DOI: https://doi.org/10.21203/rs.3.rs-2081923/v1
This paper investigates the role of the institutional framework in the accumulation of
central government debt. We employ the Economic Freedom Index (EFI) as a proxy for
institutional framework and study the causal link between institutions that promote economic
freedom and the creation of public debt. The results presented in this paper are the
evidence of a direct causal link between institutions and debt ratios. They suggest that
not only the institutional and structural framework of economies matter in public debt
accumulation, but also show that countries with higher institutional scores are less likely
to accumulate high levels of public debt. In particular, a 10-point increase in the economic
freedom score, on average, reduces a country’s debt stock by 7 percentage points. Government
size plays a major role in debt reduction, but it does so in different ways across
corresponding samples. Developing countries can more effectively reduce debt through
a cutback on the tax burden, whereas developed countries are more likely to do so with
policy oriented in reducing government spending. We also find evidence on the importance
of legal institutions in developed countries, especially in the forms of enforcement
of property rights and judicial corruption, in determining levels of government debt.