Summer 2010

Debt Karma

– The Wilson Quarterly

Poor countries and enormous foreign debt go hand in hand.

Poor countries and enormous foreign debt go hand in hand—that is, except for the one-third of all developing countries that regularly borrow from abroad and haven’t wound up with a serious debt problem. What enables these all-stars to escape owing huge sums to foreign creditors? Democracy, theorizes Thomas Oatley, a professor of international political economy at the University of North Carolina, Chapel Hill.

The 40 most heavily indebted developing countries entered the 1990s owing an average of 220 percent of their gross domestic product (GDP). Research into why some countries ended up so far underwater has suggested that the key factor was simply bad luck: oil price shocks, recessions in industrial countries, weak commodity prices, high interest rates. But in his study of 78 developing countries from 1976 to 1998, Oatley sees little evidence that such factors have significant long-term effects. Political institutions, he finds, provide a much better explanation. Over a 20-year period, an average autocracy would rack up twice as much debt as a percentage of GDP as an average democracy.

What accounts for the variation? Autocracies, perhaps because of doubts about their long-term survival, borrow recklessly and spend unwisely, often wastefully. Their economies stagnate, leaving little tax base from which to draw revenue to pay back the debt. One such country, Zambia, increased its foreign indebtedness as a percentage of GDP by an average of nine points per year from 1975 to 1991, when it hit 210 percent.

Democratic regimes, by contrast, tend to invest their borrowed money, which over time ensures a more stable, growing economy, and, as a result, debt shrinks as a percentage of GDP. With reasonable tax rates, they are able to service their loans. Democratic Botswana, for example, saw its foreign debt burden fall by 1.6 percentage points per year from 1975 to 1991.

Oatley says that the results of his study provide some basis for optimism. Countries “are not driven ever deeper into poverty by a hostile global economy over which they have little influence,” he writes, and political reform can help push societies toward better policies. But those who promulgate widespread debt forgiveness should be wary: Their policies may help autocracies most.

THE SOURCE: “Political Institutions and Foreign Debt in the Developing World” by Thomas Oatley, in International Studies Quarterly, March 2010.

Photo courtesy of Flickr/United States Mission Geneva