12/24/2006 04:34 pm ET | Updated May 25, 2011

Ecuador's New Government Talks Default on Debt: Latin America's New Reality

Mark Weisbrot

Unless you are following Latin America closely, you may not have noticed that Ecuador's bonds plunged last week on the statements from the new President, Rafael Correa, and finance minister, Ricardo Patino, indicating that they are willing to pursue an "Argentine-style" default on the country's foreign debt.

"If our moral duty to provide health, education and housing to our people impedes us from paying debt, we won't hesitate two seconds," Correa said at a news conference with Venezuela's Chavez. "We don't rule out a unilateral moratorium on our external debt."

This development is significant for several reasons. First, it is a reversal of the usual pattern where politicians campaign on a promise to put the people's interest first, and then cave to creditors. Or as a Goldman Sachs Latin America economist said of the new Ecuadorian government last week, "Slowly the market is starting to realize that they mean what they say."

Second, it is common in media and policy circles to lose sight of the basic economics of foreign borrowing. The purpose of foreign borrowing is to acquire more resources, which if invested properly, can provide a real return to the economy that is greater than the cost of the borrowing. If a country is simply borrowing to pay off debt, and looks to be in that situation for the foreseeable future, it may make sense to default and start over. This is what individuals who declare bankruptcy in the United States do.

Argentina defaulted on $100 billion of debt at the end of 2001, and after three months of economic decline, began a robust economic recovery that has now seen 45% growth, or a remarkable average of 8.6 percent annually, for nearly five years.

This is not to say that default is a good solution for most countries or should be taken lightly - it can be costly. But in some situations it is clearly the best option.

Before Argentina's default, a powerful creditors' cartel headed by the IMF had a credible threat of punishing a defaulting country by depriving it of credit from most sources, thereby increasing the cost of a default. That is no longer the case. Furthermore, Ecuador can likely borrow whatever it needs from Venezuela, which has $36 billion in reserves, and has lent billions of dollars to Argentina, and also provided loans and aid to Bolivia and other countries.

All this is part of the new reality in Latin America, and means that the left/populist governments throughout the region can, if they are so inclined, pursue a much greater variety of economic and development policy options - and deliver on their promises without much fear of retribution from international financial markets or institutions, including the United States government.

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