Transparent motives: democratic advantage in international credit markets

Abstract

Do democracies have an advantage in international credit markets? According to Schultz and Weingast (2003), they do, as democratic governments can be held accountable and, thus, their commitments to pay are more credible. However, this argument does not apply to much of the developing world, in which potential lenders are often not domestic and lack the ability to punish the sovereign through domestic political institutions. Saiegh (2005) argues that there is no 'democratic advantage' in developing states, as he finds developing democracies more likely to reschedule foreign debt than non-democracies. In this paper, we also find that democratic governments are more likely to default. However, we argue that this ability to reschedule loans precisely is a democratic advantage. Democratic countries are more likely to default because they can do so without fear of being punished by global credit markets; and when they do, developing democracies are also more likely to receive credit following default. The source of this democratic advantage is transparency, which makes democratic governments credible, not only in their promises to pay, but also in their claims about their ability to pay.