Cleaning up Third World Debt Without Getting Taken to the Cleaners

Should taxpayers of wealthy countries finance a leveraged buyout of third world debt? The case for establishing an international debt discount facility rests on the belief that the overhang of foreign commercial bank debt is stifling growth in the Highly Indebted Countries, and that coordination problems among private sector banks are blocking efficiency-enhancing debt reduction schemes. Thus there is scope for a multilateral government agency to step in, buy up the debts, and pass on the efficiency gains to struggling debtors. Our contention is that a debt discount facility would in fact be a black hole for aid funds, and would yield only minimal efficiency benefits. Our assessment of the debt crisis suggests a very different approach. Development aid should be divorced from debt negotiations and instead should be tied to countries' performance in areas such as environmental policy, drug interdiction, and population control. Future aid allocations should not be disguised as loan guarantees, and the massive bond obligations of existing multilateral lenders ought to be placed on the books. Finally, we recommend reversing a number of legal and regulatory changes made in the 1970s that served to encourage the loans in the first place.