Debt-for –Nature Swaps and the Coase Theorem

Abstract

Debt-for-nature swaps have emerged as one method for debt burdened nations to retire their foreign debt through international markets.  In a typical debt-for-nature swap, conservation groups buy some portion of a nation's debt, usually in secondary markets at discounted prices, in return for long-term commitments from the country to preserve domestic ecological zones.  The first debt-for-nature swap occurred in Bolivia in 1987.  Since then these programs have been used by a variety of Least Developed Countries (LDCs) as a means of reducing debt loads.

While an extensive literature exists on the practical workings of these programs and on the level of their usage, there exists a dearth of theoretical explanations for the development of debt-for-nature swaps.  The premise of this paper is that debt-for-nature swaps can be interpreted as an application of the Coase Theorem to the problem of environmental degradation.

In 1960, Ronald Coase published "The Problem of Social Cost".  This work has had tremendous influence on the way that the legal system and many economists view the problem of externalities or third-party costs.  As Coase stated in his 1991 Nobel prize acceptance speech: "I explained in ‘The Problem of Social Cost’ that what are traded on the market are not, as is often supposed by economists, physical entities, but the rights to perform certain actions..."

The Coase Theorem, in simple terms, posits that in the presence of low transaction costs and competitive markets, solutions aimed at maximizing societal welfare will present themselves.  Coase presented an alternative to the widely accepted Pigouvian solution forexternalities.  In the Pigouvian framework, direct taxation can be used as a means of reducing the social costs associated with externalities.  The Coasean solution becomes especially pertinent when the influence of international institutions is limited.  The ability to institute Pigouvian solutions on an inter-country basis is severely limited because it involves taxation across national boundaries.  

I hypothesize that debt-for-nature swaps exhibit secondary markets for debt which are relatively competitive combined with three institutional entities willing to propose non-traditional solutions to the dual problems of debt and the environment - nations, environmental groups, and financial institutions.  This paper investigates the current state of debt-for-nature swaps, though the major theme is to develop the theoretical ties between the Coase theorem and these swaps.  In his acceptance speech, Coase stated that it was his belief that the full impacts of his writings have yet to be determined in the arena of economic analysis.  This paper attempts to contribute to that progression.