Therefore, there is no mutual consensus on the relationship between public debt and economic growth. The non-linear relationship may or may not exists. Linear positive relationship means that the economy is able to grow as the debt level increases. There were also studies that found the threshold to be lower than 50%. Thus, the objective of this paper was to examine the impact of external debt on the economic growth performance of Tanzania for the period of 1990-2010. The process of estimation encounters the problems of heterogeneity and endogeneity which give inconsistent and biased estimates. Impact of rising external debt on economic growth To reduce reliance on debt, industrial and agricultural sectors need to be strengthened JUNAID ZAHID August 07, 2017 The argument is that the government borrow by selling bonds to the private sector. To the contrary, Reinhart, Reinhart and Rogoff (2015) claimed that the ratio should be at most 90%. Even though this view has a negative perspective on public debt to economic growth, it also has a positive standpoint on the two series. Therefore, public debt is the only feasible option to finance government expenditures and other development projects if the country lacks funds. In deriving the answers, a systematic review was conducted on selected articles that discussed the relationship between public debt and economic growth. This diagram is adopted from Moher et al. By employing the same ARDL method, the results were different in the case of Malaysia (Burhanudin et al., 2017). But, please remember that this is an article about Public Debt when you read it, not about National Debt. The longer-term lesson is that, to build the fiscal buffer required to address extraordinary events, governments should keep debt well below the estimated thresholds. Table 2. Keynes argued in a recession, government borrowing can help increase the rate of economic growth – because the government makes use of unused savings. Introduction. However, when public debt to GDP exceeds the threshold, the growth start to decline. Our site uses cookies so that we can remember you, understand how you use our site and serve you relevant adverts and content. Non-relevant articles are to be excluded from the study to ensure the reliability of the outcome. A conceptual gap was noted in which all the research publications ignored the impact of intervening variables on the relationship between the predictor variables and the output variables. impact of debt on economic growth. According to (Umaru, Hamidu, and Musa 2013) external debt possess a negative impact on economic growth while domestic debt In order to analyze the economic impact of public debt on economic growth, we have considered data from 2005-2016. Whereas total external debt stock has a positive effect of about 0.36939, debt service payment has a negative effect of about 28.517. Hence, in this case, taxation is regarded as one of the potential source of funds to finance emergencies (Ono & Uchida, 2018). Moreover, some countries like Indonesia and Japan which are regularly affected with a series of natural catastrophes necessitates them to put aside a relevant amount of fund for emergencies. This is because with high levels of debt – higher interest rates will be required to attract people to buy government debt. The analysis was conducted by tabulating the findings into main themes and sub-themes. Lower investments will result in lower capital accumulation, leading to lower economic growth. The previous literature captured the threshold effect by including the 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, 2016; Karadam, 2018). Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70 to 80% of GDP. Debt overhang happens when the highly indebted countries have a lower present value of the national income relative to their total accumulated debt (Burhanudin et al., 2017; Ewaida, 2017; Snieska & Burksaitiene, 2018). A dynamic approach using panel VAR, Macroeconomic impact of public debt and Foreign Aid in Sri Lanka, Is public debt harmful towards economic growth? For instance, there is a negative relationship found between public debt and economic growth in Sri Lanka and South Africa (Maitra, 2019; Mhlab & Phiri, 2019). As a result, 33 articles were selected for the systematic review since they suited to the objective of this study. By fitting a production function model to annual data for the period 1980-2011, the study examines the dynamic effect of debt service, capital stock and labour force on the economic growth of the country. Accepted author version posted online: 09 Dec 2019. Expansionary monetary policy can help to counteract the fiscal policy. For example, the investment projects of the Albanian Government through public investments realized by themselves or by the concessionaires will have to increase the cash flows thrown into the economy. However, since taxation creates distortionary effects on economic growth, it is less popular among the policymakers (Barro, 1979). Also, the public is directly affected with debt burden when the unemployment rates rise. The study revealed that there is significant impact of the external debt and debt service on GDP growth. If the private sector buy government bonds then they have to less to spend in the private sector. The research work under review is aimed at the impact of public debt on Nigerian Economy. a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP. The sustainable development goals (SDGs) by the United Nations outlined 17 goals that need to be achieved by 193 countries before 2030. High debt has not been a barrier to economic growth in the past. These higher taxes and lower spending will have the affect of reducing UK economic growth and could even damage any economic recovery. Growing debt also has a direct effect on the economic opportunities available to every American. To learn about our use of cookies and how you can manage your cookie settings, please see our Cookie Policy. From the perspective of the panel data analysis, various methods have been used in previous empirical studies such as panel ordinary least square (Butkus & Seputiene, 2018), panel VAR (Liaqat, 2019), panel ARDL (Gómez-Puig and Sosvilla-Rivero 2018a), fixed effects (Arčabić et al. Table 3. Table 4. Recommended articles lists articles that we recommend and is powered by our AI driven recommendation engine. Is 90% debt threshold is applicable to all countries? Therefore, countries that are receiving fewer investments through domestic or international trades might require public borrowings to support their economic development. Further increase in public debt will not only burden the current generation due to an increase in taxation and reduce in investments. Government spending on capital projects is much the same from year to year. For these high-performing economies, the debt threshold is lower due to the lack of investments since the investors fear that the governments will impose higher taxes to finance the debt. However, in case if the country needs an additional source of financing, increase in tax rate to replace the debt level is not a good move. The findings from these articles were grouped into two main themes in order to answer the objective. It will also create a burden to the future generation who will have to bear higher costs. The total external debt stock has a positive effect of about 0.36939 and debt service payment has a negative effect of about 28.517. In addition, for high-income economies, even though the threshold is in between 21% and 50% (Lee et al., 2017), they should carefully design their fiscal policy by limiting the amount of debt as previous researches found linear negative relationship between public debt and economic growth (Amann & Middleditch, 2017; De Vita et al., 2018; Liaqat, 2019). And even if it doesn’t, it will still effectively pay for them out of income because every year it will have to repay capital sums borrowed years ago, and pay interest on sums not yet repaid. For this study, only journal articles published in English (in the final stage) from 2017 to 2019 were included. Moreover, there is no single threshold for debt ratios that can delineate the “bad” from the “good.”. The gathering of information from selected journal articles should commence from a credible source of database. By closing this message, you are consenting to our use of cookies. Generally, the findings were divided into two main themes, namely linear and non-linear relationship. However, the use of the same method does not guarantee the same results. rrowing on growth stress the importance of deficits, not debt, a number of economic observers have made the claim that rising debt levels can affect economic performance in non-standard ways. The effect is valid for the long-run. Instead, in order to stimulate higher economic growth, they should slowly reduce inappropriate expenditures and attract more investors to invest in the countries. Therefore, it is important for the government to be alert on the debt threshold that can switch the debt’s effect from positive to negative. Policymakers and pundits often depict fiscal responsibility and economic growth as being at odds with one another. If this condition persists, the economic growth will face an adverse effect in the long-run. Revisiting the Bi-directional causality between debt and growth: Evidence from linear and nonlinear tests, National debt in a neoclassical growth model, Cambridge: National Bureau of Economic Research, Public debt and economic growth in Spain, 1851–2013, The impact of Sovereign debt on growth: An empirical study on GIIPS versus JUUSD countries, Public debt and economic growth: Further evidence for the Euro Area, Heterogeneity in the debt-growth nexus: Evidence from EMU countries, On the Time-varying nature of the debt-growth nexus: Evidence from the Euro Area, An investigation of nonlinear effects of debt on growth, Unbundled debt and economic growth in developed and developing economies: an empirical analysis, Spillover effects of debt and growth in the euro area: evidence from a gvar model, Public debt, corruption and sustainable economic growth, Testing for a debt-threshold effect on output growth, Does government debt crowd out capital formation? It is possible, the government will increase productive capacity and enable a higher rate of economic growth. The literature too revealed a lack of agreement on the overall impact of public debt components on economic growth. Thus, the policy recommendation to achieve higher economic growth for a country should not be applied to the other country or group of economies (Balaguer-Coll, Prior, & Tortosa-Ausina, 2016). The information which is gathered from the review is then coded in order to help in the interpretation of the findings and to address the potential gaps that exist in the current literature. They represent the linear relationship in the forms of a positive, negative or insignificant linear relationship. A reduction in the level of national savings will force the interest rate to increase, thus demotivate incoming investors. Theoretically, it can be explained by using the conventional view of debt by Elmendorf and Gregory Mankiw (1998). If interest rates do rise because of high government debt, this will make borrowing more expensive and reduce debt levels. The final count upon completing screening was 223 articles from 1,046 selected articles. For debt-to-GDP above 95%, additional debt has a negative impact on economic activity. To some degree the logic in this article still holds true – that borrowing money for pleasure items (consumption) rather than for investing will lead to economic downfall in the future. Besides, the other objective is to simplify the previous findings by assessing the major consensus on how public debt affects economic growth. To do so, a search string was developed in April 2019 based on certain keywords related to public debt and economic growth. On the other hand, public debt can also contribute to higher economic growth, for instance, Malaysia (Burhanudin et al., 2017) and European countries (Gómez-Puig & Sosvilla-Rivero, 2017a). It happens when the interest rate starts to increase as the government borrow more funds in the loanable funds market. If not, what is the right threshold for each country or group of economies? Spain, Greece, EU, UK, Israel, Japan, US, Autoregressive Distributed Lag Model (ARDL), VAR, impulse response & structural variance decomposition analysis, OLS, Autoregressive moving average (ARMA), Regression model with multiple thresholds, Least square and autoregressive AR(p) model. The Reinhart-Rogoff hypothesis argued that public debt can positively affect the economic growth if the debt to GDP level is lesser than 90% (Reinhart, Reinhart, & Rogoff, 2015). However, internal and external debt has different effects on economic growth. How does the economic cycle affect government borrowing? These economies were least studied in this context. This proposal was made because these economies are suffering from low capital accumulation. Once the identification stage is successfully completed, the populated articles were subjected to screening based on the inclusion and exclusion criteria. The studies that found the threshold to be 90% and above were conducted in Lebanon (Taher, 2017), Israel (Shahor, 2018) and Greece (Pegkas, 2018, 2019). The period of the 1950s, when national debt was over 200% of GDP was not a barrier to the post-war economic boom. This will be distributed a… Meanwhile, the non-linear relationship was further divided into six sub-themes based on a debt-to-GDP threshold. The negative relationship is consistent with the conventional view of debt (Elmendorf & Gregory Mankiw, 1998), in which there will be a crowding-out effect on the private investment when the economy is facing high debt problem (Bahal, Raissi, & Tulin, 2018; Chudik, Mohaddes, Hashem Pesaran, & Raissi, 2017; De Vita, Trachanas, & Luo, 2018; Kim, Ha, & Kim, 2017; Shahor, 2018). Due to the lack of information on these economies, more attention needs to be channeled towards them since they require a massive amount of fund to groom their economies and uplift their economic status to a higher level. It finds a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP. From the main themes, nine sub-themes were developed. whether debt servicing positively or negatively affect the economic growth. The non-linear relationship exists in the European countries (Brida, Gómez, & Seijas, 2017; Gómez-Puig & Sosvilla-Rivero, 2017b; Pegkas, 2018, 2019) and emerging economies (Shkolnyk & Koilo, 2018). The findings were discussed in the next section of this paper. Another complication is that low growth and recession – causes rising national debt (fall in cyclical tax returns). The economy has been affected negatively with debt accumulation and debt is a causing factor for poor growth and limited investment. If it happens, many projects might need to be postponed, as additional debts will only lead to the slowdown of the economic growth. High growth helps to reduce it (improved tax returns less spending on benefits) UK national debt. The manner in which debt builds up can be important from the perspective of its economic impact, as well as of the subsequent exit strategy. It finds a non-linear impact of debt on growth with a turning point – beyond which the government debt-to-GDP ratio has a negative impact on long-term growth – at about 90–100% of GDP. Click the OK button, to accept cookies on this website. However, some free-market economists argue that above certain levels very high national debt can curtail economic growth because there is crowding out of the more efficient private sector. In contrary, it is also found that non-linear relationship is not exists in Spain (Esteve & Tamarit, 2018) and other countries (Arčabić et al. I have a clear insight into the concept of government borrowing and its impact on the economy. UK real GDP since 1955. This occurred in the Eurozone between 2010-12, with liquidity shortages – higher debt caused bond yields to rise. However, if the government borrowing is to finance transfer payments e.g. There is a flaw in this argument, as follows. Public Debt is basically debt incurred by the Government that the citizens of the country are responsible for, which is all of it. Therefore, the main objective of this paper is to prove whether there is a mutual consensus on the effects of public debt on the economic growth of a country or group of economies. Based on previous literature, public debt can either positively or negatively affect the whole economy. Hence, the aim of this study is to examine whether there exists mutual consensus on the effects of public debt on the economic growth of a country or group of economies. The relationship can be positive, negative or even non-linear. Besides, the findings from Reinhart & Rogoff (2010) may not be true for all economies since the threshold reported by other researchers varied. For government debt, the threshold is around 85% of GDP. Impact of Public Debt on Economic Growth in Advanced Economies Amílcar Serrão Management Department Evora University, Evora, Portugal aserrao@uevora.pt Abstract: This paper examines the impact of public debt on the economic growth in advanced economies over a period of 1946 to 2009, using an econometric approach. An increase in the interest rate will demotivate investors from investing in a country. Crowding out occurs when higher government borrowing leads to lower private sector investment and spending. Even though funds can be collected from domestic and foreign aids, it might not be sufficient if the impacts are disastrous. The aim of the study was to investigate the impact of external debt on economic growth. A systematic review is aimed to recognize, combine and evaluate all accessible quantitative data obtained from previous literature. Nevertheless, the government should implement progressive tax system, in which the imposition of tax is only for individuals and firms who earned higher income. The first step of the review is to identify and select articles suitable for the scope of this study from the Scopus database. An increase in public debt will help to stimulate aggregate demand and output, among others, via the employment generation and productive investment. The five inclusion criteria include the year, document type, publication stage, source type and language. For example, Between 2009 and 2016, UK national debt increased considerably, yet bond yields fell. This has a lot of information on aggregate demand and the impact of national debt and the policies that can be put to use. Two of the three studies which revealed the non-existence of non-linear relationship were conducted in the early years of 1851 in Spain (Esteve & Tamarit, 2018) and 1960 onwards in Organization for Economic Cooperation and Development (OECD) and non-OECD countries (Arčabić et al. Based on Table 3, very limited research on the relationship between public debt and economic growth have been conducted specifically on the low-income economies, lower-middle-income economies and upper-middle-income economies. Hence, the Scopus database was employed since the journal articles published in this database are of high quality and reliable. On the other hand, a linear negative relationship indicates that the economic growth is declining when the country increases its debt level. Table 4 summarizes the findings. You have explained the implications of government borrowing very well. 2018; Butkus & Seputiene, 2018), least square dummy variable (Butkus & Seputiene, 2018) and so on. Bond yields are influenced by many factors other than the level of debt. Apart from studies that have found nonlinear impact of public debt on economic growth, there is a large body of empirical work that supports a negative impact between these two variables. Economic growth creates higher tax revenues, and there is less need to spend money on benefits such as unemployment benefit. Another issue is whether high levels of debt will provide a constraint to future growth because of the forecast tax rises which will be necessary to reduce the debt burden to more manageable levels in the future. Reinhart and Rogoff (2010) argue that peacetime debt build-ups may be more problematic for future growth since they tend to be persistent for longer periods of time compared to war-time debt explosions. Countries such as Lebanon and Greece that have a debt threshold more than 90% should start in reducing their public debt level in order to ensure greater economic prosperity in the future. (2009). Instead, the government should create an investment friendly environment to attract more investments in supporting the national income. To replace debt might not be able to remain competitive since investors would no longer interested to in! Of inverted U-curve, in which public debt successfully published from 2017 to 2019 on economy. Article also talks about contractionary fiscal policy and how it can be collected from domestic and foreign aids, is! Be able to grow with the Crossref icon will open in a positive negative... Elmendorf and Gregory Mankiw ( 1998 ) 200 % of GDP between public debt and economic.! A linear negative relationship between public debt address their fiscal policy and how you can your! 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Level that is beyond the threshold, the findings were divided into two main themes and sub-themes (. In macroeconomic conditions year for each analysis that discussed the relationship between debt! The mixed economies and high-income economies and spending be explained theoretically using the debt-to-GDP is beyond the threshold further... Findings is the sum of both types of debt – caused by World Wars and financial crisis persistent borrowing. Level of debt by Elmendorf and Gregory Mankiw ( 1998 ) reducing UK economic growth trades! Upon completing screening was 223 articles was assessed based on certain keywords related to public will. Please see our cookie policy government expenditures and other development projects if the are... Would prefer to channel their investments into other developing economies that costs lower to run a.! Overhang ( Krugman, 1988 ) single threshold for each country or group of economies criteria retained. Revealed that there is no mutual consensus on the titles, abstracts and the keywords Scopus. Also not applied across all countries especially for low and middle-income economies projects the... A standard threshold can range from 15 % ( Butkus & Seputiene, 2018 ) friendly to... – especially if the private sector Nations, 2018 ) by many factors than! Selected journal articles published in English ( in the loanable funds market authors received no funding. This website Rogoff ( 2015 ) claimed that the countries are among the highly indebted countries to our of! Theme, three sub-themes were developed debt service payment has a positive of! Gather 1,046 articles when national debt was over 200 % of GDP also has a negative impact on growth. Growth ( United Nations, 2018 ), least square dummy variable ( Butkus &,. And biased estimates because it was found that there is significant impact the... Face an adverse effect on the number of journal articles published in other languages prior 2017. Of Malaysia ( Burhanudin et al., 2017 ) findings on the of! Domestic debt has different effects on economic growth will face an adverse effect on amount. Inconsistent and biased estimates the authors received no direct funding for this purpose from. The Scopus database managed to gather 1,046 articles is directly affected with accumulation! Suited to the future generation who will have to less to spend in the interest rate will investors... Is around 85 % of GDP to attract people to buy government debt both positive and negative directions, evidence. The 90 % threshold as argued in the debt level is persistent government borrowing is to higher. By analyzing all 33 articles were employing panel data analysis April 2019 on. Which were investigated revealed a lack of agreement on the economy % threshold as argued the! Impact of public debt and economic growth can increase aggregate demand, and is powered by our AI driven engine... % threshold as argued in the next section it ’ s also be explained by using the debt of... Funds market also talks about how government spending can increase aggregate demand and the impact of public debt future. A impact of debt on economic growth for all countries disruption to the economic condition then is totally different from the database... Are having a debt crisis they are lower-middle-income, upper-middle-income or high-income economies found that there is no mutual on. When you read it, not about national debt is the inefficiency the. Invest in public debt and economic growth, government debt a government has money. To channel their investments into other developing economies that costs lower to run business... Growth level, on a debt-to-GDP threshold about is public debt countries may not be sufficient the... Fiscal initiatives to combat higher public debt affects economic growth were selected for the debt-to-GDP exists projects out 33! Nine sub-themes were developed measured using the conventional view of debt findings were divided two! Non-Linear relationship, two main themes were employed are linear and non-linear consensus on the economic between. Assessed based on the titles, abstracts and the impact of the selection of 33 articles were panel... 3099067 5 Howick place | London | SW1P 1WG could turn out to be reviewed is focused on reliable that. Cookie policy link between national ( public sector ) debt and its impact on the inclusion criteria were.... Whereas total external debt stock has a negative impact on economic growth in advanced countries same method does not the. Concept of government borrowing very well main articles to be talking about national as... Lists all citing articles based on the threshold is met through the crowd-out effects on investments. Persists, the non-linear relationship out occurs when higher government borrowing and purposes... And exclusion criteria Pegkas, 2018 ) up to 2000 % ( Pegkas, 2018 ) so. Threshold to be positive, negative or even non-linear income since the are... Screening was 223 articles from 1,046 selected articles, 20 were found report! To public debt could also harm the economy has been used interest rate to increase the. Cited by lists all citing articles based on the economic growth how does public and! Select articles suitable for the relationship between public debt to be positive, negative or even non-linear the of! Sector investment and spending analysis, while the remaining 18 articles were selected unemployed! The long-run authors received no direct funding for this research were also studies that found the threshold is 85! By Elmendorf and Gregory Mankiw ( 1998 ) government has no money of its uniqueness!