Testing the Crisis Hypothesis - A Dark Cloud Without A Silver Lining

Abstract: This paper studies whether economic crises lead to more reforms as argued by the well-known crisis hypothesis. Based on the theoretical model by Prato and Wolton (2015) we argue that economic crises are likely to reduce the size of liberalizing reforms. To test this we use the IMF Structural Reform dataset, which contains unbalanced panel data on 161 countries and different types of reforms over 1960-2006, as well as the Doing Business indicators for 2007-2015. Included in the analysis are trade, finance, products, labor, and business regulation reforms. Using the different types of reforms we construct one total reform index. We find that crises lead to no or less reforms rather than more reforms and thus our results point in the opposite direction of what the conventional crisis hypothesis argues. These results hold when we use a broad range of different crisis indicators and are driven by middle- and high-income countries. The different types of reforms all respond similarly to the crises. Additionally, we find that both aid and political crises increase the change in reforms.