Main contribution of In Defense of Public Debt

Let me start, then, by briefly summarizing the book’s main contribution and arguments. By adopting a long-term perspective which starts two thousand years ago with the first written records of public borrowing, and which ends with the Covid-19 pandemic, the authors aim at rehabilitating sovereign debt from the one-sided picture painted by much popular discourse and political rhetoric, according to which sovereign debt is always dangerous, destructive and ‘fundamentally immoral’ (182). ‘Never was this morality play more intense and policy debate more heated than in the twenty-first century, when countries suffered through the Global Financial Crisis, the Euro Crisis, and the Covid-19 crisis’ (181). That the German word for debt – Schuld – is also the word for guilt, so the authors argue, shows how deeply ingrained the intuition is that the acquisition of debt is immoral.

Against the backdrop of this disdain for sovereign debt, the authors thus set out to provide a balanced account of the positive and negative aspects of public debt which, in their minds, entails ‘placing more weight on the positive aspects than is typical of the literature’ (5). They show how states have employed debt to secure their borders, invest in infrastructure and supply social benefits. In the early centuries of the second millennium CE, the capacity to issue debt was central to state building, with European sovereigns borrowing to finance military adventures and repel threats. As incomes rose, governments also started to borrow to finance large public infrastructure projects. ‘It’s hard to imagine the transition to modern economic growth without railways’, the authors argue, ‘and it’s hard to imagine those railways and cities without debt finance’ (213). By the end of the 19th century, the market in sovereign debt was globalized, with debt being issued by governments in every part of the world and being traded across borders. Debt issuance became regular and ongoing, not only in times of war, but to foster economic cohesion and growth. In the 20th century, the focus then shifted towards the provision of social services. Stressing both commonalities and changes of the uses to which sovereign debt was put over time, the authors explain how sovereign debt developed into a safe asset and how it contributed to the development of financial markets, and the economy more generally, serving as an important tool for counter-cyclical spending which limited the incidence of economic depressions.

While stressing the positive aspects of the issuance of debt by sovereigns, the authors are not silent about the difficulties that an unsustainable debt burden may create. Once a state faces debt sustainability problems of the current magnitude, it is extremely challenging to return to a path of debt and macro-economic sustainability. Writing about the most recent spike in indebtedness, they acknowledge that running the sort of large, persistent primary surpluses required to bring down the level of indebtedness generated by Covid are rare, that attempting to raise taxes is challenging when the wealthy and their financial assets can move, and that a burst of inflation that liquidates debt burdens seems unlikely in the current context. Attempting to resolve the difficulties springing from unsustainable public debt by drastically cutting public spending is also no promising avenue. ‘Countries that have successfully addressed problems of debt sustainability without major economic, financial, and political dislocations have done so by maintaining stable financial conditions, turning to fiscal restraint when the time was right (not before), and growing their economies’ (223). Despite the difficulties created by unleashing ‘a tsunami of debt’ (199), the authors are adamant that a failure to act in the face of a national emergency – such as a war, a systemic financial crisis or a pandemic –would rob a government of its legitimacy. ‘To refuse to borrow and incur debt under such circumstances would have been for the state to default on its essential functions’ (9).

A nuanced moral assessment of the IDA today

Let me take this opportunity to focus on one aspect that the authors discuss, namely the international debt architecture, to show how a true ‘defense of public debt’ requires assessing the moral aspects of the issues discussed in greater rigour. The contemporary IDA today comprises sovereign debt contracts, institutions such as the IMF and the Paris Club, and policy frameworks that support orderly debt restructurings. Private institutions, such as Credit Rating Agencies, are also a part of the IDA since their ability to define a country’s credit rating, directly affects a country’s ability to borrow and finance their debt.

Eichengreen, El-Ganainy, Esteves and Mitchener discuss debt restructurings at several points in the book, from early restructurings of the Venetian Republic in the 13th century, to the most recent restructurings of Argentina and Ecuador during the Covid-19 pandemic. They acknowledge that restoring debt sustainability may sometimes require debt restructurings and denounce the reluctance of debtors, creditors and international financial institutions to do so in an early and sufficiently deep manner.

The authors also explicitly examine the current international debt architecture. They argue that the G20’s Debt Service Suspension Initiative (DSSI) is insufficient, in that it fails to offer a solution to the solvency problems of the few countries that are eligible to it, namely the 74 Low Income Countries that are part of the World Bank’s International Development Association (IDA). In addition, they criticise the DSSI for exclusively covering bilateral official debt (that is, debt extended by governments and State-Owned Enterprises), and excluding debt accrued with the private sector. Middle Income Countries, moreover, were excluded from the DSSI’s scope from the get-go and were left to their own devices. While the Common Framework for Debt Treatment beyond the DSSI, the second large initiative approved by the G20 in the midst of the pandemic, is not discussed by the authors, it is fair to assume that a similar judgement would be passed. For although the Common Framework does seek to offer a solution to solvency problems (rather than merely liquidity problems, as the DSSI) of IDA countries, Middle Income Countries are still excluded from the initiative. In addition, since its adoption by G20 Finance Ministers in October 2020, only three countries have applied to the initiative (namely Chad, Zambia and Ethiopia), and none of them have completed the process of restructuring their bilateral official, and private debt. Collective Action Clauses (CACs) – provisions specifying that a supermajority of bondholders can change the terms of a bond – are also discussed by the authors. The aim of CACs is to make it harder for minority creditors to disrupt sovereign debt restructurings by ‘holding out’ – or threatening to do so – to receive payment in full at the expense of the restructured majority. The authors argue that, though helpful in recent restructurings, they are insufficient to ensure timely and sufficiently deep restructurings. The authors’ ultimate assessment is that the international community’s ‘lack of acknowledgment that the existing ad hoc machinery for dealing with defaults and restructurings was unable to cope with an impending wave of emerging market debt crises [is] deeply troubling’ (202).

The authors’ assessment is an excellent example of one of the instances in the book where a more nuanced normative analysis might have been called for. When one assesses the IDA today, one needs to assess it against a yardstick; something considered optimal. It is here where a more rigorous normative analysis could be helpful; a normative analysis which defines principles and criteria for the type of restructuring the IDA should facilitate. So far, the limited (and not yet unanimous) consensus that exists among economists is that restructurings should aim at being efficient, to provide conditions for a fast and sustained economic recovery (Guzmán et al. Reference Guzmán, Ocampo and Stiglitz2016). An efficient restructuring is one in which (i) the outcome of the restructuring restores debt sustainability and puts the country back on a sustainable path (not too little) and (ii) the process of the restructuring encourages early restructurings (not too late). An adequate architecture should thus ensure restructurings that are neither too little, nor too late.

The question remains, though, whether efficiency should be the only high-level principle which restructurings ought to meet and which an adequate IDA ought to ensure. Surely, the relation between creditors and debtor countries engaging in a restructuring should also seek to reflect a certain equality in starting positions, with each party being afforded a reasonable opportunity to present their case under conditions that do not place them at a disadvantage vis-à-vis their opponent. Philosophers are ideally placed to provide an answer to the question of what a fair treatment between the actors involved in a debt restructuring might entail.

The legal principle of equality of arms, for instance, which has become applicable to all adjudicative processes – both civil and criminal – might be worth exploring in this context. It responds to the assumption that the unequal distribution of resources can affect the outcome of legal controversies in several ways, both in and out of court. This is held to be inconsistent with the ultimate goal of any adjudicative process, which is to provide just results (Wertheimer 1988: 304). The principle of equality of arms, or the idea that each party should have reasonable opportunity to present their case, can be easily translated to sovereign debt controversies. In debt restructurings, both creditors and debtors must be afforded a fair opportunity to influence the conditions of the negotiations and outcome. This would imply that, when debtors and creditors interact, the background conditions should be such as to ensure that the starting positions are roughly equal. Complete equalization will, of course, be impossible as a range of determinants may shape the starting positions of the respective parties, which are in themselves already very different types of actors. These include, for example, the negotiating skills or the mastery over the subject matter in the negotiation. Nonetheless, if the background conditions are such that they are systematically tilted in favour of one of the parties, then the starting positions will be unjustifiably unequal, and the background conditions could be said to be unfair. In short, we might want to introduce an additional principle to the principle of efficiency, which ought to guide restructurings and which an adequate IDA ought to ensure.

In addition to ensuring efficiency and fairness, an adequate architecture might also want to reduce uncertainty and seek to maximize predictability. This is not always easy. First, because welcomed innovations in debt markets, and/or the emergence of new types of creditors and borrowers may raise new, unexpected challenges in restructuring. Second, because contracts are inherently incomplete and residual uncertainty regarding contractual interpretation is likely to remain. In the absence of a system or framework for sovereign debt restructuring – with an independent authority or oversight commission that settles interpretation disputes, the outcome of the restructuring process thus continues to depend on contextual circumstances, as well as on the good faith, knowledge, skill and power of the negotiating parties. It might thus be a feature of an adequate IDA to manage uncertainty successfully and increase predictability both for creditors and for borrowers.

Identifying principles that any restructuring should meet – principles such as efficiency, fairness and/or predictability – is of great practical significance for a policy debate that is highly entrenched. On the one side of the debate, you have defenders of the contractual approach, which focuses on improving bond clauses, e.g. through model CACs. On the other hand, you have those who favour a statutory approach featuring a centralized institution as arbitration forum between creditors and debtors. If agreement is found on a principle level – on the type of restructuring that the IDA should facilitate – then this could be a significant contribution to move the debate forward on the policy level. A more nuanced and rigorous normative discussion of the IDA is thus an important missed opportunity for authors whose ultimate objective it is to defend the issuance of public debt by sovereigns and who recognize that restructurings are often needed to restore debt sustainability.

It is not only institutions, however, which ought to be morally assessed but also individual and collective actors. Also here, the authors provide ample food for thought, triggering questions which would require deeper normative analysis to provide an exhaustive and robust defence of public debt issuance.

Take, for example, the authors’ remarks on Credit Rating Agencies (CRAs). The authors start by noting the obvious, namely that the pandemic has hit countries differently. While advanced economies organized large fiscal packages, emerging economies could not compete: ‘Brazil, Turkey, and South Africa, three hard hit emerging markets, ran larger primary budget deficits in 2020 than during the Global Financial Crisis. Yet even their stimulus packages were small by the standards of advanced economies. And other emerging markets, such as India, Indonesia, and Mexico, did considerably less’ (201). In part, these differences in the ability to respond to the pandemic reflected developing countries’ more limited fiscal space. This was not the only relevant criterion, however. Countries’ overall standing in the global economy was equally significant; a criterion for which a country’s credit rating is a good proxy. In their discussion on the Covid-19 pandemic, the authors criticize CRAs for the speed with which they downgraded developing countries; ‘even more quickly’ (201) than during the Global Financial Crisis. CRAs also warned to do so indiscriminately: in the context of the debate around the Common Framework, for instance, CRAs stated that regardless of whether a country would merely seek to reprofile its debts, or whether it would attempt a deeper restructuring (entailing interest and principal losses for creditors), the mere application to the Common Framework would trigger a downgrade. This was heavily criticized by policymakers and civil society alike.

Especially in the aftermath of a systemic crisis such as Covid-19, the effectiveness, objectivity and methodology of ratings, including the timing of rating announcements needs to be re-evaluated. Credit ratings today are monopolized by the ‘Big Three’ credit rating agencies, namely Moody’s, Standard & Poor’s (S&P) and Fitch Ratings, all private institutions who control around 95% of credit ratings in the financial markets. The existence of risk evaluation by private credit rating agencies implies transferring the regulatory authority from the government (which is normally entrusted with this task) to the private sector (ECLAC 2021). This can create significant problems since credit rating agencies do not have a mandate to provide information or evaluate credit risk in the interests of public objectives, but rather to maximize profits and shareholder value (Gavras Reference Gavras2012). CRAs are, moreover, more than just opinion-makers – they have significant influence over market movements and can affect not only the value of assets and of collaterals, but also volatility and financial stability (ECLAC 2021). A more detailed discussion on what the role of CRAs should be, and what sort of reform would be needed for them to live up to that mandate is thus within the scope of a book seeking to counter a blanket moralization of and defend public debt. Arguably, a change in CRAs’ methodology might be a step in the right direction. But it could also be argued that a public, multilateral credit rating agency ought to be established.