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External debt and growth: An econometric study Marianna Koli IDPM, University of Manchester ESDS International Conference London, 3 December, 2007.

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Presentation on theme: "External debt and growth: An econometric study Marianna Koli IDPM, University of Manchester ESDS International Conference London, 3 December, 2007."— Presentation transcript:

1 External debt and growth: An econometric study Marianna Koli IDPM, University of Manchester ESDS International Conference London, 3 December, 2007

2 Research objectives 1.To assess the significance of debt as a determinant of growth 2.To test the debt overhang hypothesis 3.To find the critical debt ratios where the impact of debt on growth becomes negative

3 Context Growth Mainstream variable Often proxy for development Debt Instrument of public dev. discourse Need hard evidence of real situation Little research into exact critical ratios Debt overhang hypothesis (Krugman)

4 Debt overhang hypothesis GDP per capita growth Debt/GDPGrowth-maximising debt level

5 Previous literature A wealth of studies on determinants of growth –Large country samples (100+) Some studies on debt/growth and debt overhang hypothesis –Pre-2000 papers 10-30 countries –Recent papers 20-100 countries

6 Original contributions of this study Middle-income countries only Smaller subgroups of countries –Lat Am/non-Lat Am –Severely/moderately/less indebted Determination of critical debt level New data compared to previous literature on same topic

7 Sample 25 middle-income countries as classified by UN based on GDP pc Middle-income versus low-income: –Lower levels of absolute poverty, HIV and other urgent wide-scale problems –Better possibilities for strategic planning –Better institutions –Better government?

8 Sample Exclusions: –Population less than 1 000 000 (islands) –Independence after 1960 (EECA, SSA) –China excluded for poor data availability 85 data points of 7700 (1.1%)had to be estimated using combination method: two moving averages and two econometric techniques, with equal weights

9 Subgroups Indebtedness –Severely/moderately/less indebted –Effect of debt level on debt/growth relationship Latin America –Endemic debt crises in 1980s –To find out whether debt/growth relationship is different in Latin America

10 Methodology Regression with fixed effects –chosen through logical method and OLS/FE/RE diagnostic statistics comparison Robustness tested through country groups

11 Results Significance in several subgroups: debt/GDP, debt service/X, short-term debt/total debt, budget balance/GDP, terms of trade, investment/GDP and economic openness Results reflect the current theories about financial crises in middle- income countries

12 Results: debt variables External debt/GDP is highly significant in all groups except non-Latin America External debt without lag gives U- shaped Laffer curve External debt with lag gives inverted U- shaped curve All sub-samples give same shape for curve

13 Results: Cubic Laffer curve GDP per capita growth Debt/GDP Growth-maximising debt level Non-lagged variables Lagged variables

14 Results: insignificant variables Education, population growth, tax revenue/GDP, economic freedom Solow model variables found insignificant, possibly because of heavy focus of model on debt Taxes and economic freedom possibly neutralised by other variables (budget balance, investment)

15 Results: Being in Latin America Small number of significant variables Significant variables: external debt, budget balance and short-term debt Debt service is insignificant Different causes of growth slowdowns: –Lat Am: debt overhang –Non-Lat Am: debt service crowds out investment, reducing growth

16 Results: Indebtedness level SICs: debt, stability, openness (negative!) LICs: debt, investment and stability MICs: debt, ST debt, terms of trade, education, economic openness, investment rate Conclusion: debt is significant in all groups, but reasons may be different

17 Results for debt overhang Mixed evidence for DOH (total of 24 squared coefficients, of which 12 significant, of which 6 negative) Some evidence for DOH found in all subgroups except Less Indebted Countries

18 Critical debt ratios (90% confidence interval) Pattillo et al (2002)Debt/GDP15-20% Pattillo et al (2002)DS/X80-85% Elbadawi (1997)Debt/GDP97% This studyDebt/GDP (All)300-5260% This studyDebt/GDP (MICs)110-820% This studyDebt/GDP (Lat Am)120-320% This studyDS/X (MICs)20-35% This studyDS/X (non-Lat Am)32-38%

19 Explanation of critical ratios: debt/GDP High error margins in some groups, but all critical debt/GDP ratios over 100% Higher thresholds than earlier research – improved debt tolerance? Previous studies included 1970s and included both low- and middle- income countries Latin America shows lower tolerance than whole sample of 25 countries

20 Explanation of critical ratios: DS/X We find lower critical ratios than Pattillo et al (2002) Possibly explained partly by sample composition: high exporters give low DS/X ratios (e.g. Thailand, Philippines) No clear statistical explanation for lower ratios – does this mean debt service tolerance has fallen?

21 Laffer curve findings: debt/GDP Four countries found on wrong side of the Laffer curve during 1980-2001: –Bolivia (1986-87) –Jordan (1987, 1989-1995) –Panama (1988-1989) –Syria (1983-2001) All but Bolivia are still severely indebted

22 Laffer curve findings: DS/X Seven countries exceed the 30% mark for longer periods of time, mostly Lat Am: –Argentina (range: 25-80%) –Bolivia (30-60%) –Brazil (20-80%) –Chile (15-70%) –Hungary (20-50%) –Mexico (20-50%) –Peru (10-50%)

23 Conclusions 1.Crisis avoidance and growth objectives are equally important 2.Infant institutions argument is valid, particularly in SICs 3.Policies should be tailored to country circumstances 4.Model may be specific to conditions where debt is important


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