Applying the Odious Debts Doctrine while Preserving Legitimate Lending

Literature › Works

Seema Jayachandran; Michael Kremer; Jonathan Shafter (2005). Applying the Odious Debts Doctrine while Preserving Legitimate Lending.

Type	working paper
Scope	Comparative and methods
Method	theoretical or conceptual
Period studied	1985–2005
Regions	South Africa, Iraq, Croatia, Nicaragua, global
Themes	sanctions divestment, macro fiscal finance debt, comparative theory, transition post apartheid
Citation key	jayachandran2005a

Argument

The paper argues that odious debts, incurred by regimes without popular consent or legitimate public purpose, are in practice still repaid by successor governments who fear losing access to credit markets. A theoretical reputational model shows that credible loan sanctions would deter lending to odious regimes, discourage would-be dictators, and spare populations the short-run costs that trade sanctions impose. The authors criticise the 'Classical Model' (judicial determination of odious status, subjective creditor awareness) as indeterminate and likely to chill legitimate lending. They propose a prospective 'Due Diligence Model', in which a political body designates regimes as odious-debt prone ex ante, and lenders to those regimes must follow pre-approved monitoring plans. South Africa appears only as an illustrative case of a successor government that did not repudiate apartheid-era debt, and of a regime where a UN loan sanction could have been declared.

Evidence and method

Formal game-theoretic model (repeated lending with reputational enforcement, building on Bulow and Rogoff) with five propositions. Illustrative cases are Somoza's Nicaragua, Tudjman's Croatia, Iraq and apartheid South Africa, drawn from press reports and policy documents. Legal and policy literature on odious debt is also used. No South African data.

Findings

• The authors define odious debt as debt incurred without consent or legitimate public purpose. (p. 2)

  Odious debts are debts incurred by the government of a nation without either popular consent or a legitimate public purpose.

• The paper uses apartheid South Africa as a counterfactual: a UN loan sanction alongside the 1985 trade sanctions might have deterred bank lending. (p. 5)

  when the United Nations imposed trade sanctions against the apartheid government of South Africa in 1985, it also could have declared that it would not consider debt incurred by the apartheid government as a legitimate obligation of the successor government.

• Banks would likely have refused to lend if they doubted successor regimes would repay after such a declaration. (p. 5)

  If banks doubted that successor regimes would repay loans issued after the announcement, they likely would have been unwilling to make such loans.

• Post-apartheid South Africa is cited as an example of a successor government that declined to repudiate its predecessor's debt to preserve its standing with investors. (p. 11)

  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.

• Successor governments typically honour inherited debt regardless of regime type, because of reputational concerns. (p. 11)

  successor governments, concerned about their reputation, typically accept responsibility for debt, independent of the nature of the preceding regime.

• Loan sanctions are self-enforcing whereas trade sanctions are undermined by defectors. (p. 14)

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

• Loan sanctions can improve the welfare of a population under an odious regime if the gain from not inheriting debt outweighs short-term costs. (p. 14)

  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

• Classical odious-debt reform is criticised because classifying regimes as democratic or dictatorial is too indeterminate for a judicial forum, so lenders would curtail lending. (p. 17)

  There are simply no legal definitions of democracy or dictatorship with sufficient clarity for a judicial forum to rule upon.

• The proposed Due Diligence Model makes lenders liable only for loans to regimes designated in advance as odious-debt prone. (p. 20)

  Only loans made to nations which were specifically targeted by the implementing organization prior to the loan's issuance would be at risk for possible invalidation.

• Apartheid South Africa is named as a case where UN Security Council consensus on odious-debt designation might have been achievable. (p. 23)

  in some important historical cases such as apartheid-era South Africa or Tudjman-era Croatia it might well have been possible to gain necessary consensus for action at the Security Council level