Journal Issue

Reflections on Debt and the Environment

International Monetary Fund. External Relations Dept.
Published Date:
January 1992
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Is debt a major cause of environmental degradation? No, but sometimes reducing debt may help improve the environment

As the 1990s open, the debt crisis seems to be waning as an international development crisis while the threat of environmental degradation attracts more and more attention, and rightly so. Although standards of living fell sharply in severely indebted countries, a number of developing countries managed to sustain reasonable growth rates without incurring unmanageable debt loads, and some of the worst debtors have resolved their debt crises and are now resuming growth. However, the depletion of natural resources (including waste disposal capacity) looms as a threat to future growth, and the costs of preserving the environment are rising.

What is behind the increasing rate of environmental degradation? According to many commentators, a significant share of the blame should be placed squarely on the debt crisis and related adjustment programs. Some even assert that debt alleviation, per se, will help solve environmental problems. This argument holds a bare grain of truth, so it is very appealing, particularly in the developing world. But it is potentially dangerous, because it confuses the causes and cures, and thus if acted upon might lead to inequitable solutions, validate inappropriate behavior, and create moral hazards.

This article, by contrast, argues that the debt crisis and the environmental crisis both stem from the same root cause. Simply put, the former resulted from the drive for rapid growth, which, given external circumstances and the accepted development models, led to levels of foreign borrowing that could not be sustained, particularly when the borrowed resources were not invested productively. Similarly, environmental degradation resulted from the drive for rapid growth, which, given social structures and technologies, led to consumption of environmental resources beyond sustainable levels. In both instances, the culprit was the attempt to increase consumption above levels the economy and environment could sustain. These unsustainable aggregate demands for economic and environmental resources were the result of a myriad of individual decisions shaped by a country’s policy framework and structure. In some cases, this was due to subsistence demands of the poorest segments of the population. But in many cases, it was the relatively well off trying to increase their living standards quickly.

The challenge now is to find ways to steer the dynamic forces of growth so that further development can be sustained—in terms of the environmental resources, the wealth and savings, and the human capital that are really at the long-term disposal of each country. If this is done, standards of living will continue to improve without aggravating debt or the environment. If not, then even wiping out all debt will have little lasting effect on the environment or the plight of the poor.

The drive for growth

The seeds of the current dilemma date back to the 1960s. The development community then believed that sustained rapid growth could be achieved by public planning of investment coupled with substantial foreign capital inflows. Most developing countries themselves readily accepted these principles, believing this approach would provide better standards of living for their growing populations. It also served as a justification for exercising greater control over their own economic destinies. But this model assumed that the international environment would remain stable and interest rates would stay low. Its chances of success were compromised by the unprecedented price volatility in commodity (including oil) and financial markets (interest and exchange rates) that followed the oil price increase of 1973.

Economic independence. Developing countries entered the 1970s expecting the “Decade of Development” to yield substantial growth dividends. Many had embarked on ambitious national development programs based on government planning and the use of national entities as the engines of growth. Rejecting external economic and political domination, they followed policies that relied on the state and state-owned enterprises. The pressure for economic independence included taking control of natural resources. But rather than acting to preserve national wealth, all too often these resources were exploited by national interests, in the same manner as foreign owners, to increase incomes rapidly. The resulting economic policy distortions led to large debt accumulation and natural resource depletion, but only rarely managed to deliver on the promise of better standards of living for most of the population.

Higher living standards. The developing world’s desire for better standards of living was translated into a demand for higher levels of consumption—requiring higher output. More investment and more inputs were needed to increase the capital stock and levels of production, which in turn, placed a greater strain on the natural resource base for minerals, agricultural and forest products, and waste absorption. The demand for increased consumption in the short term tended to reduce overall savings in many developing countries, thereby raising their demand for foreign savings (borrowing) and their exploitation of natural resources (using natural capital to supplement current income). Rarely are the costs of natural resource depletion and pollution adequately represented in national income accounts or in public or private budgets, meaning that drawing heavily on the environment can easily appear to substantially raise measured output (often overvalued) and lower measured costs (often undervalued).

Modern economic growth tends to bring with it increasing income disparities, as some parts of the economy (usually the modern sector) grow faster than others. This is often acceptable when total income is rising quickly, because the poor do not lose in absolute terms. However, when GDP is not growing very fast, or indeed falling, there is usually a scramble to protect incomes, frequently to the detriment of the poor. The failure to resolve these internal distribution problems within the constraints of available resources has, in some cases, encouraged governments to follow shortsighted poverty alleviation policies that are detrimental to the environment, such as opening fragile virgin land to cultivation by the poor—an environmentally expensive, but fiscally cheap, off-budget palliative.

Volatility. As developing countries tried to accumulate and allocate capital productively, they found themselves battling more volatile price movements in financial and goods markets, a phenomenon that affects not only income flows but also the distribution of wealth. In the financial markets, the volatility came from many sources: the move by major industrial countries away from fixed to floating exchange rates; the liberalization and deregulation of financial markets; and the shift in US monetary policy to stabilizing money supply growth, which resulted in more volatility in interest rates and very high rates in the early 1980s. On the commodity front, the greater volatility was compounded by a secular decline in prices after 1975. This was the consequence of a slowdown in growth in the major consuming nations, the discovery of substitutes for many primary products (e.g., fiber-optics for copper wire), and competition between primary product exporters who needed the foreign exchange revenues.

Few developing countries were in a position to protect themselves adequately from the risks they faced in these markets. The domestic political pressures in many of these countries were such that in boom times, increased receipts tended to be spent fully on projects that locked in expenditure levels above sustainable trends. This meant that when external circumstances took a turn for the worse, reducing expenditures was very difficult, if not impossible. Moreover, there was (and still is) often a perverse pressure to increase, rather than decrease, production of these primary products as prices fell in order to sustain revenues.

How the problems began

Having accepted the primacy of GDP growth targets, developing country governments adjusted their resource mobilization programs to these targets, rather than adjusting their targets in line with the resources available. When domestic resources fell short, it was assumed that more external capital would be provided to meet these resource needs—a view generally supported by the development community and commercial lenders before 1982, but not after. Desiring to avoid foreign control, governments preferred borrowing over direct foreign investment, and financial markets in the 1970s were disposed to increase lending. Greater efficiency from new investment would, of course, have eased this dilemma, but it generally did not occur, partly due to the inappropriate policies prevailing in many countries.

Indeed, market instruments emerged in the 1970s that were conducive to a rapid buildup of debt. The Euro-credit, with its floating interest rate, foreign exchange denomination, debtor government guarantee, and substantial up-front fees seemed to banks an ideal instrument for lending to developing countries. Many readily borrowed more than they could really afford, as there were few controls on such credits; and banks equally readily lent, as they believed they faced few risks. Incentives to use the funds productively were weak in a number of countries, and misallocation not infrequent. Borrowing often allowed countries to avoid making hard policy decisions about economic adjustments and to be less mindful of advice from the World Bank and the International Monetary Fund. In the severely indebted countries, there has been little increase in productive capacity or incomes to show for all their debt.

On the environmental front, problems with degradation started long before the debt crisis—and indeed persist today, including in countries where there is no debt problem or where debt is not being serviced. Even as recently as the 1950s, when world population was about half what it is now, land and forest resources still appeared plentiful, nearly unlimited. Such resources were considered “free” for the taking, and policies were designed to encourage the exploitation of resources to raise income levels.

By the 1980s, however, it was increasingly clear that environmental resources were not unlimited, and in many cases, were actually becoming scarce. But this occurred just at the moment when many developing countries were facing pressures to restore income growth and increase exports to raise imports or repay debt. So perhaps not surprisingly, the pressures to continue to convert natural resource wealth into current income were the ones that prevailed. Part of the problem may be that national accounting practices and domestic price structures faced by economic agents fail to show the real long-term costs to the economy of resource exploitation, so growth based on exploiting resources often appears to be “cheap” in the short run. Deforestation, overgrazing, failure to control pollution, excessive fertilizing, and soil erosion are but a few examples, as they represent a great deal of asset depletion that is counted as income.

What can be done

Given that both the environmental and debt crises stem from the same drive to increase incomes in an increasingly volatile and congested world, solutions lie in applying policies that are based on better development paradigms—not in panaceas such as wide- scale debt cancellations. Already, an international strategy to deal with the debt problem has been put in place that enjoys wide acceptance in the international community. If elements of this model can be adapted to environmental issues, then indeed efforts to resolve the debt crisis may also be able to make a positive contribution to mitigating the environmental crisis.

Debt relief. The “Brady Initiative,” despite its shortcomings, has proven a reasonable mechanism for providing debt relief. The economic policies required for successful growth are now better understood and accepted, so improved guidance can be provided in this area. Programs of debt reduction are conditioned on the adoption of appropriate economic adjustment policies. These policies are monitored by the multilateral institutions and creditor countries, which provide the resources needed to support adjustment and finance debt reduction. Debt relief, after all, is a form of wealth transfer, and creditors—both official and commercial—have budgetary and fiduciary responsibilities to their taxpayers, depositors, and shareholders. Their decisions to effect this transfer depend in large part on their judgment that such a transfer is an effective use of the resources provided to the debtor country, not on an inherent “right” of the debtor to receive relief.

Although adjustment policies have been criticized for being “too tough,” “not tough enough,” and “environmentally insensitive” (and in individual cases, some criticisms are undoubtedly true), there can be no doubt about the need for improved economic policies. The development community and government officials should develop and implement sustainable economic policies that are more effective, including securing enhanced environmental results, rather than abandon adjustment efforts.

Environmental sustainability. Achieving environmental sustainability has become a major goal of the 1990s, and we now know that stopping environmental degradation and eliminating the waste of natural resources are essential. Although further analysis and research is needed to understand how to design and implement better policies to this end, much is already known about how to improve environmental policies. It is also clear that most developing countries will need access to more technology and resources if they are to succeed in these endeavors.

A key step is for developing countries to undertake national environmental assessments. Indeed, that is the best way they can be sure to properly identify the critical environmental issues and determine priorities for subsequent action plans. These plans need to be closely integrated with the economic adjustment programs underway in most developing countries. Fortunately, many of the reforms associated with these adjustment programs have favorable environmental effects. For example, lowering subsidies and raising prices to fully cover costs often help discourage waste of natural resources. Better education and extension services can reduce soil degradation. But economic reforms do not address all of the environmental sustainability issues. Further environmental reforms will be needed—including the reduction of population growth rates.

Where does this leave us in relating the debt crisis to environmental concerns? Although one problem did not cause the other, it is possible to link them in imaginative ways to help resolve both. Most improvements in environmental policies require resources that are lacking in many developing countries. At the same time, debts represent claims on these scarce resources. Thus reducing debt burdens could facilitate achieving environmental objectives as well as encouraging growth. For this link to be effective and the resource transfer justified on environmental grounds, however, beneficiary countries would need to give assurances that their intended environmental policy reforms would lead to sustainable growth patterns—much the way past debt reduction has been conditioned on economic policy reform. Otherwise, debt reduction will not help much, either economically or environmentally. It might even hurt to the extent that it appears to reward the behavior that led to the debt crisis and to the extent that resumption of growth along old lines continues to degrade the environment.

As the international community sets down this road, it should take great care to first determine how large a resource transfer is needed (or obtainable) for a country to implement its environmental reform program. Then the appropriate instruments of assistance can be identified, including, but not limited to, debt relief. Some countries have been able to swap part of their foreign debt for local instruments that help fund environmental programs. This is a useful approach, so long as the resource transfers meet the environmental objectives. But a few limitations should also be recognized: (1) these programs can mobilize only a small proportion of the resources needed to support environmental sustainability; (2) they affect only a small portion of the outstanding debt; and (3) debt relief may be appropriate and effective for some countries but not for others. Other sources of funds will also have to be used to meet most of the resource needs faced by developing countries (including nondebt crisis countries) to achieve environmental sustainability.

Equity. As countries tackle the debt and environmental problems, two issues of equity should be kept in mind—both of which involve the distribution of existing income or claims on wealth. The first concerns internal equity, a problem that predates the debt crisis and affects the consumption of resources. Unless extreme domestic income inequity is addressed and reduced, it will be hard to achieve sustainable environmental policies. The second concerns external equity in the allocation of official assistance among developing countries. All developing countries have national environmental problems, and many will require external resources to help solve them. Thus there is little logic in relating external resource transfers for environmental reasons primarily to past inability to service debt.

Closing reflections

The juxtaposition of the debt and environmental crises is much more an index of our inability to cope systematically with multiple resource limitations than any evidence of strong causal links between the two issues. As a result of the debt crisis, it is satisfying to note that received development policy has come to terms with how to use market forces more effectively for the efficient allocation of resources to achieve growth. But from the still reluctant responses to the environmental crisis, it is apparent that we have only begun to consider means for assuring the environmental sustainability of development as well. These are issues of the scale of economic activity, of the rate of resource use, and of appropriate distribution of income derived from economic activity and from natural resources. These issues are not as easy to deal with in conventional neoclassical economics as are the production and allocation efficiency questions related to adopting market-oriented practices. But the fundamental criteria of maintaining total uses of resources within sustainable levels must be respected.

John D. Shilling

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