Download EFFECT OF PUBLIC DEBT ON ECONOMIC GROWTH OF THE

EFFECT OF PUBLIC DEBT ON ECONOMIC GROWTH OF THE EAST AFRICAN
COMMUNITY MEMBER COUNTRIES
JAMES OCHIENG BABU
A Thesis Submitted to the Graduate School in Partial Fulfilment of the Requirements for
the Award of the Master of Arts Degree in Economics of Egerton University
EGERTON UNIVERSITY
MARCH, 2014
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ABSTRACT
This study empirically explored the effect of public debt, as a share of Gross Domestic Product
(GDP), on economic growth (real per capita GDP growth rate) in the East Africa Community
(EAC) over the period 1970-2010. Most past empirical studies have investigated the impact of
external debt on growth in developing and developed economies but do not consider the
influence of domestic, external and total public debts in distinct since they have different effects
on growth. This study aimed at complementing the existing evidence focusing on developing
countries by doing a more comprehensive analysis based not only on total public debt, but on
both domestic and external public debt and their effects on growth. The research sought to
examine the effect of public debt on economic growth in the EAC and to explore the channels
through which it may manifest itself. The objectives of the study were: to establish the
contribution of domestic, external and aggregate public debts to economic growth in the EAC, to
investigate the effect of public debt on public investment in the EAC and to establish the effect
of public debt on total factor productivity (TFP). This study was based on Solow growth model
augmented for debt. The study used secondary data which were obtained from sources such as
the Kenya National Bureau of Statistics (KNBS), Central Banks of the five countries, World
Bank (WB) and Penn World Tables (7.1). The Levin-Lin-Chu test (LLC) and Engle-Granger
approach were used to investigate the properties of the data with respect to Unit roots and
Cointegration respectively. Error Correction Model was adopted due to non-stationary
characteristics of the data. The collected data was analysed through regression analysis of panel
data using panel fixed-effects corrected for heteroscedasticity. This study found that domestic
debt has a positive significant effect on per capita GDP growth rate. However, the study
established that expansion of external and total public debt had negative significant effect on
economic growth. This study also found that a rise in debt levels leads to “crowding out” of
public investments in the EAC due to debt servicing. The empirical result of the impact of
domestic debt expansion on total factor productivity was found to be insignificant during the
period under study. In contrast, external and total public debt revealed a negative influence on
the growth rate of TFP. From a policy perspective based on the findings of this study, it can be
concluded that the EAC countries can propel their growth through external and total debt
reduction strategies as this promotes investments and technology growth. If internal debt is well
utilised, it will boost growth.
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TABLE OF CONTENTS
DECLARATION AND RECOMMENDATION ..........................Error! Bookmark not defined.
COPYRIGHT ...................................................................................Error! Bookmark not defined.
DEDICATIONS ...............................................................................Error! Bookmark not defined.
ACKNOWLEDGEMENT ...............................................................Error! Bookmark not defined.
ABSTRACT ................................................................................................................................... 2
LIST OF TABLES ...........................................................................Error! Bookmark not defined.
LIST OF FIGURES .........................................................................Error! Bookmark not defined.
ACRONYMS AND ABBREVIATIONS ........................................Error! Bookmark not defined.
CHAPTER ONE ..............................................................................Error! Bookmark not defined.
INTRODUCTION............................................................................Error! Bookmark not defined.
1.1 Background Information ......................................................Error! Bookmark not defined.
1.1.1 General View of Debt and Growth in East Africa.........Error! Bookmark not defined.
1.1.2 Multilateral Debt Relief Initiative and the Trend of Debt in East Africa .............. Error!
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1.2 Statement of the Problem .....................................................Error! Bookmark not defined.
1.3 Objectives of the Study ........................................................Error! Bookmark not defined.
1.3.1 General Objective ..........................................................Error! Bookmark not defined.
1.3.2 Specific Objectives ........................................................Error! Bookmark not defined.
1.4 Research Hypotheses............................................................Error! Bookmark not defined.
1.5 Justification of the Study ......................................................Error! Bookmark not defined.
1.6 Scope and Limitations of the Study .....................................Error! Bookmark not defined.
1.7 Definition of Terms ............................................................................................................... 6
CHAPTER TWO .............................................................................Error! Bookmark not defined.
LITERATURE REVIEW ...............................................................Error! Bookmark not defined.
2.1 Introduction ..........................................................................Error! Bookmark not defined.
2.2 Public Debt and Economic Growth ......................................Error! Bookmark not defined.
2.2.1 Internal Debt and Economic Growth .............................Error! Bookmark not defined.
2.2.2 External Debt and Economic Growth ............................Error! Bookmark not defined.
2.3 Public Debt and Public Investments.....................................Error! Bookmark not defined.
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2.4 Theoretical Framework ........................................................Error! Bookmark not defined.
2.4.1 The Solow (1956) Model ...............................................Error! Bookmark not defined.
2.4.2 The Augmented Solow Model .......................................Error! Bookmark not defined.
2.4.3 Growth Accounting and Total Factor Productivity .......Error! Bookmark not defined.
2.5 Conceptual Framework ........................................................Error! Bookmark not defined.
CHAPTER THREE .........................................................................Error! Bookmark not defined.
METHODOLOGY ..........................................................................Error! Bookmark not defined.
3.1 Introduction ..........................................................................Error! Bookmark not defined.
3.2 Research Design ...................................................................Error! Bookmark not defined.
3.3 Study Area ............................................................................Error! Bookmark not defined.
3.4 Data Analysis and Presentation ............................................Error! Bookmark not defined.
3.4.1 The Empirical Model: Panel Data Estimation ...............Error! Bookmark not defined.
3.4.2 Hausman Test ................................................................Error! Bookmark not defined.
3.4.3 Panel Data Unit Root Test .............................................Error! Bookmark not defined.
3.4.4 Testing for Cointegration Using Engle-Granger Two-Step Procedure. ................ Error!
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3.4.5 Growth Accounting and TFP .........................................Error! Bookmark not defined.
3.4.6 Post-Estimation Panel Diagnostic Tests ............................Error! Bookmark not defined.
3.4.7 Justification for Panel Data Approach ...........................Error! Bookmark not defined.
3.4.8 Meeting the Objectives ..................................................Error! Bookmark not defined.
3.5 Justification of the Variables, Measurement and Sources of Data ..... Error! Bookmark not
defined.
CHAPTER FOUR ............................................................................Error! Bookmark not defined.
RESULTS AND DISCUSSION ......................................................Error! Bookmark not defined.
4.1 Introduction ..........................................................................Error! Bookmark not defined.
4.2 Descriptive Statistics ............................................................Error! Bookmark not defined.
4.3 Correlation Results ...............................................................Error! Bookmark not defined.
4.4 Econometric Methodology ...................................................Error! Bookmark not defined.
4.4.1 Panel Unit Root Tests ....................................................Error! Bookmark not defined.
4.4.2 Cointegration Tests: Engle-Granger Two-Step Approach .......... Error! Bookmark not
defined.
4.4.3 Hausman Test ................................................................Error! Bookmark not defined.
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4.5 Domestic Debt and Economic Growth in the EAC..............Error! Bookmark not defined.
4.6 External Debt and Economic Growth in the EAC ...............Error! Bookmark not defined.
4.7 Public Debt and Economic Growth in EAC.........................Error! Bookmark not defined.
4.8 Conclusion on Economic Growth-Debt Regression ............Error! Bookmark not defined.
4.9 Public Debt and Public Investments in EAC .......................Error! Bookmark not defined.
4.9.1 The Error Correction Model (ECM) ..............................Error! Bookmark not defined.
4.10 Conclusion on Public Investment-Debt Regression ...........Error! Bookmark not defined.
4.11 Public Debt and Total Factor Productivity in the EAC ......Error! Bookmark not defined.
4.12 Conclusion on TFP-Debt Regression .................................Error! Bookmark not defined.
CHAPTER FIVE .............................................................................Error! Bookmark not defined.
CONCLUSION AND POLICY IMPLICATIONS .......................Error! Bookmark not defined.
5.1 Introduction ..........................................................................Error! Bookmark not defined.
5.2 Conclusion............................................................................Error! Bookmark not defined.
5.3 Policy Implications ...............................................................Error! Bookmark not defined.
5.4 Areas for Further Research ..................................................Error! Bookmark not defined.
REFERENCES .................................................................................Error! Bookmark not defined.
APPENDIX .......................................................................................Error! Bookmark not defined.
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1.7 Definition of Terms
Cointegration: Is a long-run relationship between two or more non-stationary variables.
Crowding out: It is where increased public debt drives down public investments spending.
Debt Overhang: A situation where the debt stock of a country exceeds its future capacity to
repay it.
Debt Service: The cash that is required for a particular time period to cover the repayment of
interest and principal on debt.
Government Size: The ratio of general government final consumption expenditure to GDP.
Growth Accounting: Decomposing the economic growth rate of a country into contributions
from different factors.
Heteroscedasticity: It is where the variance of the error terms differ across observations.
Openness to Trade: The sum of exports and imports of goods and services as a share of GDP.
Panel Data: A data set in which the behaviour of entities are observed across time and thus
provides multiple observations on each individual in the sample.
Public Debt: Money or Credit owed by any level of government.
Public Investment: Capital expenditure by the government.
Real Per Capita GDP Growth Rate (Economic Growth): Annual percentage growth rate of
GDP per capita based on constant local currency.
Serial Correlation: It is where the error terms from different time periods are correlated.
Terms of Trade (TOT): Refers to the price of a country’s exports (PX ) relative to the price of
its imports (PM) (TOT= PX / PM ).
Total Factor Productivity: It explains economic growth which is not captured by factor
accumulation.
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