Debt Forgiveness
Brian Gongol

Is Debt Relief Always a Good Idea?
Debt relief for developing nations sounds like a great idea. The initial impression goes something like this:
If countries are poor, then why should they have to pay back debts to rich countries? It only makes them more poor. Isn't it only fair to give them a chance? Don't we have an obligation to lend them a helping hand?
Unfortunately, the debt-relief issue isn't quite so clear; in fact, debt relief can have completely counter-intuitive results -- results that could make poor countries even poorer.

Pulling Poor Countries Out of Poverty
Poverty is the absence of wealth. So, naturally, the only way to get rid of poverty is to create wealth. Here's how that can be done: Direct aid usually feels pretty good -- but it's not a long-term solution to the problem of poverty. The old maxim, "Give a man a fish, feed him for a day; teach him to fish, feed him for a lifetime" applies here. There are cases in which immediate, direct aid is sensible -- under some circumstances during disaster-relief efforts, for instance. But in the long term, it creates dependency and never really gets to the real causes of poverty.

Trade and commerce are actually the best ways to create wealth. Hong Kong and Singapore never really had much of anything to offer the world in terms of natural resources, but due to trade and commerce with the rule of law, they are among the wealthiest nations in the world. There's really nothing else that can make a country rich in the long term except trade with other countries.

But the problem is the middle step between direct aid and trade -- getting countries to the point where they have the capacity to produce things that are marketable to the rest of the world. Almost always, some investment is required before a profit can be made: Roads have to be built, children (future workers) have to go to school, clean water has to be available, and power lines have to reach factories and warehouses. Barring investments made by companies that are willing to build these things themselves because the profit potential is so big (like Aramco could afford to do when building oil facilities in the Middle East), then these investments usually have to be made by the locals. This means loans have to be made.

Thus, loans themselves to poor countries aren't bad or wrong or evil -- in fact, they're necessary to moving those countries out of poverty.

When Good Loans Go Bad
The problem with loans to poor countries is that they're subject to abuse. The first two problems explain exactly why debt-relief isn't any good without a sober review of the political and economic institutions in a country. Even in the United States, Americans rarely make voluntary contributions to reduce government debt, even though it's suggested in the instructions for most personal income tax and corporate tax forms.

Without Disciplined Government, Debt Relief is Doomed
Americans know that their own government lacks the fiscal discipline to bring spending under control. Without that political reform, "voluntary" contributions to reduce the public debt will have little or no meaningful long-term impact on the nation's indebtedness. In the words of PJ O'Rourke, "Giving money and power to government is like giving whiskey and car keys to teenage boys."

Unfortunately, the same problem holds true for poor countries. Debt relief is absolutely no good without political and economic reforms. On this matter, rich and poor countries have to work together to fix the problems.

The usury question is a different story -- it has to be addressed by the wealthy countries themselves. Risk is always related to reward; hence, high-risk investments earn high rates of return. But loans to poor countries are a special case: When the loan is made to a government, the lender in a way gets a special exemption from risk. Countries don't actually go bankrupt -- they can confiscate and tax everything in sight in order to pay their debts, even when the things they're taking belong to people who never benefitted from the loans and who never approved the borrowing in the first place. Public-sector borrowing is, in this regard, a special case. On the other hand, if lending is made too restrictive, it may become difficult or impossible for worthy borrowers to get access to the capital they need to make good investments. So by cracking down too hard on loans to poor countries, we could actually end up leaving more people in poverty.

What To Do About Borrowing and Debt Relief
With a multi-billion dollar debt relief program approved by the G8 countries, the reasonable question to ask is how to keep up the flow of capital to poor countries without stepping right back into the problems that made the debt untenable in the first place.

Approach Description Possible Consequences
Tax profits from loans made to specific countries Governments from wealthy countries could impose taxes on private-sector loans to specific poor countries in order to reduce the premium that lenders would earn by sending money to those countries
The incidence of a tax on interest profits would be shared between the lender and the borrower; thus, a US tax on loans to, for instance, Botswana, would be paid partly by the US lender and partly by the people of Botswana, ironically forcing the people of the poor country to subsidize the government of the rich country.

A tax on interest profits could be re-invested in other forms of aid to the poor country, like scholarships for talented students to study in the wealthy country

A determined lender could move the money to a third-party country (offshore banking is available everywhere) and hide the investment from the government trying to control the loans
Bans on loans to specific poor countries Governments from wealthy countries could prohibit loans to countries with a history of loan abuse, or countries that are clearly incapable of repaying certain levels of debt
This approach lacks the finesse of other approaches -- it's using a sledgehammer to kill a fly. Embargoes and other prohibitions on trade (including trade in finances) almost never work.

Loan prohibitions cut off the flow of capital to places where it's needed. Even in places where governments are corrupt and where the environment is bad for most investments, opportunities exist. The flow of capital into poor areas at reasonable rates of interest is exactly what works best for reducing overall poverty. The Grameen Bank is an excellent example of how small loans can have a significant impact on improving people's lives, even where the government fails to use lending properly.
Moral suasion Leaders in wealthy countries can use their moral suasion -- the power of the bully pulpit -- to persuade lenders to adhere to ethical lending standards, offering loans only at reasonable rates of interest to truly qualified applicants
Whenever elected leaders can achieve a worthwhile policy goal not through legislation but through persuasion, they strike a blow for freedom.

The bully pulpit has no enforcement power -- no authority with which to compel action. Some lenders will always be unscrupulous enough to keep at unethical lending, even when public opinion is against them.
Project-centered loan administration by disciplined managers from wealthy countries Assuming qualified applicants could be found for the position, wealthy countries could send qualified financial and project managers to poor countries to administer development loans, ensuring that the funds are used appropriately and prudently
The recent history of the UN's oil-for-food program indicates that the temptation to corruption in positions like these can be great.

If done appropriately, the dispatching of qualified managers could result in a very favorable exchange of human capital to the poor country; that is, what better way to learn fiscal discipline and project management skills than from someone who has made a successful career of those things in a wealthy country?

Sending loan administrators with any authority to control the use or borrowing of development funds may smack of imperialism, which rarely sits well with the locals.

Finding a sufficiently large corps of disciplined managers could be an expensive proposition. Some people would surely do it just for the experience (much like joining the Peace Corps), but skilled managers and financiers aren't known for moving to foreign lands just out of the goodness of their hearts.