External debt, growth and investment for developing countries: some evidence for the debt overhang hypothesis

Abstract

We investigate the effect of total, public, and private external debt stocks on the growth rate and also on total, government, and private investment by using data for a large sample of developing countries. We find a significant and negative growth effect of total external debt stock, lending evidence for the debt overhang argument. Moreover, our results importantly indicate that external debt lowers growth only in countries with ethnically fractionalized and ineffective governments. Furthermore, our empirical findings don’t support the existence of a non-linear or threshold relationship between external debt and growth. Similar to the growth effects of external debt, the significantly and negatively estimated coefficients on the three measures of external debt stocks imply that external debt reduces investment, again providing a robust evidence for the debt overhang argument. Finally, our estimations show that private investment level is more sensitive to the government external debt than the private external debt.

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Notes

  1. 1.

    Polity IV defines regime durability as “the number of years since the most recent regime change (defined by a three point change in the polity score over a period of three years or less) or the end of transition period defined by the lack of stable political institutions.”

  2. 2.

    A list of countries is presented in Appendix, Table 7.

  3. 3.

    We present the results of fixed effects estimations in Appendix, Tables 8 and 9. Note that fixed effects model can remove the effects of unobserved country characteristics but the endogeneity of explanatory variables can still be problematic. To overcome this endogeneity issue and a host of other potential estimation problmes, we rely on the system GMM estiamations.

  4. 4.

    We also estimate the regressions by incorporating different threshold values for external debt, ranging from 30% to 90%, with increments by 10 percentage points. None of the estimated coefficients on external debt is significant. Moreover, we also employ a quadratic specification including the level and square of external debt stock. In this case, we don’t find any significant growth effect of debt stocks. There is thus no evidence for the threshold or non-linear effect. To save space, we dont report these regression results here but available from the authors.

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Correspondence to Taner Turan.

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Halit Yanıkkaya± The second author acknowledges support from the Turkish Academy of Sciences

Appendix

Appendix

Table 7 List of countries
Table 8 External debt and growth: fixed effects
Table 9 External debt and growth with government effectivenness: fixed effects

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Turan, T., Yanıkkaya, H. External debt, growth and investment for developing countries: some evidence for the debt overhang hypothesis. Port Econ J (2020). https://doi.org/10.1007/s10258-020-00183-3

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Keywords

  • Public and private external debt
  • Growth
  • Investment
  • Debt overhang

JEL codes

  • E20
  • F30
  • O47