It is a well documented empirical regularity that developing countries typically face an upward sloping supply schedule for international debt, and may be altogether excluded from international capital markets during bad states of the world (Diaz-Alejandro, 1984; and Sachs, 1989; Eichengreen and Lindert, 1989). In a recent paper, Reinhart, Rogoff, and Savastano (2003) take this evidence one step further. Combining macroeconomic data for the post-1970 period with information about sovereigns’ credit histories since the early nineteenth century, they argue that an important subgroup of middle-income countries or “emerging markets” have been systematically afflicted by what they call “debt intolerance.” That is, even though their external debt-to-GDP ratios are moderate by international standards and substantially lower than those of several high-income countries, these economies are perceived as riskier and unable to tolerate as much debt. Simply put, their sovereign riskiness appears to be out of proportion to the size of the respective debt burdens.

To explain this phenomenon, Reinhart, Rogoff, and Savastano (2003) invoke history. Virtually all these countries have tarnished credit histories, with several of them having defaulted a few times on their public debts. To the extent that those that have defaulted once or more in the past are likely to do so again in the future, the market threshold of what can be considered “safe” borrowing levels for these countries tends to be lower.2 As a theoretical story, however, this argument raises some important questions. For one, it touches on the contentious issue of what lenders take into account when evaluating sovereign risk.3 Also, it neither explains what causes serial defaulters to default in the first place, nor how most of today’s advanced economies—which have also defaulted several times in their history—managed to graduate out of the debt intolerant “club.”