Policymakers in the Global North have mostly responded to rising inflation by raising interest rates. That’s bad for their own workers — and it’s creating a debt crisis for many countries in the Global South.
At the end of last year, Ghana defaulted on its debt as the government suspended payments on most debts owed to foreign creditors. Earlier in 2022, Sri Lanka also entered default as inflation sent the country’s currency tumbling, exacerbating the cost-of-living crisis as imports of essential goods like food and medicine became more expensive.
This year, Pakistan finds itself on the brink of default as the combination of high inflation and climate breakdown fueled environmental disasters devastated its economy. Pakistan’s situation is particularly worrying given the fact that the country is the world’s fifth largest by population. Other countries like Zambia and Lebanon have been in default for much longer.
High inflation and slow global growth have wracked many poor economies at the same time as rising interest rates have made debt servicing more expensive. Fifteen percent of poor countries are already in debt distress — when a country is unable to fullfil its financial obligations and debt restructuring is required — while half are in danger of entering it.
In short, the world economy is already in the midst of a sovereign debt crisis. The United Nations Conference on Trade and Development (UNCTAD) has warned that the developing world faces a “lost decade” as a result of the debt crisis, estimating that debt servicing alone will cost these states at least $800 billion.
There are, of course, notable differences in the economic and political situations of the countries currently in, or on the brink of, default. Ghana’s situation is unique in that much of its debt is owed to domestic rather than international creditors. Its default, therefore, risks creating a deep shock to the domestic financial sector, which would likely reverberate throughout the rest of its economy.
Sri Lanka, previously a golden child of international financial markets owing to its strong record of debt repayments, mismanaged its negotiations with creditors when the economic crisis became particularly acute. And countries like Pakistan and Lebanon, which is also on the verge of default, have suffered from decades of corruption and political mismanagement.
But while it is important not to insulate domestic elites from responsibility for the role they have played in exacerbating their countries’ debt crisis, it is also critical to recognize the global factors that are driving debt distress across the developing world — one of the most important being the way in which the rich word is dealing with its own economic crisis.
The inflationary crisis that began to tear through the world economy from last year is being driven by three main factors: the uneven recovery from the pandemic, the war in Ukraine, and — often forgotten — climate breakdown. These are not issues that can be solved by fiddling around with the cost of borrowing. And yet this has been policymakers’ central response.
By raising interest rates, central bankers hope to slow growth and investment, increasing unemployment and disciplining workers into accepting less pay. The idea is that, even though workers did not cause the crisis, they can be made to pay for it.
Yet across most of the rich world, real wages are failing to keep pace with inflation, meaning that most workers are facing pay cuts. If policymakers really wanted to curb inflation, they would focus on profits, which in many sectors have soared even as input costs have risen. As the political economist Isabella Weber has forcefully argued, many large companies have taken advantage of inflation to raise prices higher than their costs, pocketing the difference.
So, interest rate hikes won’t solve the inflationary crisis in the rich world. They will, however, make it much more expensive for poor countries to finance their debts. The monetary policy currently being pursued in the rich world has been designed to impoverish workers domestically, with the added bonus of impoverishing poor countries globally.
We have been here before. In the 1980s, when the then chair of the Federal Reserve, Paul Volcker, sent US interest rates through the roof to discipline US workers, it led to dozens of defaults in the Global South. The so-called Volcker shock laid the foundations for neoliberalism in the United States and, conveniently, it also provided the perfect pretext for imposing neoliberal policies on the Global South.
When poor countries were forced to appeal to international financial institutions for emergency lending, they received this assistance in exchange for introducing policies like privatization, deregulation, and tax cuts. The terms of these loans — referred to as structural adjustment programs — decimated many economies and permanently increased inequality in others.
Yet no lessons appear to have been learned from the debt crisis of the 1980s. As countries like Ghana and Sri Lanka have appealed to international financial institutions for assistance, they have been forced to introduce austerity policies that are likely to constrain growth for years to come.
If austerity hasn’t worked in the rich world, it’s certainly not going to work in the poor world, where significant investment in infrastructure and public services is necessary for sustainable development. In fact, forcing poor countries to cut spending at a time when vast sums of money are needed for decarbonization and climate change mitigation is likely to exacerbate both the climate crisis and global inequality.
Debt cancellation is urgently needed to deal with both the global debt crisis and the climate crisis. Rather than forcing countries to implement regressive and self-defeating austerity measures in exchange for emergency lending, new lending could be directed into investment in green infrastructure and climate mitigation — as well as protecting important carbon sinks like rainforests and tundra.
But over the long run, even debt cancellation will not be enough to close the gap between the rich and poor worlds. The reason that poor countries have been forced to take on so much new debt is that they have been kept in a position of dependence in a global economy structured to enrich the wealthy and impoverish the poor.
An extractive international financial system, regressive intellectual property rules, and enforced neoliberal policies have denied many poor countries the resources required for sustainable development.
China is, of course, the major exception to this rule. It has achieved development by ignoring the rules laid down by the Global North, protecting industry and prioritizing investment. In fact, China is now the single largest lender to many poor countries, and its attitude toward debt restructuring — influenced more by geopolitical than economic considerations — will significantly impact how this crisis is resolved.
In an optimistic scenario, poor countries would be able to take advantage of the cooling of relations between China and the West to access lending on more favorable terms. As they once did through the Non-Aligned Movement, poor states could work together to resist imperialism and achieve real debt cancellation.
In a pessimistic scenario, these countries will be caught in the middle of the new Cold War. Western lenders may refuse to negotiate with Chinese ones over how to write down the debts of poor countries, leaving these states stuck in limbo. This is exactly the situation currently faced by countries like Zambia, whose creditors have failed to come to an agreement about its debt for several years now.
One thing is for certain: the world economy can’t fully recover until the Global South debt crisis is resolved. But when it comes to debt, politics always trumps economics. What happens next will be determined by what politicians and policymakers in China and the West consider to be in their interests, rather than what is most likely to promote sustainable development.
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