Transparency, political conflict, and debt

In this paper we argue that an important and not-yet analyzed determinant of the observed heterogeneity of government debt across countries is the interaction between political conflicts and transparency of institutions. In the empirical part of the paper we show that whereas these two variables, per-se, are not significant determinants of observed debt levels across countries, their interaction is a key factor to explain debt-levels heterogeneity. Specifically, political conflicts imply higher borrowing only in non-transparent economies. In the theoretical model we propose a rationale for this effect. When the incumbent has preferences over distribution of resources across different groups, in a transparent economy political uncertainty leads to precautionary savings. Nevertheless, assuming that in more non-transparent economies the probability of an incumbent to be re-elected is more strongly a function of current economic conditions, then political uncertainty leads to borrowing incentives. We structurally estimate the two frictions in our model (political conflict and lack of transparency) by using their macroeconomic implications. Then, we compare the estimated frictions with the proxies for political conflict and lack of transparency in the data and we find a significant relationship, which supports our theory. (C) 2020 Elsevier B.V. All rights reserved.