Integrating a Theory of the State into Sovereign Debt Restructuring

Abstract

A theory of the state should motivate any system of sovereign debt restructuring. Governments should borrow funds in order to promote the long-term welfare of their citizens. This borrowing, however, increases the possibility of later financial distress, which can decrease the welfare of the nation's citizens. This essay draws on recent scholarship in the corporate and individual bankruptcy realms and argues that a sovereign debt restructuring system premised on a theory of the state would further three goals - encourage efficient investment, protect citizens against the extreme consequences of the nation's financial distress, and promote the adoption of responsible fiscal policies. A right on the part of the state to discharge some of its debt could further the first two of these goals. This discharge right could reduce the agency costs that often exist between the country's leaders and its citizens by encouraging lenders to better monitor the planned use of borrowed funds in the first instance. Such a right also provides a form of mandatory insurance for the country's citizens against extreme distress. As to the goal of prompting better fiscal policies, a sovereign debt restructuring system can achieve this by predicating relief on the adoption of such policies. Perhaps the biggest impediment to implementing a sovereign debt restructuring system along the lines sketched here is that few of the current players in the sovereign debt system have an incentive to advocate such a regime.

Keywords: Sovereign, debt, restructuring

JEL Classification: G33, K00