The Political Economy of Debt and Entitlements

Laurent Bouton, Alessandro Lizzeri, Nicola Persico

NBER Working Paper No. 22570
Issued in August 2016
NBER Program(s):Political Economy

This paper presents a dynamic political-economic model of total government obligations. Its focus is on the interplay between debt and entitlements. In our model, both are tools by which temporarily powerful groups can extract resources from groups that will be powerful in the future: debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove five main results. First, debt and entitlement are strategic substitutes in the sense that constraining debt increases entitlements (and vice versa). Second, if entitlements are unconstrained, it is sometimes welfare-improving to relax debt constraints, even in the absence of shocks that require smoothing. This is because borrowing constraints lead to higher entitlement spending and reduces overall provision of public goods. Third, equilibrium entitlements are excessive from a utilitarian perspective because they transfer resources to powerful agents who are already in a privileged position. However, very tight constraints in entitlements limit agents' opportunities to smooth consumption. Fourth, debt and entitlements respond in opposite ways to political instability and, in contrast with prior literature, political instability may even reduce debt when entitlements are endogenous. Finally, we identify a possible explanation for the joint growth of debt and entitlements.

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Document Object Identifier (DOI): 10.3386/w22570

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