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Last week, we provided an overview of some of the financial sanctions against Iran and their complex and partly unanticipated effects. A presentation by Kimberly Ann Elliott on Syria caught our eye, as it exploits another angle—the long-standing concept of “odious debt”—to discourage contracts with target states. Elliott knows of what she speaks; she is co-author of the Peterson Institute’s Economic Sanctions Reconsidered, with Gary Hufbauer, Jeff Schott and Barbara Oegg, a pioneering study that helped spawn a growing academic literature on the topic. She was also a member of a task force at the Center for Global Development on Preventing Odious Obligations.
The idea stems from a long-standing issue in international finance: whether governments should be held responsible for the debts of predecessor governments. The question seems simple; it would be difficult to write long-term contracts if they were rewritten with every change of government or even regime. But the task force lays out the scenario in which it is much less obvious that all contracts should be honored:
“An illegitimate, unelected regime signs a contract with a foreign agent, handing over part of the national patrimony in exchange for a short-run payment, which the regime appropriates or uses in part to finance repression. Legitimate successor regimes often need to levy taxes to fulfill debt contracts incurred in this manner for fear of legal retribution and loss of reputation with investors if they fail to repay. And in the case of natural resource contracts, citizens continue to suffer from the sweetheart contracts that deprive the government of deserved revenues.”
Elliott’s response? Have the countries that house major financial centers—the US, UK, France, Germany, the Gulf States—declare in advance that any contracts signed with the target government will be considered illegitimate and unenforceable vis-à-vis any legitimate successor regime. Elliott’s presentation focuses on Syria, but the idea clearly has wider application.
The hook, as with many new financial sanctions, is the way in which market incentives end up multilateralizing sanctions. Any firm doing long-term business with a target country will need to consider the risks that their contracts will be unenforceable. At a minimum, such measures would raise the risk premium that illegitimate governments have to pay to conduct business and shorten the time horizons of investors. Such restrictions would also probably reduce the scale of investments and transactions. In surveys we have done on Chinese firms doing business in North Korea, some of these problems already appear to be in play in North Korea because of the weak property rights environment.
