Regulation and government debt
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Government debt is large in most developed countries, and while budget deficits may reflect short-term attempts to kick-start the economy in times of crisis by means of fiscal stimulus, the longer-term consequences may be detrimental to investment and growth. Those negative consequences make it important to identify factors that are associated with public debt. While previous studies have related government debt to economic and political variables, they have not incorporated the degree to which the economy is regulated. Using a measure of regulatory freedom (absence of detailed regulation of labor, business and credit) from the Economic Freedom of the World index, we conduct an empirical analysis covering up to 67 countries during the period 1975–2010. The main finding is that regulatory freedom, especially with respect to credit availability, reduces debt accumulation. The effect is more pronounced when the political system is fractionalized and characterized by strong veto players, indicating policy stability and credibility, and when governments have right-wing ideologies.
KeywordsDebt Economic freedom Regulation Markets Stimulus Keynesianism
JEL ClassificationE02 H63
The authors wish to thank Niklas Potrafke and participants at the 2016 Conference of the Italian Society of Law and Economics in Torino, especially Enrico Colombatto, the 2017 Research Workshop of the Institute for Research in Economic and Fiscal Issues (IREF) in Manchester, the 2017 Conference of the European Association of Law and Economics in London and the 2018 conference “The Importance of Janos Kornai’s Research for Understanding the Changing Role of the State in the Economy” at Corvinus University in Budapest for valuable comments and suggestions. Olga Pugatšova provided excellent research assistance. Financial support from the Swedish Research Council (Grant 2103-734, Berggren), Torsten Söderberg Foundation (Grant E1-14, Berggren), the Czech Science Foundation (GA ČR) (Grant 16-19934S, Berggren) and the Institute for Research in Economic and Fiscal Issues (IREF) is gratefully acknowledged.
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