Working Paper: NBER ID: w27221
Authors: Viral V. Acharya; Raghuram Rajan; Jack Shim
Abstract: How is a developing country affected by its odious government’s ability to borrow in international markets? We examine the dynamics of a country’s growth, consumption, and sovereign debt, assuming that the government is myopic and wants to maximize short-term, socially unproductive, spending. Interestingly, access to external borrowing can extend the government’s effective horizon; the government’s ability to borrow hinges on its convincing investors they will be repaid, which gives it a stake in the future. The lengthening of the government’s effective horizon can incentivize it to tax less, resulting in higher steady-state household consumption than if it could not borrow. However, in a developing country that saves little, the government may engage in more repressive policies to enhance its debt capacity, which only ensures that successor governments repress as well. This leads to a “growth trap” where household steady-state consumption is lower than if the government had no access to debt. We characterize circumstances in which odious government leads to odious debt and those in which it does not, and discuss policies that might ameliorate the welfare of the citizenry.
Keywords: Sovereign Debt; Odious Debt; Economic Growth; Government Repression
JEL Codes: F3; G28; H2; H3; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| myopic government (H11) | external borrowing (F34) |
| external borrowing (F34) | steady-state household consumption (D10) |
| myopic government (H11) | steady-state household consumption (D10) |
| myopic government (H11) | repressive policies (J18) |
| repressive policies (J18) | debt capacity (G32) |
| debt capacity (G32) | growth trap (O11) |
| growth trap (O11) | lower household consumption (D12) |
| external borrowing (F34) | wasteful spending (H56) |
| wasteful spending (H56) | long-term welfare (I38) |