Debt Restructuring: Evolution or Revolution?

The papers by Bulow, Sachs, and White illustrate the interconnections inherent in most important economic policy issues, not least those concerning the structure of the international financial system. One of the most timely of these issues is whether there should be an international bankruptcy court for sovereign debt. Two of the three papers in this symposium, those by Bulow and Sachs, provide brief answers to that question within a more expansive essay on what is wrong with the international financial system. Both argue that a thorough reform of the system is needed; a bankruptcy court is an important side issue in Sachs' view and a distraction in Bulow's. There are some similarities in their critiques, but they differ fundamentally on the central issue of sovereign debt. Sachs wants governments to provide more financial resources to heavily indebted countries, including through the international financial institutions (IFIs) and streamlined debt relief, to give those countries a fresh start. Bulow wants governments and markets to provide fewer resources because national and international institutions have squandered what has been provided in the past, and he argues further that those institutions should first be largely privatized. Sachs and Bulow cannot both be right in their prescriptions for the international financial system. My judgment is that they are both mostly wrong, but that is for another day.

Bulow and Sachs in their papers do provide a service. They remind us that the issue of sovereign debt is connected with the structure of economic institutions and incentives for sound policies. Sachs also implicitly reminds us that a well-functioning international financial system must deal with countries that differ in their economic and financial circumstances over time and across a broad continuum. Not all are perennial financial basket cases. At least four of the countries that Sachs identifies as having chronic, continuing debt crises—Bolivia, Côte d'Ivoire, Ecuador, and Nigeria—were borrowers in international financial markets on commercial terms not so long ago. Further along the continuum, Turkey is not a new member of the club of advanced industrial countries (the Organization for Economic Cooperation and Development) whose external financial crisis, like Mexico's or Korea's, demonstrates at least to some that it should not have been admitted; Turkey has been a member of the club for many years. Finally, during the era of floating exchange rates, even Italy, the United Kingdom, and the United States have borrowed from the International Monetary Fund. Circumstances change, and thus to consign all current basket cases permanently to the international welfare rolls is fundamentally flawed as an initial premise.

I would like to address the issue of international bankruptcy arrangements by posing three questions. First, is an international bankruptcy court an appropriate solution to problems of sovereign debt? Second, what are the connections between this concept and recent proposals for a so-called sovereign debt restructuring mechanism (SDRM)? And third, should we expect revolution or evolution going forward?

Bulow's answer to the first question is no: although the SDRM proposals may be a step in the right direction, a bankruptcy court is unnecessary. Sachs' answer is yes: such a court is needed to give countries a fresh start. White says the analogy to domestic bankruptcy procedures is weak, but a court or the equivalent may be needed if we are serious about solving the three basic problems in this area that she and others have identified: reining in rogue creditors, providing seniority for private sector financing to countries while their debts are being restructured, and forcing closure on the parties.

My own view is that an international bankruptcy court for sovereign debt would be useful in addressing these problems, and it would be desirable (largely for the reasons advanced by Sachs), but it is not now feasible. It is closer to being feasible today than when I participated in drafting the Group of Ten's 1996 report (the Rey Report), but it is still not feasible because the intellectual and political foundations have not yet been laid. First, a consensus is still lacking about the economic principles upon which such an institution should be based...