| Since the 1990s, a number of countries have experimented with decentralizing political and fiscal arrangements to allow subnational governments (SNGs) a greater role in local governance. Among the issues in fiscal governance is the degree to which SNGs are responsible for and able to finance local capital projects. As SNGs experience greater autonomy from higher-level governments, pressure on them mounts to meet citizen demands for infrastructure investment. There is tremendous variation in the degree to which SNGs issue long-term debt; some do not issue any debt, others issue debt from a single or a narrow set of public or private sources, and still others borrow from multiple sources. This study considers how the institutions of information asymmetry resolution, conditional on other existing institutions, relate to the development of SNG capital markets. A number of institutional factors have been identified as important covariates of SNG debt, including economic, financial and market, political, and legal institutions. However, they fall short of fully explaining the growth of not just SNG debt, but the composition of debt among different instruments and sources of capital. Despite robust empirical evidence of how information impacts private-sector capital markets, the theoretical and empirical literature has been deficient on exploring the institutions of information resolution that contribute to, or retard, the use of SNG debt. And yet, the underlying principles of economics of information are equally present in any capital market, be it for private-sector firms or SNGs. Within a nation’s credit system, market participants are often exposed to the same institutions for information resolution, whether the investments are stocks, corporate bonds, or SNG securities. The theoretical thesis in this article is that the ability of a system to resolve information asymmetry problems, analogous to credit market development in the private sector, rests on the contractability in the system, which refers to the transparency, disclosure, and regulation of information. Based on a sample of fifty-two countries with various degrees of market-based approaches to public debt finance, this study evaluates the extent to which a country’s macrolevel ability to resolve informational problems covaries with the size of SNG capital markets from 2007 to 2014. Empirical findings show that transparency and depth of credit information resolution and extent of disclosure in the private sector positively relate to SNG debt levels, other institutional capacities held constant. These findings support the hypothesis that the ability of a system to support information resolution, or ensure contractability between borrowers and lenders, controlling for existing economic, financial and market, political, and legal institutions, is most critical for SNG credit markets. The research offers recommendations for policy advisors who are engaged in building capital access to SNGs. |
