A Model of Sovereign Debt in Democracies

IMF Working Papers, June 1, 2008

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A Model of Sovereign Debt in Democracies

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Bibliographic details

• Authors: Ali Alichi
• Published: June 1, 2008
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451870107.001

Summary

• This paper develops and empirically tests a political economy model of sovereign debt.
• The main incentive for repaying sovereign debt is to maintain access to international capital markets.
• In democracies, generational voter composition can induce default or repayment independent of intergenerational consequences:
  • An old generation with little concern for future access to capital markets can force a default if it constitutes the majority of voters.
  • If the younger generation is more numerous, it can force repayment of previously defaulted debt.
• Other voter heterogeneities, such as in income, can generate similar results.

Major findings

• Political-demographic composition (age distributions of voters) is a key determinant of sovereign default versus repayment decisions.
• Access to international capital markets serves as the primary incentive for sovereigns to honor debt obligations.
• Majority voting dynamics can produce outcomes where current generations prioritize their own welfare over future generations by choosing default.

Empirical approach and scope

• The paper both develops a theoretical political economy model and subjects it to empirical testing.
• Subject areas explicitly listed: Debt default, Insurance, Insurance companies, International capital markets, Public debt.

Policy implications and scenarios

• Scenario: Old-majority electorates may choose default even when it harms future generations, suggesting political-demographic risks to sovereign creditworthiness.
• Scenario: Young-majority electorates can reverse defaults by enforcing repayment, indicating potential for endogenous improvements in access to capital markets as demographics shift.
• Implication: Evaluations of sovereign credit risk should account for voter heterogeneity (age and income) and majority-rule incentives, not solely macroeconomic indicators.

Content in this bundle

• A Model of Sovereign Debt in Democracies; Ali Alichi; IMF Working Paper 08/152; June 1, 2008
  • A Model of Sovereign Debt in Democracies; Ali Alichi; IMF Working Paper 08/152; June 1, 2008 (Markdown version)
  • A Model of Sovereign Debt in Democracies; Ali Alichi; IMF Working Paper 08/152; June 1, 2008 (PDF)