Sunday, March 14, 2010

Democracies and Sovereign Debt (Again)

. Sunday, March 14, 2010

I have a very different take on Greece's sovereign debt struggles.

Here’s a random thought (writes Doug Muir): this blog has seen a lot of posts recently talking about economic problems in Greece, Spain and the Baltic States. All of these are countries that were, within living memory, governed by brutal non-democratic authoritarian regimes. Accident? Or is there something else at work here?
Will develops the point further: "democracies are exceptionally prone to the sort of time inconsistency problems that lead to things like debt crises. As such, there is a huge potential for moral hazard built in if states are able to escape their debt obligations without pain. Just ask California. It's an internal contradiction of democracy, if you like."
I must demur. I just published a piece in ISQ (ungated version) that explores the relationship between democracy, autocracy, and sovereign foreign debt in developing societies. The article suggests that in general, democracies are substantially less likely to accumulate crushing sovereign debt burdens than autocracies. The finding is robust to model specification and estimation technique. The relationship is so apparent it even shows up in simple descriptive statistics: not one of the 44 countries that evolved into so-called Heavily-Indebted Poor Countries Initiative was a democracy for any meaningful period of the time during which it accumulated sovereign debt.

The typical difference between autocracies and democracies is very large. For example, take the average debt held by all developing country governments in the late 1970s, roughly 33 percent of GDP. Then allow this debt to grow at the average borrowing rate for the average autocracy and by the average annual borrowing rate of the typical democracy. After twenty years, the autocracy owes its foreign creditors 98% of GDP while the democracy owes its foreign creditors half as much (49% of GDP). Thus, at least during the last forty years, democracies are substantially less likely to accumulate large sovereign debt burdens than autocracies. Consequently, democracies are substantially less likely to confront sovereign debt crises than autocracies.

Of course, because my sample does not include Greece my results don't speak to the Greek situation directly. They do suggest, however, that Greece is an anomaly, i.e., a democracy that accumulated a very large sovereign debt. Because it is an anomaly, I would be reluctant to use the Greek case to derive general propositions.


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Anonymous said...

Doug Muir from the Fistful here.

Quick question: what happens to your findings if you throw out Africa? In the generation after independence -- roughly 1965-1990 -- several Sub-Saharan African countries accumulated astonishing levels of debt relative to GDP. And just including, say, Zaire/Congo is probably enough to move the numbers.

So what happens if you say "well, Africa, special case" and toss them out? Do the numbers move much, or are the results still robust?

Doug M.

Thomas Oatley said...

Hi Doug,

Thanks for the comment. I am never sure how to handle this question. I can't really exclude African countries from a study of foreign debt in developing societies simply because they became (on average) more indebted. That kind of biases the sample, doesn't it? Moreover, there is substantial variation within Africa that needs explanation.

Having said that, the findings are robust to the inclusion of an African dummy. I also estimated models that excluded every country one at a time without finding that any is substantially influential.

I am not sure what to make about the Spain, Portugal, and Latvia question. I am still thinking about that.

Democracies and Sovereign Debt (Again)
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