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Who Wins? The Political Economy of Sovereign Debt Restructuring


Throughout history, sovereigns have borrowed from banks, bondholders, other countries, and international institutions to fund their policy objectives. Without international laws to enforce the lending promise, many have puzzled over why lenders lend and why borrowers repay. However, few have asked what happens after default breaks the lending contract. How do borrowers and lenders negotiate a new contract? Who bears the distributive consequences of a broken commitment?

I analyze the debt restructuring process as a bargaining game over the size of creditor concessions, or "haircuts," which vary from zero to reductions in payments above 80%. I argue that governments' political will to repay their foreign debt is private information for which the political leadership has incentives to misrepresent. Not only do governments have incentives to plead distress to lenders, they have reasons to hide their economic distress from voters who will punish the government for financial mismanagement. Governments that are unwilling to pay, however, can convey their ``type" by publicly signaling their distress and invoking political punishment. I build on this political economy model to derive and test several hypotheses in four empirical chapters.

Using both quantitative and qualitative evidence alongside original data on creditor characteristics, I find that public declarations of debt distress do indeed elicit higher creditor concessions, but only where the action is politically costly. I also offer an extension of the model to investigate how creditor heterogeneity effects governments' preferences for costly signaling. Disperse groups of creditors are more difficult to coordinate and governments are more willing to use costly signaling as the number of creditors increases.

My findings provide important insights into debt restructuring specifically and the role of domestic politics in international negotiations generally. By introducing new variation to the processes and outcomes of debt restructuring, I lay new groundwork for analyzing how debt crises are resolved. I also demonstrate that leaders can strategically induce political costs born in equilibrium, in order to win concessions from their international negotiating partners. Leaders go public not because of appeals to transparency or democratic idealism, but because electoral constraints can be strategically leveraged to win favorable outcomes.

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