Why Not Default? The Structural Power of Finance in Sovereign Debt Crises Jerome Roos Thesis submitted for assessment with a view to obtaining the degree of Doctor of Political and Social Sciences of the European University Institute Florence, 19 May 2016 European University Institute Department of Political and Social Sciences Why Not Default? The Structural Power of Finance in Sovereign Debt Crises Jerome Roos Thesis submitted for assessment with a view to obtaining the degree of Doctor of Political and Social Sciences of the European University Institute Examining Board Prof. Pepper D. Culpepper, European University Institute (supervisor) Prof. László Bruszt, European University Institute Prof. Robert H. Wade, London School of Economics Prof. Daniel Mügge, University of Amsterdam © Jerome Roos, 2016 No part of this thesis may be copied, reproduced or transmitted without prior permission of the author Researcher declaration to accompany the submission of written work Department of Political and Social Sciences - Doctoral Programme I , Jerome Roos, certify that I am the author of the work Why Not Default? The Structural Power of Finance in Sovereign Debt Crises, which I have presented for examination for the Ph.D. at the European University Institute. I also certify that this is solely my own original work, other than where I have clearly indicated, in this declaration and in the thesis, that it is the work of others. I warrant that I have obtained all the permissions required for using any material from other copyrighted publications. I certify that this work complies with the Code of Ethics in Academic Research issued by the European University Institute (IUE 332/2/10 (CA 297). The copyright of this work rests with its author. Quotation from it is permitted, provided that full acknowledgement is made. This work may not be reproduced without my prior written consent. This authorisation does not, to the best of my knowledge, infringe the rights of any third party. I declare that this work consists of 98,087 (109,119 incl. bibliography) words. Signature and date: 2nd May 2016 ii Acknowledgments: Some debts can neither be repaid nor repudiated – only acknowledged. Unlike the liabilities piling up in the fnancial system, what makes these obligations so special is that, instead of leaving us individually poorer, they tend make us collectively stronger. Notwithstanding the neoliberalization of our societies and universities, personal and scholarly debts often re- main of this “virtuous” kind. I know because I have incurred many in writing this thesis. Academically, I am above all indebted to my supervisor, Pepper D. Culpepper, whose sharp eye, straight-shooting style and balanced approach to supervising – always there to help yet allowing the necessary space for independent research – is the best thing a graduate student could wish for. I am also profoundly obliged to the members of the jury, and not just for their close reading of and helpful feedback on the thesis. To Robert Wade I actually owe the original inspiration for this research, which properly began with his thrilling IPE course at the London School of Economics in late 2008, as fnancial panic raged through the City. Daniel Mügge's excellent comments, both on the thesis and on an earlier paper presented in Berlin in 2013, have been of great help in making sense of some of my own remaining questions and concerns. Lászlo Brúszt's course on capitalism and crisis during my frst year at EUI helped provide some of the early theoretical foundations. Intellectually, I have been very lucky to have benefted from conversations with and com- ments by some of the greatest living theorists of capitalism and the state: David Harvey, John Holloway (who kindly hosted us at the Institute in Puebla), Wolfgang Streeck, Leo Panitch, Bob Jessop, Toni Negri, Michael Hardt and the unforgettable Manolis Glezos. On a personal level, I will never be able to repay my dear parents, Ronny and Peter, for their unconditional support throughout all my travels and travails; my beloved sisters, Louise, Milou and Mimi, for tolerating my long absences and always giving me such joy in coming home; my parents-in-law, Jan and Dominique, for showing so much interest and excitement throughout; and of course to all the compas, especially in Greece: Leonidas iii Oikonomakis, Markos Vogiatzoglou and Myrsini Antoniou, Maria Kanellopoulou, Manolis Michelakakis, Antonis Vradis, Dimitris Dalakoglou, Katerina Tsapopoulou, Manos Cizek, Theodoros Karyotis, Antonis Broumas, Christos Staikos, and so many more. I owe the compagne e compagni in Collettivo Prezzemolo for the fun and action in Florence, and the ROAR Collective for their help with the new print journal: Leonidas Oikonomakis (again!), Carlos Delclós, Jelle Bruinsma and above all my good friend Joris Leverink. Special thanks to Ingeborg Beugel for sharing her knowledge of Greece during the many late-night political discussions on Hydra, to Michael Albert for landing me a columnist gig while wri- ting up the thesis, and to Marianne Maeckelberg and Brandon Jourdan for their help with our research foundation. A special shout-out to Dr. 7 and I.G. Karfeld. This thesis is dedicated to the people of Greece who are now opening their arms and doors to those feeing war, poverty and persecution even as they face the most severe economic calamity in living memory. Over all these years, the Greeks have taught me more than any social science degree ever could about the true meaning of solidarity. As the wayward son of a stingy creditor nation, I know we owe them more than we will ever know we owe. But personally, above all, I owe Tamara, mi querida compañera de vida. She was there at the beginning and at the end of it all. Only she knows what went into this thesis – so much of it hers. Its cover may bear my name, but her boundless love, brilliance and support refects back on every single line of the 320 pages that follow. iv Abstract: This thesis aims to answer a simple question with far-reaching implications: why do heavily indebted peripheral states not default on their external debts more often? Building on case studies of substantively important sovereign debt crises in Mexico (1982-'89), Argentina (1999-'05) and Greece (2010-'15), the fndings of this research demonstrate that the traditional explanations of debtor compliance proposed in the economics literature – centering on reputation, sanctions and democratic institutions – hold limited explanatory power. Instead, the thesis spells out a political economy approach to sovereign debt that recognizes the importance of social conficts and power struggles over the distri- bution of adjustment costs. In these conficts, it is argued that fnance possesses a unique advantage over indebted states: through its capacity to withhold the short-term credit lines on which the latter depend for their reproduction, len- ders can infict debilitating spillover costs that greatly limit the debtor's room for maneuver. This structural power of fnance has increased markedly as a result of globalization and fnancialization, and the main objective of this project is to identify the exact mechanisms through which it operates and the conditions under which it is efective and under which it breaks down. The fndings highlight the importance of debt concentration in the lending structure (which eases the formation of creditors' cartels, strengthening market discipline); the exposure of big banks and institutional lenders in core countries (which compels creditor states and international fnancial institutions to inter- vene as lenders of last resort and provide emergency loans under strict policy conditionality); and the bridging role fulflled by bankers and elites inside the borrowing country (which endows them with a privileged position in fnancial policymaking and internalizes fscal discipline into the debtors' state apparatus). The thesis concludes by spelling out the implications of these fndings for the quality of democracy and the study of political economy more generally. v vi Contents: Introduction: The Default Puzzle 1 Why Do Countries Repay their Debts? 1 A Very Brief History of Sovereign Default 3 The Puzzling Absence of Default Today 5 A Comparative Study of Mexico, Argentina and Greece 8 Summary of the Argument: The Structural Power of Finance 10 Structure of the Thesis: Chapters Outline 15 Chapter I – Theory of Sovereign Debt and Default 19 The “Enforcement Problem” of International Lending 19 Reputation: Capital Market Exclusion and the Reluctance to Repudiate 22 Sanctions: Asset Seizures, Trade Embargoes, and Gunboat Diplomacy 25 Institutions: Private Property, Credible Commitment, and Democratic Advantage 31 Spillover Costs: Bank Runs, Output Losses and Private Borrowing 36 Repoliticizing the Theory of Sovereign Debt 39 Problematizing the Unitary Agent Assumption 41 Making the Structure of Sovereign Lending Visible 44 Distinguishing Between Ability and Willingness to Pay 45 Towards a Political Typology of Default 49 vii Chapter II – The Structural Power of Finance 53 Business Power and the Capitalist State 53 Polyarchy: Robert Dahl and the Pluralist Approach 54 The State-as-Object: Miliband and Instrumental Marxism 57 The State as Social Relation: Poulantzas and Structural Marxism 59 Public Finance: O'Connor and the Structural Dependence of the State 61 The Market as Prison: Lindblom and the Privileged Position of Business 64 Globalization, Financialization, and the Debt State 66 The Impossible Trinity and the Capital Mobility