HICS OPTIMAL TRADE OPENNESS AND THE MODELING OF THE DEFAULT PENALTY

Aizenman suggests that highly indebted countries' (HICs') credit marke t policies should aim at increasing the degree of trade openness, sinc e in the social optimum openness is larger than in the competitive mar ket outcome. In this paper I show that when it is costly for creditors to impose sanctions on a defaulting country, there is a penalty struc ture alternative to Aizenman's which will be preferred by creditors. A izenman's results on debtor's optimal openness and credit market polic ies may then be reversed. (C) 1998 Elsevier Science Ltd. JEL classific ation: G1.