Book Chapter
Resolving the HIPC Problem

Is Good Policy Enough?

Recent analysis of the HIPC problem argues that the short time horizons (high discount rates) of governments lead to bad policy and economic decline. This paper argues that this is an incomplete explanation of the HIPC problem. Instead, the paper argues that the root cause is institutional decline, resulting in competition between social groups (often along ethnic and regional dimensions) that is increasingly unregulated by rules of the game-the formal rules being weak (or ignored) and the informal rules having buckled under economic and environmental stress.This has two effects on external debt. The first is to reduce time horizons leading to bad policy such as real exchange rate overvaluation that discourage tradables production (the effect highlighted in recent analysis). But second, unregulated social competition reduces the time horizons of communities and the larger private sector by raising investor uncertainty. These producers move out of sectors with long-term returns (tropical cash crops etc.) and switch to activities with more immediate returns (subsistence agriculture and commerce). The former are largely tradables, the latter are non-tradables. The tradables base of the economy, and its capacity to service foreign debt, is therefore squeezed from two directions-bad policy and investor uncertainty-both rooted in unregulated social competition. The paper then investigates which of these effects is more important in explaining the probability of becoming a HIPC.The first effect, bad policy, is found to be less important than the second effect, investor uncertainty, in explaining why countries become HIPCs. Therefore efforts to improve policy are not enough; fundamental political and social reforms, including democratisation, are needed to provide new institutional frameworks to govern social competition. This will lengthen the time horizons of governments, communities and the private sector, and increase the investment necessary to achieve growth and to avoid debt crisis.