Effects of commodity price windfalls on external debt: The role of political institutions

Rabah Arezki, Markus Brückner, 15 June 2012



Booming commodity prices have generated large foreign currency inflows for commodity exporting nations. Such inflows, however, are not always associated with positive outcomes for the commodity exporters. Phenomena such as corruption (Bhattacharyya and Hodler 2009) and the ‘natural resource curse’ (Brunnschweiler and Bulte 2012) often plague nations rich in natural resources. The political impact of large foreign currency inflows are important (Brollo et al. 2010), as is the optimal management of the revenue (Van der Ploeg and Venables 2011).

A related but distinct set of issues concerns a classic topic in the development and macroeconomics literature, namely, whether in commodity-exporting countries commodity price booms lead to a significant debt overhang (e.g. Krugman 1988, Sachs 1990, and Manzano and Rigobon 2001). This is a concern that the Global Crisis has highlighted as critical to countries' macroeconomic performance and resilience to shocks.

The effects of international commodity price shocks on debt: New evidence

In our recent paper (Arezki and Brueckner 2012), we examine empirically the effects of international commodity price shocks on debt. The main finding of our research is that the impact depends upon the form of government.

  • In countries with some political competition and constraints on the political executive, we find that a 1% increase in the international commodity export price index induces a reduction in external debt of over 1.6%.
  • In autocracies on the other hand, such windfalls did not lead to a significant reduction in external debt.

To provide an explanation for the above finding we examine the response of government spending.

It is well known that higher commodity prices are associated in developing and emerging economies with higher revenues that accrue to the government sector. What is less well-known is whether governments in these countries systematically use the additional revenues to increase government consumption expenditures, or reduce the level of debt.

We find that in autocracies, windfalls from international commodity prices lead to a statistically-significant and quantitatively-large increase in government consumption spending.

  • A 1% increase in autocratic countries' international commodity export price index is associated with an increase in government consumption expenditures of over 0.9%.
  • In democracies, the response is quantitatively small and statistically insignificant.

Hence, an examination of movements in government consumption spending shows a significant procyclicality of government consumption expenditures to commodity windfalls in autocracies, while in democracies government consumption expenditures are acyclical.

The strong procyclicality of government consumption to commodity windfalls in autocracies may explain why external debt was not significantly reduced in these countries. Additional revenues accruing from international commodity price booms were directly spent by autocratic governments with little savings left from which to finance a reduction in external debt.

To examine this spending channel further, we document that while in democracies commodity price booms are associated with increasea in real per capita GDP growth, it is not the case in autocracies.

Managing coffee windfalls: Columbia vs. Burundi, Ivory Coast, or Nicaragua

There is a number of telling country examples that fit the pattern documented by our regressions. For example, Colombia during the coffee price boom of 1975-1978. Colombia had at that time free and fair elections and significant constraints on the political executive. Throughout the 30% annual increase in world coffee prices during the 1975-1978 period Colombia experienced real GDP per capita growth one percentage point above world average. However, Colombia’s government consumption grew by less than one percentage point, and external debt grew by less than 12 percentage points relative to the world average. Other coffee-exporting countries such as Burundi, Ivory Coast, or Nicaragua who were at that time ruled by autocrats with little or no political constraints, experienced an annual government-consumption growth that was more than one percentage point above the world average and their external debt increased at a rate that was equal or above the world average external debt growth.

A note on causality and estimation framework

The research question we are interested in requires that our estimates reflect causal effects (and not simply correlations). In order to estimate such causal effects we applied rigorous panel fixed effects estimation techniques, using a panel of over 90 countries spanning more than three decades. In all our regressions we controlled for both country and year fixed effects. The effects of commodity windfalls on external debt are identified from the within-country variation of the data. The year fixed effects are important because they control for global shocks such as changes in the world business cycle.

It is also important that the variation in commodity windfalls is plausibly exogenous to commodity exporting countries' macroeconomic conditions. To that end, we constructed a country-specific commodity export price index that weights time-series variation in the international commodity prices with the country-specific export shares. Importantly these export shares are kept time-invariant. This is necessary in order for the time-series variation in the commodity export price index to be plausibly exogenous to commodity exporting countries' external debt.


The findings in our paper suggest that political institutions play an import role in shaping countries' external debt policy. In countries with significant executive constraints and political competition windfalls from commodity price booms lead to a significant reduction in external debt. In autocratic regimes, on the other hand, external debt is often not significantly reduced. Instead, the windfalls from commodity price booms are used by autocrats to increase consumption expenditures. Our findings support the view in the political economy literature that institutions matter for the macroeconomic effects of resource wealth.


Arezki, R. and M. Brueckner (2012). "Commodity Windfalls, Democracy, and External Debt", Economic Journal 122: 884-866.

Bhattacharyya, Sambit and Roland Hodler (2009) “Natural resources and corruption: Is democracy the “missing link”?”, VoxEU.org, 13 November.

Brollo, Fernanda, Tommaso Nannicini, Roberto Perotti, and Guido Tabellini (2010), “The political resource curse”, VoxEU.org, 10 March.

Brunnschweiler, Christa and Erwin Bulte (2012), “Institutional reform and the so-called resource curse”, VoxEU.org, 28 May.

Krugman, P. (1988). "Financing vs. Forgiving a Debt Overhang", Journal of Development Economics 29: 253-268.

Manzano, O., and R. Rigobon (2001). "Resource Curse or Debt Overhang?" NBER Working Paper 8390.

Sachs, J. (1990). "A Strategy for Efficient Debt Restructuring." Journal of Economic Perspectives 4: 19-29.

Van der Ploeg, F. and A. Venables (2011). “Harnessing Windfall Revenues: Optimal policies for resource-rich developing economies", Economic Journal 121: 1-30.

Topics: Development, Macroeconomic policy
Tags: debt, political regimes, resource curse

Rabah Arezki

Economist at the IMF Institute

Markus Brückner

Associate Professor in Economics, National University of Singapore