The roadblock to a sovereign bankruptcy law.

• Author: Sachs, Jeffrey D.

Bankruptcy law is a necessary feature of a modern economy, and the principles for a bankruptcy apply whether the debtor happens to be a sovereign or not. The essential point is that markets cannot handle situations of extreme financial distress or debtor-creditor workouts in an efficient manner without a sound legal framework. Indeed, Adam Smith himself was a champion of applying bankruptcy processes to insolvent sovereign debtors, arguing that when the situation warranted it, bankruptcy was a sensible alternative to the chaotic ways that sovereign insolvency was otherwise handled. (1) Thus, the fact that the private financial community continues to oppose a sovereign bankruptcy law is quite unconvincing, especially since an enormous number of countries has had a sovereign workout at some point in history.

Debt Relief to Promote Growth and Democracy

When the Berlin Wall fell and I was advising the Polish government on how to handle the debt it inherited from the Soviet Union, I knew that we needed to get the debt canceled so that free post-communist Poland would have a chance to resume economic growth, regain social stability and develop its democracy. The big opponent at the beginning was Germany, so I went to the Library of Congress and took out the 1953 London Debt Agreement that granted Germany a substantial reduction of its pre-war and post-war debts to allow the new German government to function and to consolidate democracy. I gave the Polish Finance Minister Leszek Balcerowiez a copy of the London Debt Agreement for his meeting with Chancellor Kohl. At first the Chancellor rejected the idea of debt forgiveness, but when Balcerowicz handed him the London Debt Agreement, he looked at it and said, "Well, we may have to do something about this indeed!" Germany then became a supporter of Poland's debt cancellation and the rest is history.

Although there have been dozens of eases in which bankruptcy-type principles were eventually applied, there has never been a proper system for dealing with them. Managing sovereign insolvency is all polities--whose favored pupil or geopolitical ward you are, or perhaps whose enemy you are. Countries of special geopolitical or military concern to the United States get special treatment. Israel and Egypt got debt cancellations from the United States, as did Indonesia in 1969. Poland, the bulwark of NATO and Eastern Europe, got its debt cancellation. Quite obviously, these debt cancellations were driven by...