Working Paper: NBER ID: w31943
Authors: Marina Azzimonti; Nirvana Mitra
Abstract: Emerging countries exhibit volatile fiscal policies and frequent sovereign debt crises, that significantly diminish the well-being of their citizens. International advisors typically suggest developed-world solutions as a remedy. We argue that the root of the problem lies in the institutional environment, which does not incentivize responsible policymaking, particularly tax-smoothing practices. Focusing on democratic representation and control of corruption, our dynamic political-economy bargaining model shows that nations with weaker institutions experience frequent default episodes and greater economic volatility. Our results are in line with stylized facts from a panel of 58 countries between 1990 and 2022. Through counterfactual experiments, we find that while emerging economy policymakers might favor moderate reforms to improve democratic representation, achieving the institutional depth seen in developed countries is politically unfeasible, despite its clear advantages for citizens.
Keywords: sovereign default; tax smoothing; corruption; institutional weakness; emerging economies
JEL Codes: D72; E43; E62; F34; F40; F41; H20; H4; H6; P33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Weak institutions (O17) | Frequent defaults and economic volatility (E32) |
| Weak institutions (O17) | Lack of tax smoothing (H29) |
| Lack of tax smoothing (H29) | Fiscal instability (E62) |
| Strong institutions (D02) | Responsible fiscal policy (E62) |
| Democratic representation and accountability (D72) | Stabilizing economic shocks (E63) |