Growth Effect of Public Debt: The Role of Government Effectiveness and Trade Balance

Abstract

A growing number of recent works support the idea of debt threshold level (turning point), above which debt starts reducing economic growth. However, estimated threshold varies sharply across studies and gives a little insight into what the optimal level of debt is. The point is that there is no single turning point that could be applied to all countries and a proper investigation is needed on factors, which shape the debt impact on growth. This study aims to investigate whether debt threshold level depends on government effectiveness (one of the aspects of countries’ institutional quality) and trade balance. Our SYS-GMM estimates (and alternatively OLS and LSDV for robustness check) are based on the unbalanced panel of 152 countries over the period of 1996–2016 and on two strategies: (i) splitting of sample into subsamples according to trade balance and government effectiveness and (ii) including debt and government effectiveness, debt and trade deficit interactions. The obtained results are in line with those which confirm inverted U-shaped debt-growth relationship with clear debt turning point dependence on government effectiveness. However, effective governance is not enough to avoid the negative debt effect. Trade balance seems to be more crucial factor than institutional quality, on which threshold level depends.

Estimating Optimum Growth-Maximizing Public Debt Threshold for Nepal

“…In addition, when public debt can affect economic growth in both positive and negative directions, the non-linear relationship appears. The literature captured the threshold effect by including square term of debt in the growth equation (Ahlborn & Schweickert, 2016;Butkus & Seputiene, 2018) or by conducting the panel smooth transition regression (Chen, Yao, Hu & Lin, 2017;Karadam, 2018 Kim et al, 2017). The Reinhart-Rogoff hypothesis argued that public debt can positively affect economic growth if the debt to GDP level is lesser than 90% (Reinhart, Reinhart, & Rogoff, 2015).…”

“…Empirically, the evidence from previous literature demonstrated that the debt-to-GDP threshold for all countries is not necessarily 90%. The threshold can range from 15% (Butkus & Seputiene, 2018) up to 2000% (Pegkas, 2018).…”

“…Beyond the threshold, public debt will cause an adverse effect on an economy. Many other studies in developed and developing economies, however, contradict the 90 per cent benchmark and ranges from 15 per cent (Butkus & Seputiene, 2018) up to 2000 per cent (Pegkas, 2000). Hence, the fundamental objective in this context is to find public debt and economic growth relationship and identify any such threshold ratio in Nepal.…”

Public Debt Threshold in the Republic of North Macedonia

“…While some empirical studies confirm the adverse impact of government debt on growth (Rahman, Ismail & Ridzuan, 2019), a growing number of recent works investigate the aforementioned idea of optimal level of government debt and a non-linear, an inverted U-shaped debt-growth relationship. The point here is that there is no single turning point that could be applied to all countries (Bentour, 2018) and a proper investigation is needed into factors that shape the debt impact on growth (Butkus & Seputiene, 2018). Alfonso and Alves (2014) analyzed the effect of public debt on economic growth for annual and 5-year average growth rates, as well as the existence of non-linearity effects of debt on growth for 14 European countries from 1970 until 2012.…”

Testing the Ricardian Equivalence Theorem: Time Series Evidence from Turkey

“…A rising level of government debt can create a high level of risk for investments and even create difficulties for investors in the lending markets. In addition to this, it raises the issue of adequacy of the fiscal policy formulated by the government (Butkus and Seputiene 2018). Further, it also increases the level of fiscal deficit, which in turn leads to a rise in inflation in long term.…”