Friday, July 22, 2005
It's axiomatic that a contract is, in the famous words of the Second Restatement, a promise "for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty." What happens when you have a contract that a court can't enforce?
Well, there's always self-help. And when self-help is used in the case of a foreign sovereign debt contract, it tends to involve warships, guns, and the U.S. Marines. In a new paper from the National Bureau of Economic Research, Supersanctions and Sovereign Debt Repayment, Kris James Mitchener (Santa Clara Econ) and Marc D. Weidenmier (Claremont-McKenna Econ) investigate the use of what they call "super-sanctions," the self-help measures to which nations resort to get the money they're owed. Here's the abstract:
Theoretical models have suggested that sanctions may be important for enforcing sovereign debt contracts (Bulow and Rogoff, 1989a, 1989b). This paper examines the role of sanctions in promoting debt repayment during the classical gold standard period. We analyze a wide range of sanctions including gunboat diplomacy, external fiscal control over a country's finances, asset seizures by private creditors, and trade sanctions. We find that "supersanctions," instances where military pressure or political control were applied in response to default, were an important and commonly used enforcement mechanism from 1870-1913. Following the implementation of supersanctions, on average, ex ante default probabilities on new debt issues fell by more than 60 percent, yield spreads declined approximately 800 basis points, and defaulting countries experienced almost a 100 percent reduction of time spent in default. We also find that debt defaulters that surrendered their fiscal sovereignty for an extended period of time were able to issue large amounts of new debt on international capital markets. Consistent with policies advocated by Caballero and Dornbusch (2002) for Argentina, our results suggest that third-party enforcement mechanisms, with the authority to enact financial and fiscal reforms, may be beneficial for resuscitating the capital market reputation of sovereign defaulters.