Katarina Sehm-Patomäki, NIGD

From a global perspective, mechanisms of unfair exchange and falling terms of trade have prevented economic development for countries in deficit vis-à-vis those countries showing a surplus. The breeding ground for these mechanisms was set in the terms of agreement of the Bretton Woods Institutions. Back then, and in contrast to the proposal by John Maynard Keynes where the debtor and creditor would both have been equally responsible for deficits and excesses in their balance of payments, the terms of agreement set out that debts were the responsibility of the debtor alone. Keynes' proposal would have invited to a common strive for global economic balance, whereas the present system created settings where debtors had few alternatives but to head into a debt trap. Predictably, and since the 1970s, these two factors of unfair exchange and falling terms of trade have been combined with a spiralling debt mechanism (Millet & Toussaint 2004: 27). Further, the spiralling debt mechanism threw a loop following the recommendations of the illiquidity theory of the 1970s and 1980s, which suggested that the debt crises were only temporary crises of payment due to short-term lack of liquid means. Consequently, countries in payment crisis were encouraged to take on more loans to service their debts ultimately leaving the borrowing governments in mountains of debts. Mechanisms of unfair exchange, the downgrading of terms of trade and the spiralling debt mechanism constitute a triad of structural causes that have put countries and groupings of countries in quite different positions in today's global race for economic profits.

1. The debt of the North

From a Southern countries' perspective, their debt burden is mounting and this is creating serious situations. The debt burden, however, forms only one part of the mechanisms by which the North extracts wealth from the South. From the South, we hear calls for the North to compensate the South for exploitation dating back to the beginning of the capitalist system. As summarised in the editorial of a book of Southern points of view regarding the debt problem: "It was mercantile at first, when it was responsible for the extermination of entire populations, slavery and the pillage of wealth. Then it was industrial capitalism that established the colonialist era at the cost of numerous wars. The current mechanisms of unequal exchange pursue the same ends." (Alternatives Sud 2002: 249) These current mechanisms have also been referred to as means of recolonialising the South (Tandon 2001 see also Raffer & Singer 2004:54). "Not only should the cancellation of the debt of the South be fought for, but also compensation from the North, above all through a total revision of economic relationships between North and South." (Alternatives Sud 2002: 249) In order to mend North-South relations and create a basis for healthier relations, Yash Tandon and others have proposed setting up a North-South truth commission (see the conclusions of Rikkilä & Sehm-Patomäki 2002). Reconciliation through a fair truth commission process could be a useful step leading to trust between nations.

There are further specific features regarding culpabilities in the causes of the debt problem. The peoples of the countries previously led by dictators active on the borrowing front - such as Baby Doc, Bokasa, Mobutu, Pinochet, Somoza and Suharto who used much or all of the loans they took on for consumption rather than investments - do not see why they are responsible for repaying these loans since they never benefited from them in the first place. Many are the examples showing that creditors were well aware of the intended actual use of the credits (for numerous examples of background documents with early warnings for future misuse of funds, see for instance Hertz 2004, Raffer & Singer 2004 and Millet & Toussaint 2004).

2. The debt of the South

In short, from a creditor's perspective, loan agreements are agreements that entitle them to get the agreed amount repaid according to the agreed schedule and agreed interest rates. Regarding international lending, and since the latter part of the 1980s there are four factors in particular that have contributed to the discussions on international lending policies. The first one was the Brady Plan in 1989, which was the first initiative that approved of debt cancellation instead of previously adopted debt restructurings. The second factor was Jeffery Sachs who in 1989 was the first to suggest that debt reduction could create favourable incentives in an indebted country. Thirdly, following the direction taken by Kunibert Raffer some groups started to compare international lending with national lending, where the borrowing party can declare itself bankrupt and thus unable to repay its loans. The fourth factor is highly visible and vast civil society mobilisation around the issue of debt. First in line were the massive civil society mobilisations in the 1990s culminating in the G7/8 shadow meeting in Birmingham in May 1998, a phenomenon recently repeated in Gleneagles at the G7/8 meeting in 2005. Reportedly, the Jubilee 2000 campaign of the 1990s for cancelling third world debt attracted as many as 24 million signatures worldwide. According to recent estimates by the New York Times, some 160 million people have been involved in some kind of work on the debt problem. International lending policies have emerged as the outcome of political super power rivalry in a cold war setting resembling much a complex mosaic coloured of greed, naivety, posing threats to human rights, while appealing to moral obligations and global consciousness.

In her book on the debt issue, Noreena Hertz cites Sonny Callahan, conservative congressman from Alabama who says that "debt cancellation would be money down a rathole". Callahan believes that additional monies being asked for would only encourage the World Bank and others to continue to make bad loans and leave poor countries to have to borrow and get into debt all over again. (Hertz 2004:15) Often it is also pointed out that cancelling debts would jeopardise future lending. Callahan's comments summarize much of the arguments put forward on the creditor's side. In a way these arguments reflect the structural causes underlying the world?s financial and economic systems, and perhaps also recognition of a lack of political will to mend the basis.

3. A political problem but without democratic participation mechanisms

Since the 1970s, civil society has been calling for cancellation of debts. The debt problem appeared on the political agenda in 1982. Although the default of Poland in 1981 was already a major shock, it was only the following year when Mexico declared itself unable to honour its debt obligations that is conventionally seen as the beginning of the debt crisis (Raffer and Singer 2004:158). Since the late 1990s the debt problem has been on the agenda of the annual G7/8 meetings. Today, almost a quarter of a century later, and despite numerous debt relief programmes, the same debt administration system still remains. During the same period of time, the actual debt burden of developing countries has grown around 2,5 to 3 times. In pure interest, the amounts paid to International Finance Institutions, IFIs, private, and public creditors is six times what was owed in 1985. The facts that actual amounts paid to creditors exceed the debts (figures from 1985) while simultaneously the debt stock have been on the rise reveal that the debt problem cannot be seen as a pure economic problem. On the contrary, civil society organizations and movements consider the debt problem of the developing countries to be above all a political problem.

So far, the various debt relief programs and other initiatives taken forward (Club of Rome & London, Baker Plan, Venice Terms, Brady Plan, Toronto Terms, Heavily Indebted Poor Countries programme, HIPCs, Poverty Reduction Strategy Papers, PRSP) have all been initiated and controlled by creditors. These initiatives have not led to decreased debt burdens, on the contrary. The total debt burden of developing countries is on a steady rise, and this trend has not been broken. As Jürgen Kaiser, then of Jubilee Germany, pointed out at a meeting on debt arbitration organised by the African Forum on Debt and Development, Afrodad, in Lusaka, Zambia, that based on the recent HIPC analysis by the World Bank, it is clear that the indebted poor countries will have to loan more to cover their present loan servicing costs. From the angle of the international financial institutions, this means that the institutions keep "throwing good money after bad" with vanishing hope ? or few assumptions - of ever receiving payments for the original credits.

In contrast to the failure of debt relief programmes to decrease debt burdens, the initiatives that have had political motivations (in contrast to economic ones) are the ones that have ultimately led to a decreased burden of loans for individual countries. The first example of these kinds of successful initiatives as regards actual reduction of debt include the case of Germany in 1953 in light of fears that the Versailles treaty following the World War I had led to the rise of Hitler and a repetition of this scenario was very much seen as undesirable - the risk that nazism would re-emerge had to be reduced. Secondly, in 1969 Suharto?s new Indonesian regime received a debt reduction very similar to the German case, and as Indonesia was substantially indebted to Communist governments, this demand was also of great political importance (Raffer 2001:31). Thirdly, in 1980, Polish debts were reduced in hope of suffocating socialism and fourthly, in 1991, the debts of Egypt were reduced in thanks for their support in the first Iraq war. The most recent example is of course the case of Iraq, when its debts were reduced following the set up of the new regime in 2004.

The fact that the initiatives to date have been creditor-controlled rings badly with principles for the rule of law. Here these principles mean equal possibilities of participation and influence by all parties while presuming that there are no asymmetric dependency relations between countries or groups of countries. One of the few proposals from the debtors were the idea of a Club of Debtors initiated by Cuba in 1982. This idea fell through because of the launch of new negotiation processes shortly thereafter flashing a false hope of forthcoming positive changes (Hernandez Pedraza 2002:32). It does not help that the articles of the Paris Club (the group of sovereign creditors to which a country must go to negotiate debt rescheduling) explicitly deny borrowing countries the right to negotiate in groups.

Rather than bringing about necessary debt relief, which could open up possibilities for structural changes in the global economy, debt relief initiatives so far have come with two main sets of problems. Firstly, debt relief is granted only following the implementation of certain policy measures as required by the creditors (so called conditionality). Considered from a democratic point of view, external involvement in national political decision-making is problematic. This endangers the national democratisation process where voters elect their political decision makers according to their politics. A second set of problems with debt relief proposals has to do with the idea that large sums are injected to creditors in compensation for lost credits (proposals by Gordon Brown, the proposal of selling the IMF gold reserves). Most of the credits owed by indebted developing countries have small prospects of ever being repaid. If the IFIs were handed large sums in compensation for loans (that they would never get paid back anyways) it is possible that they would use this money to do what their terms of agreement binds them to do: use to money for new loans in the future. There are no new winds in the air signalling that the news loans would come with less conditionality. Further, this process would not at any point allow for the questioning of the accuracy and accountability of the policies practiced by the IFIs, which is something especially southern civil society movements and actors speak strongly of. For instance, in contrast to mostly middle-income countries in Latin America where the debt is largely composed of private debts, the debts of the countries of the African continent are mainly official loans (Birdsall et al 2004: 61), or in other words, exactly the type of loans that the IFIs make and administer. In sum, lending policies should be revisited as future lending is an important policy instrument.

4. Debt arbitration as a means to introduce democracy internationally

In 1987, Kunibert Raffer first suggested that the Chapter 9 Insolvency Law of the US Code could be applied to international debt. Chapter 9 is a "procedure for solving the insolvency of a governing body, a Municipality, without violating or undermining its governmental power. Applied to sovereign countries, the law would not violate sovereignty of the state". In explaining the essence of a Fair Transparent Arbitration Process, Kunibert Raffer cites UN Secretary-General Kofi Annan who, in describing the role of the UN in the 21st century, suggested a "debt arbitration process to balance the interests of creditors and sovereign debtors and introduce greater discipline into their relations".

There are two particular examples of successful situations similar to debt arbitration that have taken place post World War II; the London Accord with Germany and the Indonesian solution of 1969. Both roughly halved the present values of these countries' debts. In the case of Germany in 1953 a German banker had de facto the authority of an arbiter, as creditors were willing to follow his views. This German experience suggests that debt arbitration would not disrupt international lending to the country involved in an arbitration process. Another example is Indonesia where a German banker de facto was given the authority of an arbiter. (Raffer 2001: 30-31)

However, not everyone feels comfortable with debt arbitration, much because it is seen as a function of declaring oneself (the country in question) insolvent, which in turn is perceived as humiliating. These organisations, which do not support debt arbitration (the Jubilee South, for instance, an offspring to the Jubilee 2000 movement), speak for debt cancellation - full stop. Proponents of debt arbitration processes/mechanisms counter the demands for immediate debt cancellation by saying that also cancellation must happen as a result of some form of process and by some form of mechanism. Demanding the cancellation of unpayable debts means demanding an independent entity empowered to decide (Raffer 2001:21).

Appointing an independent entity to decide over wrongs and rights resembles the initiative of setting up a North-South truth commission. Forsberg and Teivainen have looked into truth commissions and conclude their research saying that "debt arbitration could indeed constitute themes under which truth-commission-like consideration on forgiveness and reconciliation could play a role". However, they point out that given the current relations of power, it is not surprising that some of the radical social movements express doubts about the proposal of arbitrating the debt of developing countries. (Forsberg & Teivainen 2004:28)

In order to avoid the use of the sensitive term "insolvency" when discussion arbitration, civil society organisations have started to the term debt arbitration with "Fair Transparent Debt Arbitration Process" (FTAP). A FTAP could be carried through as an ad hoc, cheap and immediate mechanism. At a first instance, the FTAP should be independent, which means that in order to remain impartial it should not be administered under any of the present international institutions and certainly not under the IFIs. Once the debts - or a majority of the debts - of the poor countries have been arbitrated, the FTAP process could be transformed into a Fair Transparent Debt Arbitration Mechanism (FTAM) that could be set up on a permanent basis for instance within the UN system (one alternative being with the UNCITRAL, the UN Commission on International Trade Law). Due to present power play at the UN, it would however not be advisable to launch the process from within the UN. In turn, a successful debt arbitration process could open up new possibilities for UN reform and other transformation processes (for more information see Patomäki & Teivainen 2004).

Civilised insolvency laws are applicable to practically all debtors except developing countries. Therefore, developing countries should demand a neutral institution assuring fair solutions (Raffer 2001:14). Because impartiality of national courts, whether located in a creditor or a debtor country, cannot be guaranteed, a neutral court of arbitration must be established to allow absolutely fair and equitable international Chapter 9 proceedings, devoid of overreaching, however subtle. The Chapter 9 model could be implemented internationally as an orderly framework to determine which part of their debts insolvent debtors can actually pay. It is the only procedure protecting governmental powers, and thus applicable to sovereign (Raffer 2003:2). It could be implemented quickly and it would be fair to all concerned, avoiding unnecessary costs on debtors or the international community (Raffer 2003:5) In addition, all creditors should be subject to arbitration (2). The inclusion of all parties is important because a large proportion of debts are public debts, that is credits by the IFIs. By putting the credits for IFIs up for arbitration, this means that also lending policies of the IFIs would be politicised. The policies of the IFIs would thus be held accountable. Acknowledging the political difficulties in conveying the Bretton Woods Institutions (the IMF and the WB group) to take part in an arbitration process, one way of developing the debt arbitration process could be to link it with the development of other forms of alternative financing.

As said above, the Chapter 9 provides an insolvency framework to determine what debts the debtor actually can pay. In addition, there are certain debts that are perceived as illegitimate and which the debtor thinks should not be paid. One guideline is the concept of odious debts, which exists as a doctrine in international law. This legal precedent (dating back over 100 years to when the US captured Cuba from Spain) became law in 1923 and could allow for the cancellation of such debts by international agreement. Odious debts are debts incurred by dictatorial regimes for their own benefit and against the interest of the population of a state, without its consent and with full awareness of the creditor (King et al). Three basic issues come to light in the definition of illegitimate debts, thus the absence of consent, absence of benefit and creditor awareness in the manner the debt in incurred. In this case, the burden of service was imposed on the people by regimes in collusion with the loan providers amid discreetly. (Lungu 2004:17) If the arbitration process rules a debt odious it should not be paid. This could for instance be the case of loans deliberately made to dictators, whose record of the use of loans suggested that new credits were never intended for the peoples. These loans were usually made for political reasoning in exchange for political loyalty and support. Today, the loans remain as a reminiscent of the Cold War.

5. Launching the debt arbitration process in practise

As is usual practice in international law, each side should nominate the same number of persons, who, in turn, elect one further member to achieve an uneven number. One of the arbitrators is elected as chairperson by simple majority, or, if the debtor and creditors should wish so, by qualified majority. This was also the kind of neutral body of arbitration that was established by the London Accord, which reduced Germany's debt burden in 1953. (Raffer 2001: 22) IFIs, such as the IMF or the IBRD, cannot be considered unbiased and neutral because they are both controlled by majorities of creditor States and creditors in their own right. All claims have to be verified loan-by-loan at the beginning, as routinely done in any domestic insolvency. (Raffer 2001:23) Loans by the IFIs would also be subject for arbitration. The process could be launched following an identification of a certain credit and once the debtor and the creditor have agreed to submit their claims to the arbiter. At present, mostly civil society organisations are working on setting the process in motion.

The obstacles for setting a debt arbitration process in motion are political, and more precisely, the creditors themselves constitute the main obstacle. It is difficult to tempt creditors to come on board binding themselves to the outcome. Politically, the first step is the hardest and once the first debts are arbitrated, it could be easier to arbitrate subsequent debts.

In parallel, it could be encouraged that new loans should include a clause that the loans are subject for arbitration upon signing new loans.

6. Arbitration pre-empts new debt crisis

In the beginning, I mentioned falling terms of trade as one of the structural causes leading to the debt problem. The task of regulating the prices of the commodity markets (the main export of developing countries) was left outside the framework of international institutions. Consequently and alarmingly, UNCTAD predicts in its recent reports that there will be a new debt crises within the next five-ten years, given that interest rates do not rise before that. If interest rates raise, the crises would be deeper and steeper. Falling commodity process and accumulated debt makes the equation of sustainable economics difficult to solve. In light of the structural causes behind the debt problem and UNCTAD's predictions, solving the debt problem has now become a pre-emptive measure on a global scale. Other measures and mechanisms should then be introduced, in particular regarding regulation of the prices on commodity markets.(3) An immediate launch of a debt arbitration process could make all the difference.

Sources:

Birdsall, Nancy, Stijn Claessend and Ishac Diwan (1994): Policy Selectivity Forgone: Debt and Donor Behavious in Africa, in Addison, Tony, Henrik Hansen and Finn Tarp (2004): Debt Relief for Poor Countries, Studies in Development Economics and Policy Series, Palgrave, in association with UNU-WIDER, Houndmills, Basinstoke, Hampshire and New York, p.61

Forsberg, Tuomas and Teivo Teivainen (2004): Past Injustice in World Politics - Prospects of Truth-Commission-Like Global Institutions, Crisis Management Initiative, Office of President Ahtisaari, Helsinki, http://www.cmi.fi/?content=publications, accessed on 15 July 2005

Hernandez Pedraze, Gladys Cecilia (2002): La dette externe du tiers Monde: nouvelles initiatives ou vielles recettes? In: Raisons et déraisons de la dette. Le point de vue du Sud. Alternatives Sud Vol. IX (2002), n 2-3, l'Harmattan, Louvain-la-Neuve

Hertz, Noreena (2004): I.O.U. The Debt Threat and Why We Must Defuse It, Fourth Estate, London

King, Jeff, and Ashfag Khalfan, and Bryan Thomas Advancing the Doctrine of Odious Debts

Lungu, Joseph (2004) The Case for the Establishment of a Fair and Transparent Arbitration on Debt, Afrodad Discussion Paper presented in Lusaka, Zambia in September 2004

Millet, Damien, and Eric Toussaint (2004) Who Owes Who? 50 Questions about World Debt, Zed Books, London and New York

Patomäki, Heikki and Teivo Teivainen (2004): A Possible World: Democratic Transformations of Global Institutions, Zed Books, London & New York

Raffer, Kunibert (2001): Solving Sovereign Debt Overhang, http://www.jahrbuch2002.studien-von-zeitfragen.net/Weltfinanz/RAFFER_1/raffer_11.HTM

Raffer, Kunibert (2003): To Stay or Not to Stay - A Short Note on Differing Versions of the SDRM, see http://www.jubileeplus.org/latest/raffer310103.htm

Raffer, Kunibert and H.W.Singer (2004): The Economic North-South Divide: Six Decades of Unequal Development. E Edgar, Cheltenham

Rikkilä, Leena and Katarina Sehm-Patomäki (2002): From a Global Market Place to Political Spaces, NIGD Working Paper 2002

Endnotes:

(1) A shortened version of this paper was published in Finnish in Kehitysmaiden velkakriisi tänään [Today's situation of the debt crisis of developing countries], edited by Teppo Eskelinen, 2005, Attac ry, Finland, see http://www.attac.fi/velkatanaan

(2) For instance, the Sovereign Debt Restructuring Mechanism, SDRM, model building partially on arbitration by the IMF exempts multilateral institutions and is evasive about Paris Club members. (Raffer 2003:2)

(3)For a discussion on world trade politics, commodity markets, and power mechanisms, see for instance Katarina Sehm-Patomäki (2004) Maailman kauppapolitiikan pohjavirrat [Undercurrents of World Trade], NIGD Discussion Paper 3/2004 nigd/democracyandwto and nigd/keskustelupaperit