Distributional aspects of debt adjustment

Abstract

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