Third-World Debt

Historical Origins

The origins of the debt crisis in the third world can be traced back to the oil price shock of 1973–1974. At the time, the member states of the Organization of Petroleum Exporting Countries (OPEC) limited the supply of oil, which resulted in a huge increase in the price. This had a significant impact on all importers of oil, including many newly independent countries in the third world. The excess profits that OPEC members received were then invested in the Western commercial banking sector. The banks then sought to find new borrowers to lend this money to. Countries in the third world, which were in need of development assistance to soften the impact of increased oil prices, were considered a sensible and safe option by the banks. This meant that during the second half of the 1970s, a significant proportion of the flows of capital to the third world came from commercial banks. This flow of funds from OPEC-member states to commercial banks and then on to countries in the third world is often described as petrodollar recycling.

Three key factors led to the emergence of a crisis in third-world debt in the early 1980s. First, there was a second oil price shock in 1979. This led to economic recession in Western economies and also put a further strain on the balance of payments of oil-importing countries in the third world. The banks offered further loans to third-world countries at this point so they could satisfy these pressures. Second, a shift in economic policy making took place in the West (in particular the United States and the United Kingdom), and this resulted in the use of interest rates to control inflation. With inflation set to rise sharply as a result of the increase in oil prices, interest rates were significantly increased in an effort to contain inflation. This rise in global interest rates dramatically increased the costs of debt servicing for third-world countries. Third, the recession in the West multiplied the problems for the third world. Faced with the need to raise additional foreign exchange to meet their debt repayments, one option would have been to increase their exports. However, the market for what were mostly primary commodities had declined as a result of the economic downturn in the West, and this depressed prices for the majority of third-world commodity exports.

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