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Third world countries debt crisis Essay

Third world countries debt crisis


       Debt Crisis is a condition in which a country has heavy external debts and is unable to pay the principle of the debt. Moreover, it also refers to a situation where a state uses large percentage of its foreign exchange in serving the debts and even goes to an extent of borrowing more loans, so as to meet the most urgent and important duties in its economy(Aluko and Arowolo 2010a). This problem is of staggering proportions with these countries owing the external creditors more than $1 trillion and Latin America countries alone owing about $400 billion. The cost of trying to service these debts has become a great burden to many of them over the years(Madrid 1992).

       For a long time, the debt crisis in third world countries has been a major challenge. It is because of this crises countries hardly develop economically hence making the citizens languish in poverty(Shah 2007).Various factors like loans must always be paid in ‘hard currencies’[1] while the developing countries have soft currencies only, dropping of the exports value of these countries and refinancing[2] of the loans have made these loans to keep growing(Hargroves and Smith 2006). The case is different for developed nations since unlike third world countries,developed countries continue to acquire wealth in theforms of loan repayments and interests. Hargroves & Smith (2006) note that the causes and consequences of the crisis originates partly in the international expansion of U.S banking organizations (during 1950s and 1960s) together with the rapid growth in the world’s economies including the LDC[3]s.It is worth noting that the loans are also the reason of the third world countries have many debts, hence the crisis. This paper will provide an analysis as to why third world countries entered the debt crisis and also relay more information on how such burdens can be resolved.

Origin of the Debt Crisis

       The debt crisis first came to existence in the 1970s when the prices of oils increased fourfold, which led to slow growth rate of the real domestic product of the LDCs (which dropped from 6% to about 4%).As a result, there was an establishment of U.S. corporate investment and the international banks were willing to support such activities[4]. New international financial systems like Eurodollar market cropped up and made the U.S. banks to have access to funds that were used to give loans to the Third world countries in large scale(Madrid 1992).

       Drastic increase in oil prices caused inflation pressure in the industrial world, led to serious problems in BOP[5]s for developing nations resulting to increased prices of imported goods and oil. To finance these deficits, the developed countries began borrowing enormous sums from banks in the international capital market. Another result of increased oil prices was increasedfunds in the Eurodollar market, which came from oil producing and exporting nations depositing most of their funds in western banks (E.Richard & Kallab, 1994). With an intention of making profits, western banks loaned most of the money to third world nations.  Although western banks had the objective of recovering the funds in a short time, this was not the case because third world countries failed to repay their debts. Further, the high oil prices led to theglobal recession which in turn led to low prices of commodities and high global interest rates (Sarah, 2009). This increased the debt burden of the developing countries.

       After the oil ban of 1973 was removed, borrowing rose sharply from $29 billion to $159 billion in 1978. The LDC debt servicing problem was even made worse by another oil shock in 1979. The Latin American nations experienced a debt-service ratio of more than 30% of the export earnings. Meeting the debt commitments was even made worse by the increased dollar exchange rate as the U.S. interest rate increased in 1980s[6](Correa and Sapriza 2014a). Bearing in mind that the LDC debt was placed in dollars, the servicing of the debts becomes even worse as time went on. To make the matter worse, the LDC continued with their heavy borrowing, a situation that saw debts increasing from $159 to $327 billion between 1979 and 1982. This led to the outbreak of the crisis[7] because the U.S. banks responded to this demand by increasing their lending.

       According to Baird (2000), the total amount of funds owed by third world countries had risen dramatically from the early 1980s. Apart from commercial banks, third world countries also owed money to other organizations such as IMF and World Bank as well as First World Governments. In relation to studies conducted by Aluko & Arowolo, (2010) by 1990, most developing countries owed industrialized nations a total of 1.3 trillion US dollars[8].During this period, some of the biggest debtors comprised of nations such as Mexico, Argentina and Brazil that had debts amounting to $97 billion, $61billion and $116 billion respectively (Rogoff, Gauvain, and Ellis 1991).

Effects of Debt Crises

       The debt crises have negatively affected economic development in third world nations, political stability as well as national security. The effects are still rife in developing nations even to date. The poor and developed countries have a lot of resources, which continuously flow to the developed countries. Going by the dependency theory, the developed countries benefits more at the expense of the developing countries; according to Aluko & Arowolo(2010), the theoretical premises of the depedancy theory are:

  • The poor countries provide natural resources, cheap labor, a destination for obsolete technology and markets to the wealthy Without this, the developed nations cannot enjoy the living standards they enjoy.
  • Wealthynations always maintain a state of dependence by various means. Thisis done through various mechanisms like media control, economics control, politics, banking, education, culture, sports and all spheres of human resource development.
  • Wealthynations actively counter the attempts by the developing nations to control their influence by means of economic sanctions and use of military forces.

       This style of integration to the world system makes these countries remain poor and always in the debt crisis. The main cause of this vicious cycle can be traced in the debt crisis(Aluko and Arowolo 2010a).

         Developing nations get financial loans from developed nations such as the US and Japan, but the high rate of corruption is also the reason behind the crisis. The reason as to why developing nations are ever languishing in poverty is due to the high rate of money embezzlement. This is according to the bourgeois scholars that the underdevelopment of the LDCs is due to their internal flaws such as lack of close integration, diffusion of capital, technology and institutions, bad leadership, corruption and mismanagement(Edwards 2009; Aluko and Arowolo 2010a). The underdevelopment and dependency are caused this internal factors and the solution out of this mess is scouting for more foreign assistance. This takes them back to the crisis.

       Due to the ever-increasing rate of poverty in developing nations because of corruption in addition to the embezzlement of funds by those in power, it is quite evident that these economic debts are hardly repaid in full. They continue to demand more external resources until the repayment of the loans becomes a problem. Provision of basic needs becomes a challenge and more money has to be borrowed to cater for them. This can lead to a critical condition where the borrowed principal keeps increasing due to negative compound interest effects and its capitalization. The economy becomes trapped in debts which can result in their strategic financial institutions being taken over by the guarantors. Sarah Edwards (2009) states that institutions like central bank and finance ministry are taken. This is done to monitor and ensure that the resouces are not misused or channeled to anything else other than servicing the external loan (Aluko and Arowolo 2010a). This is a burden to even the generations that inherit the governance of such economies.

       Developing nations borrow loans from developed countries due to a number of problems affecting each of them as a nation. There is a great difference when it comes to comparing the ways of living between developed nations such as the US and third world countries, for instance, in continents like Africa and Asia. The root cause of these include consistent decline in the prices of their raw materials in the international market, widening trade deficits and persistent BOP problems resulting to external aid, slavery and exploitation of their resources by the developed European countries, neglect of agriculture resulting in export deficit, shortage of food with consequent crave for imported foods which turns foreign reserves to bad leadership resulting in inappropriate economic policies, mismanagement, misappropriation, corruption and even misplaced priorities(Edwards 2009). The result is poor provision of social amenities like good health facilities and schools, intercommunity conflicts, ineffective governments, insecurity, the regions become politically unstable and many negative effects to the citizens. This denies them a sense of belonging and gives them a good experience of theharsh life.

       Health and food are the most crucial aspect of development in the community. A sick and hungry community is never productive in anyway. Research conducted in third world nations state that children living in developing nations normally stand a higher chance of dying of diseases compared to those in developed nations. The case is similar when it comes to pregnant mothers whereby those residing in developing nations are more likely to die while giving birth (Ferraro and Rosser 1994). The low mortality age depletes the economies work force. It is worth noting that the most chronic diseases like HIV/Aids, Ebola and Malaria are very common in these countries. Everyday people in Africa die from even curable diseases, poverty and hunger. This is because the governments cannot use money to help their populationas they must pay huge amounts to the World Bank and IMF in debt repayment.

Causes of Debt Crisis

       Due to the high level of poverty, only a little percentage access formal education. This is because most families prefer spending a little money they have on food and other necessities and not education. Lack of education further makes these nations fall deeper into poverty; this is because most of the people are illiterate and only make little money through activities such as farming, which earns them little income[9](Karlson and Smith 2013). The debt crisis was quite rife during the 1980s-1990s. For instance, in mid 1980s, the debt crisis was quite severe that a number of nations around the world felt it either directly or indirectly. The crisis was as a result of debts from third world nations such as those in Latin America, Asia and Africa. The problem reached its climax when Mexico declared its inability to serve the international debt it had(Catherine, 2005). After Mexico’s announcement, other developing nations around the globe followed suit. Reckless financial policies by the financial institutions did make the situation more intense. They were lending money to people who were not in a position to repay the loans. This made the financial market be exposed to large debts and ended up losing trust of the lenders. E.Richard & Kallab, (1994) calls this credit crunch. This behavior was the main cause of the crisis that left many ordinary people suffering.

       Loans, official grants and long-term loans from thecommercial bank were the main causes of debt crises that occurred in the 1980s,(Correa & Sapriza, 2014)he case was different in the 1990s. This is because unlike the 1980s, apart from the short-term loans from commercial banks, the other cause behind the crisis was securities markets, which comprised of bonds and equity.The borrowers also contributed to the crisis. The use of loan awarded stands in fully in the responsibility of the borrower, and the lender takes no part in the risk. This has always encouraged irresponsible behavior in the spending of the money. This made many countriesbe in a position of not able to repay their loans. These results are that many people in the developing countries have to bear the consequences of a few irresponsible leaders and institutions.

       Capital flight[10] played a major role of facilitating the debt crisis (Ashman, Fine, and Newman 2011). Statistics released by the World Bank claimed that during the late 1970s and early 1980s, countries such as Argentina and Mexico had capital flights amounting to 67% of their capital inflows. According toDavies (2007), capitalflights causes reduced production capacity, loss of tax base and control over monetary aggregates. These factors facilitate illegal activities in the country(Davies 2007b). For instance, Mexico was one nation that went on record as having high rates of corruption. This is because only a small percentage of the loans borrowed were used for the intended purpose. This implied that a large percentage of the loans borrowed by the Mexican government were rarely accountable.

       Apart from Mexico and other Latin American nations, incidences of corruption were also rife in continents such as Asia and Africa. It is, therefore, quite evident that thecorruption contributes a lot on debt crises especially in developing nations. This is because it made the prospect of loan repayment quite unrealistic. Additionally, debt crises usually came as a result of borrowing loan for the purpose of long-term projects (Ashman, Fine, and Newman 2011). Most of these projects were not profitable to the LDCs but to the developed countries. This was because of the national inequalities and structural forces that were used by the developed countries to exclude the poor countries from the market opportunities. This unfair trade polices went on to deny millions of people in the LDCs a chance to get out of the poverty state[11].A good example is the unfair trade rules which led to the falling of the prices of the primary commodities in the worlds market. Those who benefit are the developed countries while the developing countries suffer the losses[12].

       The developing countries will always be the most affected when financial crisis occurs. This is because the developed countries are the major investors in the developing countries(Mankiw 2012). According to an investment survey conducted in 2010 by the IMF, out of the $199.5 billion inward investment in sub-Saharan Africa, the European union (EU) the lion’s share of 67%; out of the $20.1 billion direct investment in Near and Middle-east economies EU had a share of 30%; and out of the $1,199 billion direct investment in Central and South Asia, the EU countries had 29%(SESRIC 2010). This obviously ranked it the first foreign direct investor in the developing countries. Therefore in any case there is a financial crisis in the EU; the worst effects would be felt in these regions. Therefore, the developed countries ought to be very careful in the financial decisions that they make and also put the interests of the developing countries close to theirs if not at the same level.

Cost of the Debt Crisis[13]

       These are the consequences faced by the countries in the developing world that are always in heavy debts. Effects such as thedecline in the quality of life within the LDCs, political violence resulting from the decline and the persistent negative effects of the declined quality of life are mostly felt. They take these countries to the extent of just begging for international assistance, in theform of more loans and grants. Taking to considerations that the population of these countries is increasing, their economic states continued to worsen during the debt crisis periods. This affected their potential for future economic growth. There has been a continuous declining trend of investments since the crisis. About 40% between 1980 and 1987, where the worst case was between the year 1982 and 1983;this has fallen far much below the recovery point.

       When a debt crisis emerged, it came alongside a number of repercussions. For instance, apart from the decline in international relations and loss of trust with debtor nations, the crisis also resulted to political violence in addition to a drop in the economic status hence resulting to global banking crises (E.Richard & Kallab, 1994). One common effect of the crisis that is present to date is that of capital outflow normally with the intention of financing the debt.  Research conducted states that during the 1980s, a total of 50 billion dollars were sent from developing nations to rich countries (Ferraro and Rosser 1994).

       The second effect that came alongside debt crises in third world nations is the decline of living standards. Heavily indebted nations experienced the highest decline in the rate of living standards. According to studies, the poor living standards are the main reasonmany third world nations are ever involved in political violence (Ferraro and Rosser 1994). Negative effects that come alongside debt crises are so grave to the extent that that they are currently equated to a silent war (Karlson & Smith, 2013).Even though it is different from the common type of war, the results are usually similar. Just like the real war, debt crises also result to damage of property in addition to pains, miseries as well as loss of lives.

       Poverty is another main consequence that comes alongside the third world debt. Catherine Isabelle Cax(2005) notes that more than 70 per cent of people residing in third world nations are in abject poverty.There rate of poverty is usually directly proportional to the debt crisis a nation has. This implies that the more debt a nation has, the more citizens of that nation languish in poverty(Cax 2005). The reason why third world nations have a high rate of poverty is because they are ever exporting most of their products to developed nations in a move to acquire foreign exchange so that they can repay their debts (Sarah, 2009). Most nations in Asia and Africa normally practice agriculture and mining, hence, they usually end up exporting most of these products to developed nations. This makes them remain with little agricultural products and thus subjecting citizens to more poverty.

       Exportation of these resources to developed nations usually ends up doing more harm than good to third world nations. This is because it widens the gap between developing and developed nations (Sturzenegger & Zettelmeyer, 2006) . Apart from exportation of resources, third world nations are ever repaying loans and interests to developed nations hence making these nations richer. About $12 billion are remitted from third world nations to developed countries inform of debt servicing. Many nations in the African continent spent half of their national budget in repaying loans to developed countries(Hargroves and Smith 2006). Furthermore, they are not given a chance to add value to their exports. As a result, they end up exporting their raw materials at throwaway prices and importing back processed goods at higher prices. The development of industries in the poor countries was curtailed (as has always been) by the unfair trade deals. Hence, they are always trapped in the poverty cycle(SESRIC 2010).

       Some of the LDCs introduced seriously sever measures like cutting in salaries and allowances of workers and banning importation of some certain goods that unvaryingly affect the consumption pattern of the people. Stiff tariffs like payment of high import duties, increased taxes and subsidies of essential items like energy were removed(Peterson, PE and Nadler, DJ 2014). All this measures were taken to reduce the government expenditure and try to save some to service the loans. In some worse situations employment has been banned and even workers retrenched. This caused increased unemployment. These resulted to poor living standards and increased poverty to the citizens.


       There is a need to come up with permanent solutions to solve the existing economic problem which resulted from the debt crisis as its effect is being felt even to date. It has led to the lagging behind of the LDC economies since they have to pay large amounts of to the World Bank and IMF as interest fee. According to Aluko & Arowolo(2010), the two institutions have chained down the developments in the developing countries making them remain in a state of economic satgnation if not continous decline. These countries have sought assistance with an aim to further their developments, but this has caused them suffering[14]. Below are some of the possible solutions;

  1. Cancellation of the debts[15].

       When the debts are cacelled, they no longer exist and the developing countries will not need to repay them together with their interests. This can be a very appropriate solution because, in the real sense the developing countries owes nothing to the developed nations. these countries have repaid their loans many times over when paying their loan interests. Secondly, the developing countries have paid more than they have been granted in terms of loans, aids and investments. For example, each year africa spends about $15 billion in repayment of loans and in return they only receive a gain of $12.7 billion. Also, all the developing countries must pay the excessively high interest rate of $1 billion a day as interest to the World bank. For every $1 African nation receive in grants towards development, they pay $13 in interest to the World bank[16](Aluko and Arowolo 2010a)

       However according to Catherine Cax (2005), debt relief is not sufficient in enhancing growth in poor countries. Instead, other aspects like social, political character must be fulfilled to qualify for debt releaf. Aid should not be decreased with increasing debts because many countries could remain cought in traps of the negative or even low growth.

  1. Swaping the debts

       This step is aimed at helping the developing nations to reduce their debts. Some organizations like UNICEF’s Debt for Childs Relief have used this methodand helped the some developed countries with debt problems. A deal was made between the UNICEF and the international banks where some of the money that the developing countries owed to the banks was paid to UNICEF instead of the bank(Hargroves and Smith 2006). UNICEF then collected the debts in local currecies[17] and spent the money in the same countries to help children. The banks got their money through tax deductions. In this method, both the parties benefits. More so the developing countries gets a chance of enjoying their hard earned incomes.

  1. Reschedule the debts

       Here the terms of repaying the loans are adjusted and more time is given to repay the loan. Due to difficulty in loan servicing, most of the countries opt to reshedule their repayments. In the african continent, the twenty four countries that are grouped as being severy indebted, only three have not rescheduled their dept. these includes Burundi, Ghana and Kenya(Mankiw 2012). To give the debtors an easy time, the banks should take the initiative of evaluating the conditions of their clients and reschedule their loan repayments.

  1. The banks to change their policies

       An institution like the world bank only makes the people in the developing contries to suffer because of its institutionalized corporate policies(Peterson, PE and Nadler, D 2014). By changing or abandoning such policies, they will have taken responsibility in creating the debt crisis to the LDCs. This will also be a relief to the penniless people who are always forced to pay debts that did not benefit them. The loans have played an imporatnt role in driving the african countries away from the developments. A good example is the contry of Nigeria which borrowed $5 billion and currently having paid $16 billion, there remains $32 billion on the same debt today due to inflated interest rates(Correa and Sapriza 2014a).

  1. Debt repudation

       This is where a country refuses to take responsibility of paying back the loan. Some countries like Brazil, Bolovia, Costa Rica and many others have taken this step but was just for a period of time. This step is not taken because, most of the countries may fear the steps that would be taken by the financial institutions. These institutions can take steps like elimination of trading credit for the country and this would make the situation even worse(Correa and Sapriza 2014a). Further, the relation of the country that would take repudiation as an option with other creditor governments or multilateral lending agencies would be negatively affected. This would put such a country in a bad situation incase it needs financial support from any of the above institutions. Globaleconomies relations would be disrupted, the debts would be lost immediately and a possible political crisis would result. Therefore, this option is not preffered by majority of the countries.

  1. Joint responsibilities of both the lender and the borrower.

       The debt crisis was partly caused by irresponsible behaviors of the lenders. The borrowers have also indulged in corruption and spent the loans in useless or overpriced projects. This has continued to place unlawful debt burdens on the poor citizens. Response to this should, therefore, involve collective responsibility from both parties. For a long time, the lenders have ignored theirs sense of any responsibility. Efforts to tackle the indbtedness of borrower countries have been made with creations of bodies like Heavily Indebted Poor Countries (HIPC) scheme and Multi Relief  Debt Initiative (MDRI)(Edwards 2009). All these are attempts to deal with the debts of the poorest countries in a more comprehensive manner, with an interest of protecting the creditors and the financial systems.

       Countries like lesotho have also been left out in the HIPC process even if they have high levels of poverty and pay severely on the debt service than on basic services to its citizens. On the other hand, the lenders do not bind to the relief schemes(Aluko and Arowolo 2010a). They thus make the heavily indebted countries to forcibly repay the defaulted debts. All these are self-centered approaches and the investor shouldtake responsibility too.


       From the facts established by this paper, it is clear that for the current debt crisis to be contained and to prevent a contageous one like of the 1980s, all the stake holders must take responsibility. The recepient countries should not misuse the foreign loans since they lead to harsh effects. Bad governance in the developing countries has also greatly contributed to the unpayable debts. The loan borrowed should be used in an accountable way in oreder to lessen the barden placed on their citizens.

       The financial institutions like the World Bank and the IMF should impliment the possible policies available that will be most suited to all the stake holders. Initiatives like the HIPC should be very well implimented since they would help ease the financial burden on the heavily indebted countries. Since the banking crisis is always followed by the debt crisis, their failure can readily affect the lest of the economy(Correa and Sapriza 2014a). Therefore, if these institutions implement the good policies, the debt predicaments are likely to be controlled. The policy of the rich to grow reacher as the poor gets poorer should be brought to an end.


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——— 2010b, ‘Foreign aid, the Third World’s debt crisis and the implication for economic development: The Nigerian’, African Journal of Political Science and International Relations, p. 8.

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Cax, CI 2005, ‘Does Debt Relief Enhances Growth in Third World Countries?’, University of Copenhagen

Correa, R & Sapriza, H 2014a, ‘Sovereign Debt Crises’, Working Papers — U.S. Federal Reserve Board’s International Finance Discussion Papers, no. 1103-1105, pp. 1-36.

——— 2014b, ‘Sovereign Debt Crises’, International Finance Discussion Papers, p. 36.

Davies, VAB 2007a, Capital Flight and War, World Bank Publications, Washington.

——— 2007b, Capital flight and war [electronic resource] / Victor A.B. Davies, Policy research working paper: 4210, Washington, D.C. : World Bank, Development Research Group, Growth and Macroeconomics Team, 2007.

Edwards, S 2009, A NEW DEBT CRISIS? Assessing the impact of the financial crisis on developing countries, Jubilee Debt Campaign, London.

Ferraro, V & Rosser, M 1994, ‘Global Debt and Third World Development’, in Michael Klare and Daniel Thomas (eds), World Security: Challenges for a New Century, St. Martin’s Press, New York, pp. 332-55.

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Peterson, PE & Nadler, DJ 2014, The global debt crisis : haunting U.S. and European federalism / Paul E. Peterson and Daniel J. Nadler, editors, Washington, D.C. : Brookings Institution Press, [2014].

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[1] Hard currencies are the currencies whose value does not change greatly (stable currencies) like the US dollar, Japanese Yen and the Swiss Franc.

[2] Refinancing a loan is when more money is borrowed to repay the earlier loans(Aluko and Arowolo 2010b).

[3] The Less Developed Countries commonly referred to as the Third World Countries. They are characterized by low standards of living and have potentially strong natural resources that are either untapped or mismanaged.

[4] Many nations provided financial services.

[5]Balance of Payments. It is a summary of a countries transactions with other countries in a given period of time.

[6]The value of the dollar increased by 11% in 1981 and 17% in 1982 against the then strong currencies.

[7] The outstanding loans of the 8 largest money centers increased by more than 50% (from $36 to $55 billion)

[8]The Demise of the Dollar? – Antony P. Mueller – Mises Daily.(n.d.). Retrieved from http://mises.org/daily/1125/The-Demise-of-the-Dollaru_br

[9] The agricultural activities are carried out using the traditional methods and in some cases they are abandoned completely.

[10] It is the rapid out flow of capital or resources from the economy of a country. It is caused by exchange rate misalignment, financial sector constraints, repression, fiscal deficits and disbursement of new loans to LDCs. They are also caused by other non-economic factors like corruption and excessive access to government funds(Davies 2007a).

[11] Some of these unfair trade polices includes trade barriers, increased agricultural subsidies, aggressive rules on investment, service and intellectual property by the developed countries among many others. The aggressive rules are specifically aimed at reinforcing global inequalities(Correa and Sapriza 2014b).

[12] The poor countries loose more in these unfair deals than they receive in aid. These unfair deals are also caused by lack of power of negotiations by the third world countries. The rich countries has always threatened to reduce the aid given to the poor countries if they fail to support the unfair trade deals.

[13] These are the counterparts of the enforcement problems. They are the reasons why countries choose to repay their debts. They also make the countries want to avoid debt crises and sometimes may lead to the country to borrowing up to the threshold where the debt becomes risky(Sturzenegger and Zettelmeyer 2006).

[14] Some of the bad effects experienced by this countries is the heightened level of economic growth.

[15] Calls for freezing the interest and dissolving the all the existing debts.

[16] African countries repay millions of dollars to the wealthy nations yet as they do so, millions of Africans live in famine, disease, internal and external conflicts and even lack of resources(Aluko and Arowolo 2010b).

[17] They are also the soft currencies and are the money found in developing countries. They have a lower value compared to the Hard currencies and hence are friendlier to the developing nations when used to repay loans.

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