On Economic Loans to Poor Countries A Cost or benefit?
Written by Mohamed Barani
Introduction: It is well known that governments from time to time borrow money. The issue then, brought up by this essay, is specifically; are loans to poor countries good or bad for them? Its purpose is also to look into how to improve the efficiency of the loans if the answer is that loans are good and on the other hand why poor countries continue to take loans if they are bad for them and how they can find alternatives.
Problem definition: This essay is based on the assumption that both alternatives present for a poor country (i.e. to borrow or not to borrow) both have their specific advantages and disadvantages. In this section I will outline the main advantages and disadvantages with both alternatives. Later I will also discuss the possibility of choosing an alternative but without the disadvantage associated with it. The main problem facing poor countries is obviously their lack of capital. To make up for this poor countries take loans to stay afloat. The problem with this solution is that loans aren’t free but that they come with a price. In addition to having to pay back the loan there is an interest on the loan. But as many poor countries feel that they don’t have another choice they still take the loans because the alternative i.e. not taking a loan is equally disastrous in their opinion. Either the country has a budget deficit which it won’t be able to cover or it has important investments that won’t materialize or it has both. A more cynical approach would lead us to think that poor countries are more or less forced to take loans through the institutional, military, economic and political arrangements and the balance of power in the present world order (see new colonialism). Not taking a loan would rid the country from obligations to foreign countries but would leave it without liquidity.
A middle road? The major problem with loans isn’t the loans themselves. On the contrary the loans are very good because they keep a country afloat until its own revenues have been restored or increased. The problem is interest and especially compound interest which bogs down
countries and makes them stuck in the swamp that is debts. By the time they have managed their crisis and restored revenues and are able to begin paying back the loan the interest and compound interest begins to play its role, its often devastating role. And by the time a country has paid off the loan the interest on the loan has grown to a sum sometimes no lesser than the original loan itself, and so the vicious cycle is perpetuated. As we have now identified that the major cause of capital bleeding in poor countries is interest perhaps there is a way to take loan without it. Unfortunately not many are willing to give loans without interest but the good news is that there are alternatives to loans altogether. We said that the two major causes that drive countries to taking loans are budget deficits and crucial investments (the major cause for budget deficits and important investments not materializing is corruption, so this is also something for these countries to consider). As for the deficits the only way to get rid of them is by reducing expenditure, reducing corruption and increasing revenues. And to increase revenues without raising to much taxes investments are needed. As for funding the investments there is -in addition to reducing corruption- the solution of partnership. Partnership essentially has the benefits of a loan (capital) without its downsides (interest). The only addition of downsides is that any profit must be shared but this is outweighed by a number of benefits including sharing of risks. In addition to that the project itself other benefits include job opportunities, production of goods and services, taxable activities and increase demand. And even if there is no partnership and only a foreign investment (i.e. the project is financed completely by a foreign party) these benefits will materialize but without a direct profit or loss for the government.
Summary: When talking about loans to poor countries we concluded that both borrowing and not borrowing were bad alternatives because of their respective disadvantages. To solve this we had to solve the root of the problem causing loans to be needed which were budget deficits and corruption (and to solve this the government needs to have a great deal of legitimacy although dealing with this issue is not within the scope of the essay). Another solution when it came to increasing capital was the idea of partnerships, or if the country was extremely poor; investments. So to conclude this issue the state needs to set up the rule of law, reduce
expenditure and gear the economy towards a partnership and investment friendly environment.