First World Governments and Third World Debt

First mexico, then Asia, then Russia and Brazil. Now Argentina and Turkey. As always when financial crises occur, questions arise about whether first world governments should change their role in the restructuring of third world debt, by restructuring the multilateral international financial institutions (IFIs), creating an international bankruptcy court, or adopting one of the many other proposals for reforming the international financial architecture.¹

Kenneth Rogoff and I wrote a series of papers addressing these and related issues between 1988 and 1992:²

• — In 1988 we argued that the existence of the official creditors led to increased emerging-market and developing-country debt, because private creditors would be able to count on the official creditors to pay back part of their loans.³ In 1990 we further claimed that the existence of the official creditors made debt renegotiation more difficult and complex, by hardening the positions of debtors and creditors.

• — In 1990 we argued that the legal infrastructures of the industrial countries were being used to lend developing countries more money than the underlying economics warranted. We maintained that it would be better if creditors were forced to rely much more on debtor-country legal structures to create a level playing field for equity and foreign direct investment.

• — In 1988 and 1992 we argued that official creditors, defined broadly as a group, are at best equal in seniority and possibly even junior to private creditors.⁴

  These arguments underlay the reform proposals that we made in our 1990 paper. Rogoff reiterated many of these views shortly before becoming chief economist at the International Monetary Fund (IMF). Similarly, my views have not changed. The proposals we made then still make sense today:

  • — Multilateral loans should largely, and in some cases completely, be replaced by aid.

  • — The United States should repeal the relevant portion of the Foreign Sovereign Immunities Act of 1976, and the United Kingdom the part of the 1978 State Immunity Act, that allows developing countries to waive their immunity when they borrow money abroad. That is, to the extent possible, jurisdiction over a sovereign's debts should be in its own courts. This would include the debt of banks that are nationalized during debt crises.

  • — The IFIs should be kept out of the international bailout business.⁵

  • — The aid should be disbursed through an International Citizenship Fund and focused on issues that involve externalities, such as environment and education, rather than on macroeconomic structural adjustment.

In the context of our 1990 proposal, I would be extremely cautious about proposals for either a real or a metaphorical international bankruptcy court. Such proposals run the risk of moving some sovereign obligations from debtor-country courts to external jurisdictions, making it even harder for industrial-country governments to avoid getting enmeshed in resolving these crises. Proposals to coordinate creditors through collective action clauses, such as those suggested by Under Secretary of the U.S. Treasury for International Affairs John Taylor or already existing in U.K. law, or through mechanisms that also coordinate different classes of creditors, as suggested by the IMF's First Deputy Managing Director Anne Krueger, have some appeal in simplifying the renegotiation bargaining problem. Countries may well want to adopt such provisions within the context of their domestic restructuring laws. But the key step is to coordinate as much of the bargaining as possible under the auspices of the debtor's own legal system.

Whereas in 1990 our proposals were treated as quite radical, they no longer seem so today. The Meltzer Commission has now advocated aid in place of loans, and the White House and the Treasury have called for dramatically increasing the proportion of aid in official financing for developing countries, particularly the poorest.⁶ Similarly, our 1988 moral hazard view of official lending is at least widely debated, if not fully accepted.⁷ Still, these proposals are worth reviewing after twelve more years and several more debt crises.

Of course, opening up their agricultural and other markets to developing-country goods is probably the best thing rich countries can do to support good governments in poor countries...