Default and development

Lei Li and Gabriel Mihalache

Journal of International Economics, 2025, vol. 155, issue C

Abstract: We develop a quantitative theory of the long-run frequency of sovereign default, in which the government’s willingness to risk crises reflects the sectoral composition of the economy. Development and structural transformation alter the trade-offs faced by the government, with the implication that default is largely a lower income country phenomenon, as in the data. Default impacts adversely the balance sheets of financial intermediaries, who then offer unfavorable rates on working capital loans to producers. The resulting contraction in activity is asymmetric across sectors, based on their financing requirements, and tax revenues fall. Governments find it unappealing to risk default if the economy is more vulnerable to financial distress, due to a larger share of value added from manufacturing and services, even for the same Debt to GDP ratio. This mechanism supports the notion of countries eventually “graduating” from sovereign default crises.

Keywords: Sovereign default; Structural transformation; Discretionary policy (search for similar items in EconPapers)
JEL-codes: E44 H6 O11 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:155:y:2025:i:c:s0022199625000455

DOI: 10.1016/j.jinteco.2025.104089

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