The surge in international lending, 1974-1982
Before World War I there was a large amount of international lending, with Britain as the main creditor and the growing newly settled countries (the United States, Canada, Argentina, and Australia)as the main borrowers.To a large extent this international lending fit the well-behaved model, as lending sought out high returns.During the 1920s, a large number of foreign governments issued foreign bonds, especially in New York, as the United States became a major creditor country.But in the 1930s, the depression led to massive defaults by developing countries, which frightened away lenders through the 1960s.Lending to developing countries remained very low for four decades.
The oil shocks of the 1970s led to a surge in private international lending to developing countries.Between 1970 and 1980, developing country debt outstanding increased sevenfold, with debt rising from 9.8 percent of the countries’ national product in 1970 to 18.2 percent in 1980.
The oil shocks quadrupled and then tripled the world price of oil, and these shocks caused recessions and high inflation in the industrialized countries.How did the shocks also revive the lending? Four forces combined to create the surge.Firstly, the rich oil-exporting nations had a high short-run propensity to save out of their extra income.While their savings were poling up, they tended to invest them in liquid form, especially in bonds and bank deposits in the United States and other established financial centers.The major international private banks thereby gained large amounts of new funds to be lent to other borrowers.The banks had the problem of “recycling” or reinvesting the “petrodollars”.But where to lend?
Secondly, there was widespread pessimism about the profitability of capital formation in industrialized countries.Real interest rates in many countries were unusually low.One promising area was investment in energy-saving equipment, but the development of these projects took time.For a time the banks’ expanded ability to lend was not absorbed by borrowers in the industrial countries, which encouraged banks to look elsewhere.Attention began to shift to developing countries, which had long been focused to offer higher rates of interest and dividends to attract even small amounts of private capital.
Thirdly, in developing countries, the 1970s was an era of peak resistance to foreign direct investment (FDI), in which the foreign investor, usually a multinational firm based in an industrialized country, keeps controlling ownership of foreign affiliated enterprises.Banks might have lent to multinational firms for additional FDI, but developing countries were generally hostile to FDI.Populist ideological currents and valid fears about political intrigues by multinational firms brought FDI down from 25 percent of net financial flows to developing countries in 1960 to less than 10 percent in 1980.To gain access to the higher returns offered in developing countries, banks had to lend outright to governments and companies in these countries.
Fourthly, “herding” behavior meant that the lending to developing countries acquired a momentum of its own once it began to increase.Major banks aggressively sought lending opportunities, each showing eagerness to lend before competing banks did.Much of the lending went to poorly planned projects in mismanaged economies.But everyone was doing it.