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After Secession, What Happens to the National Debt?

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Tags U.S. HistoryWorld History

08/03/2022

The topic of secession has become more common in recent years as various regions and minority populations (e.g., California and Texas) have suggested breaking away from the United States. The idea is put forward with varying levels of seriousness, but the fact that talk of secession is increasingly open and regular suggests increasing strength for what the political scientists call "centrifugal" forces. That is, cultural and political trends increasingly point toward growing separation and away from increased union. 

But even those willing to entertain the idea of national separation will bring up many practical questions about how such a separation would actually take place. One of the most common questions among these people is what happens to the government's debts after secession. 

Fortunately, there are some historical examples that help shed some light on this. In most cases, what happens to the debt comes down to negotiations among successor states. The ideal model in these cases is probably the Czech-Slovak separation in 1992. But post-Soviet states and Latin America provide other examples as well. 

Often what happens to the debts depends not only on negotiations between the successor states, but also on negotiations with the third-party states who see themselves as representing a large number of creditors hoping to get their money back. That is, third-party regimes often intervene in secession disputes to pursue arrangements that will increase the repayment odds of at least a sizable portion of the debt in question. 

[Read More: "Repudiating the National Debt" by Murray Rothbard]

But sometimes negotiations don't go very far, and successor states—and their supporters—are sometimes simply willing to pay the economic price of separation without a clear plan in place. 

In any case, experience shows that in spite of debt repayment being a concern in these cases, national separations can and do happen, often without a need to repudiate existing debts. 

Dividing Up the Debt

A decade after gaining de facto independence from Spain, Great Colombia (a.k.a. Gran Colombia) began to split up into three smaller countries: Venezuela, Ecuador, and New Granada. Bondholders primarily pursued New Granada for repayment, but the New Granada regime refused to take on the full burden of Great Colombia's old debts. As part of an effort to gain diplomatic recognition from Britain, Venezuela, Ecuador, and New Granada all agreed to apportion debt obligations in proportion to the successor states' populations.1

The debt was not repudiated, although it was renegotiated on more than one occasion. 

The same "population principle" was again accepted in the aftermath of the breakup of the Central American Federation (a.k.a. the United Provinces of Central America). Consisting of what is now Guatemala, Honduras, El Salvador, Costa Rica, and Nicaragua, the federation broke up in 1840. External debt—much of it owed to British creditors—was divided proportional to each new republic's population in return for British recognition of the new states' sovereignty.2 

But the population principle has not always been used, and in some cases, one party has taken over all the external debt (the "zero-option" formula). This was true of Colombia, which took on all external debt when Panama seceded in 1903, as well as Pakistan, which retained external debts after Bangladesh's secession in 1971.3

Other examples of lopsided debt allocation can be found among the numerous cases of generally peaceful decolonizing secession in Africa. In these cases, former colonies seceded but were not expected to take on a share of the debt owed by the "mother country." 

Post-Soviet Secession

On December 26, 1991, the Soviet Union legally ceased to exist, leaving in its wake fifteen new independent states, the largest of which were Ukraine and Russia. Naturally, many creditors who had loaned money to the USSR still wanted repayment—from someone. This led to a series of negotiations in which the G-7 states essentially imposed a repayment system on the new states, based on the so-called joint-and-several formula. Beatriz Armendariz de Aghion and John Williamson explain how it was supposed to work: 

The joint-and-several formula imposed on the Soviet successor states was … a novelty in the context of international debt. Indeed, it is an idea drawn from the very different world of domestic loans made jointly to several partners. In domestic loan contracts, lawyers include the joint-and-several provision to increase the assurance that a loan to multiple partners will be serviced on schedule: the inability of any one partner to pay its share will be offset by additional payments by the others; the lender will suffer no loss as long as at least one of the debtors remains solvent and liquid. Because there is increased assurance of repayments, the loan is presumably made on finer terms than the lender would otherwise concede.4

For a variety of reasons outlined by the authors, the joint-and-several idea was a "blunder" and it failed. None of the new states other than Russia paid any debt service under the scheme. In the end, the new Russian Federation ended up offering the zero option. The Russian regime volunteered to take on all the debts of all the successor states in exchange for control of all external Soviet assets, such as gold, foreign exchange, and real estate, including embassies, and the USSR's loan portfolio. Ukraine, however, argued in favor of taking on a share of the debt itself "in order to demonstrate its sovereignty in the area of international finance." The Russian state finally paid off its Soviet debt in 2017

The Czech-Slovak Split 

Perhaps the "ideal" national split is the dissolution of Czechoslovakia in 1992, which was a case of a "highly integrated" federal state peacefully negotiating a separation into two new sovereign states.5 Although negotiations were often tense, both sides did eventually agree to a plan of dividing assets and debts "generally based on relative population and location." That is, debts were allocated based largely on a 2:1 ratio, with Czechs being the more populous group. However, many aspects of the negotiations were problematic. Both Czech and Slovak activists contended they were being exploited by the other side. The Slovaks, who were outnumbered by the wealthier Czechs, often felt that the Czechs received an unfair advantage because the outgoing federation's assets tended to be concentrated in Czech areas. Ultimately, however, negotiations concluded peacefully. 

Politics Often Trump Economics in Negotiations

The downside of national separation has long been the problem of political and economic uncertainty: it tends to drive up lending costs and drive down investment due to investor reluctance to put money in jurisdictions with an uncertain political future.6 Empirical studies of secession movements suggest that seceding areas often face a short-term capital flight as investors hold back to see how things turn out.7 Unionist activists claimed that separation would be disastrous for local finances, for example, in arguments against Quebecois secession in Canada and against Brexit in the United Kingdom. Indeed, some research shows that investment fell in Quebec even when secession was merely being contemplated—out of fear the region would lose direct access to the larger Canadian economy. 

Separation can bring a "secession dividend" in some cases, however. Estonia and Lithuania have clearly benefitted economically from exiting the Soviet Union. Their economies consistently outpace that of Russia. The United States—itself a product of (a very disorderly case of) secession—has often enjoyed an economy that has outpaced that of the United Kingdom in terms of economic growth and development. Both Czechia's and Slovakia's economies recovered from their initial postseparation recessions within five years

Any financial costs of separation must also be viewed in light of what internal political instability, injustice, or violence might be endured if political union continues. Yet it must be admitted that separations and national dissolution do come with financial costs, especially in the short term. 

Not all of separation's costs and benefits can be counted in monetary terms, however. Separatists often know that separation comes with costs but proceed anyway to pursue the psychic benefits of self-determination and the possibility of future economic improvement beyond the near term. This was often true of national liberation in the post-Soviet Baltics and the decolonization process in the Americas and in Africa. Sometimes the gamble has paid off financially. Sometimes not so much. 

Even in the Czech-Slovak split, separatists appeared prepared to accept that the separation might bring significant economic costs. As Robert Young notes in his study of the split, as time went on, the idea of national separation became more and more of a fait accompli in citizens' minds—regardless of possible economic consequences. What began as a tentative move toward separation thus took on a life of its own, and after a time, "the choice was no longer between splitting up and staying together but between the orderly and disorderly dissolution of the country."8 In other words, once Czech and Slovak nationalists—a growing portion of the population at the time—made up their minds that separation would happen, the details of dividing up debts and assets in an orderly way became simply a best-case scenario rather than a precondition for separation. As Young put it, "On matters where agreement was impossible…. [the Czech government was] prepared to accept impasse and to deal themselves with the repercussions."9

The lesson here is that not having every aspect of debt repayment squared away is not necessarily an impediment to national separation. Other political considerations may simply relegate that concern to the back seat. Economists and financiers often like to think they have the most convincing and compelling arguments, but this is often not the case. Moreover, successor states are often willing to negotiate debt repayment terms. New regimes often do this in hopes of facilitating international recognition, and in the hope of establishing themselves as reliable places for new investment. National divorce does happen, and debts are not necessarily repudiated as a result. 

  • 1. Beatriz Armendariz de Aghion and John Williamson, The G-7's Joint-and-Several Blunder, Essays in International Finance 189 (Princeton, NJ: International Finance Section, Department of Economics, Princeton University, 1993), p. 2.
  • 2. Ibid., p. 4.
  • 3. Ibid., p. 2.
  • 4. Ibid., p. 11.
  • 5. Robert Young, The Breakup of Czechoslovakia (Kingston, ON: Queen's University, 1994), p. v.
  • 6. Dane Rowlands, "International Aspects of the Division of Debt Under Secession: The Case of Quebec and Canada," Canadian Public Policy 23, no. 1 (1997).
  • 7. Tim Sablik, "The Secession Question," Econ Focus, First Quarter 2015, p. 16.
  • 8. Young, The Breakup of Czechoslovakia, p. 56.
  • 9. Ibid., p. 64.
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Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Send him your article submissions for the Mises Wire and Power and Market, but read article guidelines first. Ryan has a bachelor's degree in economics and a master's degree in public policy and international relations from the University of Colorado. He was a housing economist for the State of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.

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