Lessons from the 1980s Debt Default Crises
The Latin American debt crisis began in 1982 when the Mexican finance minister stated that Mexico could no longer service its debts. Suddenly, banks stopped lending to Latin America, and a serious credit crunch ensued. By October 1983, 27 countries owed $239 billion. The premise that lending to countries is safe because “countries don’t go bankrupt” led commercial banks to over lend to Latin American LDC’s. In a corporate default, a bank can go after the assets of the corporation. Going after the assets of a country in default is less clear. The countries did not go bankrupt, but the banks learned that a prolonged period of default is also very painful. Given the overextension of both countries and banks, loan rescheduling turned out to be an exercise in mutual self deception by both parties. Rescheduling attempts did allow the banks time to reduce their exposure to the LDC’s sufficiently to remove the threat of financial system collapse. Restored confidence in the ability of the international financial system to take losses enabled the Brady Plan to succeed in reducing LDC debt (Giddy).
The key idea in the Baker Plan was that the LDC’s would grow their way out of debt. That can work as long as the growth rate of the country is higher that the real interest rate on its debt. The World Bank has identified four policy tenets for enhancing growth:
1) Investment in people including primary education, health and family priorities.
2) Improving the climate for enterprise by reducing government intervention in pricing, deregulating entry into markets, infrastructure improvements and legal system improvements.
3) Open international trade and investment by reducing tariffs non-tariff barriers to trade.
4) Firm macroeconomic policies including debt management, inflation targeted monetary policy and incentives for private savings and investment (Giddy).
Throughout the crisis decade debtor governments struggled to implement economic reforms required by the IMF, World Bank, or Paris Club. The precursor to implementation of growth enhancing policy – or any policy- is government stability. Developed country governments must find a balance for supporting stability of LDC governments without interfering in domestic issues.
Going forward, developed country governments must cooperatively ensure the stability of the international financial system, being lender of last resort and maintaining confidence in the lenders, and maintaining confidence in the system by making sure borrowers are able to pay. Borrowing governments and borrowing economies are responsible for fiscal, monetary, and trade adjustments to assure debt repayment and maintain capital inflows necessary for development (Kahler).
References:
1. Giddy, Ian H. "Global Financial Markets." Lexington, MA 02173: D.C. Heath and Company, 1994. 297-315.
2. Kahler, Miles. "Politics and International Debt." International Organization, Vol 39, No.3 (Summer 1985): 357-382.
