Developing Country Debt and Economic Performance.pdf

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Jeffrey D. Sachs

adjustment. Therefore, two counterintuitive propositions could be true
when a country is deeply indebted: “Good behavior” (such as a higher
investment rate) can actually reduce national welfare, by increasing
the transfer of income from the debtor country
to creditors; and explicit debt relief by the creditors can increase the amounts of actual
debt repayment, by improving the incentive of the debtor country to
make the necessary adjustments.
Before turning to these arguments at greater length, we should consider one additional argument sometimes made for official lending. The
argument is occasionally made that since countries are more averse to
defaulting on official loans than they are on private loans, it is safe for
official creditors to lend even when private creditors will not. This
argument can sometimes be correct, but it is often mistaken. If official
loans just raise the country’s debt burden without raising its debtservicing capacity, then repayments to the official creditors might simply crowd out repayments to its private creditors, and thereby undermine the smooth functioning of the international capital markets.
The issues of conditionality and debt relief will be discussed as follows. Section 6.2 outlines the theory of conditionality and section
focuses on the empirical record of high-conditionality lending. Section
6.4 shows the linkages between the overhang of debt and the effectiveness of conditionality, and demonstrates the potential role for debt
relief in high-conditionality lending. Section 6.5 then discusses the specific problems raised by the macroeconomic situation of the heavily
indebted countries: high inflation, excessive inward orientation, large
budget deficits, and a prolonged economic downturn, all exacerbated
by the problem of high foreign indebtedness. The recent history of
stabilization has shown that few countries have been able to solve even
one or two of these problems at a time, much less all of them simultaneously, and the record suggests that adjustment programs have the
highest probability of success when macroeconomic stabilization precedes large-scale trade liberalization and a shift to outward orientation.

IMF and WorldBank
6.2 High-Conditionality Lending by the
The argument for high-conditionality lending is that the IMF and the
World Bank can compel countries to undertake stabilizing actions in
return for loans, thereby making the loans prudent even when the
private capital markets have declared the country to be uncreditworthy.
A full theory of conditionality would have to explain three things. First,
if the actions being recommended to the country are really “desirable”
for the country, why is it that the country must be compelled to
undertake the policy? Second, if the country must indeed be compelled
to undertake the actions, what types of force or sanctions could be