Reviving Reputation Models of International Debt

Abstract

A general reputation model is developed in which countries repay their debt even when they do not face direct sanctions. The basic idea of the model is that if countries misbehave in one relationship, they will suffer negative consequences in other relationships. A necessary condition for countries to repay their debt is that misbehavior in the debt relationship spills over to a relationship that has enduring benefits for the countries. It is shown that when spillovers stay within the debt arena, reputation cannot support lending. Viewed this way, the benefits of maintaining a good relationship in one arena cannot be calculated simply by looking at that arena alone. Instead, account must be taken of the ramifications in a variety of other arenas, which, at least on the surface, may not seem to be directly connected to the arena in which the misbehavior occurs. This basic idea can be applied in many contexts.