Sovereign Debt and the Tragedy of the Commons

Abstract

In this paper I study a tragedy-of-the-commons model: a small open economy composed of different groups that compete for access to government resources and a government can save and borrow from risk-neutral foreigners. I show that the same economic forces that generate overspending in a tragedy-of-the-commons model can also guarantee that a small open economy repays its sovereign obligations. The groups may agree to repay the sovereign debt to avoid having the assets spent inefficiently, even though they can cooperate after defaulting. The fundamental reason for repayment is the same as in Eaton and Gersovitz (1981): countries repay because they would like to borrow again. 1

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