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Stephanie Blankenburg discusses what governments really need to finance transformative development & to manage financial and/or debt crises in a way that will not undermine their nation’s economic growth potential and future ability to contract and pay for debt

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Part 1

LYNN FRIES, TRNN: Welcome to the Real News Network. I’m Lynn Fries in Geneva. When the creditor-debtor relationship involves a sovereign state, that nation’s people and its economy are at stake. Here to talk to us about issues of sovereign debt is economist Stephanie Blankenburg who joins us in Geneva. Stephanie Blankenburg is Head of the Debt and Development Finance Branch of UNCTAD, the United Nations. Welcome, Stephanie. STEPHANIE BLANKENBURG, HEAD OF DEBT AND DEVELOPMENT FINANCE BRANCH, UNCTAD: Thank you. FRIES: We’re talking about sovereign or or external debt. In other words, public debt governments owe to foreigners or international creditors. Taking recent history, say from post-World War II, talk about some cases of public debt crisis, and whether they were self-inflicted or otherwise. BLANKENBURG: Well, it depends a bit on what you mean by self-inflicted. Because in the case of Germany, of course I might reference to Germany’s role as a state and a government plus as a people in two world wars. And especially in the second world war and the resulting, the resulting debt. So that’s relatively straightforward, it’s not a question of government versus the people, it’s a question of political processes and the responsibility for having harmed their own economy as well as the economy of other countries very substantially in the context of war. Now, that is obviously a very specific situation. Beyond that, the question–or a broad question–is has sovereign debt been caused by public profligacy, i.e. by decision making in the public sector that has meant unsustainable spending patterns for whatever either political or economic goals there may have been, emphasis on unsustainable. Badly planned, badly managed and so on. Or are we in a situation in which most of debt has in a very decentralized way been contracted by private entities. That can be companies, that can be households, to the extent of being exposed to a debt crisis once financial instability hits those debt contracts for, again, a number of reasons. Once that happens and there is financial instability, there might be a debt crisis. Then governments very often have to socialize a lot of the private debt in order to manage it, in order to deal with it, in order to maintain access to international financial markets for the economy as a whole, and in order to limit bankruptcies in the economy, for example. Now, this has been the much more typical pattern of the emergence of public finance crisis in developing economies as well, of course, as in many of the affected eurozone economies in the context of the euro crisis. So that would mean it’s not a self-inflicted crisis from the point of view of the public sector. It’s a crisis that has been inflicted systematically and over the long-term by the private sector, both on the side of irresponsible borrowing as well as of irresponsible lending to private agents. FRIES: Talk more on the point you make that for the economy as a whole governments need to maintain access to international financial markets. Give us some context of what all this means for sovereign states today. BLANKENBURG: Well, it simply means that the access that governments have to multilateral debt, i.e.–to multilateral finance, I should say. So finance that comes either from multilateral organizations, or that comes from groups of other states, nowadays is limited. And as in other parts of the economy of the world economy, there has been a process of privatization. In particular of course in the area of finance, which means that governments in order to contract external debt will be accessing much more international financial markets, will be going in particular to bond markets at much higher interest than they would in the context of contracting multilateral debt from international organizations or from groups of other states, or even bilateral states, i.e., government-government debt. That’s part of financialization over the last 20-30 years, and it basically means that the market for sovereign debt is now dominated by, or is at least strongly influenced by private bondholders. From a legal point of view what that means when you enter into a bond contract, you have to do this under some jurisdiction. There’s no international jurisdiction under which you can do this. And very many developing country states will allow their debt contracts to be issued under in particular U.S. and UK legislation–jurisdiction, sorry, because this reinforces investor confidence in the credibility of the process. In cases, for example, where investors otherwise would not have much confidence, say, in the Argentine legal system or the legal system of another developing country. Rightly or wrongly so, but they wouldn’t, and therefore would not acquire a bond, i.e. would not be lending to this economy. So in that sense, governments clearly are much more exposed to the vagaries of international financial markets, the developing country governments in particular. There are always two sides to the coin. It does often mean that they of course can have very often rapid access to a lot of international finance. There is what then is in retrospect often referred to as irresponsible lending. So it can mean that for example, access by governments to finance that they think they require can be fast, can be quick. But of course, the liabilities that result from this can be much more complex, much more difficult to resolve than would be the case under some kind of multilateral process. FRIES: Before we get into the multilateral story, talk more on structural challenges facing governments as they contract sovereign debt. BLANKENBURG: On the side of the structural problem, we are looking at economies that operate at relatively low levels of productivity compared to the leading economies in the world economy, and that have to undergo very, very long-term, very profound transformations of the way in which their economies are organized, on the way in which they are often–social sectors are organized as a consequence, their other institutions are organized, the administration is organized. These are very, these are mega-processes of change. Now, those have to be financed. And that means that there is an enormous finance need, enormous finance requirement. The more risky financing of this process is, the more likely are we going to have destabilizing crisis. And if a crisis hits you–let me put it another way. If you have a crisis that hits your dairy sector, you will have a lot of small dairy farms, a dairy farm here or there might be affected. That’s not going to affect your overall economy. If that crisis hits a very large steel factory, or you get this wrong then that may affect your overall economy. So if you are dealing with these mega-transformation processes and you enter into a phase of financial instability, it can have very, very big effects on that transformation process. It’s not just a simple growth process. It means changing the whole of society and not just the whole of the economy. Now, clearly the finance need for that, as I said, is enormous. And it will come from many sources. So that’s one aspect of it. The other aspect is of course that we have governments in places even in developing countries that may or not use the resources they do have access to for the purpose of this overall transformation, and they may do so more or less effectively. So we can run into problems also because governments engage in spending patterns that are not necessarily helpful to that transformation. And finally we have a whole world outside that transformation process in any particular developing country that determines very largely how money is lent. And the more of this money that is being lent comes from multiple private sources who themselves are all part of that big casino that is the international financial market, the less stable that finance will be. FRIES: And what then if a debtor country runs into trouble, and needs to get its international creditors around a table? Do more difficulties lie ahead? BLANKENBURG: Yes. I mean there’s certainly, certainly what countries that contract sovereign debt, sovereign external debt, face up to these days is an extremely fragmented system. So there are a number of institutions that deal with debt between states as well as between–as with debt between states and private creditors and that these are different institutions. Plus there are also direct debt negotiations between governments without any intermediary between governments and private creditors. And those private creditors can of course be multiple creditors. They can be financial institutions. They can be other forms of private companies. They can even in principle be private individuals. All of this multitude of creditors has to be organized by the governments themselves, or there are a few international ad-hoc arrangements they can use, such as the London Club or the Paris Club, for example. Of course, the IMF can get involved. So there are multilateral elements of international organizations dealing with aspects of external debt of sovereign countries. Plus, then, a number of ad-hoc arrangements to deal with this too, as well as private creditors. So this is basically, it’s a chaotic system. So this is why I said before, what we really need is multilateral processes both for the financing of these mega-transformation processes as well as for dealing with situations where crisis, financial crisis, debt crisis, has happened as they inevitably will under such quite demanding circumstances. FRIES: Thank you, Stephanie. Talk more about that next. We’re going to take a short break and be right back with economist Stephanie Blankenburg.

Part 2

FRIES: Welcome back. BLANKENBURG: Thank you. FRIES: We’re going to pick up with your concluding point from Part 1, that what governments really need, both for the financing of mega-transformation processes as well as for dealing with situations of financial and or debt crisis is a multilateral process. Governments the world over apparently agree with that, this according to an historic UN vote. Tell us about that. BLANKENBURG: Well, this is a resolution that was passed with a majority in September of last year in the UN General Assembly, by the UN General Assembly, that calls for the establishment of a multilateral legal framework to address sovereign debt issues, to address sovereign debt resolution. Now, this is precisely the idea that we need to institute an international process that uses multilateralism in order to systematically and in an orderly process that has a number of features allows external sovereign debt to be addressed such that it will not undermine an economy’s growth potential and therefore also future ability to contract and to pay for debt. That’s what, what this resolution calls for. It’s in this respect a very important step, since it makes clear that a majority of members of the UN consider this necessary and important at this moment in time. FRIES: Talk more about the sovereign debt restructuring process to give us some context on why governments would call for a multilateral legal framework. BLANKENBURG: Yes. I mean, certainly legal judgments in terms of in particular holdout litigation, i.e. vulture funds trying to make very high rates of profits on the back of discounted government bonds. That–those kind of judgments certainly have strengthened creditor rights. And generally it is probably fair to say that over the past 20-30 years there has been a gradual strengthening of creditor, private creditor rights in particular, in regard to sovereign debt markets. A multilateral process would therefore reintroduce more balance into sovereign debt restructuring simply by allowing for an orderly system to emerge that can explicitly take account of the fact that you’re here not dealing private creditor to private debtor but that you are dealing private creditors as well as official creditors to a sovereign state, and that therefore in negotiations, say, about restructuring the interest of that sovereign state has to be taken into account explicitly. It cannot just be a matter of saying, well, that contract is like any other private contract. It just has to be stuck by, it just has to be following the rules, since the impact on millions of people, in terms of their everyday livelihood as well as in terms of their future livelihood and the future potential of an economy are at stake here. There’s just too much at stake. As someone said at some point, I think it was Martin Wolf in the Financial Times, debt servicing is very important but it’s not more important than everything. And that would be recognized in a multilateral process where you can then establish international rules, internationally accepted rules, hopefully by a large number of either member states of the UN or member states of the international community more broadly, that will allow for space for, for example, deciding at which point an economy will ask for debt restructuring. When you ask for debt restructuring, you are basically admitting that you have a problem. If you are highly exposed to international financial markets with very volatile investor sentiment, this can in itself have repercussions. So even if you’re not already in a crisis, you might very well be in a crisis relatively soon just simply because you’ve said you might have a problem. So you will have rules about how debt restructuring is asked for that will contain the possibility of a simple panic crisis in response. You will have rules about what we often–what we call standstill provision, i.e. you will have rules that while negotiations are going on about what should be done about an economy’s situation, what type of debt problem it has, how this should be addressed, in the time in which this is being assessed and negotiations start about what to do about it, there cannot be any litigation. That’s what that means. You will also have provisions for, for example interim finance, i.e. that while negotiations happen, while it’s being assessed at an international level under international rules what the country’s problem exactly is, what best should be done about it in order to preserve its future growth potential, while all this is happening finance will be provided at reasonable conditions to for example allow the economy to maintain necessary imports, to give you an example. Or generally speaking, keep running. Or keep at least the basics running. There will be rules that would allow an economy, for example, to impose capital controls while a process of adjustment is happening. And also during negotiations in order to avoid damage happening just on the basis that these negotiations are happening, or an impending crisis might be unfolding, to use capital controls in order to prevent capital flight, damaging capital flight from the economy, and so on. So there would be a number of steps put into place. You would have a clear framework whereby both private as well as official creditors could get a sense of what will happen if a crisis is declared, or a problem, at least, is declared. What will happen, what are the likely outcomes to be. The clarity of this alone, the orderliness of it alone, the potential predictability even within limits of this alone would probably be very helpful to avoid a number of crisis, and to avoid mega-economic recessions that often are at least in part the result simply of the fragmented and disorderly process that we have now. FRIES: So is a multilateral process for dealing with sovereign debt crisis essentially what Germany got in its historic external debt agreement, the 1953 London debt accord? BLANKENBURG: Well, it was a de facto emerging multilateral context in which the Western allies dealt with the situation in Western Germany, not what was to become Eastern Germany because the Federal Republic of Germany, i.e. what people often refer to as West Germany, had taken on Germany’s post-war debt as a whole. And that debt was then negotiated with France, Britain, the UK and a large number of other [partly] Eastern European economies for example, who had been affected by German war activity. One can say that this was a sort of emerging multilateral process, and of course it fed into what later was to become the Bretton Woods system, i.e. what was to become a much more established framework for multilateral interaction in the international economy. The whole of the Bretton Woods system was a system that emerged from the role of the allied nations and the United Nations during the second world war. So there is a direct line between this. And Germany, certainly as far as external debt is concerned, hugely benefited from this process. Probably it’s the economy that benefited most from that kind of multilateral approach, where the overall objective was to allow for German economic recovery. And fast economic recovery. FRIES: Germany’s external debt agreement has stood the test of time. In other words, it hasn’t unraveled on the back of creditor lawsuits. Is that because its creditors were governments? BLANKENBURG: Well, there were some, there were some private creditors as well. So it was a whole, what you–. German debt that stemmed both from the first world war as well as the second world war was negotiated around the table in London in 1953. And round this table you had the German side, you had the Western allies, you had other governments from, in altogether I think–I can’t remember the exact number, the amount, 19 or 20 other governments, plus Germany’s private creditors, too. So you brought all the creditors that there were round the table at one moment in time. FRIES: And it was this external debt agreement, the 1953 London Debt Accord that gave Germany its fresh start? BLANKENBURG: Yes. I mean, it was given to Germany by the Western allies in 1953. It was given with a very clear view that the most important goal was to preserve and rebuild the German economic capacities and Germany’s ability to recover, as I said, from essentially self-inflicted harm in this case even as quickly as possible. Now, the reasons for this were not just enlightened insight into how economies function, though some people were more enlightened than others. But it was of course also political. West Germany was going to become a stalwart against communism. The Cold War had started. There was a very clear political motivation for helping Germany to recover. But at the same time the economic logic of it also was very, very clear. The agreement is an exemplary template for why debt relief, why debt cancellation is needed, how it should be organized. Let me give you an example. Under this agreement, Germany was not allowed to use more than 5 percent of its export earnings in order to service debt, since this was regarded detrimental to the future dynamics of the economy. And in addition, Germany was allowed to stop debt payments the moment it registered a trade deficit. So the idea was that Germany would be repaying debt only out of trade surplus, of export earnings that constituted trade surplus, and even then only to 5 percent of this in order to allow the maximum potential of productive reinvestment into the German economy while maintaining some capacity for debt servicing. Now, that’s the correct economic logic. That economic logic stands today just as it stood then. But it is for fundamentally ideological reasons no longer accepted, and the position nowadays is exactly the opposite, namely that you have to pay the debt first then grow. How you are then supposed to grow is not, it’s not clear, but little does it matter. FRIES: Stephanie Blankenburg, thank you. BLANKENBURG: I thank you. It was a pleasure to come here. FRIES: And thank you for joining us on the Real News Network.


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Dr Stephanie Blankenburg is Head of the Debt & Development Finance Branch in the Division on Globalization and Development Strategies at UNCTAD in Geneva. Prior to joining UNCTAD in 2015, Stephanie Blankenburg was Senior Lecturer in Economics in the Department of Economics at the School of Oriental and African Studies (SOAS), were she taught and researched on global economic policy issues, industrial policy, advanced macroeconomic theory and topics in the history of economic thought. Dr Blankenburg previously was Director of Studies and College Teaching Officer at St Edmund's College, Cambridge University (UK) , and held a Junior Research Fellowship at the ESRC Centre for Business Research in the Faculty of Applied Economics, Cambridge University (UK).