Democracy Before Debt

Yale School of Management Leaders Forum, The New York Times October 22, 1999

In response to the recent crisis in emerging markets, many experts have called for a new financial architecture. But worthy as the goal is, it is incomplete. Financial change without political reform will not result in a legitimate global economic system.

Look at it this way. Suppose bankers lend to a dictatorship, as Indonesia was, or a kleptocracy, as Russia seems to have become. Suppose further that debt piles up, and the government of the borrowing country cannot service its obligations. Then the International Monetary Fund (IMF) comes in and demands severe belt tightening. Who gets hurt? Certainly not the government officials who authorized the borrowing. No, it's the ordinary citizens who suffer as the economy goes into reverse gear. Did they ever agree to assume such risks? No way.

This is in fact what has happened. Tens of millions of people in emerging markets have fallen back into poverty. Families who had entered the middle class have seen their dreams vanish. Without a democratic voice, they had no control of the risks their governments assumed. Even more outrageous, without transparent political institutions and free press they had no way to understand these risks.

Some would call this taxation without representation. At another time, in another place, people overthrew a government for that.

In fact, history is filled with examples of non-democratic governments causing great harm to their citizens when finances ran into trouble. Before World War I, the bonds of more than sixty nations traded actively on exchanges in London and Paris. Eager pre-war investors loved emerging market debt and snapped up bonds issued by Russian Tsars, Persian Shahs, Egyptian Khedives and Ottoman Sultans. When the rulers couldn't pay their bills, bondholder committees, ultimately backed by military might, imposed controls and seized assets. In North Africa, European governments levied new taxes on transportation and tobacco to collect debt payments. What began as business-like restructurings of international loan defaults eventually became colonial governance. In all cases, an enormous burden fell squarely on people who never had a say, directly or indirectly, in the original contracting of the debt.

Let's be frank: foreign loans extended to non-democratic governments should be recognized for what they are -- joint ventures in exploitation. Governments that load up on debt and other foreign obligations must be representative of their citizens, for they are taking risks that are being borne by their citizens, and the people must have a way to peacefully throw them out of office if they feel they've been betrayed.

My reason for focusing on politics as well as finance is to seek ways maintain open markets, not restrict them. The free flow of capital is an essential ingredient in the world's prosperity and stability. But free markets are sustainable only when they rest on firm political foundations.

In the months since emerging markets began to recover, more than one high level committee of finance ministers and central bankers has been established to strengthen the global financial system. But will they have the courage and the mandate to draw urgent attention to the need for emerging markets to open their political systems, build their democratic institutions, and square with their people as to the implications of future financial obligations that will be undertaken? Will they demand not only economic transparency but political transparency?

The task of building both on a global scale is far from finished, and let's not forget the right sequence. Democracy before debt.

Professor William Goetzmann, who holds an MBA from the Yale School of Management and a Ph.D from Yale, directs the School's new International Center for Finance.