The Dangers of Foreign Aid: The Economics Behind Modern Day Debt Traps

Moosa Talha Al Kaseri H.R. College of Commerce and Economics

Foreign aid and international lending for countries in dire need of economic assistance are often seen as beacons of hope, shining examples of how one country can help another in their time of need. However, much like everything else in life, this foreign “aid” comes with its own set of strings attached in the form of often deceptive terms and conditions that can render the entire purpose of providing such aid entirely useless and further hinder the growth of any country that goes ahead with such “debt traps.”

On the surface, it may seem like an act of generosity and goodwill from one country to another. However, further analysis of such onerous lending facades reveals a more insidious side to foreign aid. Many developing countries have fallen victim to the alluring promises of aid, only to find themselves entangled in webs of debt and obligation that can ultimately lead to their enslavement through such contracts.

The metaphorical Trojan horse of the Greeks comes to mind when such illicit aid packages are created wherein, the on-paper purpose is the prosperity and help of lesser developed countries, but it all just becomes a disguise for collecting more resources and power from these helpless countries. Such modern-day debt traps can be best explained by real life examples:

Sinking in Debt: Sri Lanka's Fatal Attraction to China's Infrastructure 'Aid'

The case of Sri Lankan ports and Chinese infrastructure “aid” is a classic example of the dangers of debt traps. The Chinese government loaned Sri Lanka more than $1 billion to build a new port that was supposed to become the country's second-largest. The port, located strategically near Indian Ocean shipping routes, was touted as a great achievement for Sri Lankan commerce. However, it failed to generate profits, which was as forecasted by experts.

Once the defaults started, naturally the loan agreement was restructured and an 85% stake was purchased by China Merchant Port Holdings Company after it agreed to pay close to $1.2 Bn. China foreclosed on the port's operations in 2017 and took it over on a 99-year lease. The lease agreement included wide-ranging tax concessions for the port and a 32-year tax break for Chinese firms. This seizure of the port comes when the world is already questioning the One Belt One Road (OBOR) initiative of the Chinese and its ambitions of “a natural requirement for realizing the rejuvenation of the Chinese nation."

Critics have long argued that Chinese loans often come with deceptive terms and conditions that create debt traps for countries in need of economic assistance. These terms ultimately serve the interests of the lender ratherthantheborrower. Moreover,whenacountryfails to repaytheseloans,thelendertakes overits strategic assets and infrastructure, increase interest rates even higher, force the indebted country to follow its political interests in military conquests and much more.

It is now more important than ever to ensure that international lending practices are fair, transparent, and sustainable for all parties involved. Only then can we ensure that vulnerable and at-risk countries aren’t taken advantage of and shackled in debt under such false pretences and noble intentions of so-called “infrastructural development”.

Cost of Borrowing from Beijing: A look at African and Pakistani Economies

Debt as a tool can be immensely helpful if leveraged in the proper amount and at the appropriate times, but it is a double-edged sword which has caused insolvencies and destroyed some of the biggest economies of the past if not used with caution.

China does give out loans to countries that need them but as discussed earlier in the article, these come with their own set of prerequisite conditions to be met, one such as that of using Chinese labor and purchasing materials for infrastructure projects from Chinese firms. This critically limits the proper use of funds for these countries since as soon as China gives out its loans, the money goes back to different Chinese firms in accordance with the agreements and domestic labor market gets hurt to the point where there have been numerous demonstrations by labor unions in the past. These hidden costs are often ignored or just not understood due to a lack of proper due diligence which adds on to the vulnerabilities of such economically deprived countries.

African countries such as Djibouti, according to some estimates, have external debt to China amount to around 80% of its gross domestic product (GDP). This high level of indebtedness has raised concerns about Djibouti's ability to manage its debt obligations and maintain its economic independence. Some observers have also raised concerns about the potential for China to use its leverage over Djibouti's debt to secure strategic assets or gain military influence in the region. China has had friendly relations with Djibouti since 1979 and Djibouti too has backed China’s stance on the issues of Xinjiang and Hong Kong in the United Nations. Critics thus argue that China's creation of "debt traps" are a deliberate tactic to coerce poor African states into voting with it in the UN General Assembly, endorsing its stance on Taiwan, or obtaining valuable African real estate that could be converted into military bases. It's important to note, however, that these are allegations, and they have not been found to be objectively true as of yet.

Pakistan’s current economic crisis is one of the most recent stories of how too much debt and “aid” that comes attached with unfavourable conditions can create chaos. There are people that are starving, experiencing out of control inflation and witnessing a politically unstable nation. According to some sources, CPEC has created a Chinese debt of US$ 64 billion on Pakistan, which was originally valued at US$47 billion during 2014. This debt has increased Pakistan's vulnerability to external shocks and reduced its fiscal space for development spending. At the same time, many CPEC projects have been criticized for being overpriced, completely inefficient or even environmentally unsustainable.

China's role in Pakistan's economic crisis is quite significant and complex. While China has provided Pakistan with much-needed financing and infrastructure development under CPEC [China-Pakistan Economic Corridor], it has also contributed to its debt burden and trade imbalance. Pakistan needs to find ways to diversify its funding sources and improve its export competitiveness to reduce its reliance on China and improve its economic prospects. China isn’t the only one to blame here, but it is important that other countries look at this cautionary tale of overleveraged indebtedness to foreign countries and the consequences that such ill-made financial decisions bring with them.

Conclusion

It is worth noting that China is not the only country accused of using debt as a means to gain leverage over other countries. For example, the United States was accused of similar practices in the 2000s when it exerted pressure on Argentina to repay its debts. This led to Argentina defaulting on its debts and experiencing a severe economic crisis.

Similarly, some other countries in the West and few other international financial institutions have been criticized for imposing stringent and harsh repayment and default conditions on their loans, which have led to economic and social turmoil in borrowing countries. These conditions have many times included privatization of state-owned enterprises, reduction of social spending, increasing taxes on the most vulnerable, and many more inhumane clauses.

Therefore, foreign aid and loans from foreign sources must be met with extensive due diligence beforehand and politicians must keep in mind the dangers of such debt and aid.

John Adams said it best when he wrote “there are two ways of conquering and enslaving a nation: one is by the sword and the other is by debt”.

As such, there is a need for greater transparency, accountability, and responsible lending and borrowing practices to ensure that debt financing is used to promote sustainable and inclusive economic development, rather than as a means of political or economic coercion.