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Roadblock to recovery

IN THE past few weeks, former US Secretary of State James Baker has been trying to broker a deal whereby Iraq’s major creditors would agree to reduce and reschedule its foreign debt, now estimated at about $120 billion. He has provisional agreement from several European creditors, as well as Japan, and is now discussing the matter with major creditors in the Arab world. The Bush administration could make Baker’s task much easier, however, if it agreed to make a substantial contribution to the cost of Iraqi debt reduction. Such a commitment would not be unheard of - the US has done it before.

Fifty years ago, the United States and its allies were occupying a country deeply in debt to the rest of the world. A large coalition had invaded that country and overthrown a brutal dictator who had attacked his neighbours and brought destruction to his own people. Most concerned recognised the wisdom of rebuilding the occupied country’s economy and fostering the development of democratic institutions. That goal was achieved, dramatically. One important step in Germany’s road to prosperity and democracy was the London Debt Agreement of 1953, which cut Germany’s external debt in half and allowed it to repay the rest on generous terms. Those squabbling over Iraq’s debts today would do well to consider the lessons of the London Agreement.

Iraq’s external debts now total some $120 billion. The debt is creating the same problems in Iraq as it did in post-war Germany. Uncertain about Iraq’s external obligations, investors are reluctant to commit themselves to what could be a prosperous economy. The major creditors include France, Germany, and Russia - the three most important countries that opposed the invasion of Iraq. Other major creditors include Arab countries that have been victims of Saddam’s aggression in the past.

Most Press accounts have presented the Iraqi debt issue as part of the political struggle over the war itself. Baker’s efforts to achieve a debt reduction have been badly complicated by the Bush administration’s attempt to punish those opposed to the war by excluding them from Iraqi reconstruction contracts. The Truman and Eisenhower administrations took a different and much wiser approach to Germany’s debts.

At the outbreak of the Great Depression, both private and public entities in Germany were deeply in debt to foreign creditors. The Nazis and their immediate precursors defaulted on some obligations and made payments on others virtually worthless. The Germans also owed very large sums to the US, the U.K., and France for post-World War II civilian assistance. When negotiators met after the war to consider Germany’s debts, they agreed that the external debts were about $15 billion (about $100 billion in today’s dollars). This figure, while probably an underestimate of the debts outstanding, also seemed an impossible sum in light of the ruin that characterised the post-war German economy. The London Agreement gave the Germans renewed access to international capital markets, desperately needed to rebuild their economy.

In exchange Germany accepted responsibility for debts it might have hoped to avoid. The London Agreement, while recognising the economic consequences of Germany’s division into two sovereign states, also required that West Germany assume a disproportionate share of the reduced debt. The bargain was more than worth it; Germany’s economic miracle can be traced to many factors, but an important one was the restoration of access to capital markets enabled by the London Agreement.

The London Agreement was possible because the governments of France, the United Kingdom, and especially the United States accepted very large reductions in their own German loans, and pressured private creditors to accept similar reductions. Some private creditors were bitter at their governments’ pressure to write down loans they had extended in good faith. Some politicians objected to putting the interests of German debt reduction before those of their own taxpayers. The critics had a point: the German economy recovered more rapidly than expected, and Germany fulfilled the reduced obligations easily.

But repaying all the debt would have come at the expense of increased hardship for the German people, especially in the early years. The Allied negotiators understood that inflicting further suffering on Germany’s civilian population by demanding full payment would both delay the reconstruction of the general European economy and hamper efforts to build a peaceful and democratic Germany firmly anchored to the West. The concessions offered to the Germans were not just humane, they were pragmatic.

Iraqi debt reduction is in everyone’s interest. Only about $5 billion of the total is owed to the United States. Washington could forgive that amount and also repay some of the debt on Iraq’s behalf, perhaps sparing relatively poor countries part of the cost of the write-down. Iraq’s other creditors should ask whether full repayment is worth the price of continued instability in Iraq. France acted magnanimously in 1953, and in so doing helped create a Germany that is now a close partner rather than a dangerous foe. Germans might consider the strong economy and robust democratic institutions they have built over the past 50 years, and then ask how much harder those achievements would have been had they been required to repay twice as much external debt.

The Russian foreign minister recently remarked that Iraq did not deserve debt reduction because it is not a poor country. Neither was Germany in 1953; like Iraq today, it just needed time to recover from misrule. Russia now would benefit as much as anyone from a stable Iraq. For its part the Bush administration might reflect back on a United States government that was powerful enough to impose its will on virtually anyone, but wise enough to realise that doing so was not always in its own interest.

Timothy W. Guinnane is Professor of Economics and History at Yale University. This article is reprinted by permission of Yale Global Online.