You often hear in the news about poor countries being in debt. In fact, ‘third world debt’, and the potential for debt relief, has been a political topic globally for decades. But what’s less commonly talked about it why developing countries even borrow money? If these countries are poor, why do they take loans? Well, let us explain…
1. To Compensate For Low Tax Revenue
A first reason why developing countries borrow money is because they lack the revenue they need.
Governments need revenue in order to operate. They also need income to fund services such as healthcare, education and the military. Governments raise the majority of their revenue through taxes on people and businesses, with additional income coming from levies on certain goods or from duties on imports.
Many developing countries struggle to collect the taxes they need. Weak revenue collection systems, combined with often widespread tax avoidance, means poorer countries often have a revenue short-fall. In order to plug this gap, many developing countries are forced to borrow money.
As well as often having ineffective tax collection systems, many developing counties fail to collect the levies placed on goods and duties on imports. Porous borders, extensive smuggling and corruption all prevent developing country governments from collecting the income they need. This forces them to borrow money in order to continue to function.
2. Because Revenue Is Lost To Corruption
A second reason why developing countries borrow money is to compensate for income lost due to corruption.
Developing countries generally have issues with widespread corruption. Of the poorest countries in the world, the majority are also the most corrupt. Corruption is fraud or theft conducted by those in power. This could be high-level politicians syphoning state funds to private bank accounts, or low-level officials taking bribes.
Corruption is one of the major reasons why developing countries have to borrow money. Due to the significant loss of government revenue due to corruption, poorer countries are forced to take loans to cover gaps that could otherwise be filled.
All governments produce regular budgets forecasting the money they expect to raise and their planned expenditure. However, developing country governments office face a shortfall between their projected revenue and costs as it can be impossible to predict how much income may be lost to corruption. As a result, these governments must borrow money in order to meet their budgets.
3. To Fund Infrastructure Projects
A third reason why developing countries borrow money is to fund infrastructure projects.
Infrastructure – roads, railways, airports, utilities and tele-communication networks, is vital for a nation’s success. It is needed for moving people and goods swiftly and easily around a territory, as well as for information to be sharable and people to live quality lives. All nations not only need to build more modern infrastructure, but also need to maintain the infrastructure they have. This costs money.
Developing countries generally lack the funds they need to build infrastructure. They also often have infrastructure that is in poor condition that needs to be updated. Across most poorer nations infrastructure is dilapidated and in need of maintenance. However, developing countries regularly need to borrow money in order to fund infrastructure improvements.
Without taking loans, most developing countries would be unable to keep their infrastructure running. Poorer countries often rely on external funds to maintain the infrastructure they have. Without borrowing money, most developing countries would see their infrastructure fail which would have an enormous impact on economic growth and the ability of the nations’ people to live their lives and do business.
4. To Help Run Basic Services
Another reason why poorer countries take loans is because they need the money to run basic services.
As we’ve discussed, developing countries struggle to raise revenue. They also lose a significant portion of the money they do raise to corruption. However, developing countries still need to provide their citizens with a range of basic services. Education, healthcare, policing and defense are all required. As poorer countries often have a shortfall in their budgets, they need to take loans in order to fund these services.
Citizens of any nation expect a degree of assistance from their state. Although in many poorer countries people expect, and actually receive, less from the government than people in richer countries, the state in developing countries is still required to meet some of people’s basic needs. As developing countries often don’t have the money to do this, many take loans to cover the costs of running the programmes people require.
5. To Stabilize Their Economies
One reason why poorer countries take loans is in order to stabilise their economies.
Developing countries experience more financial crises then richer nations. Poorer nations are more susceptible to economic and political turmoil. These crises can have an enormous effect on the economies of developing countries. Some developing countries take loans to help stabilise their finances and limit the impact of economic shocks.
As we’ve said, poorer countries generally lack large revenue reserves. This means when economic crises hit, they do not have the financial capacity to stabilize their currency, prop-up key enterprises or provide emergency assistance to people impacted. As a result, they must often borrow money when economic crises hit.
The economies of developing countries can be significantly more unstable than those of richer nations. They also lack resilience and adaptability. As a result, when economic issues arise, poorer country governments must often take loans to ensure their economic viability.
6. To Boost Economic Growth
A key reason why some poorer nations borrow money is to help boost their economies.
Economic growth is key to lifting people out of poverty. Developing countries have a range of methods at their disposal to boost economic growth – and one is to borrow money.
By taking loans, developing country governments increase their revenue. This allows them to fund key projects such as infrastructure, healthcare and education. This, in-turn, can give a boost to the country’s economy.
Some developing nations have leveraged the economic growth built upon foreign loans to increase their tax revenue. Essentially, as a nation’s economy grows people get richer – meaning there is more wealth to be taxed. This has then created a virtuous cycle by where the government had more funds to invest in further economic boosting activities. This is seen as one major reason why developing countries borrow money.
7. To Help Recover From Disasters Or Conflicts
A final reason why developing countries take loans is to help them rebuild following disasters or conflicts.
Poorer countries are more at risk of natural disasters, such as earthquakes, floods, famines and extreme weather. These events cause widespread death and destruction. Communities impacted by natural disasters need assistance to recover. However, as we’ve discussed, developing country governments often lack significant funds. This means they are unable to use their own financial resources to rebuild after a disaster. As a result, they must often borrow money.
As well as being more susceptible for natural disasters, developing countries also experience more conflict. Poorer countries have higher rates of internal armed violence, and a more likely to face external military interference. One result of this is that many developing countries experience widespread destruction as a result of fighting. In order to reconstruct, these countries are often forced to take loans.
The lack of revenue developing countries have to recover from natural disasters and armed conflict means that for them to be able to assist people in need and recover from a crisis, they must raise money by borrowing.