On the Rank-Size Distribution of Local Government Debt
Keywords:
Local Government Debt, Power Law, Self-Organized Criticality, Complex Adaptive System, Risk and Uncertainty ManagementAbstract
Rank-size distributions of local government debt, regardless of the way in which data is categorized, whether by region, type, or all local governments, are found not to be normally distributed but rather consistent with a mathematical principle known as power law. This implies that local government borrowing resembles a complex adaptive system in the sense that it is self-organized with positive feedback among concerned parties. In such a system, a critical point could be reached wherein a local government debt crisis eventually disrupts a government’s fiscal and financial status as well as that country’s economic system. This kind of event is extremely difficult to predict in advance because it represents both an emergent phenomenon and scale-invariance. One cannot really tell beforehand what type or size of local government debt will transpire, or which local government would cause such a crisis. Therefore, rules and regulations designed to regulate and monitor local government borrowing, as well as manage the risk of local government debt, should emphasize mitigation measures in addition to disciplinary procedures. This study proposes a rule that requires each local government to maintain enough reserves to service its debts. The rationale is that, in the event of a local government debt crisis, the local government, indirectly affected by such a crisis, may encounter problems from liquidity shortage and therefore not be able to pay principals and/or interest to its creditors. Having such mitigation measures in place should not only lower the probability of local governments defaulting on debts, but also help build trust in the system.
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