Thursday, 23 October 2008

Debt changes' effects on growth

I posted a few weeks ago suggesting that economic growth may be increased when consumer debt is increased, and reduced when debt is decreased. The idea is that debt helps to fund consumer demand, so businesses can make and sell more goods. When the debt is repaid, the opposite happens.

I have investigated the proposition empirically using a particular form of debt, borrowing by governments from abroad. The mechanisms here are possibly different from the one described above, as government priorities and economic interests are distinct from the general public's. The specification is for countries with

growth in income per person
= a0 + a1*lagged growth in income per person + a2*change in capital per person
+ a3* average change in national external debt/GDP + zero mean error

Five year periods are used, and estimation is by GMM system with the levels equation instrumented by all variables lagged three periods and more, and the difference equation instrumented by growth in income lagged three periods and more. Results are split by continent. Data is for developing countries and is from UN sources and the Penn World Tables. The results are shown in the table, with ***, **, and * meaning significance at five percent, ten percent, and 15 percent.

The African data shows that debt increases have often been associated with lower growth. But then, so have debt reductions (debt reductions are negative debt changes, so their positive coefficient translates to negative growth). The coefficients are not significantly different from zero, however. The same pattern is observed with countries in Latin America.

In Asia, the pattern is different. Increases in debt are associated with lower growth, while decreases are associated with higher growth. The mechanism is apparently different from the one described at the start of the post. It is possible that Asian countries are involved in anticyclical policies, or that borrowing is accompanied by or anticipatory of difficult economic circumstances, and repayment of debt occurs during recoveries. Perhaps borrowing in Africa and the Americas is less associated with stabilisation.

No comments: