Panizza, Sturzenegger, and Zettelmeyer’s influential 2009 Journal of Economic Literature survey on the economics of debt and default has been referenced on different threads over the last few days. The message has been that the costs of sovereign default in terms debt market access and borrowing costs are relatively low. While I know that those referencing the paper know these findings provide only part of the picture, I am concerned that some blog readers will come away with too strong a conclusion.
The puzzle of sovereign debt markets is that they should only be possible if there are costs to default – and especially to voluntary default. In contrast to corporate borrowers, legal sanctions do not provide much of a deterrent for sovereign governments. The traditional explanation has instead focused on the value of reputation and thus on future access. But the finding of low direct capital market punishments for defaulters has put that explanation in doubt.
Yet sovereign debt markets are alive and well. From this we can infer that there must be costs of some sort. Recent attention has focused on domestic costs, such as the costs of severe output losses that have accompanied a number of recent debt crises.
Here is what Panizza et al. (cautiously) conclude:
If anything, defaults appear to be deterred by the domestic “collateral damage” that tends to accompany debt crises, rather than punishments from outside. While it is very difficult to empirically disentangle the causes and effects of defaults, there is at least some evidence supporting the idea that defaults may magnify the output drops observed during debt crises. Once output costs in line with this evidence are assumed in parameterized models of sovereign borrowing, the level of sovereign debt that can be sustained in equilibrium rise to more reasonable levels compared to models in capital market penalties are the only punishment.
One interesting possibility is that in a world with uncertainty about government/country type, revealing yourself as “non-honest” can have implications for broader dealings both domestically and internationally.
Even if we take a strict cost-benefit perspective, we should approach “default” cautiously – whether it is debt restructuring or the revocation of guarantees.