What this lesson teaches
I can judge how oil crises, protectionism and debt crises hurt the global economy from the 1970s.
Syllabus 9174, Paper 1, Theme II, Learning Outcomes. evaluate the challenges that affected the global economy over time
Make a guess
In the 1970s Latin American governments borrowed heavily at low, floating interest rates. What do you think happened after 1979?
- Western banks cancelled the debts to help growth.
- Rates soared and export prices fell, so debts became unpayable.
- Rates stayed low, so the loans were easily repaid.
Show the answer
Rates soared and export prices fell, so debts became unpayable.
Mexico's default in 1982 began a crisis that cost Latin America a lost decade of growth.
Cheap loans in the 1970s became unpayable debts when interest rates rose and export prices fell. Latin America lost a decade of growth.
In the 1970s Western banks lent petrodollars to developing countries, especially in Latin America. Real interest rates were low, and governments borrowed to build industry and pay their higher oil bills. Latin America's foreign debt rose more than tenfold between 1970 and 1982.
Most loans had floating interest rates. When US interest rates soared after 1979, the cost of repaying jumped. At the same time, the recession of 1980-1982 cut demand for these countries' exports and lowered commodity prices.
In August 1982 Mexico announced that it could not keep up payments on about 80 billion dollars of debt. Banks stopped lending across the region. Brazil, Argentina and many others fell into crisis, and many African countries faced similar problems.
The IMF lent rescue funds on condition that borrowers cut spending, raised taxes and opened their economies. These "structural adjustment" programmes protected the banks but caused hardship. The Baker Plan of 1985 offered new loans, and the Brady Plan of 1989 finally reduced debts.
For Latin America the 1980s became a "lost decade". Average income per head was lower in 1990 than in 1980, and poverty rose. By contrast, most East Asian economies kept growing.
- Petrodollars
- Oil surpluses lent by Western banks in the 1970s.
- Aug 1982
- Mexico cannot pay; the crisis spreads.
- Brady Plan
- 1989: debt reduction.
- Lost decade
- Latin American incomes lower in 1990 than in 1980.
Real examples to use
Mexico, August 1982
Mexico owed about 80 billion dollars when it said it could not keep up payments, and lending to Latin America froze.
Baker Plan, 1985
New loans in return for market reforms did not cut the debts, which is why the Brady Plan later offered debt reduction.
Brazil's moratorium, February 1987
Brazil stopped paying interest on much of its debt to banks, showing that the crisis was still unsolved five years on.
Worked example: Explaining the debt crisis
Who was responsible?
- Lenders: banks lent freely with little attention to risk.
- Borrowers: governments borrowed heavily, sometimes for wasteful projects.
- Developed-country policy: high US interest rates and recession.
- Oil shocks: they created the petrodollars and raised import bills.
Watch out for this
The debt crisis was caused only by careless borrowing.
Borrowers made mistakes, but events outside their control triggered the crisis: high US interest rates, recession in the industrial world and falling commodity prices.
Check your understanding
Why did floating interest rates make the debt crisis worse?
- They meant no interest was charged until exports grew.
- They fixed repayments at low levels for the whole loan.
- Repayments rose automatically when US interest rates soared.
Show the answer
Repayments rose automatically when US interest rates soared.
Right. Debts became much more expensive to service.