How does debt-trap diplomacy work?

Question

Debt-Trap Diplomacy

In the micro world of personal loans, a person will go to a bank, and say, for example: "Here's a contract: You give me $1 million, and I'll pay it back to you on XYZ schedule with XYZ interest, and if I fail to do so, you can have my house". Then, if the person in question fails to pay the debt, the bank will say "give me your house", and if the person says "no", then the bank goes to court and the court says "give the bank your house", and if the person continues to say "no" then they get arrested by the government, thrown in jail, and their house is repossessed anyway.

My question is, how does this work on the macro scale of nations? My understanding is it works something like this:

1. China loans a bunch of money to Zimbabwe.
2. Zimbabwe promises China some collateral in exchange, most probably land (because it's pretty much the only thing Zimbabwe can promise to China that it can't reliably sabotage or reneg on for "unforeseen circumstances").
3. Zimbabwe defaults on their loan, and China comes to collect.
4. Like any good loan shark, rather than actually collecting, instead China blackmails Zimbabwe to get other concessions, in exchange for a "more favourable" lending restructuring, e.g. favourable terms for Chinese business/government contracts and so on. Behind the scenes, this "restructuring" is actually just China coercing and extracting additional concessions out of Zimbabwe on a longer time scale, which is probably more valuable in aggregate to China than a small patch of grass in the middle of Subsaharan Africa.

Apropos of this, what would stop Zimbabwe from telling China to jump in a lake with regards to collecting its debt collateral, and refusing to provide China with either the land it promised or with other concessions pursuant to a debt restructuring? What would be China's options for reacting to such a declaration? Presumably there's some kind of international court that arbitrates this sort of thing, but what if Zimbabwe tells that court to jump in a lake too? Presumably, the end result would be some military goons, from China or elsewhere, come into Zimbabwe and make the governmental decision makers "mysteriously disappear" overnight, and that becomes that, but what if we replace a country with little power or influence like Zimbabwe, with a country that has a whole lot of debt with China that it has to pay, but also holds a whole lot of international influence, like the USA? What if the USA tells China and also the international court to jump in a lake?

Answer 1

No, China is unlikely to invade any countries which refuses to pay their debt. No, they will do something far worse: They will tell the rating agencies!

Every government has a credit rating assigned to it by the three big rating agencies: Standard & Poor's, Fitch and Moody's. These credit ratings are determined by analysts at these companies and serve as a guideline for all kinds of investors (governments, companies or private people) for how much interest one should demand when lending money to that government to compensate the risk that this country will default on their debt.

Some countries (like Denmark, Germany or Luxembourg, for example) enjoy the excellent AAA credit rating with all three rating agencies. This means that the rating agencies believe that these countries are almost guaranteed to pay back any money lent to them. This security means that these countries can get away with paying very little interest on loans, and in some cases even negative interest. And people still lend them money. Just because they know that their money is safe while in the pockets of these governments.

Other countries (like Argentina, Venezuela or Mozambique, for example), have awful credit ratings. Which means that the analysts believe that when you lend them money, you will very likely not get it back. So you should only do it if they promise you huge amounts of interest to make up for the risk.

So what would the rating agencies do if they heard word that a country is unable to pay back a huge loan to China?

They would immediately penalize that country's credit rating. Which means that it now gets very difficult for that country to take any more loans from anyone else without digging itself even deeper.

This also means that the big infrastructure project for which the country took the loan from China is now depleted of funding and won't get completed.

For more information on why a bad credit rating can be pretty disastrous for a country, check out this other question: How does the credit rating of a country affect its populace?

Answer 2

what would stop Zimbabwe from telling China to jump in a lake withregards to collecting its debt collateral, and refusing to provideChina with either the land it promised or with other concessions pursuant to a debt restructuring? What would be China's options for reacting to such a declaration? Presumably there's some kind of international court that arbitrates this sort of thing, but what if Zimbabwe tells that court to jump in a lake too?

Collateral and Self-Help

China is not likely not have land in Zimbabwe as collateral. Land would be an unlikely form of collateral because it is hard to seize and China doesn't want or need or have a use for land in a bankrupt African nation. Instead, China very likely might have:

1. international monetary reserves in foreign banks as collateral, which could easily be seized.

2. collateral in the form of Chinese trade goods en route to Zimbabwe.

3. loan disbursements from other businesses and organizations that lend money to Zimbabwe.

4. goods sitting in warehouses in Zimbabwe.

China also probably provides something to Zimbabwe that it needs on a regular basis, perhaps food exports or coal or some other stable whose shipments could be suspended if payment was not made.

Other permutations on this theme are possible.

Suppose that China was building a cell phone and Internet network for Zimbabwe. China could probably shut down that network. And, since consumer banking in Africa is mostly conducted via cell phone, it could effectively shut down the payment and banking system for the country as well by doing so.

Suppose that China supplied advance military supplies like guided missiles, aircraft, etc. to Zimbabwe. It might have including "kill codes" in the firmware that serves that equipment to render it useless.

Legal Forums

There is not an international court for this kind of thing. The debt agreement would specify a dispute resolution forum. It could be international arbitration (which is not a court, but would be enforced in the domestic court of some country controlling assets from which China could collect its debt afterwards), it could be enforced directly in Zimbabwe's domestic courts, it could be enforced in the courts of some other country with jurisdiction over key assets of Zimbabwe (such as a Swiss court with jurisdiction over international monetary reserves kept in Swiss banks).

Zimbabwe's domestic courts could and often would order it to pay the debt to China, but how strong rule of law is in Zimbabwe is hard to determine. There are also financial institutions that could insure China against the political risk of an unlawful debt default, either through an insurance policy or some form of derivative contract.

Litigation by holders of Venezuelan bond holders in U.S. courts to collect their defaulted sovereign bond debts which is ongoing as of 2020, is an example of the kinds of litigation that could be utilized. There was first an international arbitration panel set up on an ad hoc basis in the bond instruments, and then a suit in U.S. District Court to enforce the $1.2 billion arbitration award against various guarantors and collateral subject to the U.S. District Court's jurisdiction.

Impact On Sovereign Credit Rating

A brazen default on Zimbabwe's international debts without justification would also probably destroy its ability to raise funds by borrowing from anyone else who would fear the same treatment in turn, or would at least increase greatly the cost of acquiring such loans from new lenders. And, presumably it borrowed money in the first place because it needed it for something and will need to borrow more in the future.

Presumably, the end result would be some military goons, from China or elsewhere, come into Zimbabwe and make the governmental decision makers "mysteriously disappear" overnight, and that becomes that,

Historic Examples

The United States conducted a series of military invasions of this type called the Banana Wars in Central America between 1898 and 1934. This would be an unlikely choice for China today, but it certainly isn't unprecedented.

In the classical era, it was common for one country to invade another and then withdraw conditional on paying tributes to the conquering country with the implicit understanding that the invasion would be repeated if the tributes were note paid.

Military Scenarios

It wouldn't take an all out war.

China could dispatch small numbers of troops (perhaps little more than its embassy guards) or local private security contractors to seize and secure collateral in a warehouse.

China could make deals with Mozambique, South Africa, Zambia and Botswana to interdict goods en route to Zimbabwe in exchange for something that China provides to them in return (e.g. loans, technical assistance, military sales).

China could deploy one of its two aircraft carriers to establish a "no fly zone" over Zimbabwe, perhaps with Mozambique cooperating minimally by allowing Chinese aircraft carrier based fights to fly over its territory en route to Zimbabwe.

China could bomb a handful of strategic bridges, rail lines, major highways, airports and power plants, and so on, limiting the ability of Zimbabwe to engage in trade and with others and carry on a functioning economy (and creating demand for Chinese built infrastructure when the fighting is over).

China could covertly arm and fund a local faction seeking to carry out a military coup in Zimbabwe which pledges to honor China's debts.

but what if we replace a country with little power or influence like Zimbabwe, with a country that has a whole lot of debt with China that it has to pay, but also holds a whole lot of international influence, like the USA? What if the USA tells China and also the international court to jump in a lake?

First, the U.S. would be violating its own constitution if it did so short of in the contingency of a declared war with China.

Second, the U.S. needs trade with China and China finances much of the U.S. national debt. If it failed to honor its debt obligations to China, China could cease to trade with the U.S., confiscate U.S. affiliated business and investment assets in China, withdraw all private investment of China in the U.S., recall its foreign students in the U.S., imprison U.S. expatriates in China, refuse to buy U.S. bonds, etc. wrecking havoc on the U.S. economy which is heavily dependent upon China for manufactured goods and many key raw materials. China would find permanent substitutes for U.S. exports destroying that stream of foreign trade from the U.S. forever.

Third, the U.S. credit rating would collapse destroying the ability of the U.S. to borrow money from any country at less than an extremely high interest rate, further damaging the U.S. economy.

If anything, the U.S. would be more vulnerable than Zimbabwe because its trade with China and reliance on international finance is much greater both in absolute scale and in relative importance to its economy. Zimbabwe still has lots of subsistence farmers. The U.S. does not.

Answer 3

what would stop Zimbabwe from telling China to jump in a lake with regards to collecting its debt collateral, and refuses to provide China with either the land it promised or with other concessions pursuant to a debt restructuring?

In debt-trap diplomacy, I think it's naïve to think that money is simply being loaned out. In practice, the money will be used for projects that are somehow useful to the target country. For example, major infrastructure projects would create local jobs and they could be prestige projects for politicians. So to turn your back on the lender means:

• The project comes to a standstill, so do the jobs that came with it.

• Politicians lose face because the project they advocated for isn't complete and they're left a lot of money in debt.

• Relations with the lender deteriorate a lot. Depending on a country's relations with other countries, that major lender may happen to be an important partner for trade and security.

What would be China's options for reacting to such a declaration? Presumably there's some kind of international court that arbitrates this sort of thing, but what if Zimbabwe tells that court to jump in a lake too?

It depends. If it's a small country, and the lender, say China, has a powerful military, then it could simply enforce the agreement. In academics, the term power politics was used in the previous century:

The concept of power politics provides a way of understanding systems of international relations: in this view, nations compete for the world's limited resources and it is to an individual nation's advantage to be manifestly able to harm others. Power politics prioritizes national self-interest over the interests of other nations or the international community, and thus may include threatening one another with military, economic or political aggression to protect one nation's own interest.

While it's something we have shielded ourselves from in the West, some argue it never went away. For example, you may be interested in this book on power politics in the current century. While it's certainly not without controversy, you could ask yourself how much resistance a small country can put up against a much superior military if it comes to collect.

What if, for argument's sake, we replace a country with little power or influence like Zimbabwe, with a country that has a whole lot of debt with China that it has to pay, but also holds a whole lot of international influence, like the USA? What if the USA tells China and also the international court to jump in a lake?

I think that's impossible to predict with any degree of certainty. There are so many factors at play that you can only speculate about the outcome.

I think, as a matter of principle, the US doesn't like to subject itself to foreign courts. An example of that is the International Criminal Court, according to the Global Policy Forum:

The United States government has consistently opposed an international court that could hold US military and political leaders to a uniform global standard of justice. The Clinton administration participated actively in negotiations towards the International Criminal Court treaty, seeking Security Council screening of cases. If adopted, this would have enabled the US to veto any dockets it opposed. When other countries refused to agree to such an unequal standard of justice, the US campaigned to weaken and undermine the court. The Bush administration, coming into office in 2001 as the Court neared implementation, adopted an extremely active opposition. Washington began to negotiate bilateral agreements with other countries, insuring immunity of US nationals from prosecution by the Court. As leverage, Washington threatened termination of economic aid, withdrawal of military assistance, and other painful measures. The Obama administration has so far made greater efforts to engage with the Court. It is participating with the Court's governing bodies and it is providing support for the Court's ongoing prosecutions. Washington, however, has no intention to join the ICC, due to its concern about possible charges against US nationals.

And a similar reluctance holds for China, according to the Australian Institute for International Affairs:

On the ICC’s relationship with national jurisdiction, China was reluctant to create an international body that could replace or override national criminal jurisdiction. Although China did not veto the primary jurisdiction of the UN ad hoc tribunals over national courts, it resisted yielding its jurisdiction to an international criminal court permanently. The principle of complementarity, which means that the ICC can only act when national court systems fail to do so, then became the major legal device to overcome the above Chinese concerns. China nevertheless has reservations over the way in which the principle of complementarity was eventually implemented in the Rome Statute.

So what does it come down to in the end? I think there's a good case for the power politics argument earlier, alliances will be formed, tensions may rise, but the outcome will still be hard to tell. It may escalate into a war, or cooler heads may prevail. There's a lot to be said for the latter: trade benefitting the economy, mutually assured destruction being bad for both sides, etc. On other hand, when tensions rise high, you cannot rule out escalation.

Answer 4

In essence: There is usually another way to pressure you to pay up or cough up the rights to what you're building. And that way is economic pressure and embargoes.

(please take into account that this is done with a fair amount of hand waving and written very much in general)

China is involved in a lion's share of the world's production chains. And thanks to its political system, it can and will stop supplying you with needed materials, will apply customs limitations on products from your country, and/or put Chinese investors working with you at disadvantage.

So there is a very good chance China is not just your bank, it might also be your (infrequent) grocery store, (most probably) electronics store, (might be) supply depot, (also very probable) business partner giving your companies sweet deals or (for luxury goods) the place where you sell what you produce.

Imagine you don't pay your loan and you might not be able to buy groceries, might not finish building because the supply depot won't sell you materials and you maybe can't raise money because the market won't let sell your products, or will charge you a hefty fee meaning you cannot sell competitively. And the guy you're working with on that other large infrastructure/industrial/commercial project won't work with you anymore.

Of course, there are alternatives, but if all of this happens at once, you're in deep trouble that will take a lot of time to get out of.

Answer 5

That's not debt-trap diplomacy.

None of what you count in item #4, or what's explained in the other answers, is debt-trap diplomacy.

Debt trap diplomacy is, in fact, what the US and various countries which imitate US (like Germany) have been doing. See this YouTube video - where John Perkins (an Economist) who worked in effecting actual debt-trap diplomacy since 1980s explains what they were doing in a detailed manner.

Basically, you give a loan to a government with strings attached. The strings that are attached require 'economic reforms', which is a politically correct way to say 'privatization', 'deregulation', 'free market', lower labor costs and so on. You release the loan in increments tied to these these, especially privatization being done: so, the foreign government sells a national asset, you release the rest of the loan.

Now, the trap is already working - for, you see, each privatized national asset reduces the revenue of the foreign government that it could use to pay back the debt. So the government starts to enter a debt-cycle:

It has now reduced revenue, it needs more money. For that, new loans are arranged. New loans come with even more brutal strings. In the second stage, the lender generally asks for cuts to public services, raising retirement age, reducing or 'liberating' minimum wage and so on. The burden of the debt is not only being dumped on the public at large, as you can see. And all loans come with requirements of making reforms to have a 'more business friendly environment' - which basically means less taxes, and less regulations. These would allow foreign companies to swoop in and buy up stuff easier while still depriving the foreign government of revenue.

Now the government is fully trapped in the cycle. Every loan pushes them down the hole even worse.

If the debt cycle is not broken, you end up with privatization of entire national assets in the target country, removing of worker/employee protections, reduction of minimum wage, cutting or totally privatizing social services, retirement system, healthcare, education - you name it.

What happens if the country refuses to pay

Economic warfare: that's what US does.

• First it starts with mild 'warnings' by visits from State Dept. officials.

• Then it moves to lowering the credit rating of the target country.

• Followed by US financial circles who were going to be the beneficiary of the privatizations shuffling foreign currency in an out of the target country's economic system to punish them and create instability. (Google 'Virtual Senate').

• After that, comes 'measures' with tariffs targeting selected products.

• And it goes all the way to 'freedom loving rebels' and regime change or outright bombing or invasion.

None of these apply to China

China doesn't do any of these. None of China's loans come with requests for privatization, requests for lowering the taxes or anything that could lower the revenue of target countries.

China says 'Ok, if you can't pay your debt, then give us a port'. The foreign country leases a port. Debt is handled.

The debt-cycle part does not happen. China's solutions do not target the capability of creating revenue of the business partner.

There's nothing wrong with "giving a port" to another country as debt payment: that's just paying debt. The debt trap happens if the lending country requires 'reforms' which cut the revenue generating capability of the borrowing country, thus making it harder to pay off the existing deby.

And what happens if Zimbabwe doesn't pay?

China cuts its business with them. At least, the State owned companies do. That's it. If Zimbabwe wants to do business again, they will have to pay their debt or arrange some kind of compensation - like lending a port - to sort it out.

That's it.