When is a debt not a debt?

Global Finance, Jun 2003 by Beasley-Murray, Benjamin

The war in Iraq has called into question much of the architecture of international relations built up since the Second World War. The aftermath might shape the way that money is lent to emerging markets.

In Plato's Republic, Socrates argues that it is not always 'just' to 'give what is owed' you should not, for instance, return a borrowed sword to a man who is insane. Two millennia later, Paris law professor Alexander Nahum Sack came to the issue from the other side when he formulated the doctrine of 'odious debt'. It is not just, Sack claimed, for a nation to be obliged to repay debts that have been both harmful to it and unasked for by its people.

Sack's argument-which was formed in the wake of the Spanish American war when in 1898 America forgave Cuba's debts on the basis that they had been run up by a harmful colonizing power-has had scant impact on international law. The assumption has since been, as expressed in a US ruling, that "though the government changes, the nation remains, with rights and obligations unimpaired."

But this April, US deputy Defense Secretary Paul Wolfowitz refocused the debate on 'odious debt' when he told a US Senate committee that he believed Russia, France and Germany should write off "some or all of" the money owing them from Iraq, and added: "I hope they will think about the very large debts that come from money that was lent to [Saddam Hussein] to buy weapons and to build palaces and to build instruments of repression."

Because the Iraqi people did not back Saddam's dictatorial regime, the argument goes, and because they were instead harmed by it, they are not liable for loans that Saddam took. "If you think about the analogy in a private case, if somebody walks into a bank and claims to be me and borrows, I'm not liable for that," says Michael Kremer, a Harvard professor of economics and today's foremost champion of the 'odious debt' doctrine. "The people of Iraq really never agreed to take out these loans, and many of the loans really weren't to their benefit," he says.

The doctrine has a third condition for a debt to be considered odious, which is that lenders must be aware they are giving credit to a regime that is illegitimate and know that the loan is injurious to the country's people.The fact that not all loans made to 'bad' regimes are directly harmful is a key stumbling block for the doctrine. "The odious debt situation doesn't necessarily track or correlate with the nature of a government," says James Loftis, a partner at US law firm Vinson & Ellis and co-chair of its international litigation and arbitration group. "Even tyrannies buy food, right?" Loftis points out that whilst the Iraqi government may have put money to bad ends, it also borrowed money for projects like developing oilfields. "Presumably you still have that oilfield and in better condition than it was," he says. "It will produce an income in the future, and it might be difficult to pay off, but the moral argument that you shouldn't pay it off is much less powerful."

The fact that money is fungible is central to this problem. A loan for a country to build water purification plants may in turn allow investment in weapons research. "Money for one thing frees up money for something else," says Colin Rowat, a professor in economics at the University of Birmingham in the UK. Iraq's debts rose precipitously during the Iran and Iraq war and, says Rowat, "whatever they were nominally for, I think it's understood that these were for Iraq to continue to finance its war. Gulf Arab states gave Iraq money since they saw Iraq as fighting a war against Islamic fundamentalism on their behalf."

Kremer acknowledges that disentangling the purposes behind different loans can be tricky, but says that this is just one upshot of "the current system, where any loan is considered legitimate no matter how bad the dictator or no matter what purpose the dictator chooses." He argues that if the 'odious debt' doctrine is to be put to work effectively, it must be forward-looking rather than just retroactive. He advocates that the international community achieve consensus on regimes' illegitimacy and announce that thereafter loans to that country ought not to be honoured. "The advantage of setting up some sort of formal system," Kremer says,"is that, as with any other sanction regime, there could be discussion of when it might be appropriate to make an exception to this particular rule." So for example, he says, the international community might decide that a loan dedicated to health infrastructure, say, could be legitimate even if a country is ruled by a dictator.

In suggesting that an international body like the UN should judge regimes illegitimate and declare that future loans to that country should not be recognized, Kremer is going further than Sack's original formula. This, Kremer says, is because only recently has there developed a consensus that a government's legitimacy rests on democratic procedures. Up until the end of-and particularly during-the cold war, there was a strong presumption of non-interference in the affairs of other countries. Kremer cites the trial of former Serbian president Slobodan Milosevic and the momentum of the international human rights movement more generally as evidence of a change in international norms. "So I think there's been a big change since the time of the Spanish-American war until now," he says.