Leaders' Visits and Foreign Debt

Abstract

ABSTRACT:This paper examines the effect of a visit by a country's leader to the U.S. on the ability to attract foreign loans. The difficulty is the issue of endogeneity. As the leader's visit may attract foreign loans, leaders may also be tempted to visit countries known to be major creditors. To deal with potential endogeneity, we introduce a novel instrumental variable for the number of leader's trips. The instrument is urban distance defined as the gap between the level of urban development in the country of the leader relative to that in the United States. We conduct a Two-Stage-Least-Squares estimation (2SLS) and the Limited Information Maximum Likelihood (LIML) estimation where the urban distance serves as a source of exogenous variation in leader's trips. The data for leader's trips is derived from the historical archives of the U.S. State Department. The estimation provides evidence of a statistically significant positive coefficient of leader's trips. This result implies that these trips by the leaders signal to the creditors their commitment to use the borrowed funds properly and to repay these funds in due time. Our results are robust even after the inclusion of other control variable, using alternative samples, and accounting for the potential of instrument weakness. Borrowers ought to consider the beneficial effect of a visit by their leaders to their creditors. These trips allow the leaders to present to foreign creditors the projects that need to be financed in their countries, to persuade them to extend a loan to their country with concessionary terms, to highlight the future benefits of the loan, and to reassure them of the ability of the borrower to repay the principal and interest in due time.