Odious Debt

Literature › Works

Seema Jayachandran; Michael Kremer (2005). Odious Debt.

Type	working paper
Scope	Comparative and methods
Method	theoretical or conceptual
Period studied	1985–1999
Regions	South Africa, Croatia, Iraq, Nicaragua, Cuba
Themes	sanctions divestment, macro fiscal finance debt, comparative theory, transition post apartheid
Citation key	jayachandran2005

Argument

The paper argues that trade sanctions are fragile because third-party firms and countries have incentives to break them, and that they hurt the population as well as the regime. Loan sanctions are proposed as an alternative. These are legal changes that stop a successor regime's assets from being seized to enforce debts incurred by a sanctioned regime after the sanction is imposed. In a reputational model of sovereign debt built on Bulow and Rogoff, such sanctions eliminate equilibria with lending to the sanctioned regime. They are therefore self-enforcing, and they spare the population from inheriting odious debt. Rulings made ex post are subject to time-consistency problems, so the authors recommend ex ante decisions. Apartheid South Africa is cited as a case where loan sanctions could have mattered, but it is an illustration only and is not analysed empirically.

Evidence and method

A theoretical model (repeated lending game with alternating high and low productivity, odious and nonodious governments, palace-building). It rests on legal doctrine (Sack, Feilchenfeld) and brief anecdotal cases: Somoza and Nicaragua, Tudjman and Croatia, Iraq, and South Africa's post-1994 debt stance. There is no systematic data or archival work on South Africa.

Findings

• The authors cite the 1985 UN trade sanctions on South Africa, while private banks kept lending to the apartheid regime through the 1980s, as a case where loan sanctions could have been added. (p. 3)

  in 1985 the United Nations Security Council imposed trade sanctions on the apartheid regime in South Africa, but the regime continued to borrow from private banks through the 1980s.

• Loan sanctions applied to apartheid South Africa might have stopped creditors lending and spared today's population the debt. (p. 3-4)

  creditors might have ceased granting loans to those regimes, and the populations would not bear the debt today.

• Successor governments typically accept predecessors' debts; post-apartheid South Africa distanced itself from the movement to nullify its apartheid-era debts in order to keep investors' confidence. (p. 8)

  the South African government, in order to remain in the good graces of investors, has distanced itself from the popular movement to nullify its apartheid-era debts.

• Trade sanctions are fragile because suppliers and third countries can undermine them, and when they bind they make the population worse off. (p. 10)

  If one country with two or more marble suppliers does not agree to the sanctions, the sanctions do not affect the payoffs for the sanctioned government.

• Loan sanctions eliminate equilibria with lending to the sanctioned regime, because successor governments lose the incentive to repay. (p. 10)

  The imposition of loan sanctions against a particular regime eliminates equilibria with lending to that regime.

• Loan sanctions are self-enforcing, since creditors know that loans to a sanctioned regime will not be repaid. (p. 11)

  While trade sanctions are fragile since third parties have incentives to break them, loan sanctions are self-enforcing.

• Loan sanctions improve the long-run welfare of the population under an odious regime if the gain from not inheriting the debt outweighs the short-term cost. (p. 12)

  If the gain from not inheriting debt outweighs the short-term economic cost of a sanction, which seems plausible, then ex post a loan sanction is welfare-improving

• Loan sanctions applied to a nonodious regime would hurt the population, so the risk of politicised misuse is acknowledged. (p. 13)

  A loan sanction imposed on a nonodious regime during a low-income period (odd t) is welfare-decreasing for the population

• Ex post adjudication of legitimacy is subject to time-inconsistency and should be replaced by ex ante decisions that cover only future lending. (p. 16)

  Preventing enforcement of debts is subject to time consistency problems, so there is a case for allowing this to be done ex ante, but not ex post.

• Post-apartheid South Africa is noted as arguably carrying illegitimate debt yet ineligible for HIPC relief. (p. 17)

  other countries with arguably illegitimate debt, including post-apartheid South Africa, are not eligible for HIPC debt relief.