State dissolution, sovereign debt and default: Lessons from the UK and Ireland, 1920-1938
Nathan FOLEY-FISHER (email@example.com) Federal Reserve Board
Eoin MCLAUGHLIN (firstname.lastname@example.org) University of St Andrews
We study Ireland´s inheritance of debt following its secession from the United Kingdom at the beginning of the twentieth century. Exploiting structural differences in bonds guaranteed by the UK and Irish governments, we can identify perceived uncertainty about fiscal responsibility in the aftermath of the sovereign breakup. We document that Ireland´s default on intergovernmental payments was an important event. Although payments from the Irish government ceased, the UK government instructed its Treasury to continue making interest and principal repayments. As a result, the risk premium on the bonds the UK government had guaranteed fell to about zero. Our findings are consistent with persistent ambiguity about fiscal responsibility far-beyond sovereign breakup. We discuss the political and economic forces behind the Irish and UK governments´ decisions, and suggest lessons for modern-day states that are eyeing dissolution. “Further, in view of all the historical circumstances, it is not equitable that the Irish people should be obliged to pay away these moneys” – Eamon De Valera, 12 October 1932 —
Review by Anna Missiaia
The current public debate on the possible secession of Scotland has largely focused on the economic effects for Scotland (as opposed to the rest of the UK). Paul Krugman’s eloquent post “Scots, What the Heck?” warns on the monetary issues that would arise after a victory of the “yes” to Scottish independence on September 18th, while Martin Wolf’s article “What happens after a Yes vote will shock the Scots” explains how Scotland would face years of negotiations and uncertainty before settling down. All of which would come at a cost. But do all economic consequences of independence really fall exclusively on those who leave? Economic history can bring some insights on the matter.
The paper by Nathan Foley-Fisher Eoin McLaughlin was circulated by NEP-HIS on 2014-09-05. This research explores how the Irish independence of 1921 was dealt with in terms of public debt inheritance by Ireland.
After independence and as a result of the negotiations on sovereign debt, the Irish committed to repay land bonds that were previously used to implement a land reform in that country. In 1932 the Irish Government decided to stop interest and principal repayments of these bonds. Ireland effectively defaulted on public debt that it had inherited from the UK. However, the Irish default had no consequences on bondholders because the British Government decided to asume those liabilities and continue with the payments.
Foley-Fisher and McLaughlin looked at the evolution of the spread between Irish land bonds and the “regular” British bonds to assess the reaction of investors. Their methodology was very intuitive and straightforward: it encompassed the identification of structural breaks in the spread series to assess which events affected the risk premium. The two main breaks correspond to the Anglo-Irish War, during which there was an elevated risk of default by farmers and the second one in 1932, when the possibility of Ireland defaulting on the land bonds started to emerge.
The estimates of Foley-Fisher and McLaughlin suggest that that the increased spread (originated by both breaks) remained “high” long after independence and in spite of the formal commitments by both the Irish (to repay) and British (to guarantee payments). Following the Irish default, the spread return to zero once the UK Government started to repay bondholder.
The authors identify several reasons why the British Government decided to back the Irish rather than pass the burden of the default on to the bondholders. These reasons included the relatively contained cost for the UK Treasure, the fact that most bondholders were based in the UK and the fear by the UK to be accused of a lack of commitment. Therefore, the cost of the default was greater for the British. Foley-Fisher and McLaughlin also point out that the willingness by the British to take up such a burden depended on the particular situation between Ireland and the UK. In other cases, such as the default of Newfoundland in 1932, the British government was happy to let its former colony default as the consequences of this default was low or negligible for British bondholders.
In summary, the paper by Foley-Fisher and McLaughlin goes straight on to the point, is well organised and engaging. With a fairly simple empirical strategy they show insights that are easily read by economic historians but also those who are now commenting the Scottish referendum. The “take home” message from this history is the following: after independence, a risk premium on inherited public debt has to be paid and this risk premium can be requested by investors for many years after secession. The Treasury of the former union might (or not) decide to guarantee all the former debt in case the new independent state decides to default. However, the choice of doing so depends on many factors, and these factors are not all foreseen. In the words of Martin Wolf: “however amicably a divorce begins, that is rarely how it ends” and the wealthy abandoned spouse might decide to guarantee for the debts of its other half. Or not.