View
216
Download
0
Category
Preview:
Citation preview
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 1/8
American Economic Association
A Review of Michael Tomz's "Reputation and International Cooperation: Sovereign Debt acrossThree Centuries"Reputation and International Cooperation: Sovereign Debt across Three Centuries by MichaelTomzReview by: Mark GersovitzJournal of Economic Literature, Vol. 47, No. 2 (Jun., 2009), pp. 475-481Published by: American Economic Association
Stable URL: http://www.jstor.org/stable/27739929 .
Accessed: 05/06/2013 04:37
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp
.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.
.
American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to Journal
of Economic Literature.
http://www.jstor.org
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 2/8
Journal ofEconomie Literature 2009, 47:2, 475-481
http:www.aeaweb.org/articles.php?doi=10.1257/jel.47.2.475
A Review of Michael Tomz s
Reputation and International
Cooperation: Sovereign Debt across
Three Centuries
Mark Gersovitz*
Repudiation and expropriation pose obstacles to the international mobility of capitaland thereby to efficient international allocation of resources. Tomz discusses the deter
minants of lending in theface of the threat of repudiation. Using history, he arguesthat debtor countries have sougfit
a reputation for compliance with loan agreementsto access future loans and thatmilitary or trade sanctions have been unimportant in
sustaining lending. He discusses when and why banks have been more active as lend
ers relative to bondholders. This article situates Tomz s concerns in the broad themesof thought
on obstacles to capital mobility and evaluates his arguments.
Michael
Tomz, apolitical scientist, has
written a useful book on the mecha
nisms that support the international mobil
ityof capital?Reputation and International
Cooperation: Sovereign Debt across Three
Centuries (Princeton University Press, 2007).
Capital mobility has long concerned econo
mists. In 1817, David Ricardo set out the bigthemes for an investigation of international
capital mobility, arguing that the interna
tional movement of capital faces significantobstacles:
The difference in this respect, between a sin
gle country and many, iseasily accounted for,
by considering thedifficulty ith which capital moves from one
country to another, to seek
*Gersovitz: Johns Hopkins University.
a moreprofitable employment, and the activity
with which itinvariably passes from one
province to another in the same
country. (Ricardo
2005, pp. 87-88)
His reason was that
Experience, however, shows that the fancied
or real insecurity of capital, when not under
the immediate control of its owner, togetherwith the natural disinclination which everyman has to quit the country of his birth . . .
check the emigration of capital. These feel
ings. . . induce most men of property to be
satisfied with a low rate of profitsin their own
country, rather than seek a moreadvantageous
employment for their wealth inforeign
nations.
(Ricardo2005, p. 88)
Ricardo must have seen these obstacles
to capital mobility as quite large and quite
immutable because he based his theoryof comparative advantageon them: In the
475
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 3/8
476 Journal ofEconomie Literature, Vol. XLVII (June 2009)
absence of capital mobility, how does trade
substitute for capital mobility and what is itsrole in raisingwelfare?
Maximization of world welfare requiresan international allocation of capital that
establishes a common marginal product
anywhere that capital can be productive.
Although the factor composition of trade
can move the world economy toward such
equalization, capital mobility is probablystill needed to achieve the fully efficient
allocation. But achieving this allocation
encounters Ricardo's presumption that owners of capital who invest abroad fear that
theymay get neither their capital back nor
a reward formaking it available. In particular, lenders to foreign governments may fear
repudiation and direct investors may fear
expropriation?fears sometimes termed
countryor
sovereign risk.
These general considerations lead to the
motives of providers and recipients of capital across international boundaries and the
constraints they face. In turn, the circum
stances of these market participants deter
mine the international allocation of capital,the occurrence of hostile acts toward providers, the implications of the foregoing for the
welfare ofmarket participants, and the role
forpolicy by governments and international
organizations. To develop such a positiveand normative theory of obstacles to capital
mobility and their consequences, it is easiest
towork backward from a breakdown in relations between providers and recipients and
itsdeterminants.
Research over the last thirty years has
emphasized that the willingness to pay of
recipients of capital determines whether
recipients uphold the terms on which theyreceived capital. The idea is that the recipients make a cost-benefit analysis of honor
ing the terms. The cost is the terms of the
contract, such as
paying
a return to the
providers. The benefits are avoiding the penalties that aggrieved providers could impose.
Providers of capital want to maintain a suf
ficient probability that these benefits to therecipient exceed costs so that the providers
get adequate recompense, leading to a strat
egy of credit rationing based on the available
penalties and the attributes of the recipientsof capital.
In the economics literature, the majoralternatives to willingness to pay are sol
vency and liquidity. Solvency is the notion
that a recipient country cannot eversatisfy
the terms of itsagreement with the providersof capital?a cannot-pay-ever approach. An
example would be a country with a presentdiscounted value of national income known
to be less than the present discounted value
of its obligations. But solvency is unlikely to
be operative because, longbefore itcould be,
providers would know that recipients would
not be willing to honor contracts. A liquidity
problem arises if the recipient cannot satisfythe terms of its agreement in the short term
but could(and would) later
on?a cannot
pay-now approach. The major objection to
aliquidity explanation is that the recipient
canusually declare a unilateral moratorium
and wait for problems to abate because by
hypothesis they will. Providers of capitalwould then be forced to float the troubled
recipient until the temporary lack of funds is
past. An exception would be a recipient who
needs new additional funds to deal with an
immediate problem,ones that itwould be
good for later on but without which itwouldbecome insolvent in the future. Perhaps ithas
to finish somelarge investment project that
would otherwise come to permanent grief.Providers of capital may have trouble coor
dinating the provision of the new funds, but
I have not seen this dynamic offered as an
explanation of actual crises between recipients and providers. So thewillingness-to-pay
approach seems firmly in the saddle if one
choosesamong
it,solvency,
andliquidity.The next question in understanding inter
national capital mobility is the nature of
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 4/8
Gersovitz: A Review ofReputation and International Cooperation 477
the penalties that sustain willingness to pay
undersome circumstances?a controversial
topic of much research. The plausible penalties are rather indirect and probably often
weak in that they do not support the interna
tional equalization of the returns to capital.The presumption in the literature has been
that rational providers of capital will not
send itabroad unless expected returns are at
least equal to their opportunity cost of funds.
Expected returns are determined in part bythe probability of trouble with the recipi
ents of capital, which in turn is determinedinpart by the availability of penalties. Later
1 return to themotivations of providers,an
underexamined topic.The penalties
are indirect for a number
of reasons. Providers cannot get collateral
because thewhole purpose of the provisionof capital from abroad is to put itwithin the
foreign countrywhere capitals product ishigh
by hypothesis butwhere capital isvulnerable
to therecipients
control.Similarly,
courts
will either not render a judgment against a
sovereign government or their judgmentscannot be enforced. This situation leads to a
qualitative contrast with the recourse often
available against private borrowers within a
lenders owncountry.
Tomz s goal is sorting out which of the
conceivable indirect penalties is operativein the case of financial transfers between
providers of capital (banks and bondholders)
and recipients of capital (the governments ofcountries). He argues that the loss of futureaccess to capital from a loss of reputation for
trustworthiness is determinative. Chapter 1
sets the context, chapter 2 provides his con
ceptualization of how reputation sustains an
equilibrium with positive international lend
ing, and chapters 3 to 5 provide evidence for
the approach.Economists will probably find chapter
2 on thetheory
to be the weakestpart
of
the book. Tomz does not present a preciseabstract formulation of the behavior ofmar
ket participants who pursue objectives in the
face of constraints. His presentation couldhave been greatly improved byan
algebraicstatement of the problem he is addressing.Tomz postulates that there are three typesof recipients of capital: stalwarts (who tend
to service debts in good times and bad),/airweathers (who repay in good times but not
bad), and lemons (who regularly default in
bad times and sometimes in good times).Lenders are said to learn about the type of
aspecific borrower as the borrower responds
to good times and bad. As time passes without bad behavior, lenders become more confi
dent that they are dealing with a good type.These generalities
are about all that the
chapter contains, however. Itwould be goodto know why Tomz does not use a model in
which there is only one type of borrower,one who is always willing to contemplate
repudiation under the right circumstances.
Equilibrium of the lender and borrower is
thendetermined by
the need to ensure that
the penalty of exclusion will be applied to
repudiators in such a way that lenders are
prepared to lend given the incentives of bor
rowers to repudiate. In thisway, one avoids
the artificial hypothesis of inherent types as
exogenous to themodel and can instead tryto
infer how characteristics of the equilibrium,such as the amount of lending and the prob
ability of repudiation,are affected by objec
tive circumstances that can be examined
empirically. Thus the concept of reputation is
replaced by a notion of strategic equilibrium.In any case, there is certainly
alarge relevant
literature of formal models both on interna
tional capital mobility and on game theory,
includingwhen there are more than one typeof player with type at least initially known
only to the player. Tomz even cites some of
these contributions and itwould have helpedthe reader if he could have adapted these
models toincorporate
the features he feels
are special to his approach. Instead, there is
no concept of equilibrium, certainlyno proof
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 5/8
478 Journal ofEconomie Literature, Vol. XLVII (June 2009)
of itsexistence, no comparative analysis. Thus
there is littleof substance in this chapter thatjustifies Tomz in repeatedly referring to itas
"mymodel."
There is also almost no substantive dis
cussion of what determines a type. Does it
have something to do with processes that
would seem morepolitical than economic?
For instance, there may be regimes that
value isolation or at least forwhom isolation
is an inevitable byproduct of their goals and
strategies. For these regimes, sanctions bycreditors that isolate the country may makelittle difference or even be a plus. Regimes in
the Soviet Union, Communist China, North
Korea, Cuba, Iran, Bolivia, Peru, Venezuela,or Zimbabwe may gain support by arguingthat a revolution or country is under siegefrom foreigners and may benefit from beingable to undermine domestic enemies as
foreign agents or appeasers and consolidate
power. If isolation is desirable, then beingcut off is a benefit not a cost.
Althoughthe
countries of this kind that comeimmediately
tomind do not provide the bulk of recorded
breakdowns between lender and borrower,
they include some prominent cases and there
may be less overt instances as well. Tomz
mentions some of these countries but there
is noanalysis of their situation. A parallel
political economy approach might be to look
atwho within the borrower country benefits
economically from isolation consequent on
sanctions and to ask when the political process is such that these people determine pol
icy.Provoking isolation may not be a Pareto
policy but itmay be the best feasible for these
people given the political system. The typesof borrowers inTomz s discussion, however,
largely remain quite abstract.
Tomz next turns to evidence on the costs
of not fulfilling the terms agreed with credi
tors and he has some really quite interesting
things
to
say.
I think that hispredilection
for
informality serves him better inhis empirical
investigation, which benefits from a creative
eclecticism, whereas itservesbadly inhis con
ceptual discussion, which needsmore
rigorous and focused development. Nonetheless,the empirical discussion could have been
helped by a stronger conceptualization that
would have guided which regularities to look
forand how to interpret them.
Chapter 3 presents statistical evidence
from the eighteenth and nineteenth centu
ries on the rates thatborrowers have paid. He
finds that new entrants generally paid higherrates than seasoned borrowers who had hon
ored their obligations and that these ratesfell if the new borrowers in turn honored
their obligations. He relates the interestingcase of a fictional (and fraudulent) sovereignborrower, Poy?is, which first entered the
London market in 1822 paying the same rate
as a number of South American countries
newly independent of Spain. The informationon its true status took almost a year to leak
toLondon with a consequent collapse in the
valueof
itsdebt.
Chapter 4 examines investment advice
from American and British publications on
the purchase of foreign government bonds
between 1919 and 1929. Tomz identified
four comprehensive bibliographies from this
period and drew a random sample of their
references and then coded the principlesof risk assessment thatwere discussed. He
finds that the predominantconcern was with
repayment history. There was some very sec
ondary consideration given tomilitary intervention as a
possible consequence of failingto honor bond payments but virtually
no
mention of trade sanctions. Tomz addresses
the concern that he is examining opinionsrather than actions by emphasizing that these
publications were meant toprovide advice to
actual or potential bondholders so that the
authors themselves had a reputation tomain
tain for relevance.
Chapter5 looks at the
experienceof bor
rowersduring the interwar period. Of partic
ular interest is the second half of this chapter
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 6/8
Gersovitz: A Review ofReputation and International Cooperation 479
that looks at three countries thatmaintained
their payments during the 1930s: Australia,Argentina, and Finland. Here and in chapter7 (pp. 175-77), Tomz recounts the intense
debate among Argentine politicians who
explicitly recognized the benefits of future
access to credit from paying under such dif
ficult conditions. All three countries were at
least able to borrow at lower (nominal) rates
during the 1930s.
Chapter 6 discusses the role of coercion
of recalcitrant borrower states by the states
of lenders. The upshot of Tomz s examination of the nineteenth century, the sup
posed heyday of gunboat diplomacy, is that
there is virtuallyno evidence of this type
of enforcement of loan contracts. The rea
son is quite simple: the governments of rich
countries have a lot of interests and they do
not particularly like their agendas upset by
imprudent and importuning lenders. Of
course, there was the coercion exercised
incolonies through the arrogation of the
monopoly of force and other governmental functions to the m?tropole. Doubtless,India had much easier access to the London
capital market as part of the British Empirethan itwould have had otherwise and so the
international state structure must surelyhave
something to do with themobility of capital.But Tomz s concern is narrower: the coercion
of an otherwise sovereign state in the inter
ests of its foreign creditors.
The way that Tomz gets to his conclusion about the unimportance of interstate
coercion is perhaps ofmoregeneral interest
than the conclusion itself.He begins withsome evidence from the Correlates ofWar
(COW) dataset. These or similar data are
the rawmaterial ofmany studies in politicaleconomy, such as the literature on civilwars,whether as an explanatory or dependent vari
able. Tomz shows that there is a statistically
significantcorrelation between debt defaults
and military disputes (short ofwar) whether
in a bivariate ormultivariate analysis, the lat
ter controlling forvarious factors thatmake
conflict between two countries more likelyregardless of debt problems.
Tomz thenmoves to discredit these infer
ences from the COW data by showing that
the vast majority of the military disputesoccurred in the middle of long default episodes. As he points out, this finding raises the
questions ofwhy creditor nations waited so
long and, most importantly, ended the mili
tary dispute without resolving the default.
Perhaps the correlations aremisleading. He
then develops thehistorical narrative of these
military disputes, showing that they had
little to do with default, including a conflict
between Britain and Venezuela often cited as
the best example of gunboat debt collection.
Furthermore, he examines an enormous cor
respondence between British officials and
their aggrieved citizens who lent abroad
showing that the officials repeatedly told the
importuning lenders thatmaking risky loanswas
theirown
lookout. Some British officials,however, did urge governments in default to
take account of the consequences for their
reputations as borrowers, precisely the con
siderations thatTomz stresses. Finally, Tomz
argues that citizens of smaller countries, such
as Switzerland, were active lenders to coun
tries that could not possibly be coerced bythe home countries of the lenders. All in all,I found Tomz sdiscussion tobe a veryworth
while consideration of diverse evidence and
much preferable to a mechanical statistical
analysis of the COW data. This chapter provides a valuable model of how to scrutinize
findings from the COW data using a more
historical approach.
Chapter 7 focuses on the role of trade
sanctions in sustaining international capital movements. Here, Tomz's conclusion
is unambiguously negative?he is a strongdetractor of the position that the potentialfor interference with a
country'strade
provides the incentive for it to service itsdebts.
He begins with a detailed examination of
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 7/8
480 Journal ofEconomie Literature, Vol. XLVII (June 2009)
the Argentine experience during the 1930s
when he finds the threat to future borrowing, not to trade, was operative. Iwas most
impressed by two of his observations. First,
Argentina serviced debts to U.K. and U.S.
lenders equally despite the United States
having little tradewith Argentina and there
fore negligible scope for trade retaliation
at the same time that the Argentine debts
to the United States werelarger and at
worse terms than their debts to the United
Kingdom. Second, asalready mentioned, the
debate among Argentine politicians pivotedon the loss of access to future lending not
trade. The remainder of chapter 7 presents a
broader analysis of debtor-creditor relationsas they relate to the importance of bilateral
trade between the two types of countries
during the 1930s. Tomz's evidence suggeststhat countries that had high trade volumes
with the countries of their lenders and presumed vulnerability to trade disruption
were no morelikely
to servicetheir debtsthan otherwise. Finally, Tomz reports on his
examination of "96,000 scrap book pages" of
newspaper articles maintained by the British
Corporation of Foreign Bondholders from
1870 to 1914. There ismention of trade sanc
tions in only two instances; in neither case
werethey applied.
The penultimate chapter discusses
whether and when lenders are better organized as bondholders or banks. Much of the
literature has placed emphasis on the sup
posed greater cohesion of banks in dealingwith recalcitrant lenders and Tomz does
provide an exhaustive list of reasonswhy
this relative cohesion might be expected.He points out, however, that the petrodollar
lending episode of the 1970s and 1980s was
unique in the predominance of banks as
lenders. This fact suggests that banks' cohesion and, hence, their suitability to dealing
with recalcitrant borrowersmay
not be whataccounts for their prominence in the petrodollar period because this factor also should
have applied at other times when banks did
not, however, predominate. Instead, Tomzargues that lending by banks as
opposed to
bondholders was uniquely favored by other
circumstances in this period.Tomz draws on the writings of Karin
Lissakers and others topoint out that, duringthis period, bank lending to foreign govern
ments enjoyed special advantages from U.S.
foreign tax credits. Sovereign borrowers paidinterest to banks as
though itwere net of the
borrower country's taxes, thereby generating
potentially huge tax credits to shelter banks'incomes from other sources from U.S. taxes.
The U.S. tax code subsequently became less
favorable. Tomz also argues that the mone
tary authorities in the countries of the lenders
implicitly guaranteed bank loans.
The favorable climate forbank lending at
this time also included explicit government
guarantees thatTomz does not, however, dis
cuss, for instance from the Export-Import
Bank of theUnited States. This storyof explicitguarantees has yet tobe toldbut hints of itcan
be found in data when acountry's liabilities
are broken out bywhether they are owed to
private or public lenders. Thus one can see
in the case of countries thatwerereported in
thepress as nonpayers that subsequently their
liabilities to private creditors fellwhile thoseto public creditors rose. Such a reallocation
most likelydoes not represent the repaymentof debts by the sovereign borrower toprivatelenders coincidentally offsetby a rise indebtsto public lenders. Instead, therewas a direct
transfer from the public entity in the lender's
country that has guaranteed the debts to the
private lender as the guarantee was invoked
leading to a change in the identity of the
claimant on the borrower without, however,
any direct involvement of the sovereign borrowerwhose liabilitieswere reallocated.
Of course, as I write in the fall of 2008,financial manias and bailouts are
uppermost in everyone's mind, and it raises the
issue much mooted in the 1970s and 1980s
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AMAll use subject to JSTOR Terms and Conditions
7/28/2019 Gersovitz Review of Tomz Reputation and Sovereign Debt
http://slidepdf.com/reader/full/gersovitz-review-of-tomz-reputation-and-sovereign-debt 8/8
Gersovitz: A Review ofReputation and International Cooperation 481
about banks' internal controls and incen
tivesjust prior
to the LDC Debt Crisis of
the 1980s?the problem of themanagementrun financial institution.When outcomes are
realized significantly after loans are made, it
ispossible forbank managers, who benefit via
promotions and bonuses from such activities
as sovereign orsubprime-mortgage lending,
to argue that skeptical commentators (and
responsible regulators, ifany exist) are alarm
ists,that everythingwill be alright, and that in
themeantime themanagers of banks should
be richly rewarded for their perspicacity.Hence, we have Walter Wriston s (in)famous
aphorism that countries do not go bankrupt.
Unfortunately formany people, he did not
follow this statement by themore importantrealization that this fact is not good
news
for lenders because countries can stop, have
stopped, and probably will stop paying even
without going bankrupt. A full explanation of
thisepisode
ofpetrodollar lending
followed
by defaults seems to need attention to the
complexities of the lenders' incentives, more
than ithas received. Tomz is rare in paying
any attention to the lender's calculus, even if
he has not covered explicit guarantees or the
incentive problems of themanagerial bank.
In general, I found this book to be schol
arly and insightful,a
probing effort to seek
further understanding. And by theway, the
book has an excellent reference list. I learned
from reading it and I feel others who areinterested in international capital mobility
will aswell.
References
Ricardo, David. 2005.Principles of Political Econ
omy and Taxation. Savage, Md.: Barnes and Noble
Books.
This content downloaded from 144.173.6.37 on Wed, 5 Jun 2013 04:37:30 AM
Recommended