422/2019 Amrita Dhillon, Andrew Pickering and Tomas Sjöström

We re-examine the concept of ‘democratic advantage’ in sovereign debt ratings when optimal repayment policies are time-inconsistent. If democratically elected politicians are unable to make credible commitments then default rates are inefficiently high, so democracy potentially confers a credit market disadvantage. Institutions that are shielded from political pressure may ameliorate the disadvantage by adopting a more farsighted perspective. Using a numerical measure of institutional farsightedness obtained from the Global Insight Business Risk and Conditions database, we find that the observed relationship between credit-ratings and democratic status is strongly conditional on farsightedness. With myopic institutions, democracy is associated with worsened credit ratings on average by about 3 investment grades. With farsighted institutions there is, if anything, a democratic advantage.

Political Economy

Oxford Economic Papers

https://doi.org/10.1093/oep/gpy036