The effects of debt restructurings on income inequality in the developing world

Abstract

Developing countries, saddled with debts, often prefer investors absorb losses through debt restructurings. By not making full repayments, debtor governments could increase social spending, serving poorer constituents, and, in turn, lowering income inequality. Alternatively, debtor governments could reduce taxes and cut government spending, bolstering the assets of the rich at the expense of the poor. Using panel data for 71 developing countries from 1986 to 2016, we assess the effects of debt restructurings on societal income distribution. Specifically, we study the impact of debt restructurings on social spending, tax reform, and income inequality. We find that countries receiving debt restructurings tend to use their newly acquired economic flexibility to reduce taxes and lower social spending, worsening income inequality. The results are also robust to different model specifications. Our study contributes to the globalization and the poor debate, suggesting the economic harm caused to the less well-off following debt restructurings.