Sovereign debt and international cooperation: Reputational reasons for lending and repayment

This study addresses a fundamental question in world affairs: how can cooperation emerge in a condition of international anarchy? Through an analysis of relations among sovereign governments and foreign lenders over three centuries, I find that cooperation in global finance depends more on reputation than on the threat of retaliation. I also indicate how this result could deepen our understanding of cooperation in other areas of international and domestic affairs.; I develop a theory that explains how reputations form in international capital markets and affect the incentives of lenders and borrowers. There are, I argue, many types of sovereign borrowers, some more resolute and competent than others in meeting their foreign debts. Lenders form beliefs about each borrower and update them after watching how the borrower behaves during good times and bad. Knowing this, countries repay to avoid being classified as lemons and screened-out of capital markets.; My theory not merely posits that reputations matter, but it also generates specific predictions about how they work. Countries that repay despite extreme adversity can climb the reputational ladder and refinance their debts at better rates, while those that default without just cause cannot raise another cent. Lenders will excuse a country for suspending payments during hard times, provided it offers an adequate settlement that signals it is not a lemon. Finally, countries without a credit record are charged a risk premium, which declines over time conditional on faithful repayment. I test these predictions with both statistical analyses and case studies. The data, compiled from primary sources spanning three centuries, strongly support my theory.; This study also challenges established sanction-based theories, in which actors enforce cooperation by threatening to retaliate against cheaters. I show that the reputation and sanctioning mechanisms are distinct, though not mutually exclusive. I then argue that sanctioning theories suffer from a credibility deficit: profit-seeking bondholders and banks generally would not collaborate in punishing a government for defaulting on someone else's loans, and even the original lender may prefer not to carry out its threats. Despite a battery of tests, I find almost no empirical support for sanctioning theories.