Social Polarization, Political Institutions, and Country Creditworthiness

Abstract

The literature argues that the presence of multiple veto players (government decisionmakers) with polarized interests increases the credibility of sovereign commitments, but reduces the ability of governments to adjust policies in the event of exogenous shocks that jeopardize their ability to honor their commitments. In the case of sovereign lending, if the first effect prevails, countries would be regarded as more creditworthy; if the second, less.

Keefer and Knack address two issues. First, using measures of country creditworthiness, they ask whether the net effect of multiple veto players is positive or negative. Second, though, the authors go beyond the existing literature to argue that the net effect of multiple veto players depends on the nature of social polarization in a country. In particular, they argue that political competition is fundamentally different in countries exhibiting ethnic polarization than in countries polarized according to income or wealth. The evidence supports the prediction that multiple veto players matter more when countries are more ethnically polarized, but less when income inequality is greater.

This paper - a joint product of the Investment Climate and Public Services Teams, Development Research Group - is part of a larger effort in the group to understand the interaction of social polarization and institutions.