMF requires policy reforms as the condition of a loan and withholds the money if the conditions are not met. The conditions usually combined "stabilisation" policies, cutting the balance-of-payments deficit by devaluation, cutting the budget deficit by raising taxes and reducing spending, abolishing food subsidies, raising the price of public services and cutting wages, with longer-term "adjustment" policies such as market liberalisation, privatisation of state enterprises, stronger rights for foreign investors and a reorientation towards exports. The package is known as structural adjustment. In the 1980s the IMF and the World Bank created such loan packages for most countries of Latin America and sub-Saharan Africa, and Mexico was the first. 14 15 16

In the mid-1980s the IMF's role itself changed. It widened from the narrow task of currency stabilisation to promoting market-liberalising reforms through structural adjustment programmes, a shift that came without any formal renegotiation of its charter. The Reagan administration, in particular James Baker, who became Treasury Secretary in 1985, and his deputies, pressed the IMF to attach market-liberal reforms to its conditional loans. In the IMF, where the United States has the most votes, creditors' voices weighed far more than debtors'. A study of sub-Saharan Africa's experience sums up that structural adjustment was designed on the assumption that growth would resume only through a contraction of state activity and liberalised markets. 14 17 15

What did the "lost decade" do to people's lives? {mexico} {argentina} {brazil}

The debt crisis of 1982 was the most serious economic crisis in Latin America's history. Incomes and imports fell, growth stopped, unemployment soared and inflation ate away at the purchasing power of the middle classes. In the ten years after 1980, real urban wages fell by 20 to 40 percent. Real growth for the region was only 2.3 percent in 1980–85, and per capita it shrank by almost 9 percent. Even so, Latin America paid back $108 billion in 1982–85; money that might have gone to poverty and social needs went to debt service instead. In Latin America the period is called La Década Perdida, the lost decade. 1

The Federal Reserve's own history also judges that the remedy let the problem fester. Instead of eliminating subsidies to state enterprises, many debtors cut spending on infrastructure, health and education and froze wages or laid off state employees, with high unemployment, steep falls in per capita income and stagnant or negative growth as the result. In Mexico annual inflation reached 139.7 percent in 1987, and real wages fell to half their 1978 level. When the Mexico City earthquake of 19 September 1985 killed at least 5,000 people, the government was spending about 30 percent of the federal budget on foreign debt payments and was criticised for refusing to cut them to fund the recovery. 3 18 10 19

In Argentina, Raúl Alfonsín's government, elected in 1983, inherited the military regime's foreign debt and high inflation. The Austral plan of 1985 froze prices and wages and cut spending by even more than the IMF required, but as export prices fell and imports rose the country could no longer pay the interest on its debt, failed to meet its IMF programme and lost international financing. Africa went the same way. Zambia, dependent on copper exports, was by the mid-1980s one of the most indebted nations in the world relative to its GDP; when food subsidies were removed at the IMF's insistence, the prices of basic foodstuffs soared and the urban population rioted. UNCTAD estimates that between 1970 and 2002 sub-Saharan Africa received $294 billion in loans, paid out $268 billion in debt service and still owed $300 billion. 20 21 22

How did the Baker Plan differ from the Brady Plan?

James Baker, who became Treasury Secretary in 1985, arranged the Plaza Accord and the Baker Plan. At the centre of the plan was market-oriented reform by the debtors: Baker and his deputies pressed the IMF to attach market-liberal reforms to its conditional loans, and the economist John Williamson wrote that belief in the superior efficiency of the private sector had long been an article of faith in Washington, but that only with the enunciation of the Baker Plan in 1985 did promoting privatisation abroad become official US policy. Meanwhile US bank regulators allowed lenders to delay recognising the full losses on developing-country loans, believing that full recognition would have had the big banks judged insolvent. 17 14 23 3

After several years of negotiation it became clear that most of the loans would never be repaid. In 1987 Citibank became the first bank to set aside a loss provision on its developing-country loans, $3.3 billion, more than 30 percent of its total exposure, and other banks quickly followed. By 1989 the US government too accepted that the debtors could not repay in full while also reviving growth. Where the Baker Plan had put reform first, the Brady Plan proposed by Treasury Secretary Nicholas Brady turned to permanent reductions in loan principal and debt-service obligations; its first bonds were created in March 1989. 3 24

The Brady Plan exchanged banks' loan claims for new bonds, Brady bonds, whose principal was usually collateralised by specially issued 30-year US Treasury zero-coupon bonds. Banks chose between discount bonds, issued below the value of the original loan, and par bonds, issued at the same value but with a below-market coupon. Because the bonds were tradable, banks could take the risk off their balance sheets. Between 1989 and 1994 private lenders forgave about 32 percent of $191 billion in loans, some $61 billion, for the 18 countries that negotiated Brady reductions. In return the participants had to liberalise their economies; as the Spanish Wikipedia puts it, following the guidelines of the Washington Consensus was in effect the condition. The FDIC judges that the shareholders of the world's largest banks assumed the losses under the Brady Plan, which ended the crisis after a decade of negotiations. 24 4 25

What was the Washington Consensus?

In 1989 John Williamson, an economist at the Institute for International Economics in Washington (now the Peterson Institute), first used the phrase "Washington Consensus" in a background paper for country studies measuring how far Latin American countries had carried out reform. Every statement on the debt crisis, he noted, called on the debtors to "set their houses in order", undertake "policy reforms" or submit to "strong conditionality", and he set out to say what those phrases meant in Washington. His Washington was both the political Washington of Congress and the administration and the technocratic Washington of the IMF, the World Bank, the US government's economic agencies, the Federal Reserve and the think tanks. He listed ten points: fiscal discipline, redirection of public spending, tax reform, market-determined interest rates, competitive exchange rates, trade liberalisation, liberalisation of inward foreign direct investment, privatisation of state enterprises, deregulation and secure property rights. 23 26 27

The phrase soon came to be used in a broader sense than Williamson's ten points, for market fundamentalism or neoliberalism in general, a usage he strongly opposed; he said he had consciously excluded capital account liberalisation, monetarism, supply-side economics and a minimal state. Yet in his 1990 paper he himself noted that some believed the US interest in continued receipt of debt service from Latin America had been important in motivating Washington's support for austerity there in the 1980s. The two senses of the term and the arguments over it are covered in the entry on the Washington Consensus. 26 23

How did debtor countries and their people resist? {cuba} {burkina-faso} {brazil} {peru} {venezuela}

Structural adjustment brought resistance in the streets. The uprisings often called IMF riots usually broke out on the day subsidy cuts raised the price of bread, fuel or bus fares. In Tunisia, when the government ended subsidies on wheat and semolina on 29 December 1983 under the conditions of an IMF loan, bread prices more than doubled, and over 100 people died in the bread riots that lasted into early January. Earlier, in January 1977, the Egyptian government, then reaching agreements with the IMF, had cut subsidies on basic foodstuffs and set off the "Bread Intifada". In Mexico City in 1986 demonstrators marched against the IMF and the government. 28 29 3

The largest uprising was the Caracazo in Venezuela in 1989. Campaigning, Carlos Andrés Pérez had rejected liberalisation and called IMF staff "genocide workers in the pay of economic totalitarianism", but after taking office on 2 February, faced with reserves of $300 million and a national debt of $34 billion, he reversed course. On 16 February he announced a package of IMF-recommended shock therapy, the "Great Turn", and the cut in gasoline subsidies doubled the price of fuel. When bus fares rose on 27 February, protests and looting that began in Guarenas spread to Caracas. That same day the central bank president and the economy minister were at IMF headquarters in Washington signing a letter of intent to abide by its prescriptions. The government imposed martial law and sent in the army; the official toll was 276 dead, but after hundreds of unmarked graves were found many estimates put it at 2,000 to 5,000. 30

There was resistance at the level of governments too. In 1985 the Peruvian government of Alan García unilaterally limited debt repayment to 10 percent of gross national product and was isolated from international financial markets. On 20 February 1987 Brazil's finance minister Dílson Funaro, faced with plunging reserves, suspended debt-service payments to private banks. In May 1987 Kenneth Kaunda of Zambia broke with the IMF, before moving back to an agreement in 1989. In 1985 Havana hosted five international conferences on the world debt problem, and Fidel Castro denounced the debt, arguing that the Third World would never escape what First World banks and governments had imposed on it. 31 13 21 32

On 29 July 1987, at the summit of the Organisation of African Unity in Addis Ababa, Thomas Sankara of Burkina Faso called for a united African front to refuse payment of the debt. Debt's origins, he said, come from colonialism's origins: "Those who lend us money are those who colonized us." He called debt "a skillfully managed reconquest of Africa": "if we don't repay, lenders will not die. That is for sure. But if we repay, we are going to die." If Burkina Faso stood alone in refusing to pay, he added, he would not be at the next conference. Less than three months later, on 15 October, Sankara was killed in a coup led by Blaise Compaoré, who rejoined the IMF and the World Bank. 33 34

Which roads did the socialist-bloc debtors take? {poland} {romania}

The debt crisis did not spare the socialist states of Eastern Europe. Poland's foreign debt reached $23 billion by 1980. When the West refused further loans, imports dried up and the country had to export everything it could, food and coal included, to service its debt. At a meeting at the Bank Handlowy in Warsaw in April 1980 the Western creditor banks made it clear that the state could no longer subsidise artificially low consumer prices, and the price rises that followed led to the Solidarity strikes (see the Polish economic crisis of 1980–1981). In 1981 Poland notified the Paris Club of its insolvency, and negotiations on repaying its foreign debt were completed only in 1989–91. 35 5

Romania's Nicolae Ceaușescu took the opposite road and paid everything back. A 1986 referendum wrote into the constitution a clause barring future foreign loans; convertible-currency exports were promoted at all costs, imports severely cut and household energy use drastically restricted. By March 1989 virtually all medium- and long-term external debt had been repaid. No other heavily indebted country matched that record of paying off all its commercial bank debt, but the price was stagnation throughout the 1980s and a steep fall in living standards (see Romanian debt repayment and austerity). Yugoslavia accepted enhanced IMF surveillance in May 1982 and imposed austerity such as fuel rationing and import limits. Between 1979 and 1985 the dinar fell from 15 to 1,370 to the dollar, half of export income went on debt service, and at the end of 1989 Ante Marković's government launched a reform pegging the dinar to the German mark. 7 6

How is the debt crisis interpreted?

Mainstream accounts stress the debtors' policy failures. In 1999 Fed Governor Roger Ferguson summed up pre-crisis Latin American policy as "high domestic consumption, heavy borrowing from abroad, unsustainable currency levels, and excessive intervention by government into the economy". The argument that import substitution left economies unable to raise exports quickly belongs to the same family. The banks' and regulators' share is acknowledged here too: the Fed's history notes that letting large banks delay recognising losses may have weakened market discipline and encouraged excess risk-taking in later decades. One study finds that Washington Consensus policies raised real GDP per capita over five to ten years; another finds that in Brazil, Chile and Mexico macroeconomic stability improved but growth was generally disappointing. 3 26

Critical economists question the remedy itself. Jeffrey Sachs mocked the IMF's "usual prescription" of "budgetary belt tightening to countries who are much too poor to own belts", and Joseph Stiglitz, a former chief economist of the World Bank, argued that the IMF had been designed to fund Keynesian reflations and lost its purpose by turning monetarist, "not participating in a conspiracy, but ... reflecting the interests and ideology of the Western financial community". Williamson himself judged the results on growth, employment and poverty reduction "disappointing, to say the least". 14 26

Dependency theory, world-systems analysis and Marxists read the crisis through the relation of core and periphery. Dependency theory holds that resources flow from a poor periphery to a wealthy core, and one writer sees the decisive difference between them not in technology but in financial strength, above all the periphery's inability to borrow in its own currency. Giovanni Arrighi argued that the scarcity of capital heralded by the Mexican default of 1982 created a propitious environment for a "counterrevolution in development thought and practice", and that structural adjustment did nothing to improve the debtors' position while redirecting capital flows towards the revival of US wealth and power. The Marxist geographer David Harvey defined neoliberalism as "accumulation by dispossession", concentrating wealth and power in a few hands through privatisation, financialisation, the management and manipulation of crises, and state redistributions. 36 15 37

Revolutionaries in the debtor countries put it more directly. Sankara called debt neo-colonialism and said the crisis had not come suddenly but worsened each time the masses became more conscious of their rights against exploiters, and Castro denounced the debt, arguing that the Third World would never escape what First World banks and governments had imposed on it. The experience of the debt crisis became the starting point for understanding structural adjustment, neoliberalism and the shock therapy of 1990s Eastern Europe. Even the Fed's history records that its cost was borne by the citizens of Latin America and other developing countries. 33 32 3