Working Paper: NBER ID: w2726
Authors: Joshua Aizenman
Abstract: This paper analyzes the factors determining the effective payment on outstanding debt in the presence of partial defaults, and the feasibility of renewed investment. We show that the bargaining outcome, which determines the repayment, is dictated by the trade dependency, as measured by the substitutability of domestic and foreign products. A higher relative size of sectors with lower substitutability between domestic and foreign products will increase the trade dependency of the nation, reducing its bargaining power arid thereby increasing the resource transfer ceiling. The resultant increase in the ceiling makes the nation less risky, increasing the willingness of creditors to lend. Thus, while a strategy of outward growth has the cost of increasing trade dependency, it has the benefit of increasing the availability of external finance. Even with a partial default, investment in highly trade dependent sectors with high productivity may be warranted. This investment can be implemented by a marginal relief of the present debt service, in exchange for investment in the proper sector. Following such a scheme may require a detailed conditionality as well as careful monitoring. A way to partially overcome some of the monitoring problems is through direct investment.
Keywords: trade dependency; bargaining; external debt; investment policy; conditionality
JEL Codes: F34; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade dependency (F10) | bargaining power (C79) |
| bargaining power (C79) | resource transfer ceiling (F16) |
| trade dependency (F10) | resource transfer ceiling (F16) |
| investment strategy (G11) | bargaining outcomes (C78) |
| trade dependency (F10) | willingness to lend (G21) |