15 December, 2004Issue 4.1Economics

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Redressing the Balance

Michael Hugman & Dirk-Jan Omtzigt

Noreena Hertz
IOU: The Debt Threat and Why We Must Defuse It
Fourth Estate, 2004
256 pages
ISBN 0007178980

Writing accessible books about technical subjects is a task often attempted but seldom mastered, particularly if the goal is to retain a certain level of academic function as well. Cambridge economist Noreena Hertz demonstrated with The Silent Takeover (2001), which details the ascendancy of the global corporation, that she too has the ability to achieve this level of widespread yet substantive influence. And while one might naturally question the economic content of a book on third-world debt principally endorsed on the back cover by Bono and Bob Geldof, her second treatise, IOU: The Debt Threat and Why We Must Defuse It, remains surprisingly rigorous and scholarly while sacrificing none of its popular appeal.

Fortunately, it becomes clear in the first chapter why Bono’s name appears on the back cover, as Hertz describes his lobbying work alongside Bobby Shriver for the Jubilee 2000 campaign. It provides an insight into the inner workings of the political process: Bono was the driving force behind a campaign in the US to gather congressional support for a $535 million package of debt relief. This initially seems a gimicky starting point, but to assume over-simplification is unfair: the anecdote makes for an interesting and engaging introduction, but it also highlights the political complexity of achieving positive reform. International development is a topic that is rarely high on the political agenda in the developed world; this example illustrates the enormous efforts required to build a consensus for action amongst Western politicians more concerned with their own re-election. And perhaps more importantly, Hertz herein outlines the history of broken promises from the West to the developing world that becomes the backbone of her book’s invective—indeed, this sense of betrayal is integral in order for her to transform IOU from mere exposé into rallying cry.

The first section, largely historical, details how lending to developing countries became one of the principal tools of geo-political strategy at the height of the Cold War. The US, Soviet Union and China became locked into a cycle of competition through buying the allegiance of states through the tactical provision of aid and loans. A striking example is the civil war that ravaged Angola for 26 years, as fought between the Soviet-financed MPLA and US-backed UNITA and FNLA forces. But this is not the whole message that Hertz is trying to convey—it is not simply that lending buys influence. When distributed negligently, such loans can also prop up undemocratic regimes who fail to distribute the loans as promised and who instead absorb them despotically, therefore leaving the burden of repayment upon populations who saw no benefit from the actual transfer of money (and often, as we have seen in the case of President Mobutu in Zaire, serving to highlight certain hypocrisies—or at least oversights—in the donor state’s diplomatic altruisms). This theme is outlined early on and revisited throughout.

With these loans having the primary (if unstated) objective of tying even unsavoury governments to the donor countries for reasons of political clout rather than humanitarian relief, it is not surprising, suggests Hertz, that little money actually reaches the poor. A poignant example of this is the chlorine plant Fallujah 2, fifty miles outside of Baghdad, which was identified as part of Iraq’s chemical warfare building capacity in the now infamous UN Security Council meeting at which the US laid out its case for war. In actual fact, the British export credit agency ECGD had provided the expert insurance to build this ¬£14 million factory. That the export credit agency has provided insurance for weapon-related export is no exception: indeed between 30 and 50 percent of all exports credits prior to 2000 were allocated to cover sales by UK arms exporters.

Through focusing on specific examples of lending practices, Hertz is able to assemble a relatively complete picture of the origins and nature of debt. It was not only developing countries that benefited by accepting loans from the developed world, unsurprisingly, banks in the West became increasingly wedded to loaning from a purely profit-driven perspective. This rocketed in the 1970’s, when a quadrupling of the oil price provided excess cash to many previously impoverished oil-producing countries, who then deposited their newfound wealth—$333.5 billion—in western commercial banks.

Unfortunately, the urgency with which the commercial banks were investing their petrodollars frequently led them to turn a blind eye to the economics of the projects they were financing. In Togo, for example, a combination of export credits and a loan syndicated by German Commercial banks was used to build a steel mill. When the Togolese government realised that no iron ore was available to start production, it ordered the German technicians to dismantle an iron pier located at the port—a pier that had been constructed by Germany prior to WWI and which still functioned well. Once the steel mill had exhausted the pier as a feedstock, it closed down.

Hertz further strengthens her argument by detailing the rise of a secondary market for debt caused by the increase in lending. The Brady plan that emerged in the wake of the Latin American debt crisis of the 1980 created debt bonds, but the unforeseen consequence of this was the power that it gave the market over the fate of developing countries. The interest rate developing countries pay on their debts is extremely sensitive to the market’s judgments about the likelihood of default: Brazilian bonds fell sharply as the popularity of the left-wing presidential candidate Luis Ignacio da Silva rose in the polls. This, for Hertz, is the power of debt. Its influence is pervasive and yet the markets that make the life or death decisions for developing countries seem to care little for the consequences of their actions: as one bond trader observed, ‘capitalism has no soul.’ Hertz’s writing is at its strongest here. Balancing explanation with effect, she conveys crucial ideas that are drawn from a huge body of international finance literature without descending into the technicalities that characterise most work in modern economics.

Perhaps her most strident economic critiques, as well as her greatest moral ire, are expended on the ‘debt vultures’ on whom Hertz places particular focus. These investors buy up the debt of developing countries at reduced prices, and then set about systematically collecting repayment. The world’s poorest countries are taken to court, their assets seized, and every dollar paid in this way is, she suggests, a dollar effectively lost to health and education.

It almost comes as a surprise, then, that her commentary on the role of the IMF, and to a lesser extent the World Bank, is saved until so late in the book. However, when it comes, it is illustrated by Hertz’s own experience in post-Communist Russia as an employee of the IFC, and provides an individual’s insight into a very prominent debate and condemnation (well-known even outside development circles are the very politically-charged conditions of IMF lending and of the dreaded Washington Consensus of structural adjustment). Hertz correctly condemns some of the conditions imposed under structural adjustment programmes as profoundly undemocratic. (Nicaragua, for example, was only able to achieve entry to the Heavily Indebted Poor Country Programme [HIPC] if it agreed to the privatisation of the country’s national hydroelectric company, despite the fact that the Nicaraguan National Assembly had unanimously passed a law suspending all private concessions involving water use.)

One advantage of writing from the front line of the battle against debt is that Hertz is able to explore some of the IMF’s most recent and stark failures. The failure of the HIPC was much deeper than the fact that it attached the same stringent conditions to entry. There has been a wholesale failure to deliver the money needed to back up these solutions to global debt, raising her leitmotif of broken promises once again. Also resurfacing is her condemnation of irresponsible lending: certainly, the IMF was as guilty as anybody of lending to questionable states.

Accordingly, Hertz has already laid much of the groundwork as she moves into the second section of the book, which focuses on the danger that debt poses to developed and developing countries alike. Highlighting our collective dependence on a global market, she notes that the impoverishment of millions abroad results in financial vulnerability at home via currency crises and the transmission of macroeconomic shocks between countries.

And where these connections are present in finance, they are equally powerful in issues of health, the environment and national security. Here, Hertz follows in the footsteps of Nobel prize winner Amartya Sen and Columbia economist Jeffrey Sachs, who have prominently vocalised the wider and more fundamental repercussions of endemic poverty. Debt leads to disease, she asserts, from cholera in South America to the AIDS pandemic that sweeps Africa, which then creates the need for greater aid investment and therefore an exponentially increasing debt. The degradation of the environment functions similarly: by overusing natural resources, health crises inevitably result and the demand for imported goods rise as domestic assets dry up, thus worsening the cycle of debt. However, given today’s increasingly paranoid political climate, the idea that poverty breeds the resentment that in turn fuels global terrorism is perhaps her most effective argument for debt relief. Even to a popular audience, this argument is hardly new, but she presents it forcefully and concretely. In part this is due to the continued use of illustration and empirics to drive the message home, not just on extremist terrorism but on issues such as narcotic trade. And again, this is where her strength is—in reminding her readership that the choices we make negatively affect others, but ultimately also create a desperation that returns to haunt ourselves.

So how do we undo this self-perpetuating mess? Hertz first addresses the termination of lending with wilful negligence, and here her prescriptions are full of promise. A constant theme throughout, irresponsible lending practices are defined by three traits: that regimes that borrowed lacked democratic consent; that monies were not distributed in ways that helped the people; and that the lender could reasonably have known that this would be the case, therefore rending such practices easily avoidable. The arguments that underpin these criteria are drawn from jurisprudence and international law, and are compelling in their simplicity. Hertz then argues for a second category of debt relief. Appealing to the political philosophy of human rights, she argues that wherever the repayment of debt would result in the denial of basic human rights and amenities, then outstanding monies should be waived. Again, her chosen case studies of countries that are spending more servicing their debt than educating their children or caring for their ill have served throughout to set the scene for this argument. In order to determine which countries need such relief, Hertz then introduces her third main point, an argument for an international system of debt reconciliation—in effect a court for international bankruptcy. This is an idea that already has much credence amongst international economists, but one that benefits from being raised in such an accessible book.

At this point, Hertz’s suggestions have real potential to be a significant part of the solution. However, in going on, all too briefly, to address wider issues of development, she tries to cover too much ground. In particular, her ideas on National Regeneration Trusts (NRTs) appear almost as an afterthought. These bodies are proposed as mechanism to distribute funds that accrue from debt relief; control would be shared between government, civil society and international institutions. However, she fails to delineate how the shared control would function, how to determine which societies are ‘civil,’ itself an undefined concept, how ‘nationhood’ is itself defined, and how to prevent the coalition-based NRT from undermining the democratic function of the state in question.

Accordingly, the book is not without its faults: the devil is in the detail when it comes to economic policy and development. Having established so effectively in the opening chapter that political barriers to reform are many, it is disappointing that she does not describe in more detail how to surmount these varied challenges. Similarly, the power of the markets to veto reform of the international financial architecture is hinted at but never really tackled head-on. Finally, the strong-arming of developed country governments in setting the agenda at the IMF and World Bank is acknowledged but never really brought to the fore.

But complaints of omission and over-simplification are always going to be present where an author has taken issues of such complexity—issues normally the domain of professional economists—to a wider audience. But for the most part her criticisms are thorough and accurate, as are her solutions. The final thought that we are offered in the book is conveyed as a challenge: ‘The proposal I have laid out is a blueprint for a new way forward. Discuss it. Refine it. Improve upon it. But don’t ignore it. You can’t afford to.’ IOU is, ultimately, a call to arms: Hertz pleads elegantly and persuasively that third-world debt affects us all, and that lobbying for its dissolution is a battle that must be fought, and fought now.

Michael Hugman is an MPhil student in Economics. His research interests include the application of microeconomic theory to development policy, institutional economics, and finance issues in development economics. He also heads Research and Strategy for a charity working on education resource investment in Kenya.

Dirk-Jan Omtzigt is a Dutch graduate at Exeter College, Oxford. His M.Phil thesis is on pension reform and income inequality.