When lack of accountability allows observing unobservables: moral hazard in sub-national government credit markets in Mexico

ABSTRACT

This article estimates the amount of moral hazard effect in sub-national credit markets. I employ the case of Mexico because of the country’s lack of political accountability; a fact that I argue allows for observation of this informational problem. In particular, out of every dollar borrowed, sub-national governments spend 45 cents in activities unrelated to the purpose of credit.

KEYWORDS:

• Moral hazard
• information asymmetries
• credit markets
• sub-national governments
• debt
• Mexico

JEL CLASSIFICATION:

• H74
• O16
• O54
• D80

Acknowledgements

I wrote this article while visiting the Kellogg Institute for International Studies at the University of Notre Dame. I am grateful for their kind financial support. I also wish to thank two anonymous referees, Daniel Ventosa, Kaniska Dam, Tamon Takahashi, Jorge Chávez Presa, René Lozano and participants of the seminar at the University of Quintana Roo. Any remaining errors are my sole responsibility.

Disclosure statement

No potential conflict of interest was reported by the author.

Supplemental data

Supplemental data for this article can be accessed here.

Notes

¹ This is not the case for the insurance market. See Chiapori and Salanié (2000) and Cardon and Hendel (2001).

² http://www.cnnexpansion.com/economia/2015/02/24/6-estados-en-riesgo-de-disparar-sus-deudas-por-elecciones?newsvcnn2=1424869251

³ Mexico, as most Federal Republics, follows a revenue-sharing system. Thus, states and municipalities receive block transfers. These may be used as these two entities please.

⁴ Own revenues are those coming from state taxes.

⁵ The Hausman test suggests that fixed effects are more appropriate for estimating this model. The cross-section random yields a Chi-square statistic of 17.893342 with 5 degrees of freedom, which yields a probability of 0.0031. This test is presented in the supplementary material.

⁶ Different tests suggest that this lag guarantees no correlation between public investment and the instrument. In particular the Durbin–Wu–Hausman endogeneity test was performed. This test is in the supplementary material.