The Political Economy of Sovereign Borrowing: Explaining the Policy Choices of Highly Indebted Governments

Stephen B. Kaplan () and Kaj Thomsson
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Stephen B. Kaplan: Department of Economics/Institute for International Economic Policy, George Washington University

Working Papers from The George Washington University, Institute for International Economic Policy

Abstract: In newly democratized and developing countries, political economy theory expects politicians to use budget defcits to engineer an election-timed boom, known as the political business cycle. In this paper, we challenge this view by incorporating the Önancial constraints faced by government into an electoral political framework. Debtor governments must often borrow from foreign creditors to fund their domestic spending. Employing a formal model, we show theoretically that the extent of ownership dispersion among these creditors has an important effect on governments' economic policy autonomy. Based on our theoretical results, we argue when highly-indebted governments become more reliant on international bond markets - as opposed to traditional bank lending - politicians alter the way they respond to domestic constituents. These theoretical results Önd support in both quantitative and qualitative empirical findings. In an econometric test of 16 Latin American countries from 1961 to 2011, we show that the 1990ís financial decentralization breeds austerity through its disciplining effect on fiscal policy. These results are consistent with case studies of recent elections in Southern European countries; there too we and that politicians exhibit greater fiscal discipline when they fund a greater share of their spending through decentralized bond markets. These findings have important scholarly implications, suggesting that governmentsísocial responsiveness may in part reflect the structure of their international borrowing.

Pages: 50 pages
Date: 2014-10
New Economics Papers: this item is included in nep-cdm and nep-pol
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Citations: View citations in EconPapers (4)

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