Sunday, November 21, 2004

Debt Forgiveness

The New York Times reports that
The world's leading industrial nations agreed Sunday to cancel 80 percent of the nearly $39 billion debt owed them by Iraq, a critical step in rebuilding the country's devastated economy and an important precedent for its other creditors to follow.
I frequently argue that cancelling debt to developing countries is a counterproductive policy because of the clear moral hazard problem (once I cancel your debt, why shouldn't you just run up that much debt again? There's no reason not to, it will just get cancelled again. Empirically, this is what happens). But in this case I'm happy to make an exception. Whatever we may say about Iraq's new government, this represents a clearly new sovereign, and one which is not continuous with the previous sovereign, so cancelling debt does not introduce moral hazard issues. Yay!

This does not leave the new Iraq entirely in the clear. There is still the demand of $100 billion in reparations from Kuwait, Saudi Arabia and other Middle Eastern countries left over from the first Gulf War. It is a credit to the Bush administration that it can get European countries to forgive debt. But it is much more significant what happens with Middle Eastern countries. Getting other countries in the Middle East to support the new Iraqi government by dropping demands for reparations would bode well for future stability in the region by demonstrating that they at least partially accept the legitimacy of the new government (although it might actually be about American power...).

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