The democratic (dis)advantage: The conditional impact of democracy on credit risk and sovereign default

Many have argued that democracies are able to make credible commitments to repay their debts and consequently enjoy higher sovereign credit ratings. In contrast to this expectation, I argue that the advantage of democracies in credit ratings is conditional on the countries' level of financial vulnerability and adjustment needs. Because democracies have more diffuse decision‐making and are more accountable to the public, they encounter greater difficulty than autocracies in passing unpopular economic adjustment measures. Thus, I argue that democracies with high debt levels and low foreign reserve assets experience worse credit outcomes, whereas democracies with low vulnerability experience more positive outcomes. In a sample of up to 96 developing countries, I show that democracies have worse credit ratings and CDS Spreads and are more likely to default than their autocratic counterparts when foreign reserves are low relative to external debt. Notably, I also show that large debt burdens increase credit risk mainly in more democratic countries. I further test the causal pathway of the democratic advantage by constructing democracy scores of “market‐friendly” and “adjustment‐difficulty” democracy, finding that democracy worsens debt outcomes due to adjustment difficulty. These findings help to revise and clarify the causal logic surrounding the democratic advantage hypothesis.