Like many areas of economic policy, public borrowing is subject to a credibility problem. Borrowing on capital markets is advantageous, because it gives governments a means of deferring part of the cost of financing public goods. A state that has access to credit can expand public investment without a sharp and immediate increase in taxation. The problem is that once a government has borrowed, it may face incentives to defer repayment or even to default on its obligations, in order to reduce the burden of taxation on those who contribute to repay debts. Default was a common occurrence that hindered the development of public borrowing in early modern Europe. Today, default may no longer be a worry for those who are considering investing in bonds issued by OECD governments, but it is a major issue for governments in developing and transition economies that seek to offer assurances about debt repayment. If prospective lenders anticipate that a government may default, they will invest only if they are given a high rate of return that compensates for this risk. In extreme cases, they will refrain from lending at all.
This book investigates the link between public debt and representative democracy. In it I develop three theoretical arguments about the effect of constitutional checks and balances, political parties, and bureaucratic delegation on government credibility, and I then confront these propositions with historical evidence from England and France during the eighteenth century. In a concluding chapter I consider broader implications of my findings, focusing on links between democracy and economic performance and on the study of institutions. The theoretical sections of the book use basic game-theoretic models to examine how different