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The Great Debt Cleanup

Now that the COVID-19 pandemic has ushered in a steep economic downturn, highly indebted emerging markets and developing countries are facing potentially ruinous fiscal crises, the costs of which will fall on ordinary citizens. Fortunately, there is a way to address the problem that is both practical and just.

BOSTON – With more than $7.5 trillion owed to external creditors, emerging economies’ debt-service costs are becoming increasingly onerous just when they need as much fiscal space as possible to confront the COVID-19 crisis. While there is a strong case for canceling much of this debt, many key players oppose doing so, arguing that it would limit these countries’ access to international markets in the future, thereby reducing investment and growth.

In fact, the evidence for this view is fairly weak. Far from reliably boosting investment and growth, international financial flows are more likely to contribute to volatility in emerging markets and developing economies. Even so, it has long been assumed in academia and policy circles that international finance helps emerging economies build more effective institutions, enabling them to develop their banking system and stock markets, for example. Opponents of debt forgiveness have also argued that emerging markets need the “discipline” that international bond markets provide, because the threat of capital flight constrains misrule by autocrats and populists.

Hence, during the European debt crisis, Greeks were discouraged from defaulting on their debts to foreign banks, lest they destroy their credit profile. And even after Greek voters had rejected the terms imposed by the troika of official creditors (the European Commission, the European Central Bank, and the International Monetary Fund), the country’s left-wing government ultimately made a deal, leading many policymakers to conclude that market discipline had worked.

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