Commentary

Debt Forgiveness

By Patricia Adams
September 16, 2003

Before the recent war in Iraq began, Iraqi exiles expressed their hopes for a democratic post-Saddam Iraq, including their hopes for the disposition of Saddam’s debts. These Iraqis wanted the future administration of Iraq to review the debts accumulated under Saddam’s regime, to pay back those loans that were used for benign purposes, and to repudiate those that were used for objectionable purposes.

Their argument rang true to those who understood the inherent moral position of their case. How offensive it would be to Iraqis to be forced to repay the French, the Russians, and others who had helped Saddam oppress them. The Iraqi argument also captured the attention of governments and the press, particularly as the West learned that the Iraqi approach has a basis in law — it reflects a 100-year-old legal principle that has come to be known as the Doctrine of Odious Debts.

The Doctrine of Odious Debts was created to further international finance by limiting the ability of governments to repudiate debts. Under the doctrine, three conditions must be present before a state can repudiate a debt:

  1. The debt must have been incurred without the consent of the people of the state.
  2. The debt can not have benefitted the public in that state.
  3. The lender must have been aware of these two conditions.

The United States employed these principles after the Spanish-American War to repudiate the Cuban debts. Iraqis want to employ these principles, too. Here is how Alexander Sack, the Russian legal scholar who coined the term “odious debts,” put it:

“If a despotic power incurs a debt not for the needs or in the interest of the State, but to strengthen its despotic regime…this debt is odious….This debt is not an obligation for the nation; it is a regime’s debt, a personal debt of the power that has incurred it, consequently it falls with the fall of this power.”

A new Iraqi government could employ this doctrine by establishing a judicial debt arbitration panel, composed of respected Iraqi and international jurists, under recognized rules of arbitration — rules that Western nations now employ. This panel would then invite creditors to submit claims, including documentation that the loans were indeed used in the interests of the Iraqi people, and not, in the words of U.S. Deputy Defense Secretary Paul Wolfowitz, “to buy weapons and to build palaces and to build instruments of repression.”

The alternative to such a procedure — taking Iraq’s debts to the Paris Club without establishing their legitimacy — would be a grave mistake. The Paris Club, which uses Western taxpayer dollars to rescue misplaced loans by public lenders, has long been the world’s premier bailout agency. This club — an informal grouping of the world’s largest creditor nations — would legitimize Saddam Hussein’s debts as debts of the Iraqi people, providing France and Russia, as well as lesser lenders such as Germany, with moral victory and a partial bailout.

Those nations are entitled to neither, as Iraqis well know. Iraqis also know that under international law, they need not repay those who financed their oppression.

Because the Paris Club’s bailouts let negligent lenders and corrupt borrowers off the hook, many have been looking for an alternative. Some, including Harvard’s Michael Kremer and Oxfam, both of whom seem driven by humanitarian concerns, have seized on odious debts as that alternative, but in an ill-advised way. Rather than assessing the legitimacy of individual loans, this camp would assess the odiousness of entire regimes by creating an international body to sit in judgment of the world’s governments. It would forewarn creditors by labeling good governments as worthy, and corrupt or repressive ones as odious.

Their proposal, which places so much faith in international institutions, flies in the face of the last 50 years’ experience. During this time, unaccountable lending to (and bailouts of) corrupt and unrepresentative governments has come precisely from international agencies such as the U.N., the World Bank and the IMF. The politicized governance structure of international agencies guarantee that odious regimes will rarely be classed as such. Take the case of Iraq. Does anyone think France, Germany, and Russia would have allowed Saddam to be blacklisted?

Even if an international agency could somehow make un-politicized judgments, this approach would only entrench the moral hazard that created odious debts in the first place. Any financial institution, public or private, that extended credit to a government that had received a stamp of approval would be handed a defense if it failed to exercise due diligence in ensuring that its loans were used in the interest of the state, as the Doctrine of Odious Debts demands. As a result, the moral hazard of both creditors and debtors would rise to new heights.

The Doctrine of Odious Debts would not only promote accountability, it would promote democracy. Consider Iraq. Deciding the disposition of debts by the rule of law, through a public judicial process that allows Iraqis, the domestic and international press, and anyone else to understand who lent how much to whom and for what purpose, would give Iraqis confidence that government can work and can be trusted.

In contrast, a closed-door Paris Club conference would breed cynicism, in Iraq and around the world. It would be seen as no more than an international fix in which the United States parceled out Iraq’s resources to Russia, France and other major creditors.

An odious debt legal regime would also promote democracy in creditor states. In Canada and most European nations, the lending of state enterprises is generally hidden from taxpayers. Canada’s export credit agency, Export Development Canada, for example, is exempt from Canada’s Access to Information law. In the case of Iraq, state agencies from France, Germany and Russia may have made questionable loans. Under an odious debt process, they would need to establish that they acted with due diligence to be entitled to repayment. Knowing this, they would be less likely to make questionable loans in future.

Finally, an odious debt legal regime would further the war on terrorism. The United States has found that many Western countries are reluctant to force lenders to disclose their loans. Sometimes the lenders are state agencies, sometimes well-connected private lenders. The goal of somehow regulating the countless transactions involving terrorist states becomes infinitely easier when self-regulation augments state regulation. When lenders from France, Germany, Canada or anywhere else realize that repayment to an Iraq under Saddam, a Syria, a North Korea, a Cuba, depends on the regime staying in power long enough to see the money repaid, they will think twice about making the loans, and demand a higher premium if they do.

Some argue that the Doctrine of Odious Debts would destabilize international finance. They have it backwards. By making the rules clear, the flow of future lending for bona fide state purposes would be strengthened because lenders would know that their loans would stand up in a court of law. While the rules would permit lending to odious regimes — for roads, education and other legitimate purposes — it would discourage loans used to build palaces and to arm a regime against its own people. It would diminish the spoils of power that encourage tyrants to seek power, and more importantly, it would starve them of the funds they need to maintain their power. In the end, a world of lenders and borrowers disciplined by the Doctrine of Odious Debts would promote both economic and political stability.

Patricia Adams is executive director of Probe International and author of “Odious Debts.” This commentary, first published in the National Post, was presented at the Cato Institute conference, “Rebuilding Iraq: Prospects for Freedom and Prosperity,” June 26, 2003.