Annals of the University of North Carolina Wilmington ...Codogno, Favero, Missale, Portes, and Thum...
Transcript of Annals of the University of North Carolina Wilmington ...Codogno, Favero, Missale, Portes, and Thum...
Annals of the
University of North Carolina Wilmington
International Masters of Business Administration
http://csb.uncw.edu/imba/
SOVEREIGN DEBT SPREADS AND ELECTORAL SYSTEMS
Luis Pastor Graells
A Thesis Submitted to the
University of North Carolina Wilmington in Partial Fulfillment
of the Requirements for the Degree of
Master of Business Administration
Cameron School of Business
University of North Carolina Wilmington
2014
Approved by
Advisory Committee
Edward Graham Peter Schuhmann
Nivine Richie
Chair
Accepted by
Dean, Graduate School
ii
TABLE OF CONTENTS
ABSTRACT ............................................................................................................................. iii
LIST OF TABLES .................................................................................................................... iv
LIST OF FIGURES ....................................................................................................................v
LIST OF APPENDICES ........................................................................................................... vi
1. INTRODUCTION...................................................................................................................1
2. LITERATURE REVIEW ........................................................................................................3
2.1 Sovereign Debt Spreads.........................................................................................................3
2.2 Institutional and Political Factors...........................................................................................6
3. HYPOTHESES ..................................................................................................................... 10
4. DATA AND METHODOLOGY ........................................................................................... 13
4.1 Data .................................................................................................................................... 13
4.2 Methodology ....................................................................................................................... 16
5. RESULTS ............................................................................................................................. 20
6. DISCUSSION AND CONCLUSIONS .................................................................................. 24
REFERENCES ......................................................................................................................... 26
APPENDICES .......................................................................................................................... 29
iii
ABSTRACT
The primary focus of this article is to investigate the effects of electoral systems on sovereign
debt spreads. Moreover, the impact of other political factors, such as the government and
parliament composition, the share of the government in parliament and the government ideology,
is also analyzed. I use cross-national data from 39 democratic countries between 1981 and 2011.
Findings show that majoritarian electoral systems, contrary to proportional electoral systems,
reduce spreads. This is consistent with the correlation between electoral rules and economic
policy. Previous studies demonstrate that proportional electoral rules tend to be associated with
left-wing governments that implement more redistributive policies than right-wing governments,
instead of giving priority to the payment of its sovereign debt obligations. The results support the
importance of the institutional environment in determining sovereign debt spreads and overall
find five factors that lower sovereign debt spreads: majoritarian electoral systems, the existence
of a government coalition, fewer parties in parliament, a government majority in parliament and
the existence of a right-wing government.
iv
LIST OF TABLES
Table Page
1. Descriptive Statistics for the Country-Year ............................................................................ 14
2. Electoral Systems and Government Ideology ......................................................................... 15
3. Regression Results of Sovereign Debt Spreads ...................................................................... 22
v
LIST OF FIGURES
Figure Page
1. Electoral Systems .................................................................................................................. 15
2. Government Ideologies ......................................................................................................... 15
vi
LIST OF APPENDICES
Appendix Page
A. List of countries in the Sample ............................................................................................. 29
B. Sample Averages by Country ................................................................................................ 30
C. Correlation Matrix ................................................................................................................ 32
D. Electoral Systems Glossary .................................................................................................. 33
1. INTRODUCTION
The difference in interest rates that countries pay for their sovereign debt has been broadly
analyzed in many studies. On one hand, evidence suggests that macroeconomic forces drive
sovereign debt spreads and that greater government deficits and public debt are associated with
higher long-term interest rates and low global growth prospects (Elmendorf and Mankiew, 1998;
Baldacci and Kumar, 2010). On the other hand, an important part of the literature investigates the
influence of political and institutional factors on sovereign debt spreads. These factors include
the form of government, the quality of legal and political institutions, political stability, levels of
government intervention in the economy, and degree of fiscal consolidation (Butler and Fauver,
2006; Van Rijckeghem and Weder, 2009; Kohlscheen, 2010; Baldacci, Gupta, and Mati, 2011).
Iversen and Soskice (2006) find that proportional electoral systems are associated with center-
left governments and majoritarian electoral systems to center-right governments, and that left-
wing governments implement more redistributive policies than right-wing governments,
suggesting a direct relationship between the electoral system and the economic policy. The
electoral system is an important part of the political and institutional structure. Nevertheless,
there is a notable gap in the literature regarding how it affects sovereign debt spreads.
In this paper I investigate the effects of electoral systems on sovereign debt spreads.
Additionally, I analyze the impact of other political factors, such as the government and
parliament composition, the share of the government in parliament, and the government
ideology.
I use 676 observations from 39 democratic countries between 1981 and 2011. Findings show
that countries with majoritarian electoral systems have lower sovereign debt spreads than
countries with proportional electoral systems. Four other political factors are found to be
2
associated with lower sovereign debt spreads: the existence of a government coalition, fewer
parties in parliament, a government majority in parliament and the existence of a right-wing
government.
The remainder of this article is organized as follows: Section 2 reviews prior literature,
Section 3 presents the hypotheses, Section 4 describes data and methodology, Section 5 presents
the results and Section 6 concludes.
2. LITERATURE REVIEW
This study is closely related to the literature that investigates sovereign debt spreads. This
section has two parts. The first one summarizes the literature about the problem of high debt and
the determinants of sovereign debt spreads. The second part summarizes the literature that relates
institutional and political factors with sovereign debt spreads.
2.1 Sovereign Debt Spreads
According to the standard neoclassical model, fiscal deficits reduce national savings and
increase aggregate demand, leading to higher interest rates (Elmendorf and Mankiw, 1998).
Blanchard (2003) explains that as debt increases, countries pay more interest for their sovereign
debt. Later, if countries cannot obtain surpluses by increasing taxes or reducing spending,
countries will increase their debt again and pay even higher interest rates. This could result in a
vicious circle in which public debt continues to increase, and at some point the government
decides that the best option is to default.
In contrast, the Ricardian equivalence proposition, also known as the Barro-Ricardo
equivalence theorem, holds that private savings increase one for one with deficits in anticipation
of futures taxes, leaving total savings unchanged (Mankiw, 2003). This theory contradicts the
mainstream theories provided by Keynesian economists. The Ricardian equivalence has been
criticized, by Buchanan (1976) and Feldstein (1976) among others.
Sovereign debt interest rates have an important impact on the overall economy. Baldacci and
Kumar (2010) confirm that higher deficits and public debt lead to a significant increase in long-
term interest rates, with the precise magnitude dependent on initial cross-country specific factors.
The impact of higher deficits on interest rates is greater when there are weak initial fiscal
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conditions, weak or inadequate institutions, structural factors (such as low domestic savings), or
limited access to global capital.
There is extensive literature that studies the determinants of sovereign bond interest rates and
country risk premiums. Haugh, Ollivaud, and Turner (2009) analyze yield spreads for sovereign
bonds between Germany and other Eurozone countries. They decompose interest rates into the
risk free rate and the country risk premium. The country risk premium is the sum of the credit
default risk and the liquidity risk.
Codogno, Favero, Missale, Portes, and Thum (2003) study how international risk factors
increase default risk of sovereign bonds, and risk premiums are better explained by credit default
risk than by liquidity risk in the eurozone. Guscina (2008) identifies three different types of
factors affecting the structure of government debt in emerging countries: macroeconomic,
political, and institutional. Countries with unstable macroeconomic and political environment
and bad quality institutions will not develop a domestic debt market. Furthermore, many studies
point out global risk aversion as another important factor. Caceres, Guzzo, and Segoviano (2010)
find that earlier in the last financial crisis, global risk aversion was the most significant factor
influencing sovereign spreads, but later county-specific factors gained importance. Hilscher and
Nosbusch (2010) also find global factors to be significant and find the VIX index to be
significant and positively correlated with sovereign spreads. Pan and Singleton (2008) use the
VIX index achieving the same results. The volatility of terms of trade is also a significant
variable affecting sovereign spreads according to Hilscher and Nosbusch (2010).
Sovereign credit risk is studied from a different perspective by Longstaff, Pan, Pedersen, and
Singleton (2011). They estimate sovereign spreads using sovereign credit default swap (CDS)
contracts on external debt and also find sovereign spreads to be driven by global factors. They
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find a positive correlation between sovereign spreads and the volatility risk premium embedded
in the VIX index.
More studies support the idea that global macroeconomic forces are an important determinant
of sovereign credit spreads. Uhrig-Homburg (2013) finds higher credit spreads in global
recessions and when there are low global growth prospects. Edwards (1984), Min (1998), and
Westphalen (2001) examine macroeconomic variables to determine which ones best explain
sovereign spreads. Min (1998) finds liquidity and solvency variables to be significant. These are
the debt-to-GDP ratio, the international reserves-to-GDP ratio, the debt service ratio, and export
and import growth rates. The macroeconomic fundamentals variables found to be significant are
the domestic inflation rate, net foreign assets as measured by the cumulative current account, the
terms of trade, and real exchange rate.
Past repayment history is also an important factor influencing the premium risk. Reinhart,
Rogoff, and Savastano (2003) explain external debt intolerance may be a function of a country’s
repayment history, debt levels, and history of macroeconomic stability. A country that has
previously defaulted has more possibilities to default again on its external debt.
Overall, these studies provide different factors that may affect sovereign debt spreads. On the
one hand, spreads are influenced by macroeconomic factors, such as initial fiscal conditions,
liquidity, solvency, inflation, current account balance, terms of trade and real exchange rates. On
the other hand, variables such as quality of institutions, structural factors, access to global
capital, global factors, global risk aversion, and past repayment history also have an impact on
sovereign spreads.
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2.2 Institutional and Political Factors
An important part of the literature investigates the influence of institutional and political
factors on sovereign debt spreads. Baldacci et al. (2011) find a significant effect of political and
fiscal factors on bond spreads. Political stability, strong democratic institutions, low levels of
government intervention in the economy, and greater fiscal consolidation reduce bond spreads in
emerging economies. The literature suggests that political factors influence credit risk in
emerging markets. Butler and Fauver (2006) use a sample of both developed and emerging
markets and find that the quality of legal and political institutions are more important than
traditional macroeconomic variables and other variables commonly linked to credit risk. The
authors use six factors to measure the quality of legal and political institutions: rule of law,
political stability, voice of the people, corruption control, government effectiveness, and
regulatory quality. Hallerberg and Wolff (2008) point out the importance of fiscal institutions in
the Eurozone. Better quality institutions are shown to reduce risk premiums and lower the effects
of deficits on risk premiums.
Much has been written about the influence of the Political Business Cycle (PBC) theory on
sovereign debt spreads. Block and Vaaler (2004) investigate how the PBC affects both credit
ratings and bond spreads in developing countries. Their results show that credit rating agencies
downgrade sovereign bonds by one rating level during election years. In addition, bond spreads
are higher in the 60 days before the election than in the 60 days after it. Vaaler, Schrage, and
Block (2005) find effects on sovereign bonds spreads in developing countries during electoral
periods depending on who is expected to win the election. Sovereign risk premiums increase
when a left-wing candidate is expected to win and replace a right-wing government, and
decrease when a right-wing candidate is expected to win and replace a left-wing government.
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Studies that go beyond the effects of the political system on sovereign debt risk premium
examine the effects of form of government and electoral system, two important areas within the
political system. Van Rijckeghem and Weder (2009) and Kohlscheen (2010) find that democratic
emerging countries with presidential forms of government have greater sovereign debt default
rates than countries with parliamentary forms of government. Both agree that parliamentary
systems provide more players with political veto power, and this reduces the possibility of
default. Van Rijckeghem and Weder (2009) suggest that political institutions can reduce the debt
default risk; however, this only happens with some economic and finance conditions, specifically
high international liquidity, strong economic fundamentals, and economic openness.
Cheibub (2006) compares presidential with parliamentary systems by studying government
budget balances and finds lower deficits in presidential than in parliamentary democracies. The
results are consistent with Van Rijckeghem and Weder (2009) and Kohlscheen (2010). The
number of parties in the government and whether they have a majority in the parliament do not
appear to affect deficits. More important is the presidential or parliamentary system form of
government. In a presidential system, voters directly control the President and incentivize the
government to keep balanced budgets.
Besides the form of government, the internal processes within the political structure may also
be important. Alesina and Drazen (1991) explain the political process of negotiating who suffers
the burden of a stabilization program. To reduce the deficit, the government has to increase taxes
or reduce expenditure, with the fiscal burden likely to be imposed disproportionately on one
sector of society. More politically polarized countries will take more time to implement
stabilization programs because the negotiation process is more difficult. More cohesive societies
will experience a more equal and faster stabilization.
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Roubini and Sachs (1989) study this negotiation process in coalition governments and find
that it is more difficult to achieve an agreement in uncohesive coalition governments. They find
that budget deficits are greater when the government tenure is shorter and there are more parties
in the government. The more parties, the more veto players and the more difficult it is to reach an
agreement of who suffers the costs of the adjustment. According to game theory, as the
government tenure is shorter, there is less cooperation within the parties in the coalition
government, and stabilization programs are more difficult to implement. Furthermore, the
process of negotiation is similar to the Prisoner's Dilemma. All coalition parties know that the
stabilization is necessary, but they block spending cuts in their own areas, resulting in a
noncooperative solution.
Using data from developing countries, Saiegh (2009) finds a lower probability of debt
repudiation when there is a multiparty coalition government. The explanation is that people who
want the government to pay its debt form a small group within the population. Therefore, their
interests are more likely to be represented in the government if there are many parties in the
coalition.
Bawn and Rosenbluth (2006) explain that when there is only a one party majority, the
government only implements policies that benefit its voters. Tsebelis (2002) points out that many
parties act as veto players and lock in economic policy. These arguments suggest that multi party
coalition governments default less on sovereign debt than single party governments.
Most of the literature reviewed here refers to how political factors affect sovereign debt
default rates and deficits. There is a notable gap in the literature, however, regarding how these
factors affect sovereign debt spreads.
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Electoral systems may be a political factor that affects sovereign debt spreads as they have an
influence on the economic policy of the government. According to Iversen and Soskice (2006),
in a study of OECD countries, proportional electoral systems usually lead to center-left
governments, and majoritarian electoral systems usually lead to center-right governments.
Center-left governments implement more redistributive policies than the center-right, so
proportional electoral systems redistribute more than majoritarian systems. This could increase
sovereign debt default risk and directly affect sovereign debt interest rates.
In sum, political and institutional factors have an important influence on sovereign default
risk and, hence, on sovereign spreads. Factors included in previous studies are: political
instability and polarization, quality of legal and political institutions, strong democratic
institutions, low level of government intervention in the economy, greater fiscal consolidation,
the Political Business Cycle (PBC), the form of government, the number of parties and tenure of
the government, and cohesion of the coalition government. The effect of electoral systems on
sovereign spreads still has not been investigated. Electoral systems, however, directly affect the
economic policy of a country, thus it could influence sovereign spreads.
3. HYPOTHESES
The primary purpose of this study is to analyze the effects of electoral systems on sovereign
debt spreads. I expect higher sovereign debt spreads in countries with proportional electoral
systems than in countries with majoritarian electoral systems. Other research questions focus on
the effects on sovereign debt spreads of a government coalition, the number of parties in
parliament, a government majority in parliament and the ideology of the government.
The electoral system of a country affects its economic policy. As shown by Iversen and
Soskice (2006), countries with proportional electoral rules implement more redistributive
policies as these countries are frequently governed by center-left parties. Austen-Smith (2000)
also finds that proportional electoral systems are associated with higher redistributive policies.
According to Saiegh (2009), countries with proportional electoral rules default more often on
their sovereign debt than countries with majoritarian electoral rules. These results are consistent
with Iversen and Soskice (2006) and Austen-Smith (2000).
Another important result from Saiegh (2009) is that coalition governments default less on
sovereign debt than single party governments. However, Roubini and Sachs (1989) find higher
deficits when there is a coalition government. Bawn and Rosenbluth (2006) find greater
government spending when there are more parties in government. These results are contradictory
because sovereign debt default risk and higher deficits should be positively correlated.
Proportional electoral systems are usually associated with more parties in the parliament and
center-left governments. More parties usually lead to more political polarization and greater
political instability. This adds to the center-left government effect. In sum, proportional electoral
systems could increase sovereign debt default risk and directly affect sovereign debt interest
rates.
11
The five hypotheses tested in this study are as follows:
H1: Majoritarian electoral systems are associated with lower sovereign debt spreads.
H2: Proportional electoral systems are associated with higher sovereign debt spreads.
Saiegh (2009) finds that countries with proportional electoral systems default more on its
sovereign debt than countries with majoritarian electoral rules. In this study the focus is on
sovereign debt spreads rather than sovereign debt defaults. These hypotheses are motivated by
the finding that proportional electoral systems lead to center-left governments, which is
associated with more redistributive policies (Austen-Smith, 2000). Further, proportional electoral
systems usually lead to more parties, which is associated with higher deficits (Bawn and
Rosenbluth, 2006).
H3: Sovereign debt spreads are lower with a coalition government.
Saiegh (2009) finds lower sovereign debt default rates when there is a coalition government.
He affirms that bond holders are a small group within the population and are more likely to be
represented in the government if there is a coalition government. With this hypothesis, I expect a
coalition government to affect sovereign debt spreads in the same way as with sovereign debt
default rates.
H4: Sovereign debt spreads are higher when there are more parties in parliament.
More parties increase political uncertainty and lead to higher sovereign debt spreads. Also
more parties may increase deficits (Bawn and Rosenbluth, 2006) and should affect sovereign
debt spreads. Alesina and Drazen (1991) point out the importance of the negotiation process in
reducing a deficit. It would be easier if there are fewer parties.
H5: Sovereign debt spreads are lower when there is a government majority in parliament.
12
A government majority in parliament reduces political uncertainty and this leads to lower
sovereign debt spreads. This notion is also consistent with Alesina and Drazen (1991) because
the negotiation process of reducing deficits would be easier.
H6: Sovereign debt spreads are lower when the government is ideologically right oriented.
Center-right governments would be more concerned with debt repayment and less with
redistributive policies than center-left governments (Iversen and Soskice, 2006). This would
cause lower sovereign debt spreads when there is a right-wing government. Saiegh (2009) finds
lower sovereign debt default rates with center-right governments.
4. DATA AND METHODOLOGY
This section is divided in two parts. The first part describes the data used to test the
hypotheses and the second explains the model and methodology used.
4.1 Data
Data to test the effects of electoral systems and other political factors on sovereign debt
spreads consist of 676 observations from 39 democratic countries between 1981 and 2011. The
choice of these countries and observations was based on data availability. Appendix A provides a
list of countries included in the sample.
Sovereign debt spreads and other economic variables are obtained from the International
Financial Statistics (IFS) database of the International Monetary Fund (IMF) and from the
International Debt Statistics (IDS) database of the World Bank (WB).
The original source of most of the political data is Beck, Clarke, Groff, Keefer, and Walsh
(2001) Database of Political Institutions (DPI) 2012. However, in the case of electoral systems
data, the original source is Bormann and Golder (2013) Democratic Electoral Systems (DES)
dataset. Both DPI and DES datasets are obtained from Teorrell et al. (2013) The Quality of
Government Dataset, which is a pool of variables from other original or secondary sources, and
has helped me to merge all the variables.
Two important assumptions are made when treating the data. Firstly, the electoral systems
dataset gives the electoral systems used in the year with elections. Then I have to assume that the
electoral system remains unchanged during the years with no elections, which is a very realistic
assumption. Secondly, I use the Cheibub, Gandhi, and Vreeland (2010) classification of political
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regimes as democracy and dictatorship from 1946 to 2008 to delete non democratic countries, as
the purpose of my paper is to analyze only democratic countries. The assumption is that
democratic countries in 2008 are still democracies during years 2009-2011.
Table 1 provides the list of variable definitions and original sources and descriptive statistics
for the country-year observations. Appendix B shows sample averages by country. The
correlation matrix is shown in Appendix C.
Table 1. Descriptive statistics for the country-year
Variable Definition Original
Source N Mean
Std
Dev Minimum Maximum
SPREAD Sovereign Debt Spreads IFS (IMF) 676 1.26 3.46 -7.74 33.90
MAJ Majoritarian Electoral System DES 676 0.21 0.41 0 1
PRO Proportional Electoral System DES 676 0.61 0.49 0 1
MIX Mixed Electoral System DES 676 0.17 0.38 0 1
GOVC Government Coalition DPI 676 0.69 0.46 0 1
PP Parties in Parliament DPI 676 8.17 8.04 2 109
GOVM Goverment Majority DPI 676 0.74 0.44 0 1
RIGHT Right Government Ideology DPI 612 0.47 0.50 0 1
LEFT Left Government Ideology DPI 612 0.15 0.35 0 1
CENTER Center Government Ideology DPI 612 0.39 0.49 0 1
DEBT Government Debt (%GDP) IFS (IMF) 676 58.02 30.68 6.07 215.95
DEFSUR Gov. Deficit/Surplus (%GDP) IFS (IMF) 676 -2.56 4.58 -30.54 18.79
GDPG GDP % Growth IFS (IMF) 676 2.61 3.36 -17.73 27.18
STDR Short-Term Debt (%Reserves) IDS (WB) 96 53.02 36.48 2.76 215.38
STDTD Short-Term Debt (% Total Debt) IDS (WB) 96 17.97 10.07 1.30 45.72
SPR Sum of Past Reschedulings IDS (WB) 96 3.42 3.95 0 16
15
As shown in Figure 1, proportional electoral systems represent 61% of the observations.
Majoritarian and mixed electoral systems represent 22% and 17%, respectively. Figure 2 shows
right-wing governments represent 47% of the observations, center governments represent 39%
and left-wing governments represent only 14%.
Figure 1. Electoral Systems Figure 2. Government Ideologies
Table 2 shows the relation between the electoral system and the government ideology. The
sample is consistent with Iversen and Soskice (2006) findings. Majoritarian electoral systems are
associated with center-right governments and there are many more left governments with
proportional systems than with majoritarian ones - 70 versus 3, respectively.
Table 2. Electoral systems and government ideology
Electoral System Right Left Center Total Propotion of right
governments
Proportion of left
governments
Majoritarian 77 3 56 136 56.62% 2.21%
Proportional 150 70 149 369 40.65% 18.97%
Mixed 60 16 31 107 56.07% 14.95%
Total 287 89 236 612
16
4.2 Methodology
To estimate the impact of political factors on sovereign debt spreads, the following model is
estimated using ordinary least squares:
SPREADit = α0 + α1ELESYSit + α2GOVCit + α3PPit + α4GOVMit + α5IDEOLOGYit
+ α6ECONit + ε
The dependent variable in the model is the sovereign debt spread (SPREAD) for each country
and year in the sample and is defined as the difference between a country’s 10-year government
bond rate and the 10-year Treasury note rate of the United States. U.S. Treasury yields are
almost always used as the risk-free rate when studying country risk premium differences. They
are used by Min (1998) and Hilscher and Nosbusch (2010), among others.
Electoral System (ELESYS) is defined as either Majoritarian (MAJ), Proportional (PRO) or
Mixed (MIX) using Bormann and Golder (2013) classification. Appendix D provides a glossary
of electoral system terms. MAJ is a dummy variable that takes the value of 1 if the electoral
system uses majoritarian formulas and 0 otherwise. The coefficient of this variable is expected to
be negative. PRO is a dummy variable that takes the value of 1 if the electoral system uses
proportional formulas and 0 otherwise. The coefficient of this variable is expected to be negative.
Both variables are used to test H1 and H2: the effect of either majoritarian or proportional
electoral system on sovereign debt spreads. Saiegh (2009) uses a proportional electoral system
dummy variable to analyze how electoral rules affect sovereign default rates. MIX is a dummy
variable that takes the value of 1 if the electoral system uses mixed formulas and 0 otherwise.
GOVC is a dummy variable that takes the value of 1 if the government is a multiparty
coalition and 0 otherwise. A government is a multiparty coalition when it is formed by two or
more political parties represented in the parliament (considering the Lower House in the case of
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bicameral legislatures). Saiegh (2009) uses this variable. This variable is needed to test H3: the
effect of a coalition government on sovereign debt spreads. The coefficient is expected to be
negative.
PP indicates the total number of political parties represented in parliament (considering the
Lower House in the case of bicameral legislatures). This variable is needed to test H4: the effect
of the number of political parties in parliament on sovereign debt spreads. The coefficient is
expected to be positive.
GOVM is a dummy variable that takes the value of 1 if the government holds more than 50%
of the seats in parliament (considering the Lower House in the case of bicameral legislatures)..
This variable is used to test H5: the effect of a government majority in parliament on sovereign
debt spreads. The coefficient of this variable is expected to be negative.
IDEOLOGY is defined as the largest government party ideology orientation and includes
three dummy variables. The ideology can be either RIGHT, LEFT or CENTER. Saiegh (2009)
uses RIGHT. I use this variable to test the effect of government ideology on sovereign debt
spreads. The coefficient is expected to be negative.
GOVC, PP, GOVM, ELESYS and IDEOLOGY are the variables of study. Moreover, ECON
includes six economic control variables: DEBT, DEFSUR, GDPG, STDR, STDTD and SPR.
DEBT is defined as general government gross debt as a percentage of GDP. It is a measure of
the solvency of a country. Sovereign spreads increase as debt relative to GDP increases (Min,
1998; Blanchard, 2006; Baldacci and Kumar, 2010). This variable is used by Van Rijckeghem
and Weder (2009), Saiegh (2009) and Kohlscheen (2010) to study sovereign default rates. The
variable is lagged one year. The coefficient of the variable is expected to be positive.
18
DEFSUR definition is general government net lending borrowing as a percentage of GDP. If
the value is negative, it is a public deficit, and if the value is positive, it is a public surplus.
Public deficits increase debt to GDP and reduce the solvency of a country. This is explained
among others by Elmendorf and Mankiw (1998) and Baldacci and Kumar (2010). Blanchard
(2006) explains how when public deficits are not controlled, this can lead to greater sovereign
spreads and finally the government has to default on its sovereign debt. Van Rijckeghem and
Weder (2009) use this variable to explain sovereign defaults. The coefficient of the variable is
expected to be negative.
GDPG is defined as GDP volume percentage change. GDP growth improves the ability to
repay debt as debt to GDP rate decreases. This variable is used among others by Cheibub (2006),
Van Rijckeghem and Weder (2009), Saiegh (2009) and Kohlscheen (2010). The coefficient of
this variable is expected to be negative.
STDR is defined as short-term debt as a percentage of total reserves. It is a measure of
liquidity and considered an important measure of default risk. Min (1998) and other previous
studies confirm it. Van Rijckeghem and Weder (2009) used it in their model. The coefficient of
this variable is expected to be positive.
STDTD is defined a short-term debt as a percentage of total external debt. Very often
countries default because they are not able to roll over some of the maturing debt. If a country
with a high level of short-term debt cannot change it to long-term, the country could not be able
to repay its debt. This is confirmed by previous studies. Saiegh (2009) uses this variable in his
model. The coefficient of this variable is expected to be positive.
Finally, SPR is the sum of the number of past years with debt rescheduled (interests or
principal). The sum starts in 1991 because there is not data of total amount of debt rescheduled
19
until 1990. Past repayment history is also an important factor influencing the sovereign debt
premium risk. Reinhart et al. (2003) explains country's external debt intolerance as a result of its
repayment history, debt levels, and history of macroeconomic stability. A country that has
previously defaulted has more possibilities to default again on its external debt. Saiegh (2009)
uses the sum of past reschedulings to explain actual debt rescheduling. The coefficient of this
variable is expected to be positive.
5. RESULTS
Table 3 shows the results of three regressions on sovereign debt spreads. Model 1 and Model
3 include all economic control variables. Because of this, the sample is reduced to 96
observations. Model 2 includes less economic control variables and uses 612 observations.
Note that PRO, MAJ and MIX are highly correlated and the same occurs between RIGHT,
LEFT and CENTER. Therefore, the three categories of electoral system or ideology cannot be
used simultaneously.
Model 1 explains 24.61% of change in sovereign debt spreads. Among the economic
variables, only GDPG is significant with an expected negative coefficient, which suggest that
economic growth improves the ability to repay the debt and reduces sovereign debt spreads.
Among the variables of study, MAJ and PP are significant and GOVC and GOVM are not
significant. The positive coefficient on MAJ supports Hypothesis 1 and the negative coefficient
on PP supports Hypothesis 4, meaning that majoritarian electoral systems and fewer parties in
parliament reduce sovereign debt spreads.
Model 2 explains 17.25% of change in sovereign debt spreads. The three economic variables
used are significant. The coefficient of DEBT is negative, which is contrary to the expected sign.
The coefficient of DEFSUR and GDPG is negative as expected. The negative coefficient on
DEFSUR suggests that government budget deficits increase sovereign debt spreads and surpluses
reduce spreads. All the variables of study included in the model are significant and with the
expected sign. MAJ, GOVC, GOVM and RIGHT have negative coefficients and PP has a
positive one. These results again support Hypothesis 1 and 4, but also support Hypothesis 3, 5
and 6, adding three more factors that reduce sovereign debt spreads: a government coalition, a
government majority in parliament, and the existence of a right-wing government. This means
21
that, a part of the electoral system and the number of parties in parliament, the government
composition, ideology and its share in parliament influences sovereign debt spreads.
Model 3 explains 49.26% of change in sovereign debt spreads. This model is very similar to
Model 1 as it also includes all economic variables. However, it includes PRO instead of MAJ
and does not include GOVC. The purpose of this model is to test Hypothesis 2 (the effect of
proportional electoral systems on sovereign debt spreads) that has not been tested by Models 1
and 2. As in Models 1 and 2, GDPG coefficient is negative and significant. STDTD and SPR
coefficients are both negative and significant, which is contrary to the expected sign. All the
variables of study included in the model are significant and with the expected sign. Coefficients
on PRO and PP are positive and the coefficient on GOVM is negative. PP and GOVM
coefficients again satisfy Hypothesis 4 and 5, and PRO coefficient supports Hypothesis 2,
meaning that proportional electoral systems produce the opposite effect of majoritarian electoral
systems, and increase sovereign debt spreads.
Overall, the findings support the importance of the institutional environment in determining
sovereign debt spreads. This study finds that the electoral system, the government and parliament
composition, the share of the government in parliament and the government ideology are all
important factors in determining sovereign debt spreads. Five factors lower sovereign debt
spreads: majoritarian electoral systems, the existence of a government coalition, fewer parties in
parliament, a government majority in parliament and the existence of a right-wing government.
22
Table 3. Regression Results of Sovereign Debt Spreads
The regressions are estimated using OLS with White's (1980) corrected for heteroskedasticity.
Heterokesdasticity consistent standard errors are in parentheses. *** Significant at a 1% level,
** significant at a 5% level, * significant at a 10% level.
Model 1 Model 2 Model 3
Intercept 7.2349** 2.6883*** 9.5056***
(3.3458) (0.3598) (2.3030)
MAJ -4.1079*** -0.6139**
(1.3060) (0.2935)
PRO
8.2937***
(1.5598)
GOVC 1.4063 -0.7606***
(1.7041) (0.2567)
PP 0.0655*** 0.0382** 0.0551***
(0.0191) (0.0186) (0.0107)
GOVM -2.0805 -0.3850* -3.1352***
(1.4627) (0.2304) (0.9751)
RIGHT
-0.8434***
(0.2257)
DEBT 0.0386 -0.0148*** 0.0064
(0.0443) (0.0042) (0.0296)
DEFSUR 0.0788 -0.1646** 0.0469
(0.1630) (0.0232) (0.1049)
GDPG -0.4939** -0.0945** -0.5351***
(0.2411) (0.0416) (0.1681)
STDR -0.0041
0.0061
(0.0126)
(0.0116)
STDTD -0.0003
-0.1097*
(0.0591)
(0.0565)
SPR -0.2238
-0.5253***
(0.1817)
(0.1533)
N 96 612 96
R^2 0.2461 0.1725 0.4926
23
The higher sovereign debt spreads of countries with proportional electoral systems than of
those countries with majoritarian electoral systems is consistent with prior literature. As shown
by Iversen and Soskice (2006), proportional electoral rules are associated with left-wing
governments and majoritarian electoral rules with right-wing governments, and left-wing
governments implement more redistributive policies than the right-wing ones. This correlation
between electoral rules and economic policy is also mentioned by Austen-Smith (2000).
Moreover, Saiegh (2009) finds that countries with proportional electoral rules default more often
on their sovereign debt than countries with majoritarian electoral rules. The finding that right-
wing governments have lower sovereign spreads is also in line with Iversen and Soskice (2006)
and Saiegh (2009).
The result that countries with a coalition government have lower sovereign debt spreads
agrees with Saiegh (2009) who finds lower sovereign debt default rates when there is a coalition
government. According to Saiegh (2009), a coalition government would have a better economic
policy for the interests of the bond holders as they are more likely to be represented in the
government if there is a coalition government.
Finally, the results show higher sovereign debt spreads with more parties in parliament and
when there is not a government majority in parliament. This is consistent with the findings of
Alesina and Drazen (1991), who point out the importance of the negotiation process in reducing
a deficit. A country with many parties in parliament and without a government majority in
parliament would complicate a budget expenditure reduction proposed by the government to be
able to pay for its sovereign debt.
6. DISCUSSION AND CONCLUSIONS
The research confirms the view that the institutional and political environment matter and
influence sovereign debt spreads. The study finds that countries with majoritarian electoral
systems have lower sovereign debt spreads than countries with proportional electoral systems.
Majoritarian electoral systems lead to right-wing governments and proportional electoral systems
to left-wing governments, and this has implications in terms of economic policy, because left-
wing governments implement more redistributive policies than right-wing governments (Iversen
and Soskice, 2006). The main reason why countries with majoritarian electoral systems have
lower sovereign debt spreads may be because their governments are more concerned with
sovereign debt repayment than with applying redistributive policies. In fact, I find that countries
with right-wing governments also have lower sovereign debt spreads. Furthermore, majoritarian
electoral systems could also lead to moderation and stability within the political system, which
reduces country risk. The study also finds lower sovereign debt spreads when there is a
government coalition, fewer parties in parliament and a government majority in parliament.
The main limitation of this study is the difference in sample size between model
specifications due to data availability. When including all economic control variables, the sample
is reduced from 612 to 96 observations. Nevertheless, most of the results from Models 1 and 3
(with 96 observations) are also confirmed by Model 2 (with 612 observations). The effects of
proportional electoral systems on sovereign debt spreads is the only factor not tested in Model 2.
However, this is not an important problem as majoritarian electoral systems are tested and
confirms the significance of electoral systems on sovereign debt spreads.
The findings pose important implications for official creditors such as the International
Monetary Fund or the World Bank, as these organizations should give more importance to
25
internal political variables rather than focus almost exclusively on macroeconomic indicators to
evaluate a country’s sovereign debt sustainability. Besides, parliament members from countries
with usually very high sovereign debt risk premiums should consider these findings to analyze if
a change in its electoral system is desirable.
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APPENDIX A. LIST OF COUNTRIES IN THE SAMPLE
Country Total years
Austria 23
Belgium 31
Bulgaria 11
Cyprus 10
Czech Republic 11
Denmark 19
Finland 23
France 31
Germany 20
Greece 20
Honduras 7
Hungary 10
Ireland 31
Italy 23
Japan 31
Latvia 10
Lithuania 9
Luxembourg 16
Maldives 2
Malta 10
Mexico 11
Netherlands 16
New Zealand 26
Norway 31
Pakistan 7
Philippines 13
Poland 10
Portugal 21
Romania 5
Slovak Republic 11
Slovenia 8
Spain 31
Sweden 18
Switzerland 28
Thailand 12
United Kingdom 31
United States 31
Vanuatu 5
Venezuela, Rep. Bol. 13
TOTAL 676
APPENDIX B. SAMPLE AVERAGES BY COUNTRY
Country SPREAD MAJ PRO MIX GOVC PP GOVM RIGHT LEFT CENTER
Austria -0.03 0 1 0 1 4.48 1 0.30 0 0.70
Belgium 0.24 0 1 0 1 9.94 0.87 0.97 0 0.03
Bulgaria 1.57 0 0.73 0.27 0.91 5.36 1 1 0 0
Cyprus 1.01 0 1 0 1 7.00 0.80 0.70 0 0.30
Czech Republic 0.16 0 1 0 0.82 4.45 0.45 0 0 1
Denmark 0.12 0 1 0 1 8.11 0.26 0.58 0 0.42
Finland 0.95 0 1 0 1 8.22 1 0 0.61 0.39
France 0.40 0.94 0.06 0 1 8.23 0.77 0.52 0 0.48
Germany -0.25 0 0 1 1 5.70 1 0.65 0 0.35
Greece 3.71 0 0.75 0.25 0 4.35 1 0.25 0 0.75
Honduras 6.49 0 1 0 0 5 0.14 1 0 0
Hungary 3.53 0 0 1 0.50 4 1 0.10 0 0.90
Ireland 1.29 0 1 0 0.90 6.71 0.58 0.29 0.71 0
Italy 1.82 0 0.48 0.52 0.39 6.70 0.78 0.43 0.48 0.09
Japan -3.35 0.48 0 0.52 0.55 15.90 0.74 0.97 0 0.03
Latvia 2.39 0 1 0 1 5.70 0.70 0.22 0.78 0
Lithuania 2.09 0 0 1 1 11.33 0.78 0.43 0 0.57
Luxembourg -0.41 0 1 0 1 5.44 1 0 1 0
Maldives 5.00 1 0 0 1 18 0 1 0 0
Malta 0.76 0 1 0 0 2 1 1 0 0
Mexico 4.55 0 0 1 0.55 7.27 0 1 0 0
Netherlands -0.28 0 1 0 1 10.44 0.88 0.56 0 0.44
New Zealand 2.23 0.38 0 0.62 0.65 5.38 0.77 0.46 0 0.54
Norway 0.87 0 1 0 0.87 7.61 0.29 0.45 0 0.55
Pakistan 7.01 1 0 0 0.57 55 0.14 0 0 1
Philippines 5.99 0.23 0 0.77 1 13.69 0.77 0 1 0
Poland 2.04 0 1 0 1 7 1 0.33 0 0.67
Portugal 1.79 0 1 0 0.14 5 0.57 0.38 0 0.62
Romania 4.19 0 0 1 1 12.20 0.60 - - -
Slovak Republic 0.96 0 1 0 1 5.73 1 0 0 1
Slovenia 0.47 0 1 0 1 7.63 0.63 0 0.50 0.50
Spain 2.09 0 1 0 0.13 11.19 0.61 0.26 0.06 0.68
Sweden 0.30 0 1 0 0.78 6.72 0.67 0.33 0 0.67
Switzerland -2.61 0 1 0 1 11.43 1 0.60 0 0.40
Thailand 1.19 1 0 0 1 7.08 1 1.00 0 0
United Kingdom 0.72 1 0 0 0.03 9.45 1 0.58 0 0.42
United States 0 1 0 0 0 2.52 0.39 0.58 0 0.42
Vanuatu 3.44 1 0 0 1 6.20 1 0.20 0 0.80
Venezuela, Rep. Bol. 14.99 0 1 0 0.92 6.23 0.85 - - -
31
Country DEBT DEFSUR GDPG STDR STDTD SPR
Austria 63.52 -2.71 2.26 - - -
Belgium 111.07 -5.30 2.69 - - -
Bulgaria 36.51 0.48 3.94 64.73 27.16 6.00
Cyprus 63.38 -3.22 2.36 - - -
Czech Republic 28.34 -4.00 3.29 - - -
Denmark 53.11 0.24 1.59 - - -
Finland 40.58 0.50 2.02 - - -
France 48.71 -3.49 1.89 - - -
Germany 60.36 -2.70 1.45 - - -
Greece 98.97 -7.38 1.98 - - -
Honduras 61.23 -3.87 5.15 20.83 7.86 13.43
Hungary 65.55 -5.33 1.82 84.81 15.91 0
Ireland 68.95 -4.54 4.57 - - -
Italy 108.09 -5.45 1.22 - - -
Japan 114.06 -4.12 2.11 - - -
Latvia 17.62 -3.21 3.81 - - -
Lithuania 22.30 -3.39 4.22 - - -
Luxembourg 8.47 1.97 3.79 - - -
Maldives 56.45 -14.32 11.33 63.56 22.66 0
Malta 63.84 -4.18 2.14 - - -
Mexico 41.20 -2.45 2.11 33.61 13.87 6.55
Netherlands 58.23 -1.44 2.18 - - -
New Zealand 41.30 -0.14 2.85 - - -
Norway 41.30 7.50 2.53 - - -
Pakistan 65.19 -5.49 3.24 93.26 6.47 2.57
Philippines 59.37 -1.71 4.42 46.98 11.75 5
Poland 46.51 -5.01 4.24 - - -
Portugal 60.31 -5.29 1.73 - - -
Romania 18.78 -5.18 1.74 62.47 25.07 0
Slovak Republic 38.62 -3.93 4.76 - - -
Slovenia 28.37 -2.46 2.33 - - -
Spain 46.61 -3.64 2.62 - - -
Sweden 56.35 -0.44 2.81 - - -
Switzerland 50.56 -0.42 1.84 - - -
Thailand 46.48 -2.27 2.34 48.24 27.99 0
United Kingdom 44.41 -3.33 2.45 - - -
United States 61.57 -3.95 2.76 - - -
Vanuatu 34.12 -3.03 -1.14 16.51 5.81 0
Venezuela, Rep. Bol. 37.55 -2.51 2.81 49.99 25.09 1
APPENDIX C. CORRELATION MATRIX
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
(1) SPREAD 1
(2) MAJ -0.06 1
(3) PRO 0.01 -0.66 1
(4) MIX 0.05 -0.24 -0.58 1
(5) GOVC -0.07 -0.30 0.21 0.05 1
(6) PP 0.07 0.09 -0.12 0.05 0.03 1
(7) GOVM -0.05 0.00 0.02 -0.02 0.18 -0.11 1
(8) RIGHT -0.18 0.10 -0.15 0.08 -0.01 0.00 0.04 1
(9) LEFT 0.12 -0.19 0.15 0.01 0.20 -0.01 0.01 -0.39 1
(10) CENTER 0.10 0.03 0.05 -0.09 -0.14 0.01 -0.05 -0.74 -0.33 1
(11) DEBT -0.12 -0.07 -0.08 0.18 -0.14 0.12 0.07 0.23 -0.16 -0.12 1
(12) DEFSUR -0.19 -0.09 0.15 -0.09 0.21 -0.06 -0.08 -0.07 0.03 0.04 -0.34 1
(13) GDPG -0.19 0.01 0.07 -0.10 0.02 0.01 -0.10 -0.04 0.09 -0.03 -0.05 0.24 1
(14) STDR -0.01 0.11 -0.15 0.04 0.21 -0.18 0.13 -0.20 -0.08 0.29 0.01 -0.18 -0.10 1
(15) STDTD -0.12 -0.02 0.19 -0.15 0.35 -0.30 0.36 0.33 -0.11 -0.26 -0.55 0.12 0.05 0.28 1
(16) SPR -0.02 -0.38 0.35 0.04 -0.50 0.09 -0.45 0.44 0.08 -0.54 0.12 0.18 0.18 -0.36 -0.32 1
APPENDIX D. ELECTORAL SYSTEMS GLOSSARY
ELECTORAL SYSTEM
The electoral system determines how votes are translated into seats. There are three main
characteristics of any electoral system: a) the District Magnitude – the number of representatives
elected from the district; b) the Ballot Structure – the number of voting preferences given a voter
on a ballot for them to mark (sometimes the voter can rank-order the preferences); c) the
Electoral Formula – the method used to convert votes into seats, given the district magnitude and
ballot structure (it could include thresholds stipulating the percentage of votes necessary to get
elected).
MAJORITARIAN ELECTORAL SYSTEM
A majoritarian electoral system is one in which the candidates or parties that receive the most
votes win. Bormann and Golder (2013) include in majoritarian electoral systems: single-member
district plurality, alternative vote, single nontransferable vote, block vote, party block vote, borda
count, modified borda count, limited vote, and two-round systems.
MIXED ELECTORAL SYSTEM
A mixed electoral system is one in which voters elect representatives through two different
systems, one majoritarian and one proportional. Bormann and Golder (2013) classify an electoral
system as Mixed only when more than 5% of the total legislature is elected by a different
electoral formula (majoritarian or proportional) to that used to elect the other deputies. Mixed
electoral systems come in two varieties: independent and dependent.
PROPORTIONAL ELECTORAL SYSTEM
A proportional electoral system is a quota system or divisor system employed in multi-member
districts (where the quota is less than 50%). These voting systems attempt to make the
percentage of offices awarded to candidates reflect as closely as possible the percentage of votes
that they received in the election. This means that if a given political party) gets X% of the vote,
it should also get approximately X% of the seats in the legislature. Bormann and Golder (2013)
include in proportional electoral systems: list proportional representation systems and the single
transferable vote.