Hiding Public Debt

This paper examines the determinants of hidden public debt that is, government financial commitments and contingent liabilities that do not receive official recognition and explicit budgetary allocations, but are later on assumed by the government as additional debt outside the normal budget. Hidden debts are large in many countries and can cause fiscal and macroeconomic instability. We propose a measure of hidden debt and develop a model that explains its regularities. We show that the forces that raise the demand for public expenditure, such as fractionalization and division in the government, also motivate politicians to resort to disguised expenditure and debt as a means of alleviating constraints on explicit borrowing. The tightness of such constraints also adds to the incentive to hide debt, as do factors that reduce the costs of arranging off-budget debts. We find that these costs decline with the extent of government intervention in the economy, especially when the economy is sufficiently developed to have resources that interventionist governments can direct toward hidden expenditures. The proposed measure of hidden debt is likely to have other important applications, especially in the studies of fiscal policy that in the past have relied on budgetary deficit as a complete measure of government deficit.