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The emirate has its comeuppance, but we can learn from its entrepreneurial spirit.

STEVE CRISP

Global investors are in a giant huff over Dubai's decision to allow its flagship private company, Dubai World, to seek a six-month standstill (implying at least partial default) on payments on $26-billion (U.S.) in debt. What exactly did investors expect when they purchased bonds in companies with names such as Limitless World, one of Dubai World's real-estate subsidiaries? Talk about a bubble mentality.

The idea, I guess, was that the emirate's government would stand behind every loan, no matter how risky. And if Dubai didn't have the money, its oil-rich sister state Abu Dhabi would cough it up.

An absurd expectation, but hardly more improbable than many of the other massive bailouts we have seen recently. What really upset investors, of course, was the realization that, yes, untenable debt guarantees will have to be withdrawn some day. Eventually, an overleveraged world is going to have to find a way to cut debt burdens down to size, and it won't all be pretty.

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There are those who revel in what they see as a comeuppance for Dubai's outsized ambitions. I do not share this view. Yes, Dubai, with its hotels, man-made islands and roof-top tennis courts, is a real-world castle in the sand. Yet, it has also shown the rest of the Middle East what entrepreneurial spirit can accomplish.

Its airport has become a global hub of such significance that German regulators recently had to force Emirates Airlines to raise its rates to Frankfurt, lest national champion Lufthansa lose too much business. And with its relatively open goods and capital markets, Dubai has become a trading hub for the entire Middle East, plus parts of Africa and Asia. On the eve of the financial crisis, other Persian Gulf states were looking to it for insight into how they might diversify their economies when the oil runs dry.

Yes, Dubai is an autocratic state where finances are tightly and secretively controlled. Indeed, lack of detailed information on the emirate's finances was a central reason why the Dubai World default came as such a shock.

But in many ways, Dubai's rulers have been remarkably tolerant of free expression. A year ago, I sat through an evening of presentations by local artists at the University of Dubai. One, a photographer, presented a visual timeline of the construction of one of the stations of Dubai's new metro system. The artist emphasized how jarring the city-state's 13-year transformation has been to citizens. How does one relate to the inanimate objects rising out of the desert sands?

Another artist presented a vision of how outside lighting could be used to transform minarets, and help them to stand out in the blur of modern buildings that characterizes the contemporary Middle Eastern city. His visions were magnificent, and apparently somewhat radical. One had to be impressed that such ideas could be expressed openly.

Anyone familiar with Dubai understands that these are but small examples of a much broader embrace of creativity that has allowed the country to court elite foreign professionals in finance and other industries.

Unfortunately, Dubai ultimately proved subject to the laws of financial gravity. This time was not different. Massive speculation and borrowing led to excessive debt burdens and, ultimately, to default.

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Is this the end of the road for its epic growth? I doubt it. Throughout history, countries have defaulted on debts and lived to talk about it, even prosper. There is no way around the need for Dubai to restructure before it can resume a more sustainable trajectory, although achieving this will take time.

Will there be contagion to vulnerable countries elsewhere? Not just yet. While the Dubai case is not different, it is special, so the effect on investor confidence should remain contained for now. But investors are learning the hard way that no country's possibilities and resources are limitless.

Kenneth Rogoff is professor of economics and public policy at Harvard University and former chief economist at the International Monetary Fund.

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