Joseph Siegle
The International Herald Tribune
February 1, 2004

Washington: The Bush administration is well on its way to meeting the goal of relieving at least two-thirds of the $120 billion debt accumulated by Saddam Hussein, despite widespread international opposition to the Bush administration’s Iraq policy. James Baker 3rd, a former secretary of state, recently traveled to the Gulf region as President George W. Bush’s special envoy for Iraqi debt reduction and negotiated commitments to waive much of the $50 billion that Iraq owes the region. European leaders have made similar promises regarding the $40 billion held by Paris Club creditors.

The case for forgiving Iraq’s debts is compelling. The likelihood of its creditors getting paid anytime soon is scant. The service payments on the debt alone could consume a large share of future oil revenues. Until Iraq’s debt overhang is resolved, little new investment can be expected. A stagnating Iraqi economy only further escalates the chance of instability. One can almost hear Baker asking, “Why force ordinary Iraqis to bear the burden for Saddam’s recklessness?”

The logic of this argument is so powerful that it suggests the question of why it isn’t applied in other cases when a long-suppressed people is rid of a profligate tyrant.

Nigeria, Indonesia, Kenya and now Georgia, among others, have all recently emerged from years of autocratic rule, characterized by rapacious, patronage-driven spending. While these countries are not as prominent as Iraq, having avoided military intervention by a superpower, shouldn’t the same principles apply?

Instead, new democracies are often forced to begin their existence on a respirator. On average, a country asking a break with an authoritarian past starts with central government debt of 59 percent of gross domestic product – 10 percentage points higher than the norm for countries in comparable income categories.

Debt servicing for new democracies typically consumes a fifth of central government revenue. If a new government refuses to assume this debt, its credibility in international financial markets will plummet.

Forced to soak up the red ink left by its autocratic predecessors makes a new democracy more vulnerable. Pent-up aspirations of an oppressed society are hard to address when the largest item in the federal budget is debt servicing. Citizens can quickly become disillusioned with democracy.

Add to this the challenges faced from powerful, entrenched interest groups that have prospered under the institutions of the previous regime, and one need not look too hard to find pretexts for a return to authoritarianism. Indeed, the likelihood of a country on the path to democracy reverting to autocratic rule nearly doubles when the country is facing economic stagnation. And as research by Paul Collier and others at the World Bank shows, each percentage point off a country’s per capita growth rate raises the risk of civil conflict by a percentage point.

The argument made against forgiving debt is that it debases the rule of law. If debt is not assumed by a new regime, it signals to other emerging markets that they will not be held responsible for debt they incur – the problem of moral hazard. With a diminished likelihood of being repaid, commercial lending to emerging markets will dry up, the argument goes.

This reasoning is faulty on several fronts. Lenders to dictatorial regimes realize full well that they are not operating according to internationally accepted norms of rule of law. Having assessed the political risk, creditors gambled they could make a profit under such conditions. They were wrong. The moral hazard argument, therefore, cuts more strongly in the opposite direction. Requiring newly democratic countries to repay the debt incurred by autocrats lets international investors discount the risks they should be weighing. There is a fundamental difference when loans are extended to governments that are legitimate representatives of their societies.

Most companies understand this. The level of foreign direct investment to democracies in emerging markets, as a percentage of gross domestic product, is double that of nondemocracies, on average.

Today, two-thirds of the world’s states are on a democratic path – a reversal from just 15 years ago. And this number continues to grow. International lending to an ever diminishing percentage of countries ruled by tyrants should not be perpetuated by skewed notions of sovereign debt.

Moving toward a global system of democracy and rule of law requires ensuring that international financial structures reinforce newly democratic governments – and their investors – who play by the rules. It is right that most of Iraq’s debt should be forgiven – but so, too, should the debt for new democracies forced to endure the hangovers from the self-aggrandizing binges of their autocratic predecessors.

The writer is a fellow at the Council on Foreign Relations.