How Money Flows Uphill
The Lucas Paradox, Anthony Minghella and the worst ever global debt crisis
Poor countries are transferring billions of their own meagre resources into the coffers of rich private creditors.
Kate Mackenzie and Tim Sahay explain:
In 2023, the private sector collected $68 billion more in interest and principal repayments than it lent to the developing world. International financial institutions and assistance agencies extracted another $40 billion, while net concessional assistance from international financial institutions was only $2 billion—even as famine spread.
That process - of money flowing from the poor to the rich - is a bizarre economic phenomenon questioned by Robert Lucas in 1990, and since named the ‘Lucas Paradox’.
Lucas queried why capital defies the laws of physics and economics and, instead of flowing (downwards) from rich to poor countries, flows (upwards) from poor to rich countries.
Way back in the 1990s, as a leader of the worldwide campaign to cancel the debts of the poorest countries - Jubilee 2000 or ‘Drop the Debt’ - I too questioned these perverse capital movements. Together with colleagues we tried to explain this largely hidden reality to a wider public that believed western governments when they talked up foreign aid to poor countries, and downplayed a bigger truth: that low income countries were sending back larger sums to rich countries - as debt repayments.
Our campaign caught the eye of the brilliant film-maker, Anthony Minghella (think The English Patient and The Talented Mr. Ripley).
If my memory is correct, the year was 1999. Minghella’s short film appeared just as the Jubilee 2000 campaign climaxed. He worked with our partner, the charity Comic Relief to produce a movie that in just over three minutes illuminated, in human terms, the economics of perverse capital flows. It is titled: A Hole in the Bucket.
I have searched the web and only have this link to a copy of the film to share with you. Please take 3 minutes to watch it - its lyrics are powerful.
The Lucas Paradox today
Larry Summers and N.K. Singh in a recent article note how much the perversity of ‘uphill’ capital flows has intensified since the Jubilee 2000 ‘drop the debt’ campaign of the 1990s.
rising interest rates and bond and loan repayments meant that nearly $200 billion flowed out of developing countries to private creditors in 2023, completely dwarfing the increased financing from the international financial institutions.
These numbers have been researched more comprehensively by the influential think-tank Development Finance International. In a widely read report written by its founder Matthew Martin, we learn that despite all our efforts back then, flow reversals between rich creditors and poor debtors are intensifying. Martin explains in detail why this is the worst ever global debt crisis. Debt payments to much richer governments and corporations are
pushing aside key spending to confront social and environmental crises. Debt service equals combined total spending on education, health, social protection and climate, and exceeds it by 50% in Africa. It is 2.5 times education spending, 4 times health spending, and 11 times social protection spending.
These are usurious rates of exploitation of the poor - by the rich. They are not just unjust. They are also economically regressive and counter-productive.
The urgent need for an independent, transparent framework for the resolution of sovereign debt crises
Way back in 1776, Adam Smith in The Wealth of Nations recommended that
when it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open and avowed bankruptcy is always the measure which is both least dishonourable to the debtor, and least hurtful to the creditor” [1]
There is little that is fair and open about procedures to re-negotiate poor country debts today. For years the secretive Paris Club – a cartel of sovereign creditors - has dominated debt-rescheduling processes, hand-in-hand with the closed and bureaucratic IMF.
As things stand, private lenders to sovereign low income governments, unlike creditors to corporations, do not submit to either the discipline of insolvency law; nor to the discipline of market forces. The nationalisation of private debts, the massive accumulation of interest and compound interest on outstanding debts, and the bailing out of creditors by the IMF, makes lending to sovereign governments the most profitable business of all, George Soros once said.
International creditors - private and public - when lending to sovereigns defy the most fundamental principle of the Rule of Law: that one must not be judge in one’s own cause. Creditors must not decide on their own claims”[1]
And yet, thanks to the IMF and to helpful New York courts, they do.
To avoid such injustice, and to end the indecency of poor countries transferring their meagre resources to rich, private creditors, we need a just, independent and transparent international framework for resolving sovereign debt crises.
An independent arbitration process would have four goals: first to restore some justice to a system in which creditors play the role of plaintiff, judge and jury in their own court.
Second, to act as a brake on capital flows and introduce discipline into sovereign lending and borrowing arrangements – and thereby to prevent future crises.
Third, to counter corruption in borrowing and lending, by introducing accountability through a free press to civil society.
Finally, to strengthen economic literacy and democratic institutions in the world’s highly indebted nations.
Such a fair, transparent and accountable arbitration process does not require an international treaty, nor the jurisdiction of an international agency. It could perhaps be based on the US legal framework for managing relations between municipal debtors and creditors.[i]
Above all, the value of such a process would be to reverse the usurious flow of money from poor to rich.
[i] See the work of Prof. Kunibert Raffer “What is good for the US is good for the rest of the world” Advocating an International Chapter 9 Insolvency. Kreisky Forum Symposia, Vienna September, 1992.
That's the best article title I have seen in a long time.
For anyone interested, I have written a paper for a new monetary system that tackles this issue directly. For those interested, the current draft is available at: https://github.com/nlh30/NIYB