Does Foreign Debt Contribute to Economic Growth?

Abstract

We study the relationship between foreign debt and GDP growth using a panel dataset of 122 countries from 1980 to 2015. We find that economic growth correlates positively with foreign debt and that the relationship is causal in nature by using the sovereign credit default swap spread as an instrumental variable. Furthermore, we find that foreign debt increases investment and then GDP growth in subsequent years. Our findings suggest that sovereign default risks are responsible for "upstream" capital flows that contribute to GDP growth in OECD countries.