Growth implosions and debt explosions
Do growth slowdowns cause public debt crises?
Published at www.bepress.com
By William Easterly, Center for Global Development and My Aunt Marilyn
Grow
th Implosion: The W
orld G
rowth Slow
down
0.01
0.02
0.03
0.04
0.05
0.061951
1954
1957
1960
1963
1966
1969
1972
19751978
1981
1984
1987
1990
1993
1996
1999
GDP Growth Rate (Unweighted world average)
Debt explosion: the rise in public debt to GDP ratios (world
average)
20%25%30%35%40%45%50%55%60%
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
Change in growth 60-75 to 75-94 and Log Change in public debt to GDP ratios 1975-94
0%
1%
2%
3%
4%
5%
6%
7%
-5% -4% -3% -2% -1% 0% 1%
Change in growth 60-75 to 75-94 (by quintiles from worst to best)
Log
annu
al c
hang
e in
deb
t rat
iofr
om 1
975
to 1
994
(ave
rage
for
quin
tile)
Growth rate of debt ratio and change in growth has negative association:
• Significant correlation of -.41• Regression of annual change in debt ratio on
change in growth: change in growth has coefficient not significantly different than -1 (and coefficient on growth in each period is unity of opposite sign when entered separately)
• Implies borrowing 1975-94 was calibrated to old growth rate 1960-75 rather than to new growth rate 1975-94
Don’t borrow a lot when your growth is going down!
Message of this paper
Never take a sleeping pill and a laxative on the same night.
My Aunt Marilyn puts it in more earthy language:
Outline• The growth slowdown as an explanation for
various debt crises: the HIPCs, middle income countries, and industrial countries
• The role of growth in the government’s intertemporal budget constraint
• Policy conclusions: increasing growth is a fiscal adjustment measure!
The birth of debt crises
t
t
t
tttt
YDgr
YASTG
YD *)()( −+++−=∆
First expression is the primary deficit as a ratio to GDP. Knowing data on Change in D/Y, r, g, and D/Y, we can back out primary deficit (later we’ll calculate it from primary data for a smaller sample)
Data sources
• Public Debt (for concessional debt, present value of debt service from World Bank, for non-concessional debt Loayza, Schmidt-Hebbel, and Serven 1998)
The evolution of public debt
1975 1994Highly indebted poor countries 48% 94% 1.8% * -0.44%Not highly indebted poor countries 28% 41% 4.4% 0.14%Highly indebted middle-income countries 27% 56% 3.4% 0.52%Not highly indebted middle income countries 9% 24% 3.4% 0.40%Industrial countries 29% 59% 2.4% ** 0.06%
Total net public debt
GDP Growth rate 75-
94
Implied primary deficit/
GDP, 1975-94
HIPCs became HIPCs not because of primary deficits (they actually had primary surpluses)
but because of low growth
Similarly industrial countries’ had high public debt ratios by 1994 because of slow growth
1975-94
Public debt to GDP ratios, actual and counterfactual at 1960-75
growth rate
0%10%20%30%40%50%60%70%80%90%
100%
HIPC Industrial
1975 actual1994 actual1994 counterfactual
Public debt to GDP ratios, actual and counterfactual at 1960-75
growth rate
0%
20%
40%
60%
80%
100%
120%
Cos
taR
ica
Cot
ed'
Ivoi
re
Gab
on
Ital
y
Tog
o
actual 1975actual 1994counterfactual1994
Policy variables explain low HIPC growth 1975-94 and thus
the HIPC debt crisis
Replication of Easterly and Rebelo 1993 Growth Regression for Fiscal Variables and Other
Controls
VariableCoef-
ficientt-Sta-tistic
Constant 0.04211 1.60Public Spending on Transport and Communication/GDP 0.00255 2.01Government Surplus/GDP 0.00139 3.41Initial Income -0.00850 -2.20Primary enrollment 0.00023 2.24Secondary Enrollment 0.00019 1.46M2/GDP 0.00026 2.38Real Overvaluation -0.01187 -2.55
Dependent Variable: Per Capita Growth Estimation Method: Seemingly Unrelated RegressionPooled sample of 70s, 80s, 90s
Differentials in policy variables HIPCs vs. non-HIPC low income countries 1990s (t-stats below)Public Spending on Transport and Communication/GDP -1.65 -0.4% -12%
-2.33Government Surplus/GDP -1.43 -0.2% -5%
-0.71Primary enrollment -19.27 -0.5% -12%
-2.50Secondary Enrollment -11.16 -0.2% -6%
-2.38M2/GDP -12.29 -0.3% -9%
-3.04Real Over-valuation 0.39 -0.5% -13%
1.94Total explained growth or net worth differential -1.8% -49%Actual growth or public debt differential -1.9% 57
Policy different
ials
Net worth effect
Growth effect
Policy implications
• World Bank and IMF should be begging countries to spend more on infrastructure and education (with suitable incentives for quality spending of course) to promote growth during fiscal adjustment programs.
• Avoid repeated myopic fiscal adjustments• Haiti has gotten 22 IMF stand-bys!
The Idiot’s Guide to Fiscal Policy (i.e. guide for politicians)
• There doesn’t exist a one-period “resource envelope” or “budget constraint” for the government
• There is only the intertemporal government budget constraint.
• Any public spending that carries an above-normal financial rate of return should be done, just like in the private sector – solve the problem of financing high return projects, don’t cut the projects!
The role of growth in the government’s intertemporal
budget constraint
The government’s intertemporalbudget constraint
( ) 0tttt0
rt DdtGASTe ≥−++∫∞
−
T taxes
S seignorage
A aid reciepts
G government spending
D Public net debt at time zero
Define government net worth as: present value of primary surplus (assuming fiscal ratios remain
constant) - debt
t
t
t
tttt
t
t
YDgr
YGAST
YW −−−++= )(
Solvency constraint is that W/Y≥0
Condition for intertemporalbudget constraint to be satisfied assuming constant fiscal ratios
0
0
YD
gr=
−σ
σ=T/Y+ A/Y + S/Y-G/Y
The effect of growth on net worth
Evaluate at point of zero net worth (just solvent)
( )2/
grgYW t
−=
∂∂ σ
( )grYD
gYW
−=
∂∂ /
60-75 75-94Highly indebted poor countries 3.6% 1.8% 46% -25%Not highly indebted poor countries 3.7% 4.4% 13% 10%Highly indebted middle-income countries 4.9% 3.4% 29% -21%Not highly indebted middle income countries 4.9% 3.4% 15% -7%Industrial countries 4.5% 2.4% 30% -23%
Effect of growth on net worth and change in debt, 1975 and 1994 Growth rate
Growth effect on
net worth to
GDP
Change in debt
ratio 75 to 94
More data sources
• Government expenditures, taxes (IMF Government Finance Statistics)
• Aid from World Bank project: Chang, Fernandez-Arias, and Serven 1999
• Seignorage I calculate from IMF as (g+π)/(1+g+π) *H/Y
Slow growth (suitably instrumented) interacted with
initial debt explains number of debt reschedulings in HIPCs and HIMCs compared to other LDCs.
Results on debt rescheduling and growth for developing countries
Dependent variableEstimation method TSLS GMM
Coef- ficient
T- statistic
Coef- ficient
T- statistic
Constant 2.1 1.87 2.8 3.08Primary fiscal surplus/GDP, 1980-94 2.7 0.08 -47.8 -2.02PV Debt/GDP,1980 10.4 3.97 12.1 6.04Growth8094* Debt/GDP -272.2 -3.6 -292 -6.39observations 49 49
# of debt reschedulings, 1980-94
Instruments for all equations: PV Debt/GDP 1980, Trading partner growth*PV Debt/GDP, Africa dummy*PV
Debt/GDP, Latin America dummy*PV Debt/GDP, Trading Partner Growth, Africa dummy, Latin America dummy
Define intertemporal fiscal imbalance as difference between actual (permanent component of) primary surplus and
required primary surplus for solvency
t
t
t
tttt
t
tttt
t
t
YDgr
YGAST
YGAST
YIFB )( −−−++=−−++= σ
Fiscal adjustment and intertemporal fiscal imbalance
1975 1994 1975 1994Highly indebted poor countries -0.5% 4.3% -1.6% 0.4%Not highly indebted poor countries -1.6% 4.1% -2.3% 3.4%Highly indebted middle-income countries -1.5% 5.6% -1.8% 4.1%Not highly indebted middle income countries 0.2% 3.8% 0.1% 3.2%Industrial countries -2.2% 0.2% -2.7% -2.0%
Primary surplus/ GDP,
(permanent
Inter-temporal fiscal
imbalance/ GDP
Developing countries had attained solvency by 1994, industrial countries had not.
Industrial countries failed to adjust to the fiscal consequences
of the growth slowdown.
The HIPCs were only solvent by 1994 because of increased aid flows and inflation tax, not because of domestic fiscal adjustment
Highly indebted poor countries
1975 1994 1975 1994Including aid and inflation tax -0.5% 4.3% -1.6% 0.4%Excluding aid -3.2% -2.2% -4.4% -6.2%Excluding aid, excluding inflation tax -4.1% -4.1% -5.3% -8.1%
Primary surplus/ GDP,
(permanent component)
Intertemporal fiscal imbalance/
GDP
HIPC debt relief program may reflect aid-weariness by donors, desire to substitute once for all
debt relief for continuing flow of aid
Richest countries have intertemporal fiscal balance of 5.5 percentage points of GDP if pension liabilities are included.
Auerbach and Gale 2000 estimate intertemporalfiscal imbalance of 1.4 - 2.9 percent in US (depending on whether a tax cut is implemented)
Perhaps we now need a program of debt relief for highly indebted
rich countries’ (HIRC).(Just kidding)
When trouble arises & things look bad, there is always oneindividual who perceives a solution & is willing to take
command.
--Aunt Marilyn
Very often, that person is crazy.
Growth implosions and debt explosions: conclusions
• Growth slowdowns were a major contributing factor to the HIPC debt crisis, the middle income debt crisis, industrial countries’ debt crisis, and maybe a tangential factor in the East Asian financial crisis.
• A negative growth shock is a fiscal shock to which governments must adjust like other fiscal shocks
• Fiscal adjustment programs are myopic if they reduce growth-enhancing public expenditures -- actions to increase growth should be part of fiscal adjustment.