Democratically elected political leaders of commodity-exporting countries are much more likely than autocratic regimes to use the windfall revenues from international commodity price booms to pay down external debt, support macroeconomic stability and provide a platform for future economic growth. That is the central finding of research by Dr Rabah Arezki and Professor Markus Brückner.
Their study, which is published in the June 2012 issue of the Economic Journal, analyses data on big rises and falls in international commodity prices and the link to external debt in more than 90 countries over a period of nearly 40 years up to 2007.
The main finding is that commodity price booms are associated with a significant decrease in external debt and the risk of external debt default – but only in countries where the political institutions in place ensure a minimum degree of accountability of political leaders.
In countries with deeply autocratic regimes, where political leaders are unaccountable to the public, windfalls from commodity price booms are not used systematically to reduce external debt. Indeed, the risk of default on external debt significantly increases in these countries following revenue windfalls from commodity price booms.
To explain this finding, the researchers show that a large part of the revenue windfalls from commodity price booms are used by autocratic regimes to increase government consumption expenditures. Increases in government consumption expenditures can certainly be optimal from a social point of view if, for example, they are used to provide assistance to the poor.
But the increases in government consumption expenditures that were due in autocracies to increased revenues from commodity price booms were mostly unproductive as they did not increase the growth of GDP per capita significantly.
In democracies, in contrast, where there was no large and significant increase in government consumption expenditures, revenue windfalls from commodity price booms did lead to a significant increase in GDP per capita growth.
Commodity-exporting countries are often faced with large commodity price rises and falls that pose a number of serious challenges to their macroeconomic stability. The volatility of commodity prices and the recent debt crisis make it important for policy-makers to have an understanding of how the external debt of commodity-exporting countries is linked to movements in international commodity prices.
All in all, these findings, based on a rigorous econometric analysis, show that in countries with stronger democratic institutions, revenue windfalls from commodity price booms are administered more conservatively.
A clear benefit of the more conservative administration of revenue windfalls from commodity price booms vis-à-vis reduction of external debt is the reduction of the tax burden on future investment projects.
From a political economy point of view, a reduction of external debt should therefore be the preferred policy platform for the majority of citizens if there is a severe risk that revenue windfalls from international commodity price booms are squandered by the government on low-return projects.
Democratically elected political leaders are more responsive to the preferred policy platform of citizens and, therefore, are more willing to promote a reduction in external debt than their autocratic counterparts.
‘Commodity Windfalls, Democracy and External Debt’ by Rabah Arezki and Markus Brückner is published in the June 2012 issue of the Economic Journal.