The Political Economy of Sovereign Debt Overhang

Developing economies have heterogeneous experiences with growth and openness. This project starts by documenting a core empirical fact: The countries that grow relatively fast do so while reducing sovereign liabilities and accumulating foreign reserves. The study proposes a variant of the open-economy neoclassical growth model that emphasises political economy and contracting frictions. The political economy frictions involve a preference for immediate spending, while the contracting friction is a lack of commitment regarding foreign debt and expropriation. The project rationalises why openness to trade has different implications for growth depending on the political environment; why institutions such as the treatment of capital income evolve over time; why governments in countries that grow rapidly accumulate net foreign assets rather than liabilities; and, why foreign aid may not affect growth.

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