World Bank Document

Box 4.1
The debt cycle hypothesis
As development proceeds, changes in domestic income, 1975, but most oil-importing countries remained in the
rates of saving, capital stock accumulation, and rates of first stage until very recently. A few, such as China,
return on investment can be expected to alter the rate remained net creditors throughout all or most of this
and direction of international capital flows. This has led period.
to the formulation of the debt cycle hypothesis: countries The debt cycle model does not predict reliably how
will move through stylized balance of payments and long a country may remain in any given stage of the debt
debt stages, as shown in Box figure 4.1A. Each stage is cycle. The hypothetical example in Box table 4.IA depicts
characterized as follows:
a developing country passing from the first to the second
Stage l: Young debtor stage of the cycle, where it remains for a prolonged
period. The trade account and net interest payments
* Trade deficit. continue in deficit throughout. The rate of return on
* Net outflow of interest payments. investment (as approximated by the inverse of the incre-
* Net capital inflow. mental capital output ratio) is higher than in surplus
* Rising debt. countries, warranting a mutually beneficial transfer of
savings to the developing country. In the first decade,
Stage II: Mature debtor
the real growth rate of exports is lower than the real
* Decreasing trade deficit, beginning of a surplus. interest rate, leading to rapidly growing current account
* Net outflow of interest payments. deficits and debt; the latter rises from zero in the first
* Decreasing net capital inflow. year to $100 million after ten years. When the debt ser-
* Debt rising at diminishing rate. vice and debt to GDP ratios reach what are regarded as
their maximally sustainable levels of 30 percent and 40
percent, respectively, a surge in exports is required to
* Rising trade surplus. finance interest payments and amortization. In the fif-
* Diminishing net outflow of interest payments.
* Net capital outflow.
* Falling net foreign debt.
Box figure 4.1A Balance of payments flows and debt
Stage IV: Young creditor
stock during the debt cycle
* Decreasing trade surplus, then deficit. The balance of payments
* Net outflow of interest payments, then inflow. 11 lI IV v
* Outflow of capital at decreasing rate.
* Net accumulation of foreign assets.
Stage V. Mature creditor
* Trade deficit.
* Net inflow of interest payments.
* Diminishing net capital flows.
* Slow-growing or constant net foreign asset position.
Surplus
In the aggregate, of course, the world cannot be in Deficit
either a net debt or net asset position. Therefore, as more
countries move toward the mature creditor stage, the
relative size of their asset position should tend to diminish.
The fact that industrial countries' collective net asset
The debt cycle
position is small relative to their GNP, although gross
capital flows are very large, corresponds well with the Net debt
debt cycle hypothesis. So does the pattern of structural
balance of payment changes in the United Kingdom and
the United States over the past 150 years. Until very
recently the balance of payments of these two countries Net assets
followed the five stages quite closely.
For developing countries, the evidence is mixed. In the
colonial period, many countries, particularly primary Net capital flows (A = B + C)
product exporters, ran current account surpluses, Trade account (B)
becoming, in effect, capital exporters. A small group of Net interest payments (C)
advanced developing countries moved from the young
debtor to the mature debtor stage between 1950 and Debtstock
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