DP253 External Debt, Capital Flight and Political Risk

Author(s): Alberto F Alesina, Guido Tabellini
Publication Date: August 1988
Keyword(s): Capital Controls, Capital Flight, Debt Repudiation, Developing Countries, External Debt, Fiscal Policy, Political Economy
JEL(s): 112, 411, 432, 443
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=253

This paper provides an explanation of the simultaneous occurrence in developing countries of a large accumulation of external debt, private capital outflows and relatively low domestic capital formation. We consider a general equilibrium model in which two types of government with conflicting distributional goals randomly alternate in office. Uncertainty over the fiscal policies of future governments generates private capital flight and reduced domestic investment. This political uncertainty also provides the incentives for the current government to over-accumulate external debt. The model also predicts that left-wing governments are more inclined to impose restrictions on capital outflows than right-wing governments. Finally, we examine how political uncertainty affects the risk premium charged by lenders and how debt repudiation may occur after a change of political regime.