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Features | Bringing Iraq Back?

A Dictator's Crippling Debts

July-August 2003

Under Saddam Hussein's rule, Iraq amassed about $100 billion in debt. This estimate is rough, and it will be months before the details about Iraq's finances become clear. What is known is that repayment would be very burdensome. In addition to the debt, Iraq faces $200 billion in Gulf War compensation claims, while its gross domestic product is estimated at only $30 billion.

The Paris Club of creditor nations has procedures in place to reschedule or write off some of the debt of developing countries on the rationale that repaying the debt would further impoverish such economies. The key members of the Club have expressed the view that Iraq will qualify for such relief. But Iraq will still be left with a large burden, because much of its debt is owed to Russia and Gulf states that do not belong to the Paris Club, or to non-government creditors such as the Korean conglomerate Hyundai.

The new Iraqi government will likely refuse to repay some of the remaining debt, or at least lobby for more debt relief based on a second rationale: the fairly strong case that Saddam Hussein borrowed without the consent of the Iraqi people—almost entirely in the 1980s, after seizing power—and then spent much of the money to finance violence and repression. Hence, the new government might argue, Saddam Hussein was not legitimately borrowing on behalf of the Iraqi people. An individual is not responsible for repaying debt that someone fraudulently incurs in her name. Why should a citizenry be?

The United States might welcome an Iraqi decision to repudiate its debt, just as it encouraged Cuba, after the Spanish-American War, to repudiate the debt that Spanish rulers had run up in Cuba's name. Indeed, U.S. Secretary of the Treasury John Snow and deputy secretary of defense Paul Wolfowitz have suggested as much. Regardless of Washington's stance on the moral or legal right to repudiate illegitimate debt—or "odious debt," as early twentieth-century legal scholars who advocated its nullification termed it—this country knows that an Iraq burdened with debt would be more dependent on American aid. Moreover, there is no love lost between the United States and two of Iraq's leading creditors, Russia and France.

An Iraqi move to renounce its debt will have important consequences for international lending generally. Creditors will think twice before lending to repressive or looting governments if they do not expect to be repaid. In turn, such regimes might behave better to avoid losing their borrowing privileges. But Iraq's repudiation of its debt would also have an unwelcome side effect. Creditors may be more reluctant to lend to a legitimate government out of fear that opinion may later turn against it. Creditors who fear loan nullification will lend at very high interest rates or not at all, so legitimate governments may not be able to borrow to finance worthwhile infrastructure or education projects.

Clearly, the world needs a system to determine which loans should be considered legitimate. The way to prevent lending to illegitimate regimes without jeopardizing legitimate borrowing is to make clear in advance which loans will be considered odious, rather than nullifying them after the fact. Retroactively, there is a temptation to apply the "odious" label liberally and nullify legitimate loans as a way of transferring money from rich creditors to poor debtor countries.

A declaration that a particular government is odious and that future lending to the regime will be considered illegitimate would constitute a new and better form of sanction: a "loan embargo" that cuts off the flow of funds to targeted countries. Profiteers have strong incentives to evade trade embargoes, but creditors wouldn't want to flout a loan embargo because they would not be repaid. They will stop issuing loans to odious regimes—not because such loans are illegal or immoral, but because they are unprofitable.

For example, suppose the UN Security Council declared that any future borrowing by another current dictatorship—be it Syria, Zimbabwe, or Myanmar—would be the regime's responsibility, not that of the citizens or any future government of the country. When the regime goes to the debt market to borrow, this sanction would discourage creditors from lending. Even if the United States imposed the sanction on its own, creditors in other countries would abide by it. The United States needs only to vow political and financial backing for a successor government that repudiates new loans issued to the country's current, illegitimate regime.

If the international community adds a loan embargo to its tool kit of economic sanctions, creditors would know the rules of the game in advance and wouldn't risk nullification of their outstanding loans. Accordingly, legitimate governments could borrow at lower interest rates. Most importantly, governments recognized by the international community as illegitimate would be unable to borrow in world markets, use the funds to finance repression, or loot the money, and then saddle their ill-treated people with debt. Thus a decision by the postwar Iraqi government to renounce Saddam Hussein's debt might spur the creation of a system that prevents lending to repressive rulers in the first place.

 

Seema Jayachandran is a doctoral student in economics at Harvard. Michael R. Kremer is a professor of economics at Harvard and senior fellow at the Brookings Institution. A shorter version of this essay appeared in the Financial Times in May. A detailed explication of the authors' research on "odious debt" appears in a downloadable format at Kremer's webpage at http://post.economics.harvard.edu/faculty/kremer/papers.html.