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Latin American democratisation and currency crises (1975–2008)

Abstract

Latin America experienced a deep political transformation from authoritarianism to democracy in the recent decades. During the same period, many countries in the region also suffered severe currency crises. We contend that these two phenomena are causally related. Specifically, we argue that democratic transitions increase political demand for public spending, leading to budget deficits, and this increases investors’ propensity to liquidate local currency holdings. Moreover, we note an important ‘threshold’ effect, in which democratisation is particularly likely to lead to currency crises when the pre-existing fiscal deficits are already relatively high. Statistical analysis confirms these arguments in a sample of 25 Latin American countries in the period from 1975 to 2008.

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Notes

  1. The evidence is decidedly mixed for young democracies (Remmer 2002; Rodrik and Wacziarg 2005; Gasiorowski and Poptani 2006; Papaioannou and Siourounis 2008.)

  2. This by no means implies that new democracy is the only political regime in which the citizenry demands public spending. Morrison (2011), for instance, notes that even authoritarian regimes face pressure for public spending. As most scholars note, however, such pressures are generally stronger under democratic than authoritarian regimes.

  3. This is not to argue that public demand for expansion is unique to new democratic regimes in Latin America. In fact, non-democratic populist regimes were also known for lax government spending to accommodate their constituents’ strong appetite for public spending. By focusing on the strong popular demand for expansion in new democracies, we highlight that prudent fiscal policies expected of democracies are hard to come by until the regime matures.

  4. The list of countries is provided in the online appendix. Although usually not considered ‘Latin America’ strictly speaking, we include the former British colonies in the sample to obtain the largest sample size possible. Excluding these countries does not alter our main findings (see Table C8 in the online appendix).

  5. In addition, we also experimented on adding a count variable for the number of crises that happened in the country up to the present time, namely, ‘past crises’. While somewhat significant in itself, adding this variable does not alter our main result (see Table C5 in the online appendix).

  6. Theoretically, it is plausible that investors react to the preludes of democratisation such that currency crises are triggered before the first year of new democracy, in which case we suffer a measurement error. We ran a sensitivity analysis to see if including the year preceding democratisation in our measure of new democracy makes any difference in the result and found no substantive difference (see Table C4 in the online appendix).

  7. We also tested whether adopting alternative measures for this variable such as the number of currency crises in Latin America or the number of crises in the past two years change the result; however, we did not find any of such change (see Table C5 of the online appendix for result).

  8. Descriptive statistics are provided in the online appendix.

  9. Our control variables draw upon the literature on budget studies, such as Roubini and Sachs (1989).

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Correspondence to Byunghwan Son.

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Son, B., Krieckhaus, J. Latin American democratisation and currency crises (1975–2008). J Int Relat Dev 21, 442–463 (2018). https://doi.org/10.1057/jird.2016.11

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Keywords

  • budget deficit
  • currency crises
  • democratisation
  • herding
  • Latin America
  • political regime