Why not by default? The political economy of sovereign debt. Jérôme Roos. Princeton University Press. 2019.
In Why not by default? The political economy of sovereign debt—A book based on his doctoral thesis — Jerome Roos systematically discusses the structural characteristics of the contemporary debt market. Drawing on the analysis of historical evidence, the author proposes a theory of the structural power of creditors and the high spillover costs of default, thus answering the question posed in the title of the book. The book links the global financial system to countries’ prospects for access to international capital markets and economic development.
Why don’t nations, or in the parlance of sovereign borrowers, simply default on their debt if it could minimize financial burdens? It seems logical to go back on previous commitments in the face of macroeconomic failures or a currency crisis and an interruption in currency flows. Yet, as Roos argues, sovereign defaults have become less common. Indeed, even going back in time, despite their frequency of occurrence higher than today, sovereign defaults were the last unwanted option.
There is much to discover and learn in this dense volume. The first chapters are devoted to what the author describes as “the theory of sovereign debt”. This is then followed by a critical examination of the history of sovereign defaults, beginning with the first Italian city-states, continuing through the restructurings of the 19th century and the defaults of the 1930s. Before its concluding chapter, the Much of the book is found in the most granular exploration of three cases across three long parts focusing on Mexico (1982-89), Argentina (1999-2005) and Greece (2010-15).
The historical perspective on the evolution of debtor compliance is undoubtedly one of the distinguishing strengths of this study. The sovereign debt problem is neither new nor confined to technical fundamentals modeled by computer. And little here has been by accident and much is derived from the debt transactions and dispute resolutions of the accumulated past. This historical narrative interacts with political economy. Applied consistently throughout, this merger adds to the credibility of the book as the scattered historical episodes are stitched together under a framework of three debtor compliance enforcement mechanisms.
So why not by default? The author argues that an institutional framework in the international financial markets of execution mechanisms guaranteeing the structural power of creditors over the borrower and the high induced costs of default that the latter faces are the key to the answer.
The first enforcement mechanism is market discipline defined as “a product of the ability of private creditors to inflict indirect costs that are very damaging to the economy of a debtor by withholding more credit and investment in the event of failure. -respect ”(17). The ability of creditors to act uniformly against an autonomous borrower is essential in this mechanism. Roos documents the progression of global capital markets from a decentralized system to a more concentrated one. The bond markets of the 1920s and 1930s were very decentralized and filled with small retail investors with limited ability to coordinate their actions as creditors. The state (on the creditors’ side) in these and previous debt restructurings has played an important role, with at least diplomatic guarantees. Over time, as the global financial markets changed, as a result of the consolidation of banking systems, there was a shift towards a concentrated organization of the capital markets now imposing coordinated discipline on the borrower. It is, according to Roos, the critical element of structural power that contemporary creditors have over borrowing governments.
The second delivery mechanism relates to loan conditionality, familiar to development economists and common in crisis lending cases from public creditors or multilateral organizations. Turning from the cases of Mexico and Argentina to the recent Greek debt crisis, the book illustrates the rapid evolution of this mechanism. Along the way, the role of multilateral institutions, such as the International Monetary Fund (IMF), as lender of last resort is strengthened. Official creditor states (and individual private investors), in turn, relied on the IMF program as a prior guarantee to re-establish contact with the borrower. The mechanism appears to be gaining in efficiency as the debtor faces minimal domestic financial autonomy and no viable alternative for borrowing externally.
Finally, the third mechanism concerns the “transitional role” of local businesses and political elites in each debtor country who advocate fiscal discipline and debt repayment. Roos sees it as a complementary factor to the first two mechanisms and a by-product of the post-Bretton Woods “internationalization of debtor discipline” (79). The financial power and budgetary decision-making that national elites demand from the debtor state has a structural and country-specific element. Much of this power is intertwined with the ability of domestic business groups to attract foreign credit, which motivates their preference for fiscal austerity in an effort to avoid spillover to the profile of private sector debtors.
Collectively, the argument goes, all three strengthen the structural power of private creditors. The indirect costs of sovereign default increase as a borrower risks being cut off from international capital, compounding domestic political fallout and economic malaise. As such, external and internal pressures are exerted on the debtor, forcing the debt to be repaid and forcing a new government to accept the obligations of its predecessors. Yet a default is possible today, the book concludes, but only “when the three mechanisms of execution have collapsed” (70).
The questions raised in Why not by default? to today’s global financial markets and a discerning reader would have benefited from such a clear statement. The years following the global financial crisis of 2008 saw a rapid increase in foreign currency denominated debt in emerging markets and developing countries, in particular. Although part of this increase is dictated by the fundamentals of each country, there is also evidence that emerging markets are seizing the opportunity to borrow in global capital markets and ‘old fashioned pursuit of yield’‘by the global investor in the environment of higher liquidity and low interest rates largely influenced by the monetary easing policies of advanced economies.
As emerging markets go into debt, including, increasingly, local currency with a significant participation of foreign investors, the stakes increase for individual macroeconomically weaker economies in the event of a significant disruption in capital flows. As in the past, triggers can be a combination of external or internal factors. Of more concern, however, are the transformative indirect trends in capital markets affecting small economies. This is precisely the landscape where Roos’ combined theoretical framework of structural power and delivery mechanisms, tested in real time, can inform policy actions aimed at preventing the high spillover costs of multiple sudden flaws.
On a minor level, some might find Why not by default? be fairly detailed and with limited empirical analysis. However, the latter may not be necessary here because the book advances the conceptual vision of its author. This can leave a little impatient to read Roos’ concrete proposals to reform, if necessary, the debt markets. But such an analysis would likely require a dedicated volume with a magnifying glass focused on country-specific institutional, historical, political and socio-economic factors: fit for follow-up work. On a personal note, it would also have been interesting to know more about the challenges of sovereign debt across the post-socialist transition economies in Eastern Europe and the Soviet Union because countries in this group may or may not operate within the debtor compliance framework proposed by the book.
More broadly however, by asking ‘Why not by default?‘Jerome Roos raises unconventional, but compelling questions that economists, political scientists and policymakers face in the new era of relatively small, but growing, sovereign debt. The book is fresh and innovative in its approach to the problem of the role of creditors and amazes the reader with a painstakingly impressive treatment of the historical evidence of debt restructuring, making the analysis relevant to today’s discussions.
Globally, Why not by default? is a valuable resource in its intellectual synthesis of history and political economy, providing motivation for an informed sustainable development strategy in the present and the future.
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- The publication gives the point of view of its author (s), not the post of LSE Business Review or the London School of Economics.
- Featured Image: ‘Let Greece Breathe’ event, London, February 15, 2015 (Sheila CC BY NC 2.0)
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Alexander V. Gevorkyan is Associate Professor and Henry George Chair in Economics at the Peter J. Tobin College of Business at St. John’s University. He is the author of Economies in Transition: Transformation, Development and Society in Eastern Europe and the Former Soviet Union (Routledge, 2018). This book was recently reviewed for LSE Review of Books.