Sovereign Debt: Election Concerns and the Democratic Disadvantage

Amrita Dhillon (), Andrew Pickering and Tomas Sjostrom

CAGE Online Working Paper Series from Competitive Advantage in the Global Economy (CAGE)

Abstract: We examine default decisions under different political systems. If democratically elected politicians are unable to make credible commitments to repay externally held debt, default rates are inefficiently high because politicians internalize voter utility loss from repayment. A politician who is motivated by election concerns is more likely to default in order to avoid voter utility losses, and, since lenders recognize this, interest rates and risk premia rise. Therefore, democracy potentially confers a credit market disadvantage. Institutions that are shielded from political competition, such as independent central banks, may ameliorate the disadvantage by adopting a more farsighted perspective, taking into account how interest rates respond to default risk. Using a numerical measure of institutional farsightedness obtained from the Government Insight Business Risk and Conditions database, we find that the observed relationship between credit-ratings and democratic status is indeed strongly conditional on farsightedness. With myopic institutions, democracy is estimated to cost on average about 2.5 investment grades. With farsighted institutions there is, if anything, a democratic advantage.Keywords: Sovereign debt, Default, Risk premia, Autocracy, Democracy, Institutions JEL Classification: H63, F55, D72, D82, H75, O43, C72.

Date: 2016
New Economics Papers: this item is included in nep-pol and nep-rmg
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Related works:
Journal Article: Sovereign debt: election concerns and the democratic disadvantage (2019)
Working Paper: Sovereign debt: election concerns and the democratic disadvantage (2019)
Working Paper: Sovereign Debt - Election Concerns and the Democratic Disadvantage (2016)
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