How to Balance Debt and Development by Homi Kharas and Meagan Dooley

Many emerging markets and developing countries face the dilemma of borrowing and risking a debt crisis, or choosing austerity and risking a development crisis. Solving it will require policymakers to tackle two collective action problems that markets cannot solve on their own.

WASHINGTON, DC – The COVID-19 pandemic is, we hope, only a temporary shock to economies around the world. The appropriate policy response to such a disruption is to borrow to cushion the impact on consumption and investment. But for many emerging markets and developing countries, borrowing could lead to debt service challenges that will require years of austerity to overcome. Yet if they don’t borrow, they will have to cut government spending, which could lead to major health crises, out-of-school children, job losses and a prolonged recession.

What to do? Borrow and risk a debt crisis, or choose austerity and risk a development crisis?

In 2020, countries took very different approaches, largely tied to their income. Governments in advanced economies provided trillions of dollars in direct and indirect tax assistance, equivalent to 24% of GDP, while those in emerging and developing economies provided only 6% and 2% of GDP, respectively.

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