External debt, growth and investment for developing countries: some evidence for the debt overhang hypothesis
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External debt, growth and investment for developing countries: some evidence for the debt overhang hypothesis Taner Turan 1 & Halit Yanıkkaya 2 Received: 9 December 2019 / Accepted: 25 August 2020/ # ISEG – Instituto Superior de Economia e Gestão 2020
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. Keywords Public and private external debt . Growth . Investment . Debt overhang JEL codes E20 . F30 . O47
Halit Yanıkkaya± The second author acknowledges support from the Turkish Academy of Sciences
* Taner Turan [email protected] Halit Yanıkkaya [email protected]
1
Department of Economics, Çukurova University, 01330Sarıçam, Adana, Turkey
2
Department of Economics, Gebze Technical University, P.K. 141, 41400 Gebze, Kocaeli, Turkey
T. Turan, H. Yanıkkaya
1 Introduction Since the seminal contribution of Reinhart and Rogoff (2010), the effects of debt have been attracting considerable interest from researchers. This just demonstrates the fact that due to the continuously expanding accumulation of debt after the global crises, the impacts of debt stock on economic activity become even more important. Although recently a relatively small number of studies, such as Siddique et al. (2016), Guei (2019), investigate the growth effects of external debt, many others exclusively focus on the public debt (among others, Egert 2015; Woo and Kumar 2015; Chudik et al. 2017). Developing countries were easily able to borrow in international markets in 1970s with low interest rates. However, conditions started to change in early 1980s and these countries experienced severe difficulties in meeting their debt obligations. The external debt and its effects then naturally become more relevant and focal point in academic and policy circles. In this context, many studies, among them Krugman (1988); Sachs (1989); Savvides (1992); Cohen (1993); Fosu (1996); Clements et al. (2003), investigate the questions such as: Would a reduction in debt lead to a better outcome for creditors and borrowers? Is external debt an obstacle to growth? Does high stock of exter
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