Economic, Political and Institutional Determinants of Public Deficits

Abstract

We examine a large set of economic, sociopolitical, and institutional variables in a panel of 57 developed and developing countries over the period of 1970-90 to derive robust conclusions about which variables are important in explaining cross-country differences in public sector deficits. Financial depth, income inequality, assassinations, cabinet size, and centralization of authority in budgetary decisions are found to be significant and robust determinants of public deficits. We also propose a working hypothesis and provide supporting econometric evidence: Social polarization is important in explaining differences in fiscal outcomes across countries, yet its effects may be even more pronounced or suppressed, depending on the political and institutional structures through which social polarization is linked to the fiscal policy-making process. Indeed, effects on public deficits of the sociopolitical variables tend to be smaller in countries with better institutional arrangements. Conversely, the sociopolitical polarization has very strong effects on deficits in the presence of poor institutions. The results are confirmed by extensive robustness tests such as the sensitivity analysis and the robust estimation method.

Keywords: Public Deficit, Political Instability, Social Polarization, Income Inequality, Budgetary Institution, Sensitivity Analysis, Robust Regression

JEL Classification: H61, H62, E62, E63