GOOD DEBT MANAGEMENT PAYS
(Article Reference: Document No.3, January 1993)

EXTERNAL DEBT AND THE DEVELOPMENT PROCESS
by Ishrat Husain[1]

The determinants of economic growth and development are complex, varied and not fully understood. However, it is now recognized that factors both internal and external to a nation impinge upon its growth outcome. Internal factors include resource endowment, economic structure, social and political organizations, domestic policy performance and economic management practices while external factors include terms of trade, external capital flows, natural disasters and man-made disasters such as civil or inter-country wars.

The popular development paradigm followed in the 1960s and 1970s had many distinctive features, including an emphasis on central planning and physical target setting, administrative and discretionary controls on the allocation of scarce resources and the establishment of state enterprises for production. Furthermore, plans emphasized distribution and trade in all economic sectors, expansionary fiscal policies with budgetary deficits supported by external borrowing, and an import-substitution strategy of industrialization under protective barriers.

The results of this strategy have now become apparent primarily in Latin America and Africa where countries are heavily indebted with stagnant per capita incomes, declining living standards, massive unemployment, decaying physical assets and undeveloped human resources. It is a small group of elites who have benefitted from this strategy, accumulating large incomes as a result of access to subsidized credit, scarce foreign exchange at over-valued official exchange rates and import licenses. They have also been able to produce behind a protective wall. The result is that rents based on government policies have replaced rents based on property ownership.

In terms of debt, conventional wisdom suggests that the domestic savings in developing countries is insufficient to finance the desired level of investment and therefore, of growth. It is thought that a higher level of imports financed by foreign savings will allow for a more rapid growth of GDP than would otherwise be possible with only domestic savings.

Foreign savings, in the form of grants, concessional debt finance or non-concessional debt finance, has become a significant source of investment in almost all developing countries. The outcome has been mixed. In some cases, the import-GDP ratios declined while GDP was growing. For the countries faced with debt crisis today, the dependence on imports in consumption and production rose continuously over time. These imports were financed by external borrowing while the GDP and export earnings stagnated.

As a result, we can now identify two trends in economic development. Some countries, particularly in Asia, have grown rapidly while improving the living standards of their people. They are on the way to industrialization yet have managed to avoid the debt crisis. However, the outcome in other nations, particularly in Africa and Latin America, is a source of growing concern. Therefore it is instructive to examine the experience of the former group of countries. Perhaps the fundamental question of this paper is why the debt crisis has affected some countries whereas others have performed reasonably well during the 1980s.

---

Mr. Ishrat Husain - Mr. Ishrat Husain is currently Chief Economist, Africa Region of the World Bank. Just before this assignment he was Division Chief, Debt and International Finance Division of the World Bank. He obtained his Master's degree in development economics from Williams College and a Doctorate in Economics from Boston University, Before joining the Bank he had a distinguished career in the Civil Service of Pakistan, rising to the position of Additional Finance Secretary and Additional Secretary, Planning and Development in the Government of Sind. Since joining the Bank in 1979 he has worked as Country Economist for Liberia, Senior Divisional Economist for Ghana and Chief, Bank's Resident Mission in Nigeria. He co-authored a volume of World Bank Symposium proceedings "dealing with the debt crisis" and another volume on "African external finance in the 1990s." He chaired the World Bank conference on debt management in 1989 and published the proceedings of the conference under the title "debt management systems."

---

[1] At the writing of this paper, the author was the Chief of the Debt and International Finance Division of the World Bank. The opinions expressed in this paper, which was presented at UNITAR- EADB Seminars on Debt Management at Dar-es-Salaam and Kampala, January 15-21, 1990, are those of the author and do not necessarily reflect the views of the World Bank. At present, Mr. Husain is the Chief Economist of the Africa Region at the World Bank.

>> Next: External debt and the development process (continued) | back to Table of Contents