Debt Crises

How did the debt crisis in the 1980s emerge?

The period following World War II was characterized by strong economic growth in the industrialized countries. During the Cold War, the US and the Soviet Union fought for influence over the developing countries, and the West offered cheap loans for countries turning down Communism. In the 1970s, the debt of the developing countries grew from USD 90 billion to USD 750 billion. Developing countries gradually started having problems paying their debts, and, as a result, debt crises started to emerge in many countries in the beginning of the 1980s.

Alongside the strong economic growth of the industrialized countries following World War II, the former colonies/countries in the global South was still dependent on their export of natural resources, which gave low profits. When the Organization of the Petroleum Exporting Countries (OPEC) quadrupled the price of oil in 1973, this created shock waves in the global economy. While many countries were hit hard by the this, the high spike in oil prices led to a surplus of capital in the lending banks, who became the big winners of the high oil prices. The banks aggressively offered loans with extremely low, and even negative, interest rates.

Developing countries were hit hardest by the high oil prices, and they also became important markets for these loans. For the banks, it did not matter what the money was spent on. In addition, they never imaged that it would be possible for a state to go bankrupt.  Therefore, the banks believed that whatever happened, they would be get their money back.

At the end of the 1970s the oil crisis led to increased instability in the world economy. A dramatic increasing on the interest rates, worsening trade conditions for developing countries, and a sudden stop when it comes to new loans are considered as important reasons for the emergence of the debt crisis in the 80s.

Many of the countries were forced to take up new loans to pay back previous loans, and the debt burden of the developing countries grew fast. In 1982, Mexico announced that the country was unable to service their debt. In history this has been pinpointed as the start of the debt crisis of the 1980s. Shortly after Mexico, Brazil followed. Of the USD 315 billion Latin America had in debt in 1982 (a quadrupling over the span of seven years), more than two thirds were owed by banks. This led to a fear of the banking system collapsing.

The World Bank and IMF came onto the scene with an outspoken goal of saving the banking system. After many failed attempts to solve the debt problems, an agreement was reached in 1989 to erase 20% of developing countries’ debt, while at the same time, The World Bank and IMF made guarantees for the repayment of the remaining 80%.

Later, in the 1990s, IMF and The World Bank introduced a debt relief initiative called Heavily Indebted Poor Countries (HIPC). As a condition for debt relief through HIPC, IMF and the World Bank made strict demands about cuts in public expenditure, privatization, trade liberalization and deregulation.

New debt crises?

The financial crisis of 2008 and the following European debt crisis have shown that these types of crises can also affect high-income countries. The world is still without good and fair solutions for countries hit by debt crisis. There is also a lack of necessary regulations to lending that could help prevent new debt crises.

The level of debt for developing countries has doubled since 2000. Because the economic growth has been extremely high in many developing countries, debt as share of GDP is still on average quite low. In middle-income countries, speculative capital flows have led to a larger vulnerability towards changes in the global market, while many low-income countries have debt burdens with a higher risk profile.

Loans given by The World Bank and IMF, as well as bilateral loans, have not increased much the past few years, but loans given by private parties (like the Norwegian Sovereign Wealth Fund) have increased substantially. At the same time, new bilateral lenders, such as China, are increasing and strengthening their presence in Africa, offering loans with few or no conditions attached. More and more developing countries have over the last few years also been able to access loans from the international financial market, for example by issuing government bonds.

Debt crises look different today than before, but the systemic problem remains the same. Poor regulation and the belief that lenders always get their money back contributes to an unregulated situation with easy access to borrowed money, while the poor people in developing countries are left with the bill.