expression and beliefs, freedom for association and organization, and protection from the state in political, civil, and criminal matters. The Political Rights index captures free and fair elections, political pluralism, and government accountability. Each ranking is measured on a 1-7 scale. Our chosen proxy for _Political Freedoms_ is the sum of the two rankings. We have reversed the original scale to make them more intuitive, so that higher values represent more political openness. (There is some conceptual overlap in _Institutional Capacity_ and _Political Freedoms_ ; for example, both measure aspects of the rule of law. Empirically, the two indexes are correlated at .46.) As will be shown below, results obtained using the Freedom House _Political Freedoms_ indicator are robust to using alternative measures of democracy and of constraints on the executive from the Polity data base.

Institutional development as measured by our two indicators may affect the graduation decision through other channels, in addition to its implications for income volatility. In countries with greater _Institutional Capacity_ and more _Political Freedoms_ , growth is likely to be more inclusive, with the benefits of high incomes not confined to elites. Knack (2002) shows that in more institutionally developed countries (as measured by ICRG indicators), growth in incomes is most rapid for the lower-quintile groups in the income distribution in each country. Public resources are also likely to be used more effectively: revenues will be raised and expended in more efficient and equitable ways, producing higher-quality public services (see, e.g., Rajkumar and Swaroop 2008; World Bank 2003). Income inequality and human development are important outcomes in themselves; to the extent that higher-quality public services in health and education increase the human capital of workers, the likelihood that per-capita income will fall below the IBRD threshold will also decline.

As a third indicator of institutional development, we include a transition economy dummy variable for the countries of Central and Eastern Europe and the former Soviet Union. For given income levels, their economic and social institutions for sustained market-based development were relatively backward in the early years of transition. Engagement with the IFIs and other donors – particularly in the early transition years – focused on reform of legal, tax and other systems designed to produce a convergence with other European countries in economic and social institutions. Based on this reasoning, we would expect transition countries to graduate later than others with similar incomes. On the other hand, the desire to be like other European countries – including by joining the EU, OECD and NATO – could cause them to transition from borrower to donor status before other countries at similar income levels. The net effect of these two potential influences of transition status on the likelihood of graduating could be positive or negative.

Graduation is also supposed to depend on the country’s ability to access foreign credit markets. Actual borrowing or bond issuance would not be an ideal measure of access, however, because it depends not only on the country’s ability to borrow but also on its need or desire to do so. Instead, we measure the willingness for foreign markets to lend by Institutional Investor’s Creditworthiness ratings, based on a survey of economists’ and risk analysts’ perceptions of a country’s creditworthiness. The ratings are on a 100-point scale, with larger values representing greater creditworthiness.<sup>5</sup> This indicator measures the risk of default on sovereign debt, which should be a good proxy for access “on reasonable terms” to private capital markets. The graduation

> 5 Ratings are provided twice a year, in March and September.  We took the average of these.  We did not use sovereign bond ratings from rating agencies like Fitch and Moody’s because of the incompleteness of their coverage.  Early in our sample period, in particular, many countries were not rated.

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