Question

What fueled the accumulation of external debt in Latin America and what role did internal and external factors play in this crisis?

Answer 1

Solution(s):

The External debt of developing countrieis is the external debt that governments in developing countries owe to foreign banks and foreign governments.

Many of the countries with external debt, gained their independence post 1945. For most of these countries their debt accumulated during the 60s, 70s and 80s.

Why Third World Debt Increased

1. Investment for Structural Adjustment.

In the post war period, many developing countries adopted a policy of import substitution and industrialisation. In other words they sought to diversify their economy from being based on agriculture to investing in manufacturing industries. This required investment and this investment was funded by external borrowing. The loans were seen as helping to develop developing economies. However, not all loans were used for investment in infrastructure. Corruption siphoned off approx 20% of these debts.

2. Banks Willing to lend.

In the 1970s, foreign banks were eager to lend to developing countries. The theory was that ‘governments don’t default’. It was believed that lending to governments was safe banking because sovereign nations do not default on their debts. This is one reason why external debts became so large – private banks never imagined default would occur.

3. Oil Crisis 1973

The oil crisis of 1973, hit developing countries. Firstly, they were reliant on oil imports. Secondly, the attempts at industrialisation meant there demand for oil was greater. However, with oil prices tripling, they couldn’t afford the oil imports, so many countries borrowed to be able to continue importing. It was in the 1970s when levels of external debt really increased to difficult levels

4. Inflation and Interest Rates.

The oil price shock also caused inflation and therefore higher interest rates. This meant that the devloping countries were faced with both higher debt, but also a higher % of debt interest payments.

5. Slow Growth in 1970s and 1980s.

The expected boom in economic growth didn’t materialise. The investment in industrialisation gave poor returns, partly due to lack of sufficient labour skills and lack of previous expertise. Import substitution proved a poor policy for economic development. With rising oil prices, poor harvests and falls in agricultural prices, developing countries had a fall in economic growth, leading to lower tax revenues.

6. Decline in Credit Ratings.

As countries experienced problems repaying, their credit rating was reduced. This made it more difficult and expensive for countries to service their debt.

7. Collapse of Soviet Aid.

In the Post war period, the Soviet Union often lent to developing countries as part of the surrogate cold war. But, in the 1980s, funds from the Soviet Union dried up.

8. Fixed Exchange Rate

Some Countries experienced debt because of their efforts to maintain a fixed exchange rate. For example, in an effort to prevent inflation, during the 1980s, Argentina adopted a fixed exchange rate to prevent inflation. The idea was that if the government wanted to print more money, they had to hold an equal amount of dollars. In the old system, the government could just print more money and this caused inflation. In the new system they could only print more money if they had more dollars. But, the government desperately wanted to print money so they started to borrow dollars. Eventually this external debt became unmanageable and Argentina started to default.