The false promise of debt relief

Kenneth Rogoff, Project Syndicate

With debt relief for poor countries shaping up as a focal issue at the July G8 summit in Scotland, it is a shame that so few people appreciate what a farce such measures could turn out to be. Unfortunately, most of the public, egged on by well-meaning rock stars, religious leaders, and other popular figures, seem brainwashed into believing that debt relief is a giant step on the road to ending world poverty. But forgiving poor countries' debts without agreeing on a better framework for future aid flows is an empty gesture.

At first glance, it seems incredibly generous and statesman- like for G8 leaders to endorse debt relief for the world's poorest nations. But no one really expects the debts to be paid anyway. Indeed, thanks to ongoing grants and future loans from national aid agencies and multilateral lenders like the World Bank, most of the poor "debtor" countries look set to receive considerably more money than they pay back, with no end in sight.

Citizens of rich countries may be self-centered and self- indulgent, but things are not quite as horrible as some would have us believe. True, the ultra-rich United States does only give a pathetic 0.2 percent of its income in aid. But at least it doesn't tax poor countries, as rich-country imperialists did until well into the twentieth century.

Besides, it is not like there is huge profit for G8 leaders in trying to collect coins from impoverished peoples living on a dollar a day. What would the G8 leaders do, station troops in Africa to seize coffee beans and peanuts? Re-colonize Africa? Debt collection from poor nations is an absurdity, now and into the distant future.

The real issue is how much money rich-country governments will be giving poor-country governments, not vice versa. Third-world debt burdens are little more than a scorecard for past development failures.

Generously interpreted, past loans reflected naove optimism that with a bit of seed money, politically and economically backward countries would generate majestic growth and effortlessly repay their loans. A not-so-generous interpretation of modern aid history is that rich countries' legislatures were too cheap to give outright grants to the poorest countries, and could be persuaded to help out only if they were told that the money would be repaid.

Of course, I am focusing mainly on official loans, but private-sector lending to the world's poorest countries is generally a relatively minor issue. So now rich countries want to feel magnanimous for "forgiving" debts that should have been given as outright grants in the first place.

As all but the most belligerent critics of U.S. President George W Bush will acknowledge, America has taken an important lead in trying to make things marginally better. The Bush administration has put outright grants at the center of its foreign-assistance policy, a commitment that is embodied in its new aid agency, the "Millennium Challenge Account."

Moreover, following recent changes at the World Bank, the U.S. is aiming to follow the classic doctor's dictum: "First, do no harm." It is increasing aid, but it is trying to focus the benefits on countries that are reasonably well governed. The aim is praiseworthy: To ensure that aid will be unambiguously beneficial, and won't merely be exploited by bad governments to extend their hold on power.

Admittedly, there is still a fierce debate over the right way to assist poor countries, and this will play out behind the scenes at the G8 summit. Many Europeans believe that aid agencies like the World Bank will shrivel and die if left to depend on grants for income. But I believe that the problem could easily be solved by, say, giving the World Bank an endowment of rich- country bonds and permitting it to expend the interest.

The United Nations Development Program has championed the position that all countries should get significant aid, regardless of how they are governed, on the grounds that thousands of children die every day and there is no room for sanctimonious extremism. I beg to differ; my reading of the evidence suggests that donors really do need to take extreme care not to make things worse, and that this is far more difficult to achieve in corrupt countries than the UN suggests.

In short, the fundamental problem with the debt-relief mantra is that it looks backward rather than forward. If the G8 leaders are serious about helping poor countries, finding a reliable way to support grant aid and promote accountability for donors and recipients, not debt relief, is the place to start. If the political will were there, it would be neither difficult nor expensive to restructure aid agencies like the World Bank and the regional development banks as grants-only agencies.

For example, Prof. Jeremy Bulow of Stanford University and I have shown that by endowing the World Bank with US$100 billion dollars, it could carry out the tasks that it performs best more effectively and with greater transparency than it does today through borrowing and lending. Given today's exceptionally low long-term interest rates, the annual cost would be, well, peanuts.

The writer is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.