The political economy of sovereign debt: domestic politics, strategic choices, and suboptimal outcomes

I explore the political dimension of developing countries' foreign debt problems, one of the key issues in international political economy. I address the issue by examining three sovereign debt problems that have been salient over the past few decades. First, I examine the political determinants of sovereign default and, using a signaling game, show that it is most likely to actually occur when the level of default risk that a country's observable characteristics suggest is intermediate. It is because sovereign default occurs when risky sovereigns successfully induce creditors to provide a loan, but the most risky ones are among those least able to do so. Second, I explore the impacts of political institutions on the likelihood of a sudden stop of loan rollover and show that more transparent governments, by providing more accurate public information about the economy, help reduce individual creditors' uncertainty about each others' beliefs, thereby mitigating the likelihood of sudden stop of bond flows when good times, but worsening it when bad. Finally, I seek to explain why some countries are more heavily indebted than others. Democratic institutions that hold the leaders accountable may effectively constrain them from borrowing too much at the expensive of the voters at large, but only do so when other conditions are right. When the distribution of income is highly skewed, however, democracy empowers the poor majority who do not share the stake that the representative citizen has at the long-run health of the economy, thereby exacerbating the problem of debt overaccumulation