Policy Innovations Digital Magazine (2006-2016): Commentary: Debt and Trade: Time to Make the Connections

A few weeks ago, the Group of 8 Finance Ministers announced a plan to provide multilateral debt cancellation to eighteen countries, with the possibility of other heavily indebted poor countries joining in later. Today, however, there is ample recognition that structural features of the international trading system, and the way developing countries engage with it, are at the root of the debt crises that the developing world has suffered from chronically since the early 1980s. In this context, debt reduction, or even cancellation, cannot have lasting benefits unless structural features of developing-country trade are also addressed.

First, commodities represent a high proportion of the exports of developing countries. But commodity prices have declined steadily for the past four decades, and they are also subject to sharp fluctuations that tend to be asymmetric—that is, price busts tend to be longer than price booms. Regarding manufactures, which tend to be priced higher than commodities, developing countries have found it hard to diversify into this market. When and where they have succeeded, it has been through low-skill and low-tech products, such as clothing and accessories, with few linkages back into the domestic economy. In addition, low rates of value added mean that countries benefit little from exporting these products. When combined with the elimination of import and export tariffs as a result of progressive trade liberalization, there are further impacts on the revenues of governments, creating fiscal gaps that are often addressed through increased borrowing.

If trade dynamics have an impact on debt levels, the reverse is also true: high debt levels in developing countries act as a constant handicap in their attempts to implement a development-oriented trade policy. Servicing high debt levels diverts the funding that developing countries could use to upgrade their productive capacities in terms of infrastructure and human resources. The need to obtain increased levels of foreign exchange to service mounting debt encourages commodity-dependent countries to increase their commodity production. When multiple countries follow this strategy simultaneously, the result is overproduction, which leads in turn to falling commodity prices. Predictably, lower prices mean lower export earnings, thus reinforcing a vicious cycle of falling prices, volume expansion, and higher debt.

But probably the most significant constraint that debt overhang imposes on the successful participation of developing countries in the trading system—though one of the more difficult to quantify—is the restriction of their ‘policy space’. When loan conditionalities require countries to give up on even the modest flexibilities they negotiated as part of their trade commitments, the asymmetries and imbalances between these countries and their developed trading partners are deepened. The influence of the Bretton Woods Institutions on the trade and investment policies of borrowing countries is an important element shaping the trading system, an element traditionally underestimated.

In the face of the close interlinkages between the asymmetries in the trade system and the chronic burden of debt faced by developing countries, it is surprising that they receive so little attention in international economic policy initiatives that aim to address either the trade or the debt issues of developing countries.

One example of this is the common use of the concept of 'debt sustainability', coined by the international financial institutions. In general terms, all debt reduction initiatives since the 1996 Heavily Indebted Poor Countries (HIPC) initiative have sought to lower the debt of target countries to 'sustainable' levels—the definition of which has varied over the course of the initiative. The latest review of the HIPC initiative led to the adoption by the Bretton Woods Institutions of something called the Debt Sustainability Framework, which applies to all low-income countries (whether they did or did not benefit from debt relief). The use of such language is misleading and overreaching, as it may lull many into thinking that it is suitable to achieve and maintain a sustainable debt profile. But such a framework does little, in fact, to address trade dynamics.

Since last year, the promise of a G8 Summit focused on debt, trade, and aid offered development experts an opportunity to give renewed attention to the critical linkages between debt and trade. Ultimately, developing-country strategies for sustainable growth, development, and job creation can only succeed in an environment that adopts a holistic approach to reforming debt and trade regimes in tandem.

Aldo Caliari (Coordinator of the Center of Concern's Rethinking Bretton Woods Project) is one of many contributors to the new book-length treatment of Debt and Trade: Time to Make the Connections. The volume resulted from the proceedings of a conference organized by the International Jesuit Network for Development (Dublin, September 2004).