Saturday, July 27

The debt problem is huge and the system for solving it is broken

Martin Guzman was a college freshman at La Universidad Nacional de La Plata, Argentina, in 2001, when a debt crisis led to defaults, riots, and a devastating depression. A dazed middle class has been ruined, as the International Monetary Fund has insisted the government make misery-inducing budget cuts in exchange for a bailout.

Watching Argentina unravel inspired Guzman to change majors and study economics. Nearly two decades later, when the government was once again bankrupt, it was Guzman, as finance minister, who negotiated with IMF officials the restructuring of $44 billion in debt, the result of a previous badly-bailed bailout. conceived.

Today he is one of many prominent economists and world leaders who argue that the ambitious framework created at the end of World War II to safeguard economic growth and stability, with the IMF and World Bank as its pillars, is failing in its mission.

The current system “contributes to a more unequal and unstable global economy,” said Guzman, who resigned last year after a split within the government.

The repayment negotiated by Guzman was the 22nd agreement between Argentina and the IMF. Even so, the country’s economic spiral has only increased with an annual inflation rate above 140%, growing queues at soup kitchens and a new, self-proclaimed “anarcho-capitalist”, Javier Milei, who this week devalued the 50% coin.

The IMF and the World Bank have sparked protests from the right and left since their creation. But the latest criticisms pose a deeper question: Does the economic framework designed eighty years ago fit the economy that exists today, when new geopolitical conflicts collide with established economic relationships and climate change poses an imminent threat?

This 21st-century clash of ideas about how to fix a system created for a 20th-century world is one of the most important problems facing the global economy.

The IMF was established in 1944 at a conference in Bretton Woods, NH, to help bail out countries in financial difficulty, while the World Bank’s goal was to reduce poverty and invest in social development. The United States was the leading economic superpower, and dozens of developing countries in Africa and Asia had not yet gained independence. The core ideology – later known as the “Washington Consensus” – held that prosperity depended on unhindered trade, deregulation and the primacy of private investment.

“Nearly 80 years later, the global financial architecture is obsolete, dysfunctional and unjust,” António Guterres, the United Nations secretary-general, said at a summit in Paris this summer. “Even the most basic goals on hunger and poverty have been reversed after decades of progress.”

The world today is geopolitically fragmented. More than three-quarters of the current IMF and World Bank countries were not in Bretton Woods. China’s economy, in ruins at the end of World War II, is now the world’s second largest, an engine of global growth and a crucial hub in the world’s industrial machine and supply chain. India, then still a British colony, is one of the world’s top five economies.

The once-vaunted “Washington Consensus” has fallen into disrepute, with greater recognition of how inequality and prejudice against women hinder growth, as well as the need for collective climate action.

The gap between institution and mission has worsened in recent years. Hit by the Covid-19 pandemic, soaring food and energy prices linked to the war in Ukraine, and rising interest rates, low- and middle-income countries are swamped by debt and face slow growth . The size of the global economy and the scope of the problems have grown enormously, but financing from the International Monetary Fund and the World Bank has not kept pace.

Resolving debt crises is also much more complicated now that China and legions of private creditors are involved, rather than just a handful of Western banks.

World Bank analyzes outline the scope of the economic problems. “For the poorest countries, debt has become an almost paralyzing burden,” concludes a report published Wednesday. Countries are forced to spend money to pay interest instead of investing in public health, education and the environment.

And that debt doesn’t take into account the trillions of dollars that developing countries will need to mitigate the ravages of climate change.

Then there are the tensions between the United States and China, between Russia and Europe and its allies. It is more difficult to resolve debt crises or finance large infrastructure without running into security problems, as when the World Bank awarded Chinese telecommunications giant Huawei a contract that turned out to violate US sanctions policy, or when the China has opposed debt restructuring deals.

“The rules-based global system was not built to resolve trade conflicts based on national security,” Gita Gopinath, first deputy managing director of the IMF, said in a speech to the International Economic Association in Colombia on Monday. “We have countries competing strategically with amorphous rules and without an effective referee.”

The World Bank and IMF have made changes. The fund has moderated its approach to bailouts, replacing austerity with the idea of ​​sustainable debt. This year the bank has significantly increased the share of money allocated to climate-related projects. But critics argue that the solutions adopted so far are insufficient.

“The way they have evolved and adapted is much slower than the way the global economy has evolved and adapted,” Guzman said.

Argentina, South America’s second largest economy, may be the most notorious repeated failure of the global economic system, but it was Barbados, a small island nation in the Caribbean, that can be credited with the turbulent impetus for change.

Mia Mottley, the Prime Minister, spoke at the climate change summit in Glasgow two years ago and then followed up on the Bridgetown Initiative, a proposal to review how rich countries help poor countries adapt to climate change and avoid crippling debt.

“Yes, it is time for us to revisit Bretton Woods,” he said in a speech at last year’s climate summit in Egypt.

Mottley argues there has been a “fundamental breakdown” of a long-standing pact between poor and rich countries, many of which built their wealth by exploiting former colonies. The most advanced industrialized countries also produce most of the emissions that are warming the planet and causing extreme floods, fires and droughts in poor countries.

Mavis Owusu-Gyamfi, executive vice-president of the African Center for Economic Transformation, Ghana, said even recent agreements to address debt such as the 2020 Common Framework were created without input from developing countries.

“We demand a say and a seat at the table,” Ms. Owusu-Gyamfi said, from her office in Accra, as she discussed the International Monetary Fund’s $3 billion bailout plan for Ghana.

However, if the fund and bank focus on economic issues, they are essentially political creations that reflect the power of the countries that established, financed and managed them.

And those countries are reluctant to give up that power. The United States, the only member with veto power, holds the largest share of votes, partly due to the size of its economy and its financial contributions. He doesn’t want to see his influence diminish and that of others, particularly China’s, grow.

The impasse over vote redistribution has hampered efforts to increase funding levels, which all countries agree need to be increased.

However, as Guzman said, “even if there were no changes in governance, there could be changes in policies.”

Emerging countries need huge amounts of money to invest in public health, education, transport and climate resilience. But they are burdened by high financing costs due to the market’s often exaggerated perception of the risk they represent as borrowers.

And because they are usually forced to borrow in dollars or euros, their payments rise if the Federal Reserve and other central banks raise interest rates to fight inflation as they did in the 1980s and after the Covid pandemic.

The proliferation of private lenders and variety of lending agreements have made debt negotiations incredibly complex, but there is no international legal arbiter.

Zambia defaulted on its external debt three years ago, and there is still no deal because the IMF, China and bondholders are at odds.

There is a “big hole” in international governance when it comes to sovereign debt, said Paola Subacchi, an economist at the Global Policy Institute at Queen Mary University of London, because the rules do not apply to private lending, whether by a hedge fund or the Chinese central bank. Often these creditors have an interest in prolonging the process to hold out for a better deal.

Guzman and other economists have called for an international legal arbiter to adjudicate sovereign debt disputes.

“Every country has a bankruptcy law,” said Joseph Stiglitz, former chief economist at the World Bank, “but internationally we don’t have one.”

The United States, however, has repeatedly opposed the idea, saying it is unnecessary.

Rescue efforts also proved problematic. Last-resort IMF loans can end up worsening a country’s budget problems and undermining economic recovery because interest rates are so high now and borrowers must also pay hefty fees.

Those like Guzman and Mottley pushing for change argue that indebted countries need significantly more grants and low-interest loans with long repayment terms, along with a range of other reforms.

“The challenges are different today,” Guzman said. “Policies need to be better aligned with the mission.”