Ethical Government Bonds

Pacta sunt servanda – contracts must be kept. This legal doctrine is only acceptable from an ethical perspective if certain conditions in addition to the consent of the contracting parties have been met. These conditions include the requirement that the parties to the contract understand its content; that none of the parties dominates the other; that the background conditions that regulate how difficult it will be for either party to satisfy the terms of the contract should be sufficiently stable and predictable; and that the parties to the contract are identical to the persons bound by it.

The sovereign debt contract common today violate these requirements. Consider Greek debt: The officials in the Greek government and the members of the Greek parliament do not just enter a contract on their own behalf when they decide to issue government bonds, but they force tax obligations on Greek citizens and even their progeny to cover the servicing, and perhaps repayment of the debt. How onerous this tax burden is depends on the economic development of Greece in the next couple of decades, which is neither predictable nor likely to be stable.

Issuing sovereign debt might still be permissible all things considered, especially if legitimate institutions do so to the benefit of their citizens. But the sovereign debt contracts common today have three properties that make it all too easy for states to overburden their citizens. First, the costs of debt servicing are rigid, rather than being a function of the economic development of the issuing country. Second, sovereign debt never expires – unless it is eventually repaid, it needs to be rolled over and serviced in perpetuity. Third, sovereign debt needs to be repaid even if it is used for purposes contrary to the interests of citizens.

From an ethical perspective, it would be much better if we could develop sovereign debt contracts that do away with these three properties, while still being economically viable. The Bank of England has recently published a paper introducing two innovations to sovereign debt contracts: GDP-indexed government bonds, and state-contingent government bonds.

GDP-indexed bonds lead to lower interest payments if the GDP of the issuing country increases more slowly than expected, or even declines. This is preferable from an ethical perspective, because it makes the burden of servicing debt more predictable. They also give states more room to manoeuvre economic downturns in a way that delivers justice at home.

State-contingent government bonds include a clause that postpone the repayment of the principal in case the issuing state faces a debt crisis. The clause could for instance be triggered if a state enters a restructuring programme with the IMF or with another official institution. The ethical payoff of state-contingent debt is that it increases the predictability of the costs of servicing debt in crisis situations, because states can postpone the refinancing of their debt. Often, this will help them to escape the high risk praemia they would face if they refinanced in times of crisis.

With GDP-indexed and state-contingent debt we are off to a good start in thinking about how to issue sovereign debt in an ethically better way. But these two new instruments do not address the array of ethical shortcomings of current debt instruments. They do not change the fact that sovereign debt binds in perpetuity, and independently of the fact for which purpose the money raised is spend. We need to develop new and bold ideas to bring sovereign debt contracts more in line with our ethical convictions.

This Article has previously appeared in German on

Brooke, Martin et al. “Sovereign Default and State-Contingent Debt.” Bank of England Financial Stability Paper 27 (2013).

Reddy, Sanjay G. “International Debt: The Constructive Implications of Some Moral Mathematics.” Ethics & International Affairs 21 (2007): 81–98.

Barry, Christian, and Lydia Tomitova. “Fairness in Sovereign Debt.” Ethics & International Affairs 21 (2007): 41–79.

1 thought on “Ethical Government Bonds

  1. This is the right blog for anybody who really wants to understand this topic. You understand a whole lot its almost tough to argue with you (not that I really will need to…HaHa). You certainly put a fresh spin on a topic that’s been discussed for a long time. Excellent stuff, just great!


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