Iraq's Odious Debts

The danger of being too forgiving

Harold James
The Financial Times, UK
May 1, 2003

Washington at the moment is in a Wilsonian mood. The idea of making democracy a building block of international peace comes straight out of Woodrow Wilson’s belief in 1918 in the need for “the destruction of every arbitrary power anywhere in the world that can separately, secretly, and of its single choice disturb the peace of the world; or, if it cannot be presently destroyed, at the least its reduction to virtual impotence”.

But Wilson’s nation-building went wrong. Some newly democratised nations, such as Weimar Germany, failed. Other creations proved to be the great crisis countries of the post-cold-war world: Yugoslavia and Iraq.

It is worth thinking about why the settlement of 1918-19 failed so dramatically. The most obvious but also most surprising answer for the aftermath of the first world war is not that there was a European problem but that there was an American and an international one. The US Congress refused to ratify the peace settlement and the covenant establishing the League of Nations. In large part, this was the result of Wilson’s own blunders (he did not include any of his opponents in his negotiations). In part, however, internationalism would simply have cost the US taxpayer too much.

The second threat to Wilsonianism arose out of the financial legacy of the first world war. A debate about the distribution of war debts and reparations paralysed the international financial system and eventually contributed significantly to the financial meltdown of the Great Depression. Reparations looked like an impossible burden, in which a moral and political claim threatened the ability of the debtors – especially Germany – to service normal public and commercial debt.

There are obvious parallels with both these inter-war problems in the post-Iraq Wilsonianism of 2003. First, the US is more likely to be involved in debates about how to revive domestic growth following the stock market collapse, corporate scandals and worries about the US deficit. It is less likely to be concerned with maintaining international financial stability, if that means a cost for the US. The end of wars has also often been associated with faltering growth and deflationary collapses.

Second, the debate about the financial legacy of the Iraq war has the potential to place a fundamental new uncertainty in the international financial system. The cost of the war for the US is relatively trivial. But conflicts will arise about the priority attached to different claims on Iraq: Kuwaiti claims for reparations for the 1990 invasion; the need to rebuild and reconstitute Iraqi society after the damages done by dictatorship and sanctions; and the claims of Iraq’s foreign (non-reparations) creditors. The Iraqi debt is not large compared with total international indebtedness. But, as with German reparations in the 1920s, a small sum can blow up the system if it produces unbearable tensions.

The new debate about debt will be conducted in a world polarised by the political conflicts that led up to the war and continued while it was being fought. The largest creditors of Iraq are France and Russia (with at least $8bn each), as well as the Gulf states, on which the US may also want to put political pressure. France and Russia were the main obstructors on the United Nations Security Council.

The debt also arises in large part from the sale of weapons to Iraq, which in the case of Russia allegedly continued until days before the outbreak of war. Russian equipment designed to frustrate the precision guidance of the Global Positioning System used by US missiles is reported to have led to deaths of US soldiers in “friendly fire” incidents (where targeting was disoriented by Russian equipment), as well as of Iraqi civilians. On the other hand, little Iraqi debt is owed to the US.

Consequently, it will be tempting for the global superpower to demand the cancellation of Iraqi debt. There would be considerable US Schadenfreude at the scale of French and Russian losses, which will be seen as a legitimate penalty for supporting an immoral regime in Iraq. Americans can make a strong moral case. If those who lend money to dictators or authoritarian leaders were threatened systematically by debt repudiation, the project of worldwide democratisation and pacification would be much quicker. The same logic could be applied to Iran. This is financial Wilsonianism: the application of morality to lending to build a better world.

Yet China, the world’s fastest-growing developing economy, also has a considerable external debt ($170bn at the end of 2001). It is also, very obviously, not a democracy. And its interests are not those of the US. Could the principle of “odious debt” ever be applied to China?

Applying financial Wilsonianism would introduce high risk premiums and make much international lending significantly more precarious. Like reparations and war debts in the 1920s, which also had a basis in morality, Wilsonianism applied to the debt of dictators would produce new uncertainties and a new threat to the entire international financial system.

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