This is an essay I have written for the FDCO essay competition which is answering a question similar to the one above:

Currently around 54 low-income countries owe large debt payments[GU1]  to various lenders, preventing investment and therefore hindering development. This includes Sri Lanka which defaulted on its debts in 2022, due to them being unable to pay back their large sum of accumulated debt resulting in the further degradation of the socioeconomic state of the country. With high ratios this means that the government is unable to increase their current and capital expenditure as they are focusing on paying off various private lenders and/or multilateral institutions from whom they borrowed. Therefore, with less investment into healthcare or education, the HDI value decreases as the life expectancy and mean age of schooling values decrease.[GU2]  This results in people falling into poverty thus leading to development not improving. Currently, this affects 3.3 billion inhabitants of countries with high debt interest payments. Hence, I will propose two possible policies that could help foster growth and development for countries struggling to pay off their external debt.

My first suggestion is the introduction of fiscal reforms such as improving tax collection and tightening government spending. This means that the government has enough money to be able to not only pay off its debt but also fund its public sector expenditure on areas such as healthcare and education. This can be achieved by the government reforming their tax system by increasing the rate of income tax for those in the highest tax bracket as well as increasing corporation tax for foreign companies in these countries. They could also attempt to minimise tax avoidance by reducing the amount of cash in circulation. This forces people to exchange money electronically so the government can monitor transactions through financial institutions and ensure that people are paying taxes. Also, government expenditure on certain public services such as defence, only if the country is not on the verge of a war, doesn’t necessarily aid development and growth for the country. By reallocating expenditure towards more valuable public services such as healthcare and education, this will help improve the standard of living in the country. This increase in investment from the government can lead to an increase in the real GDP of a country as seen on the aggregate demand curve (Figure 1) with a shift in AD1 to AD2 on the AS curve due to investment being a component of aggregate demand. An increase in real GDP means that output increases causing more derived demand for labour. This reduces cyclical and structural unemployment resulting in people having higher RDY therefore increasing their standard of living which can alleviate  them from the poverty trap leading to development.

Figure 1 : Aggregate demand curve

One may argue that reforming the tax system may be particularly hard for low-income countries as the majority of their population may be part of the basic tax bracket or may not have enough income to pay tax. Therefore increasing the rate of tax may be largely ineffective and reduce people’s disposable income , pushing more people into absolute poverty. Hence, this proposal is solely effective for developed countries so developing countries should focus on other methods, such as the remedy I have proposed in the next paragraph, which can help increase investment into development.

Moreover, by improving the debt relief schemes that are currently available and possibly introducing a debt justice law there will be a great increase in the investment into development for emerging economies. Despite debt relief of $130 billion in 36 low income countries being won after the tireless Jubilee movement in 2000, occurrences of debt crises still prevailed.  Thus, reforming the sovereign lending system may allow for more fruitful debt restructuring which sees the cancellation of certain debt and rescheduling payments whilst prioritising the needs of the population over debt servicing. In addition, consideration for the sustainable development goals is also key in ensuring the debt for these countries is manageable and that sustainable development is achieved. Climate- or environment-related debt swaps, is where a small proportion of debt in the country is cancelled in exchange for the state investing the equivalent value into specific climate or environmental measures. Therefore it does not help solve the wider issue of debt sustainability and the environmental polices may not benefit the country as much as if the money was used to invest into health or education. Thus, another possible solution to the trade-off between repaying the sovereign debts of the country and ensuring the development of the population is to enforce comparability of treatment. This is when the low-income country faces equal treatment from all its creditors. By simultaneously carrying out negotiations with all of its creditors and paying them equal amounts, this will make the restructuring process more efficient and reduce the complicated nature of the process. This makes it easier for low-income countries which may lack the expertise to deal with their debt efficiently, thus they can devote more money and time towards investing in development within the country. Looking at Figure 2 it is evident that there is an unequal distribution of the types of creditors that hold debt, but this can be solved by paying back each lender within the same time frame and reducing the amount of debt needed to be repaid by the same rate for all creditors.

Figure 2 : Creditors to DSSI–eligible countries in 2020, by percentage share

Overall, these policies allow for debt to no longer hinder economic development in low income countries across the world by freeing up money that can be used to invest into sectors that help achieve this goal. I believe that if the policies of altering fiscal reforms and changing the way debt is restructured are implemented globally, debt will no longer prevent economies from growing and developing