Abstract
Why do countries delay stabilizations of large and increasing budget deficits and inflation? And what explains the timing of reforms? We use the war-of-attrition model to guide our empirical study on a vast sample of countries. We find that stabilizations are more likely to occur when times of crisis occur, when new governments take office, when governments are “strong” (that is, presidential systems and unified governments with a large majority of the party in office), and when the executive branch faces fewer constraints. The role of external inducements like IMF programs has at best a weak effect, but problems of reverse causality are possible.
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Notes
For a recent discussion of the political economy of structural reforms in the labor and product markets, see Boeri (2005). A special branch of the reform literature analyzes postcommunist transformations, but, by now, ex-communist countries are very much like other countries; therefore a special treatment of them does not seem necessary any longer (see Shleifer and Treisman, 2000).
As Drazen and Grilli (1993) point out, accumulation of debt is unnecessary as long as the inflation tax is more distortionary than the income tax.
See Hsieh (2000) for an extension of the model on this point.
More precisely, a cost parameter is drawn from the same well-behaved distribution; one group knows its own parameter and knows that the other group’s parameter is drawn by the same distribution.
It is straightforward to compute the lifetime utility of the two groups (winner and loser) because the model assumes that no more crises will occur and the economy will be in the stable equilibrium forever.
More precisely, the expected time of a stabilization is positive—that is, a stabilization does not occur immediately. It would occur immediately if one group had the maximum possible realization of the cost parameter. Also, the analysis focuses on symmetric equilibria.
See also Alesina (1988) for a discussion of several historical cases of debt reduction in line with the war-of-attrition model.
With specific reference to Latin America, Lora (2001) finds inconclusive evidence on this point.
For instance, Persson and Tabellini (2003) suggest that presidential systems follow more procyclical fiscal policies.
IMF conditionality may work better if the country feels that it “owns” the program, that is, if the program is not imposed on the country. For a recent discussion of the political economy of IMF conditionality and its relationship with domestic politics, see Drazen (2002).
Deficit over GDP for country i at time t is computed by redefining surpluses, variable series 80 … ZF. The consumer price index series are the variable series 64 … ZF. We also checked our results employing the GDP deflator from series 99BIPZF to compute the inflation rate for country i at time t. Results are robust.
The World Bank database is available online at http://www.worldbank.org/research/projects/finstructure/database.htm
We also refer the reader to the original source book of the DPI database for more information on the variables. It can be found at http://siteresources.worldbank.org/INTRES/Resources/DPI2004_variable-definitions.pdf
This is an issue particularly pressing for the cross-sectional empirical literature on the effects of political institutions. See the discussions in Persson and Tabellini (2003) and in Acemoglu (2005). Clearly, misspecification of the interaction term is possible in this panel, but by focusing on the orthogonal components across time and countries, the likelihood that our results would be solely driven by omitted variable bias is smaller than in the cross-section.
In this instance, it is sensible to discuss the role of β1 because EXECONST presents substantially higher within-country variation than PRES.
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Authors and Affiliations
Additional information
Alesina delivered the 2005 Mundell Fleming lecture based on this paper. The authors are grateful to participants at the IMF research conference for their comments, in particular to Paola Giuliano, Alessandro Prati, Ragu Rajan, and Guido Tabellini. For excellent research assistantship, they thank Anthony Nibblett. Alesina is grateful to the National Science Foundation for a grant through the National Bureau of Economic Research.
