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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 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 0.06 1963 0.05 1960 0.04 1957 0.03 1954 0.02 0.01 1951 Growth Implosion: The World Growth Slowdown GDP Growth Rate (Unweighted world average) Debt explosion: the rise in public debt to GDP ratios (world average) 60% 55% 50% 45% 40% 35% 30% 25% 19 93 19 91 19 89 19 87 19 85 19 83 19 81 19 79 19 77 19 75 20% Log annual change in debt ratio from 1975 to 1994 (average for quintile) Change in growth 60-75 to 75-94 and Log Change in public debt to GDP ratios 1975-94 7% 6% 5% 4% 3% 2% 1% 0% -5% -4% -3% -2% -1% 0% 1% Change in growth 60-75 to 75-94 (by quintiles from worst to best) 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 Message of this paper Don’t borrow a lot when your growth is going down! My Aunt Marilyn puts it in more earthy language: Never take a sleeping pill and a laxative on the same night. 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 D Gt − (Tt + St + At ) Dt ∆ = + (r − g ) * Y Yt Yt 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, SchmidtHebbel, and Serven 1998) The evolution of public debt Total net public debt GDP Growth rate 7594 1975 1994 Highly indebted poor countries Not highly indebted poor countries Highly indebted middleincome countries Not highly indebted middle income countries Industrial countries Implied primary deficit/ GDP, 1975-94 48% 94% 1.8% * -0.44% 28% 41% 4.4% 0.14% 27% 56% 3.4% 0.52% 9% 24% 29% 59% 3.4% 2.4% ** 0.40% 0.06% 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 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1975 actual 1994 actual 1994 counterfactual HIPC Industrial Public debt to GDP ratios, actual and counterfactual at 1960-75 growth rate 120% 100% 80% 60% actual 1975 actual 1994 counterfactual1994 40% Togo Italy Gabon Cote d'Ivoire 0% Costa Rica 20% 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 Dependent Variable: Per Capita Growth Estimation Method: Seemingly Unrelated Regression Pooled sample of 70s, 80s, 90s Coef- t-StaVariable ficient tistic Constant 0.04211 1.60 Public Spending on Transport and Communication/GDP 0.00255 2.01 Government Surplus/GDP Initial Income 0.00139 3.41 -0.00850 -2.20 Primary enrollment 0.00023 2.24 Secondary Enrollment M2/GDP 0.00019 0.00026 1.46 2.38 Real Overvaluation -0.01187 -2.55 Differentials in policy variables Policy HIPCs vs. non-HIPC low income different Growth countries 1990s (t-stats below) effect ials Public Spending on Transport and Communication/GDP -1.65 -0.4% -2.33 Government Surplus/GDP -1.43 -0.2% -0.71 Primary enrollment -19.27 -0.5% -2.50 Secondary Enrollment -11.16 -0.2% -2.38 M2/GDP -12.29 -0.3% -3.04 Real Over-valuation 0.39 -0.5% 1.94 Total explained growth or net worth differential -1.8% Actual growth or public debt differential -1.9% Net worth effect -12% -5% -12% -6% -9% -13% -49% 57 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 intertemporal budget constraint ∞ e ∫ − rt (Tt + St + A t − G t )dt ≥ D 0 0 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 Dt Wt Tt + S t + At − Gt = (r − g ) − Yt Yt Yt Solvency constraint is that W/Y≥0 Condition for intertemporal budget constraint to be satisfied assuming constant fiscal ratios σ=T/Y+ A/Y + S/Y-G/Y σ D0 = r − g Y0 The effect of growth on net worth σt ∂W / Y = 2 ∂g (r − g ) Evaluate at point of zero net worth (just solvent) ∂W / Y D Y = (r − g) ∂g Effect of growth on net worth and change in debt, 1975 and 1994 Highly indebted poor countries Not highly indebted poor countries Highly indebted middleincome countries Not highly indebted middle income countries Industrial countries Change in debt Growth rate ratio 75 60-75 75-94 to 94 Growth effect on net worth to GDP 3.6% 1.8% 46% -25% 3.7% 4.4% 13% 10% 4.9% 3.4% 29% -21% 4.9% 3.4% 4.5% 2.4% 15% 30% -7% -23% 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 variable Estimation method # of debt reschedulings, 198094 TSLS GMM Coef- TCoef- Tficient statistic ficient statistic 2.1 1.87 2.8 3.08 Constant Primary fiscal surplus/GDP, 1980-94 2.7 0.08 -47.8 -2.02 PV Debt/GDP,1980 10.4 3.97 12.1 6.04 Growth8094* Debt/GDP -272.2 -3.6 -292 -6.39 observations 49 49 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 IFBt Tt + St + At − Gt Tt + S t + At − Gt Dt = −σ = − (r − g ) Yt Yt Yt Yt Fiscal adjustment and intertemporal fiscal imbalance Highly indebted poor countries Not highly indebted poor countries Highly indebted middleincome countries Not highly indebted middle income countries Industrial countries Primary Inter-temporal surplus/ fiscal GDP, imbalance/ (permanent GDP 1975 1994 1975 1994 -0.5% 4.3% -1.6% 0.4% -1.6% 4.1% -2.3% 3.4% -1.5% 5.6% -1.8% 4.1% 0.2% 3.8% 0.1% 3.2% -2.2% 0.2% -2.7% -2.0% 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 Primary surplus/ GDP, Intertemporal (permanent fiscal imbalance/ component) GDP 1975 1994 1975 1994 Including aid and inflation tax -0.5% 4.3% Excluding aid -3.2% -2.2% Excluding aid, excluding inflation tax -4.1% -4.1% -1.6% -4.4% 0.4% -6.2% -5.3% -8.1% 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 intertemporal fiscal 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 one individual who perceives a solution & is willing to take command. Very often, that person is crazy. --Aunt Marilyn 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.