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Forgive or Buy Back: An Experimental Study of Debt Relief

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  • Vivian Lei

    ()

  • Steven Tucker

    ()

  • Filip Vesely

    ()

Abstract

A large share of the debt claims owed by the world’s poorest countries has been cancelled through the HIPC (highly indebted poor countries) debt relief initiative. It is believed that, with less debt burden, the HIPC will be able to devote more resources to investment and thus promote their own growth and benefit their creditors in the long run. But does debt forgiveness really provide the best incentive for those countries who suffers from debt overhang? In this paper, we adopt experimental methods to study the impact of two different schemes for relieving debt. The two schemes we consider here are debt forgiveness and debt buyback, with the latter being more market-based since it allows indebted countries to repurchase their own debt on the secondary market at a discount. We find that creditors tend to reduce more debt when the relief takes the form of debt forgiveness than that of buyback. Debtors under the scheme of forgiveness are not significantly more reciprocal than those of buyback. After controlling for the amount of debt relief, creditors are significantly worse off under forgiveness whereas debtors are indifferent between the two schemes. Overall, debt forgiveness yields less desirable outcomes than debt buybacks.

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Bibliographic Info

Paper provided by University of Siena in its series Labsi Experimental Economics Laboratory University of Siena with number 017.

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Date of creation: Sep 2007
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Handle: RePEc:usi:labsit:017

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Keywords: Laboratory Experiments;

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  1. Warner, Andrew M, 1992. "Did the Debt Crisis Cause the Investment Crisis?," The Quarterly Journal of Economics, MIT Press, vol. 107(4), pages 1161-86, November.
  2. Deshpande, Ashwini, 1997. "The debt overhang and the disincentive to invest," Journal of Development Economics, Elsevier, vol. 52(1), pages 169-187, February.
  3. Paul R. Krugman, 1988. "Financing vs. Forgiving a Debt Overhang," NBER Working Papers 2486, National Bureau of Economic Research, Inc.
  4. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
  5. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
  6. Savvides, Andreas, 1992. "Investment Slowdown in Developing Countries during the 1980s: Debt Overhang or Foreign Capital Inflows?," Kyklos, Wiley Blackwell, vol. 45(3), pages 363-78.
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