Is it punishment? Sovereign defaults and the decline in trade

Abstract

JEL classification: F34 F10 G15Keywords: Sovereign debt Sovereign default Bilateral trade Sanctions a b s t r a c t Sovereign defaults are associated with declines in defaulting countries trade. Are these declines the result of trade sanctions as the trade sanctions argument of sovereign borrowing would suggest? We devise an empirical strategy to evaluate this issue based on the idea that if trade sanctions are causing the declines, bilateral trade with creditor countries should fall more than trade with other countries. We find that this is not the case. The analysis does not yield much evidence of broader punishment strategies including a league of major creditors either. These results contradict the predictions of the trade sanctions theory of sovereign borrowing.

Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation

“…Martinez and Sandleris (2008) show that the trade declines identi…ed by Rose (2005) are unrelated to the pattern of creditor holdings of debt. Moreover, in a study of sovereign debt across three centuries, Tomz (2007) …nds no evidence that trade sanctions were explicitly used to punish defaulters and uncovers little 8 proof that creditors ever used-or even threatened to use-military intervention to enforce debt contracts.…”

Sovereign defaulters: Do international capital markets punish them?

“…This would happen because a country that defaults is likely to be undergoing a series of economic difficulties that could also be captured by the default dummy variable. Recent contributions to the literature have attempted to ameliorate this identification problem using bilateral trade data (see Rose (2005), Mitchener and Weidenmier (2005) and Martinez and Sandleris (2008)). Even though these papers advance in the identification of a punishment mechanism, they do not provide conclusive evidence for the existence of a sanction used against insolvent countries.…”

“…First, Rose (2005) estimates that default leads to a significant and persistent decline in bilateral trade between the defaulter and its creditors that could be interpreted as a punishment. Using the same data but a different econometric model, Martinez and Sandleris (2008) argue that the decline in trade is not confined to the creditor-defaulter pair, casting doubts on the punishment mechanism. Finally, Mitchener and Weidenmier (2005) favor the view that Super-sanctions like military aggression by creditor countries and the forceful seizure of foreign currency-generating assets (e.g.…”

“…the national customs administration) are the most effective mechanisms for deterring sovereign default, rather than reductions in bilateral trade. 7 Similarly to Rose (2005) and Martinez and Sandleris (2008), we will use bilateral data to test for the existence of a punishment to defaulters. Nevertheless, we will focus on bilateral capital flows instead of trade in goods and services and study a more ample set of punishment mechanisms.…”

“…The data on FDI allows us to identify which country is the source and which country is the host or recipient of FDI flows. Following Rose (2005), Martinez and Sandleris (2008) and Arteta and Hale (2008), we use data on debt restructured at the Paris Club to date default episodes. This source gives information on the countries that restructured their debts and the specific creditors that were involved in the renegotiation process.…”