The strings of the ‘golden straitjacket’: sovereign ratings and the welfare state in developed countries

Abstract

Abstract Do sovereign ratings influence social spending in developed countries? Ratings are highly publicized and fiscally consequential assessments of countries’ creditworthiness shown to penalize welfare-largesse. We hypothesize that downgrades induce governments to retrench social spending, and test this hypothesis via panel-analyses of 23 OECD countries between 1995 and 2019. Our event-study shows that downgrades are associated with spending reductions, but upgrades have no effect. Our error-correction models demonstrate that, since the global financial crisis, spending on social services and transfers is reduced after downgrades, with reductions in social transfers occurring over the longer run. Reductions are particularly pronounced in country-years with high public debt and social–democratic executives but are independent of elections. We conclude that ratings became a binding constraint on social spending since the crisis drove home developed countries’ fallibility in international debt markets.