The Devil’s Haircut: Investor–State Disputes over Debt Restructuring

• Published date: 01 September 2019
• Date: 01 September 2019
• DOI: 10.1177/0022002718811531
• Author: Patrick E. Shea,Matthew DiGiuseppe
• Subject Matter: Articles

Article

The Devil’s Haircut:

Investor–State Disputes

over Debt Restructuring

Matthew DiGiuseppe

1

,

and Patrick E. Shea

2

Abstract

When do private creditors versus debtor states accept a greater burden in

resolving sovereign debt crises? In this study, we argue that distributive politics

helps explain the “haircut”—or losses—private creditors take in debt restruc-

turing cases. Despite the expected convergence of partisan policies in a globalized

economy, we argue that right and left leaders extract different settlements in debt

negotiations. Left governments, representing constituents most likely to be hurt

from higher debt repayment, credibly demonstrate more bargaining power and

extract greater concessions from creditors. Distributive politics, however, is an

indeterminate factor in explaining states entrance into debt negotiations. We use

recently released data on the outcome of sovereign debt restructuring cases

between states and private creditors from 1975 to 2013 to test our expectations.

Results from a double-hurdle model indicate that creditors receive a larger haircut

when negotiating with left governments.

Keywords

sovereign credit, bargaining, political economy, political leadership

1

Institute of Political Science, Leiden University, Leiden, the Netherlands

2

Department of Political Science, University of Houston, Houston, TX, USA

Corresponding Author:

Patrick E. Shea, Department of Political Science, University of Houston, 447 Philip Guthrie Hoffman Hall,

Houston, TX 77204, USA.

Email: pshea@uh.edu

Journal of Conflict Resolution

2019, Vol. 63(8) 1889-1922

ªThe Author(s) 2018

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DOI: 10.1177/0022002718811531

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Recent financial crises across the globe demonstrate the importance of foreign credit

in modern governance. Rising interest rates and restricted credit access cause eco-

nomic and political consequences that leave few within a debt-burdened country

unaffected. This study focuses on how leaders of debtor states must balance the

global market’s reactions to debt restructuring with the demands of citizens who

hold varying preferences on the distributive effects of debt.

We argue that both left and right leaders want to minimize the need to seek debt

relief to limit the risk of higher interest rates. Once embedded into a debt crisis,

however, left leaders discount the importance of higher credit prices more than right

leaders. Left leaders count few capital holders among their supporters and thus care

less about future interest rates and care more about immediate available government

revenue with which to fund government programs. As a result, left leaders benefit

more from debt relief and will bargain harder for larger creditor losses.

We focus our analysis on sovereign debt disputes because restructuring outcomes

have a strong influence on a country’s ability to reenter credit markets and subse-

quent borrowing costs (Cruces and Trebesch 2013). Growing sovereign debt burdens

also suggest that default and restructuring will become more common. Europe’s

average debt-to-GDP level has increased 50 percent since the 2007 global financial

crisis to reach its current level of over 60 percent debt-to-GDP (Abbas et al. 2011,

updated to 2015). Unsustainable debt posesapotentialthreattomostnational

governments, given that sovereign debt constitutes about 20 percent of the global

financial assets (Tomz and Wright 2013). In addition, credit analysts are concerned

with a contagious trend of anti-austerity politics (Moody’s Investor Service 2015).

The situation in Europe may be the beginning of a deepening global crisis, requiring

many new rounds of debt restructuring negotiations. Greece’s finance mini ster

compared the Greek debt crisis to a sinking ship: “Of course, the people in the third

class, as in the Titanic, start feeling the drowning effects first” (Chew 2015).

Investors worry that some leaders will have difficulty “delivering centrist policies

while being accountable to political allies with a skeptical stance towards the market

economy” (Wise 2015). This worry extends beyond Greece and Europe. The global

average debt-to-GDP level in 2015 was nearly 50 percent, with high debt levels

dispersed throughout all regions. Figure 1 maps debt levels across the globe in 2015,

with darker-shaded countries representing high levels of debt. Even countries with

reasonable levels of debt—mostly petro-states—have debt concerns given low com-

modity prices. Credit raters recently downgraded Saudi Arabia’s creditworthiness,

and the United States needed to guarantee a new loan to Jordan to finance its defense

against Islamic State insurgents (Reuters 2015; U.S. State 2015). In sum, we expect

that debt restructuring negotiations will be more frequent in the future.

Most research related to debt restructuring either focuses on the economic and

financial consequences of these negotiations (Bulow and Rogoff 1989; Rose 2005;

Cruces and Trebesch 2013) or offers normative proposals on how to improve the

debt restructuring process (Kroszner 2003; Krueger 2003; Eichengreen 2003). While

our study does not seek to address or explain all dynamics of debt negotiations, we

1890 Journal of Conflict Resolution 63(8)

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60

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120+

Debt−to−GD

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Figure 1. Debt-to-GDP levels in 2015. Debt-to-GDP data are taken from Abbas et al. (2011, updated to 2015). Darker shading

represents higher debt. Gray states have missing data.

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