The following blog post was written by guest blogger Claire Seigworth. Claire graduated with a B.A. in International Relations and a minor in Spanish Literature from Marquette University. She has traveled to many Latin American countries, studied in Santiago, Chile and worked in Panama for Global Brigades.
There is hardly a more controversial topic in international finance than debt forgiveness. Some advocate that debt forgiveness allows indebted countries to spend money on public services, yet others warn of the potential of moral hazard in the international finance community. As like most polemic subjects, there is no clear cut correct answer.
According to businessdictionary.com, debt forgiveness is “Writing-off of a portion of one or more loans to a financially troubled firm by its lender(s). The objective is to help that firm in its debt restructuring so that it remains viable and is able to pay off the remaining part of the loan(s).”
Opponents of debt forgiveness base their argument on the idea of moral hazard. Moral hazard is “The risk that a party to a transaction or activity is not acting in good faith, or that one party has perverse incentives to act in a manner detrimental to the counter party.” In other words, if countries have debt forgiven, there exists the potential that these same countries will misspend other loans in the future seeing as they did not have to pay back their loans in the past. Others argue that debt forgiveness largely benefits the often corrupt and authoritarian political class that created high levels of debt in the first place.
Others argue that not all debt is bad but in highly indebted poor countries, debt stifles growth. As countries try to pay back their loans and the interest that they carry, money that could be spent on investments that could lead to economic growth instead is spent on loan repayment. According to the International Monetary Fund, debt cut in half in high debt, low income countries, economic growth would increase by 2.8 percent.
As international monetary institutions do enact debt relief programs, it appears that debt forgiveness is the path financial institutions use to assist struggling countries. Moral hazard is still important to consider because if a country has debt that is forgiven or it defaults, they can have trouble receiving loans in the future. It appears that in the debate over debt forgiveness, a case by case approach seems to be the best way to help countries struggling with debt and also create economic growth.