Conditionality and debt relief

Six years into the debt crisis, questions about the relevance of policy measures to alleviate the crisis still abound. Conditionality by international financial institutions and rescheduling by commercial creditors have been dismissed in favor of debt reduction as strategies for restoring the creditworthiness of heavily indebted countries. This paper argues that the combination of conditionality and new private money - if properly interpreted and correctly implemented - should not be dismissed too lightly. The paper contends that liquidity (the availability of current resources) in the debtor country is probably as important an incentive for a country to invest and adjust as having a small enough debt stock outstanding. Debt reduction alone, is not as efficient as simultaneously providing liquidity and debt reduction if liquidity were available. The combination of new money and conditionality will work if the debt stock is small enough and enough new money is available.Environmental Economics&Policies,Economic Theory&Research,Strategic Debt Management,Financial Intermediation,Housing Finance

Voluntary choices in concerted deals : mechanics and attributes of the menu approach

When sovereign debt trades at a discount on secondary markets, a market buyback increases the secondary market price. The wealth of private creditors increases because part of the funds used in the repurchase is a transfer payment to them. This transfer of resources can be mitigated by imposing a capital gains tax on the remaining debt. The authors show how this can be achieved by including exit and new money options in a menu of options from which creditors can freely choose. The menu approach imposes an implicit tax on the capital gains on the remaining debt by requiring lenders that do not exit to extend new loans in proportion to the debt they retain. The menu approach does not require that particular choices from the menu be assigned to each lender. Instead, it implements debt reduction through a price system, allowing different creditors to select different portfolios in equilibrium from a common set of options. The authors illustrate some of their results by analyzing the recent Mexican debt agreement. They show how to read through the complex financial acrobatics to estimate the net debt reduction. Funds provided by international financial institutions benefited both Mexico and its creditors. Mexico directly retained 62 percent of these resources and the banks 34 percent.Economic Theory&Research,Banks&Banking Reform,Strategic Debt Management,Environmental Economics&Policies,Financial Intermediation

Long term prospects in Eastern Europe : the role of external finance in an era of change

Private investors have an important role toplay in the ongoing process of reform in Eastern Europe. So external creditworthiness is crucial to a successful transition. Large government borrowing crowds out the formation of private contracts between international investors and domestic entrepreneurs and firms. Given the overall credit ceiling in international lending, the public sector needs to curtail its external borrowing to leave room for the private sector. This also implies that public debt reduction may be especially desirable in the highly indebted countries of Eastern Europe. Rather than flood the public sector with new loans, international organizations should attempt to improve domestic creditworthiness by supporting debt reduction and borrowing restraints during the transition period. Debt for equity swaps represent an attractive vehicle for debt reduction in the highly indebted countries of Eastern Europe. Such schemes, when tied to the privatization effort, are not inflationary. They simply represent a swap of public liabilities, and they create value to the extent that foreign private investment leads to positive externalities. The challenge will be to create swap mechanisms that will allow the Eastern European countries to retain a large share of those gains.Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research,Municipal Financial Management,Public Sector Economics&Finance

An analysis of debt-reduction schemes initiated by debtor countries

In evaluating the benefits of a voluntary debt reduction scheme, look for efficiency gains that allow both debtor and creditor to gain. In particular certain debt reduction operations can: (i) increase the incentives for growth in highly indebted countries; (ii) allocate risk more efficiently between debtor and creditors; and (iii) signal the credibility of a country's willingness to adjust its economy. Market-based debt conversion is more likely to improve the debtor nations welfare when: (i) the opportunity cost of foreign exchange is low; (ii) there is great probability of default with a deadweight loss to the creditor; (iii) private rather than public debt is swapped for equity investments; (iv) the country has no other way of signalling its commitment; and (v) the country has an extreme case of debt overhang.Strategic Debt Management,Economic Theory&Research,Environmental Economics&Policies,Housing Finance,Financial Intermediation

When the bureaucrats move out of business : a cost-benefit assessment of labor retrenchment in China

The author estimate the costs and benefits of labor retrenchment in state-owned industrial enterprises in China. Their results indicate the prevalence of low and stagnant labor productivity, low capital productivity, and excessively high wages in the state sector for the period reviewed (1994-97). The private sector exhibited consistently greater productivity. The authors'most striking finding: A greater gain could be realized from capital transfer than is being gained from labor retrenchment. Their simulation results for 1996 estimate that 43 percent of the workers in state enterprises and 70 percent of the capital are redundant. By itself, a transfer of labor from the public to the private sector at the current magnitude (20 percent of the labor force) would secure only two percent gains in output. A transfer of ten percent of both capital and labor would achieve a greater efficiency gain than transferring the full 43 percent of redundant workers. This is partly because the private sector uses capital more efficiently than the public sector and partly because it needs capital to hire workers transferred from the public sector. Their results suggest that reform in state enterprises should concentrate more on the efficiency of capital allocation, not just on labor retrenchment. More efficient capital allocation would reduce the pressure on labor and would bring larger gains at a lower social cost.Labor Policies,Banks&Banking Reform,Environmental Economics&Policies,Economic Theory&Research,Municipal Financial Management,Economic Theory&Research,Municipal Financial Management,Banks&Banking Reform,Environmental Economics&Policies,National Governance

Sovereign debt buybacks as a signal of creditworthiness

To solve the puzzle of attitudes toward debt buybacks, the authors use a model that combines considerations of debt overhang with the possibility of asymmetrical information between debtor countries and their creditors. In this environment, a debt overhang may create disincentives for a country to undertake a worthwile investment, and debt relief may induce the country to invest and to increase its output, raising future debt repayments. The authors show that debt buybacks can credibly reveal a debtor country's willingness to invest and to repay in the future when offered relief today. In equilibrium, countries that buy back debt get debt relief and those that do not buyback debt do not get debt relief. The authors tested and failed to reject two implications of their model : 1) that banks grant debt relief to countries that have a swap program in place, and 2) that the secondary market price of country debt, conditional on a swap, is higher than the debt price, conditional on no swap.Economic Theory&Research,Strategic Debt Management,Environmental Economics&Policies,Banks&Banking Reform,Financial Intermediation

Patents, appropriate technology, and North-South trade

In this paper, the authors discuss the possibility that the North and South may have differing technological needs. Just as the North would like to develop drugs against cancer and heart disease, and the South drugs against tropical disease, so the North's labor saving innovations are less useful in the South, where labor is cheap. Southern patents might promote the development of technologies appropriate to the South that might not have been developed if there were no patents. In this case, lower patent protection in the South would not benefit the South and increased patent protection in the South can hurt the North when the resources to go into R&D are limited. The authors develop a formal model for inteellectual property rights, emphasizing the dimension of technological choice. This model allows for a continuum of potential technologies, with a range of preferences in the North and South; free entry in the R&D sector rather than duopolistic competition; and gradations of patent protection. The report concludes by reviewing the results of the analysis.ICT Policy and Strategies,General Technology,Economic Theory&Research,Earth Sciences&GIS,Environmental Economics&Policies

Distributional aspects of debt adjustment

The report explores how the formulation of debt repayment policies can be affected by the nature of the decisionmakers and the strength of various interest groups. The authors argue that small penalties can be enough to deter default if they hurt the interests of groups that are closely associated with policymakers, especially when the costs of debt service can be shifted to groups with less influence on decisionmaking. The authors'analysis indicates that : i) governments backed by constituencies from the non-traded good sectors of the economy will tend to default more; ii) without capital mobility, capitalists in the import-substitution sectors will tend to oppose the repayment sought by capitalists of the export sectors; iii) workers interests will depend on the share of import in their consumption basket; iv) with capital mobility, labor will oppose the extent of debt repayment sought by capitalists in both the export and the import substitution sectors; v) self-fulfilling external default with large capital flight is more likely to occur when the default penalty is inelastic and when a left-wing government is in power; and vi) with perfect bargaining, governments with constituencies that oppose large debt repayments get a better debt settlement.Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Strategic Debt Management,Public Sector Economics&Finance

Debt Reduction, Adjustment Lending, and Burden Sharing

We argue that the disincentive effect of a debt overhang is generally small and consequently that debt reduction does not lead to important efficiency gains on this account. Instead, we develop a framework that highlights the inefficiency created by the liquidity constraint faced by over-indebted countries. Often, adjustment/investment opportunities that are profitable at the world interest rate cannot be undertaken for lack of sufficient funds. New creditors are deterred from investing as they expect to be 'taxed" by the old creditors who stand to gain disproportionately. This leads to an inefficient situation when a class of new creditors have a comparative advantage relative to the old creditors. We focus on the time inconsistency introduced by the shortage of liquidity. New (unconditional) loans will be consumed rather than invested. In this context conditional lending can release the liquidity constraint in a time consistent way and lead to efficiency gains that can be shared between the debtor, the old creditors, and the new creditors. The role of debt reduction then is to create the "headroom" needed for these new and more efficient creditors to step in

Patents, Appropriate Technology, and North-South Trade

We consider the differential incentives of the North and the South to provide patent protection to innovating firms in the North. The two regions are assumed to have a different distribution of preferences over the range of exploitable technologies. Due to the scarcity of R&D resources, the two regions are in potential competition with each other to encourage the development of technologies most suited to their needs. This provides a motive for the South to provide patent protection even when it constitutes a small share of the world market and hence has strong free riding incentives otherwise. A benevolent global planner will set equal rates of patent protection only when it weights the welfare of the two regions equally. We find that the comparative statics of the Nash equilibrium exhibit considerable ambiguity. Numerical simulations in the benchmark case yield the following results: (i) when the technological preferences of the two countries become more similar, the level of patent protection provided by the South is reduced; (ii) when the relative market size of the South is increased, the South enhances its patent protection. In both cases, the level of Northern patents is relatively insensitive.