Why Do Some Countries Default More Often Than Others? The Role of Institutions

This paper examines how a country's weak institutions and polarized government can affect the likelihood of its default on sovereign debt. Using a data set of 90 countries, it shows that strong institutions are associated with fewer sovereign default crises. In addition, when institutions are weak, a more polarized government tends to default more often. To explain these findings, the author develops a model showing the dynamics between the quality of institutions, the level of government polarization and sovereign default risk. Countries default more often when they lack rules and strong institutions to curb the influence of powerful groups on government policies. That is because in a polarized government, each powerful group makes decisions without considering the impact on other groups. Simulations of the model show that more than half the cross-country variation in sovereign default frequencies can be explained by institutional quality and the degree of government polarization observed in the data.