Serial Default and the “Paradox” of Rich-to-Poor Capital Flows

Abstract:

Lightning may never strike twice in the same place, but the same cannot be said of sovereign default. Throughout history, governments have demonstrated that “serial default” is the rule, not the exception. Argentina has famously defaulted on five occasions since its birth in the 1820’s. However, as shown in Table 1, Argentina’s record is surpassed by many countries in the New World (Brazil, Mexico, Uruguay, Venezuela, and Ecuador) and by almost as many in the Old World (France, Germany, Portugal, Spain, and Turkey). At the same time, a smaller and dwindling number of developing countries such as India, Korea, Malaysia, Mauritius, Singapore, and Thailand have yet to default, despite being tested by severe turmoil, including the Asian crisis of the late 1990’s. What can explain such striking differences in default performance? State-of-the-art theoretical models of debt crises stress the importance of multiple equilibria where random investor panics can become self-fulfilling. The implication is that economists may never be able to precisely explain sovereign defaults, much less predict them. Nevertheless, the fact that sovereign defaults tend to recur like clockwork in some countries, while being absent in others, suggests that there must be a significant explainable component as well.

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