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out broke countries is a remedy for the tilt or rather part or even a cause of the
The political economy of debt relief
Andreas Freytag and Gernot Pehnelt
ECIPE and Friedrich-Schiller-University Jena;
GlobEcon and ECIPE
The rationale of debt relief
There are three efficiency arguments for the provision of debt relief. The first is the
so called ‘debt overhang’. It has been stated that highly indebted countries benefit
very little, if ever, from the returns on any additional investment because of the
debt service obligation. Large debt obligations can be seen as a high tax on investment,
policy reforms and development, because a significant part of the gains
from economic adjustment would go to foreign creditors and not to the country
itself. Creditors should therefore offer debt relief to countries with large stocks of
external debt in order to reduce future debt obligations. This would increase the
share of any marginal gains from economic adjustments that goes to the debtor
country and create incentives to make these adjustments. This strategy could end
up in a win-win-situation by not only easing the debt burden of debtors but also
increasing future repayments to the creditors.
Secondly, debt relief may have a stimulating effect on investment and
economic development. The clincher with respect to the resource position of
low-income countries and therefore to the capacity to pay their obligations and to
invest, is still the net resource transfer from donors, including aid. Since the reduction
of multilateral debt is partly financed by bilateral donors (e.g. through their
contributions to multilateral funds), and these contributions usually come from
the same political reservoir, namely the donors’ aid budget, there might be a tradeoff
between debt relief and official development assistance.
The third rationale for debt relief could follow different lines. If an individual
country’s bankruptcy causes investors to withdraw their capital from other countries
with similar but not identical problems, the crisis cascades and even countries
without the structural problems of the country in question are endangered.
The determinants of debt relief
Despite these arguments, past debt relief programs have been rather ineffective.
The determinants of debt relief obviously deviate from economic reasoning. It can
be argued that neither absolute poverty nor lack of access to foreign exchange
46 The First Global Financial Crisis of the 21st Century Part II
Table 1 Crises and bailout-cost
Crisis GDP (in billions) Cost* (in billions) %GDP
USA 2008 $14,312 $1.500? >10%?
Pakistan 2008 $130 $8? 6%?
Hungary 2008 $170 $16? 9%?
Argentina 2000 $299 $22 7%
Brazil 1998 $844 $42 5%
Russia 1998 $271 $24 9%

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