Analyzing International Developmental Loan Markets With Rival Lenders

Despite the deepening of interdependence, international institutions are becoming increasingly fragmentary and unable to coordinate states' policy choices. Such a coordination failure is serious in the realm of developmental finance, where major states vie against one another in extending loan contracts to developing states through separate institutions. Competitive lending is a double-edged sword: on the one hand, it may satisfy strong credit demands for infrastructure improvement in the developing world, while, on the other, it may also generate excessive lending and borrowing, increasing the risks of repayment difficulty and even sovereign debt default. Using a model of common agency, we analyze (1) how two lenders issue loan contracts with a single borrower to induce the foreign policy behaviors they prefer and (2) how the borrower determines its foreign policy to maximize loans. The analysis hypothesizes that, when the borrower assumes foreign policy neutralism, the lenders issue greater loan contracts than what they believe are optimal and that this excess persists as long as the lenders refuse to delegate the lending tasks to a common international financial institution that can sort out their varying preferences and provide common-agency control. We test this hypothesis against quantitative data pertaining to ColdWar experiences and provide qualitative evidence on American and Soviet foreign economic policies. Our analytical results have implications for historical and contemporary Asian political economy.