Why do sovereigns bother to repay their debts? The question has perplexed scholars for decades, perhaps longer. After all, a sovereign government is by definition sovereign: there is no higher authority that can order or coerce it. In a world where credit boycotts are very hard to enforce and substitutes for foreign borrowing are plentiful (via amassing foreign reserves, for example, or domestic borrowing), creditors should be extremely averse to risking their money in sovereign debt markets. Yet they are not. “Markets have short memories” is a truism among investors in sovereign debt, and defaulters have rarely been excluded from credit markets. How can this be?

Michael Tomz's answer to the question is that borrowers' reputations can sustain cooperation—within limits. Tomz suggests that national histories and internal political institutions divide governments into three categories. Some governments (“stalwarts”) will incur very high domestic costs should they choose to default on their international debts. Such governments fight tooth and nail to repay. Others (“fair-weathers”) reap fewer domestic political benefits from religiously repaying, and pay commensurately fewer political costs from default. Fair-weathers repay only as long as economic conditions remain above a certain threshold. A third group (“lemons”) pays no domestic costs from default; lemon governments default the second that the advantages outweigh the costs. Investors, in Tomz's view, assess and reassess the reputation of borrowing countries as they develop records of repayment and default.

Domestic politics, however, may cause a country to change type, say from stalwart to lemon. Creditors, in turn, will respond to seemingly “stalwart” nations that suddenly default. They will raise interest rates, require collateral, shorten maturities, and demand third-party guarantees. In Tomz's framework, creditors behave this way not to punish the defaulting nation, but to guard themselves against future risk. Conversely, creditors will upgrade nations that suddenly offer unexpectedly fair settlements or acknowledge previously repudiated debt. Reputations, in other words, are not static.

In three concise and well-researched chapters, Tomz turns to the historical evidence. Chapter 3 presents data on borrowing terms from the eighteenth and nineteenth centuries. Newly independent states faced higher rates and worse terms than seasoned borrowers. The best anecdote in the chapter is the story of the fictional Central American nation of Poyais, putatively located on the swampy Atlantic coast of present-day Nicaragua. Invented almost out of whole cloth by a Scotsman named Gregor McGregor, Poyaisian bond yields started high, and then became astronomical as reports of disease, high settler mortality, and the nonexistence of anything resembling a government filtered back to London. Chapter 4 thoroughly and heroically reviews the 1919–1929 investment literature, and finds that the experts stressed reputation as the single most important factor in evaluating sovereign creditworthiness. Chapter 5 evaluates creditor behavior during the 1920s and 1930s, and also finds it consistent with both the reports from chapter 4 and the model. The final part of chapter 5 is particularly interesting, as Tomz recounts the internal conflicts among policymakers in Argentina, Australia, and Finland, all of which made heroic efforts to repay their foreign debt as the Depression worsened. Investors rewarded all three with lower borrowing rates. Of course, the simple fact of lower borrowing costs does not mean that those countries' governments made the right decision in terms of the well-being of their citizenry—but it provides excellent support for Tomz's theory.

The next three chapters analyze alternative hypotheses. Chapter 7 dismisses the role of trade sanctions. It begins with an excellent account of Argentina in the 1930s: Argentina continued to pay American and British creditors, even though the United States had almost no ability to impose trade sanctions. Moreover, Argentina imposed capital controls on British merchants, blocking them from repatriating their profits. Britain explicitly asked Argentina to default on the Americans in order to end the capital controls—yet Argentina refused. This is not consistent with a country that repaid only out of fear of commercial boycotts. More generally, the U.S. government explicitly refused to use trade sanctions to punish default during the 1930s. Chapter 8, similarly, examines the use of creditor cartels to punish wayward debtors. It finds that over the twentieth century, there were no serious differences between countries that borrowed from disorganized credit markets (be they bond markets or multiple banks) and those that borrowed from more concentrated and organized sources. If creditor sanctions were a threat, they were not one that anyone seemed to take very seriously.

If the book suffers from a weakness, it is from a tendency to make its argument too sweepingly. Reputation may have sustained sovereign debt markets at various periods, but that does not mean that nothing else has ever mattered. This weakness, generally minor, is most prominent up in chapter 6, which examines the role of gunboat diplomacy in debt enforcement. The chapter contains an excellent historical overview of the Venezuelan crisis of 1902 that casts a great deal of doubt on the conventional wisdom that the Anglo-German intervention was in response to creditor claims. It also contains a masterly analysis of British diplomatic correspondence from 1823 to 1853, which also shows that debt enforcement was less than a priority for London during the period. The chapter is much weaker, however, when the author turns to the Correlates of War database in an attempt to show a lack of correlation between intervention and default. The rub is that most “gunboat” intervention did not actually involve any gunboats. Rather, diplomatic pressure resulted in a defaulting country's agreement to surrender control of its fiscal institutions to outsiders without the need to land troops under fire. As Mitchener and Weidenmier have shown, for example, in 1870–1913 defaulting countries faced a 40 percent probability of either losing control of their fiscal institutions or seeing private creditors seize control of government assets. The bond prices of Circum-Caribbean nations, for example, rose precipitously upon Teddy Roosevelt's 1904 declaration that the United States would exercise an “international police power” against any nation that failed to “pay its obligations.” In fact, bond prices for the nations under the U.S. regime remained high relative to other countries until 1930, when the U.S. government decided to for its own reasons to terminate its informal financial protectorate. Today, the European Union seems to be employing a different but still effective menu of carrots and sticks to discourage defaults among its members. They may or may not fail, but it is hard to argue that they do not matter.

The above, however, is a quibble with one part of a well-researched, clearly argued, and very thought-provoking book. The argument moves a bit confusingly among time periods, and historians will worry about the scope—a lot changed over the course of the last three centuries, not the least in the late twentieth, when the last legal restrictions against suing sovereigns in foreign courts were swept away. That said, the book is not really an overview of three centuries of sovereign debt, but rather a series of tests of the hypothesis that reputation matters. For that latter purpose, the author makes his case. Reputation does, in fact, matter. The book will certainly cause readers to rethink some of what they thought they knew. I learned a great deal from reading it, and so will anyone interested in sovereign debt markets and their evolution.