Sovereign Default and Tax-smoothing in the Shadow of Corruption and Institutional Weakness

Emerging countries exhibit volatile fiscal policies and frequent sovereign debt crises, that significantly diminish the well-being of their citizens. International advisors typically suggest developed-world solutions as a remedy. We argue that the root of the problem lies in the institutional environment, which does not incentivize responsible policymaking, particularly tax-smoothing practices. Focusing on democratic representation and control of corruption, our dynamic political-economy bargaining model shows that nations with weaker institutions experience frequent default episodes and greater economic volatility. Our results are in line with stylized facts from a panel of 58 countries between 1990 and 2022. Through counterfactual experiments, we find that while emerging economy policymakers might favor moderate reforms to improve democratic representation, achieving the institutional depth seen in developed countries is politically unfeasible, despite its clear advantages for citizens.