The WorldPaper: Global Economy: World Debt Threat: Nation Debt Crises Are As Old As Time

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Global Economy > World Debt Threat

National debt crises
are as old as time

During a presentation on emerging markets at the World Economic Forum in Davos this January, international economist Kenneth Rogoff heard a common refrain from fellow attendees: “We have to make sure we never have another emerging-market debt crisis.” So, he thought, the emerging markets have learned their lessons? Not quite.

On his return to Cambridge, where Rogoff directs the Center for International Development at Harvard University, he put pen to paper and issued an op-ed warning in Newsweek International about the inevitability of another round of debt crises. “This time it’s different?” he wrote. “Sure, right.”

Rogoff is one of the world’s leading figures in international economics. From 2001 to 2003, he served as chief economist of the Research Division at the International Monetary Fund, working to connect research at the IMF more forcefully with the latest economic understanding and thinking. And a year ago, he provided a spirited defense of the IMF against an attack by Nobel Prize-winning economist Joseph Stiglitz.

In the 1990s, Rogoff published an influential article called “The Mirage of Fixed Exchange Rates,” which proved predictive of the currency crises of late 1990s. Concerned about the current conditions contributing to the heaping world debt, The WorldPaper captured these comments from Rogoff during his address at the Kennedy School of Government at Harvard in February.

"Crises have been around since the dawn of lending. They were around before the IMF, which was started up in 1946. They were around before the Washington Consensus and indeed before George Washington. Today’s emerging markets did not invent defaults. Germany, France, Austria, Spain and Portugal all defaulted more than half a dozen times. Not to mention Venezuela’s nine. The all-time record holder is Spain at 13, and France has eight. They actually had a routine way of dealing with default back under the monarchy. They would round up the creditors and behead them. I guess that’s another form of debt restructuring!

"The United States, while not as famous for its debt problems, had horrible banking problems in the 19th century and of course a bloody civil war. Something that many commentators forget is that the transition from being a poor country is a very difficult and chaotic one. It’s very seldom smooth, which leads me to my second point.

Figure:
External Debt of Developing Countries, 1970 to 2000

"You’ll see many people point to India and China and say, why can’t Latin America learn from them? This is just stupefyingly naive. What they don’t understand is that India and China are very poor countries. India has per-capita income of $500 per person, and in China, which is emerging on the world stage, it’s $1,000 per person. You cannot compare the development problems of China with, say, Korea, which has a per-capita income of $10,000, or with many Latin American countries which are nearly as large. The right way to think about it is that many countries of Latin America had their big spurt 100 years ago, and India and China are finally starting to catch up, and this transition is a very difficult point.
Figure: External Debt of Developing Countries

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"One reason we most see crises in countries in transition is because one of the fundamental stages of development, once you get past a certain point, is your credit margin. It’s not easy that crises are the rule. If you look at China today, it’s growing because it’s investing so much, but that policy does not work indefinitely. It peters out after a while. What many countries find is that they’re growing for a while, and eventually they have to try something else.... You need to find a way to channel more efficient investment, and when you do that, many of the problems and crises follow, and then you start to make yourself vulnerable.

"I think we need to constantly improve our policy advice.... One area where we do have some understanding, and where there are fairly systematic mistakes, comes from trying to fix your exchange rate. The policy, which incidentally is not a bad idea for developing countries that are poor, at least according to research I’ve done, is extremely risky for emerging markets. Frankly, every debt crisis we’ve seen over the past 10 years—with the possible exception of Brazil in 2002, which was tamer than some—had fixed exchange rates at the root of it.

"I wrote about this more than 10 years ago with Maurice Obstfeld, well before the Asian crisis, as really being a problem. In my view, fixed rates were at the root source of crises, and many commentators, especially on the Asian crisis, don’t focus on it enough. I feel that if we had had flexible exchange rates in the Asian crisis we would have seen a mini crisis instead of a maxi crisis.

"Commentators like Baghwati and Stiglitz are right to emphasize that we need to have a nuanced view for capital controls and, again, my work supports that. But in my opinion it is not Problem No. 1, which is fixed rates, and it is not Problem No. 2, which is government borrowing. Capital controls are on the private sector to stop the private sector from borrowing.

"A paper I did while at the Fund entitled “Debt and Power,” which looks at the history of emerging-market debt crises, finds that the vast majority have government borrowing at the root. What we tend to see is that countries that default once seem to have weakened institutions and default again and again. It’s an interesting thing that economists need to study and something I want to think about now that I’m back at Harvard. Perhaps the Asian countries were right to bend over backward to avoid their first restructuring, because many have never defaulted.

"Many people think that the International Monetary Fund is opposed in principal to debt restructuring, and that is absolutely not true. If we look at Argentina today, which is still a catastrophic situation, it’s creditors need to take a huge reduction in the value of their debt in order for Argentina to resume growing and to achieve a realistic outcome. I admit that what Argentina is proposing at the moment, which is a 92 percent write-down of debt, some creditors feel that it’s a headache, and a haircut, but that it will get sorted out over time. I think many proposals along these lines from 15 years ago are still right. And I might add that international financial institutions may themselves need to see a change in their balance sheet, an attempt to restructure at some point, and the events in Argentina can actually force that."

Excerpts from remarks by Kenneth Rogoff, Director, Center for International Development, Harvard University