GEI Newsletter Issue No. 2

‘Political Economy, Sovereign Debt and the Role of the IMF’ G E I Workshop, Cambridge, 7/8 July 1995 - by Sylvia Vally

Also in this issue:

Editorial
by David Vines
Global Competition Policy in the International Economic Order
by Peter Holmes
Seminars at Chatham House on Subsidiarity in the Governance of the Global Economy

Back to - Introduction

William Perraudin and Pinar Bagci in their ‘Do IMF Programmes Work?’ presented a new methodological approach for evaluating IMF programmes. The focus was on the problem of self-selection bias, which arises from the non-random sampling of countries that have programmes. Neglecting to control for self-selection implicitly means treating the decision to undertake a Fund programme as exogenous. This assumption appears to be inappropriate as recent theoretical work on political economy suggested that the decision to stabilize reflects complex bargaining processes involving different domestic interest groups. Comparing the changes in mean macroeconomic outcomes between programme countries and a control group may give a biased measure of programme effect. The empirical implementation of their methodology seems to suggest that adjusting for bias makes IMF programmes look better. This result is surprising when compared with the common presumption in the existing literature on programme valuation. Using a simple political economy model of programme adoption Bagci and Perraudin found that selectivity bias can work in either direction.

Morris Goldstein (Institute for International Economics, Washington) stressed the methodological novelty of the paper, but expressed some surprise to see that correcting for sample selection bias led to a more favourable overall assessment of the Fund’s programmes, and to positive growth effects in particular. It was argued, in the discussion, that non-programme countries should be included in the control group, even at the risk of including structurally different economies.

In ‘How Private Creditors Fared with Sovereign Lending: Evidence from the 1970–1992 Period’, Christoph Klingen (Institut für Volkswirtschaft, Basel) presented a methodology to recover the payment flows between private creditors and debtor countries from World-Debt-Table data. Based on these flows he calculated the rate of return from private lending to 24 developing countries. The rate of return from sovereign lending appeared to differ widely across countries. The overall return of developing country loans, in real terms, was calculated to be positive and equal to 2.1%. In the same period, however, the real return from sovereign lending was dominated both by the return on US government bonds and by LIBOR.

Christopher Gilbert (Queen Mary and Westfield College, London, and CEPR) using a somewhat different approach confirmed the numerical results obtained for Argentina. He pointed out, however, that Klingen’s recalculated transfers ignored the distinction between the capital and interest accounts: in Gilbert’s opinion one gets a clearer impression of the returns that the banks have obtained by looking simply at the interest yield on the outstanding debt.



In ‘The IMF-Supported Programs of Poland and Russia, 1990–1994: Principles, Errors, and Results’, Stanislaw Gomulka (LSE) suggested that the roles of the IMF and of the World Bank in Poland and Russia have been helpful but relatively modest. He argued that most post-communist economies are too large and their transition to capitalism too costly for foreign assistance to have more than a marginal effect. Some of these economies are already heavily indebted and this gives them little room for contracting new debt. The sequence of reforms and the speed of transition have been decided largely by initial conditions, new long-term goals and various internal political and institutional factors during the transition, rather than by the advice of the two institutions. A more important foreign impact may come from the inflow of Western private investments and know-how. Internal reforms rather than external financial assistance are needed for these inflows to take place, however. Gomulka criticised the Fund’s programmes for setting unobtainable paths for inflation reduction.

In his discussion Willem Buiter (University of Cambridge and CEPR) argued that it was inappropriate to have both a nominal exchange rate target and a nominal wage target as these might together define an inappropriate real wage.

Mikhail Klimenko (Stanford University) presenting his paper ‘International Mediation in the Rescheduling of Sovereign Debt’, extended some infinite bargaining models to analyse the role of the IMF as an intermediary in the negotiations between private lenders and borrower countries. In the framework used, random selection of a proposing side and discrete time were assumed. One result was that the more patient side is always more interested in the intermediate renegotiation. Only if aid is sufficiently large would the less patient side benefit from the intermediate negotiation. Economic aid as a side payment to facilitate the negotiations is not necessary to reach agreement, however, and can be explained only by purely political considerations on the side of the international bureaucracies.

Sudipto Bhattacharya (Université Catholique de Louvain) welcomed the contributions of Klimenko’s paper, but argued that the framework of the model, with complete information, implies a certain irrationality in the debtor’s economic aid (as an immediate rescheduling agreement can be reached without the IMF’s intermediation). Bhattacharya emphasized the role of the IMF as multilateral institution in a four-party model with a subgame of bilateral bargaining between creditor-country government and creditor-country banks in case of disagreement.



Finally, Kenneth Kletzer (University of California, Santa Cruz), in ‘Sovereign Debt as Intertemporal Barter’, written with Brian Wright, described the equilibrium inter-temporal exchange relationship that underlies a formal contract for loans between sovereigns. In their model, gains from intertemporal trade originate from the desire for consumption-smoothing with an uncertain endowment stream. The motivation for any payments made by any of the parties is the surplus anticipated from continuation of the exchange relationship. Two innovative assumptions of the model are that every action taken by an agent is voluntary (payments are made only if doing so raises the surplus to the agent looking forward in the relationship), and that agents can always renegotiate the terms of the relationship, notably any punishments used, to their mutual benefit (strong subgame perfection). Kletzer showed that inter-temporal exchange can be sustained when there are many competitive agents and no third-party enforcement. The equilibrium path and punishment paths are all efficient.

William Branson (Woodrow Wilson School, Princeton University, and CEPR) welcomed the novelty of the model as a good formal framework to analyse the World Bank Structural Adjustment Loans (SALs). He stressed the main characteristics of analysis and evaluation of the model which fit the SALs and noted the problems left aside from the Kletzer and Wright analysis. Finally, he questioned the assumption on the nature of stochastic income and proposed a random walk with unit roots (as an alternative to identical independently distributed shocks) which seems to be more consistent with mutually beneficial renegotiations and also with empirical results.



William Branson chaired a Round Table which drew out some of the main themes. In his summary remarks Morris Goldstein acknowledged that for developed countries with adequate access to credit markets, market discipline replaces IMF discipline; but he noted that the Fund still plays a significant informational role as ‘credit appraiser’. For countries without access to international credit – especially those in danger of debt default, speculative attacks and bank runs, which needed money quickly – the role for Fund financing was clear. (Goldstein noted, however, that it would be difficult for the existing system to cope with ‘another Mexico’ and referred to Sachs’s bankruptcy proposal for the Fund to organize orderly workouts for sovereign debtors.) Although countries were nowadays encouraged to ‘own’ their stabilization programmes, Goldstein argued that the Fund could nevertheless play a useful ‘scapegoat role’ when required. David Vines further developed these themes. He argued that the Fund’s information role was aided by both economics of scale and by its accumulated expertise, but that it could be compromised if the Fund was unable publicly to criticise official policy of countries to whom it lent money. He noted that the Fund’s expertise could help to set the macroeconomic framework for policy, that its improvement in programme design could help provide precommitment and that its money could bring in other capital flows. He thought that Sachs’s bankruptcy proposal was of considerable interest: by preventing a ‘grab-race’ by creditors, helping to change management policy and organizing equitable debt write down. More generally, he observed that global economic institutions could play a role in promoting policy reform (partly by ‘buying out’ vested interests). Michael Dooley and Stanislaw Gomulka sounded notes of caution; in Dooley’s view there is a highly elastic supply of bad proposals for the use of Fund money; and Gomulka noted that there are other institutions already at work – such as the Paris Club for renegotiating intergovernment debt and the London Club for private Bank debt.

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