Some countries have had difficulties making progress in development. Unable to repay loans, some countries have been forced to adopt unpopular austerity programs.

Loan Debt and Repayment

Developing countries borrow money to build new infrastructure, such as hydroelectric dams, electric transmission lines, flood-protection systems, water supplies, roads, and hotels. The theory is that new infrastructure will make conditions more favorable for domestic and foreign businesses to open or expand. After all, no business wants to be located in a place that lacks paved roads, running water, and electricity.

In principle, new or expanded businesses are attracted to an area because improved infrastructure will contribute additional taxes that the developing country will use in part to repay the loans and in part to improve its citizens’ living conditions. In reality, the World Bank itself has judged half the projects it has funded in Africa to be failures. Common reasons include the following:

1. Projects don’t function as intended because of faulty engineering.

2. Recipient nations squander or spend aid on armaments, or the aid is stolen through graft and corruption.

3. New infrastructure does not attract other investment.

Some countries have been unable to repay the interest on their loans, let alone the principal. Debt actually exceeds annual income in a number of countries. When countries cannot repay their debts, financial institutions in developed countries refuse to make further loans, so construction of needed infrastructure stops. The inability of many countries to repay loans also damages the financial stability of banks in developed countries.

Developing Country Debt as a Percentage of GNI

Stimulus or Austerity?

Political leaders and independent analysts have been sharply divided on the optimal strategy for fighting economic downturns. Choose a stimulus strategy or choose an austerity strategy?

1. Stimulus strategy. Proponents of stimulus argue that during a downturn, governments should spend more money than they collect in taxes. Governments should stimulate the economy by putting people to work building bridges and other needed infrastructure projects. Once the economy recovers, they say, people and businesses will be in a position to pay more taxes and pay off the debt.

2. Austerity strategy. Proponents of austerity argue that government should sharply reduce taxes so that people and businesses can revive the economy by spending their tax savings. Spending on government programs should be sharply cut as well in order to keep the debt from swelling and hampering the economy in the future.

In the United States, the stimulus strategy was initially employed by Presidents Bush and Obama to help the country recover from the severe economic downtown in 2008. After the success of Tea Party candidates in 2010, more attention was paid to the austerity strategy. European countries divided between supporting stimulus and austerity. The lack of agreement has led to serious difficulties in Europe and may possibly result in the demise of the euro currency.

Not every country gets to choose between austerity and stimulus. The IMF, World Bank, and economically healthy developed countries fear that granting, canceling, or refinancing debts without strings attached will perpetuate bad habits in economically struggling countries. Therefore, to apply for debt relief, a country is required to adopt an austerity program that imposes strict limits on government spending.

Structural Adjustment Programs

Austerity is imposed through a policy framework paper (PFP) that outlines a structural adjustment program. A structural adjustment program contains economic “reforms” or “adjustments,” such as economic goals, strategies for achieving the objectives, and external financing requirements. Reforms required of a developing country typically include:

• Spending only what it can afford.

• Directing benefits to the poor, not just the elite.

• Diverting investment from military spending to health and education spending.

• Investing scarce resources where they will have the most impact.

• Encouraging a more productive private sector.

• Reforming the government, including making the civil service more efficient, increasing accountability in fiscal management, implementing more predictable rules and regulations, and disseminating more information to the public.

Critics charge that poverty worsens under structural adjustment programs. By placing priority on reducing government spending and inflation, structural adjustment programs may result in the following:

• Cuts in health, education, and social services that benefit the poor.

• Higher unemployment.

• Loss of jobs in state enterprises and civil service.

• Less support for those most in need, such as poor pregnant women, nursing mothers, young children, and elderly people.

In short, structural reforms allegedly punish Earth’s poorest people for actions they did not commit, such as waste, corruption, misappropriation, and military buildup. The economic pain of structural adjustment programs, as well as a sense that the international trade model leaves poorer countries vulnerable to exploitation by wealthier countries, has led some to consider a return to self sufficiency .

International organizations respond that the poor suffer more when a country does not undertake reforms. Economic growth is what benefits the poor the most in the long run. Nevertheless, in response to criticisms, the IMF and the World Bank now encourage innovative programs to reduce poverty and corruption and consult more with average citizens. A safety net must be included to ease short-term pain experienced by poor people.

Pause & Reflect 10.3.4

Do the terms of a structural adjustment program seem harsh for a country or fair? Why?