December 17, 2008 [LINK / comment]

Ecuador defaults on debt

Last Friday, the President of Ecuador, Rafael Correa, announced that his government would not pay interest on the nation's foreign debt, which he declared "was obviously immoral and illegitimate." Ever the rabble-rousing populist, he referred to foreign lenders as "monsters." He has ordered government finance officials not to make the interest payments which were due on Monday, saying that he was prepared to accept any consequences. He told the people of Ecuador that the "social debt" (housing shortages, etc.) had a higher priority in his government. It is a very risky decision, however, because Ecuador depends on petroleum export revenues, and the price of crude oil has fallen sharply for the past two months. They could face a drastic shortage of external credit and find themselves unable to pay for vital imports. See BBC and CNN.com

And so, Ecuador continues to follow in the radical, nationalist footsteps of Peru during the late 1980s, when (then-and-current) President Alan Garcia undertook boldly defiant policy measures that backfired terribly. The number of parallels between the background, age, and social status of those two national leaders is truly remarkable. Garcia has matured and moderated considerably since his first term, and during his second term, which began in 2006, Peru has enjoyed one of the most successful economies in all of Latin America.

Today Correa is attending a summit meeting in Brazil with President da Silva, along with the new president of Paraguay, Fernando Lugo. Both countries owe a substantial amount of money to Brazil, and the three leaders are trying to work out mutually acceptable terms for repaying the debt. See El Comercio of Ecuador (Spanish).

Personally, I think Correa's move is reckless and bound to make his people worse off than they are at present. Nevertheless, as a sovereign nation, Ecuador is within its rights to refuse to repay its debts. There is no international debt collection agency, and it is up to the creditor nation governments to rely upon the leverage of the IMF and other international financial institutions or else the threat of coercive force. (In the early 20th Century, the United States often used "gunboat diplomacy" to force the governments of Caribbean nations to pay their debts, or to preclude European great powers from moving in with their own military force.) The issue of Third World debt has both practical and moral dimensions, and the tradeoffs are more complex than most people think. Many Third World countries, including Bolivia, are essentially insolvent, and if there were stronger international leadership, private banks would have an incentive to write off a large portion of those debts so that they could at least recoup part of their losses, while allowing the poor countries a chance to start growing again. But until that happens, defaulting on foreign debts is a very compelling alternative for the poorest of the poor. See my essay on Third World debt, excerpted from my dissertation at U.Va. (2001).

Inasmuch as Correa holds a Ph.D. in Economics from the University of Illinois, one wonders what the heck that department is teaching to its students. Upon the occasion of his inauguration in January 2007, that university's Center for Latin American and Caribbean Studies reviewed Correa's academic work at Illinois. Correa's dissertation adviser was Dr. Werner Baer.