XML

Seoul Journal of Economics - Vol. 35 , No. 4

[ Article ]
Seoul Journal of Economics - Vol. 35, No. 4, pp. 403-424
Abbreviation: SJE
ISSN: 1225-0279 (Print)
Print publication date 30 Nov 2022
Received 28 Jun 2022 Revised 01 Aug 2022 Accepted 21 Oct 2022
DOI: https://doi.org/10.22904/sje.2022.35.4.003

The crowding-out effect of public debt on private investment in developing economies and the role of institutional quality
Van Bon Nguyen
Van Bon Nguyen, Faculty of Finance, Banking, University of Finance Marketing(UFM), Vietnam, Tel: (848) 0972056093 (nv.bon@ufm.edu.vn)(boninguyen@gmail.com)

Funding Information ▼

JEL Classification: E22; H63; D02


Abstract

Public spending is a crucial instrument of fiscal policy in running the economy. Most governments use public spending actively to overcome the cyclicality of the economy. However, the increase in government spending financed by public debt can negatively contribute to the private sector investment. This study raises two research questions: (i) Does public debt in developing countries crowd out private investment? (ii) What is the role of governance in public debt–private investment relationship in these countries? For the answers, we apply the two-step difference generalized method of moments Arellano–Bond estimator to empirically investigate the effects of public debt, governance, and their interactions on private investment for a sample of 98 developing countries from 2002 to 2019. We then employs the pooled mean group estimator to check the robustness of estimates. Results show that public debt crowds out private investment, whereas governance stimulates it. Notably, the crowding-out effect of interaction on private investment seems counterintuitive. Furthermore, economic growth and trade openness enhance private investment. These findings suggest policy implications for governments in developing countries for controlling and managing public debt to promote the private sector investment.


Keywords: developing countries, governance, private investment, public debt

Acknowledgments

This research work is supported by University Finance Marketing(UFM).

Disclosure statement

No potential conflict of interest was reported by the author.


References
1. Arellano, M., & Bond, S. “Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations.” The Review of Economic Studies 58(No.2 1991): 277-297.
2. Arellano, M., & Bover, O. “Another look at the instrumental variable estimation of error-components models.” Journal of Econometrics 68(No.1 1995): 29-51.
3. Aysan, A. F., Nabli, M. K., & Véganzonès-Varoudakis, M. A. “Governance institutions and private investment: an application to the Middle East and North Africa.” The Developing Economies 45(No.3 2007): 339-377.
4. Bernheim, B. D. Ricardian equivalence: An evaluation of theory and evidence. NBER Macroeconomics Annual 2, 1987: 263-304.
5. Bernheim, B. D. “A neoclassical perspective on budget deficits.” Journal of Economic Perspectives 3(No.2 1989): 55-72.
6. Blackburne III, E. F., & Frank, M. W. “Estimation of nonstationary heterogeneous panels.” The Stata Journal 7(No.2 2007): 197-208.
7. Buffie, E. F. “Public investment, private investment, and inflation.” Journal of Economic Dynamics and Control 19(No.5-7 1995): 1223-1247.
8. Burriel, P., Checherita-Westphal, C., Jacquinot, P., Stähler, N., & Schön, M. “Economic consequences of high public debt: evidence from three large scale DSGE models (No. 2450). European Central Bank, 2020.
9. Business Standard. Global public debt could touch 98% of GDP in 2020 amid Covid crisis: IMF, 2021. https://www.business-standard.com/article/economy-policy/global-public-debt-could-touch-98-of-gdp-in-2020-amid-covid-crisis-imf-121012801495_1.html
10. De Mendonça, H. F., & Brito, Y. “The link between public debt and investment: an empirical assessment from emerging markets.” Applied Economics 53(No.50 2021): 1-13.
11. Duho, K. C., Amankwa, M. O., & Musah-Surugu, J. I. “Determinants and convergence of government effectiveness in Africa and Asia.” Public Administration and Policy 23(No.2 2020): 199-215.
12. Fagbemi, F., & Adeosun, O. A. “Public debt-investment nexus: the significance of investment-generation policy in West Africa.” Journal of Economic and Administrative Sciences 37(No.4 2020): 438-455.
13. Feng, Y. “Political freedom, political instability, and policy uncertainty: A study of political institutions and private investment in developing countries.” International Studies Quarterly 45(No.2 2001): 271-294.
14. Friedman, B. M. “Crowding out or crowding in? The economic consequences of financing government deficits.” Brookings Papers on Economic Activity 1978(No.3 1978): 593-641.
15. Gupta, S., Davoodi, H., & Alonso-Terme, R. “Does corruption affect income inequality and poverty?” Economics of governance 3(No.1 2002): 23-45.
16. Holtz-Eakin, D., Newey, W., & Rosen, H. S. “Estimating vector autoregressions with panel data.” Econometrica: Journal of the Econometric Society (1988): 1371-1395.
17. Hope Sr, K. R. “Capacity development for good governance in developing countries: some lessons from the field.” Intl Journal of Public Administration 32(No.8 2009): 728-740.
18. Jorgenson, D. W. “Capital Theory and Investment Behavior.” The American Economic Review, 53(No.2 1963): 247-259.
19. International Monetary Fund. 2021 Update of the IMF Global Debt Database, 2021a, https://www.imf.org/en/News/Seminars/Conferences/2021/12/15/2021-update-of-the-imf-global-debt-database#:~:text=The%202021%20update%20of%20the,percent%20of%20GDP%20in%202020
20. International Monetary Fund. Fiscal Monitor U pdate, January 2021, 2021b. https://www.imf.org/en/Publications/FM/Issues/2021/01/20/fiscal-monitor-update-january-2021/
21. Judson, R. A., & Owen, A. L. “Estimating dynamic panel data models: a guide for macroeconomists.” Economics Letters 65(No.1 1999): 9-15.
22. Keynes, J. M. The General Theory of Employment, Interest, and Money. London, UK: Macmillan, 1936.
23. Khan, M. S., & Reinhart, C. M. “Private investment and economic growth in developing countries.” World development 18(No.1 1990): 19-27.
24. Korsah, E., & Gyimah, P. “Does government debt affect private investment?” EuroMed Journal of Management 3(No.2 2019): 170-179.
25. Kyodo News. Global public debt remains at record-high levels in 2021: I M F ., 2021. https://english.kyodonews.net/news/2021/10/6882caef5811-global-public-debt-remains-at-record-high-levels-in-2021-imf.html
26. Lau, S. Y., Tan, A. L., & Liew, C. Y. “The asymmetric link between public debt and private investment in Malaysia.” Malaysian Journal of Economic Studies 56(No.2 2019): 327-342.
27. Li, J. S. “Relation-based versus rule-based governance: An explanation of the East Asian miracle and Asian crisis.” Review of international economics 11(No.4 2003): 651-673.
28. Li, S., & Filer, L. “The effects of the governance environment on the choice of investment mode and the strategic implications.” Journal of World Business 42(No.1 2007): 80-98.
29. Munemo, J. “Business regulations and private domestic investment in Africa.” Journal of African Business 13(No.2 2012): 157-164.
30. Ncanywa, T., & Masoga, M. M. “Can public debt stimulate public investment and economic growth in South Africa?” Cogent Economics & Finance 6(No.1 2018): 1516483.
31. Pesaran, M. H., Shin, Y., & Smith, R. P. “Pooled mean group estimation of dynamic heterogeneous panels.” Journal of the American Statistical Association 94(No.446 1999): 621-634.
32. Roodman, D. “How to do xtabond2: An introduction to difference and system GMM in Stata.” The Stata Journal 9(No.1 2009): 86-136.
33. Salsman, R. M. The political economy of public debt: three centuries of theory and evidence. Edward Elgar Publishing, 2017.
34. Su, C. W., Sun, T., Ahmad, S., & Mirza, N. “Does institutional quality and remittances inflow crowd-in private investment to avoid Dutch Disease? A case for emerging seven (E7) economies.” Resources Policy 72(2021): 102111.
35. Vanlaer, W., Picarelli, M., & Marneffe, W. (2021). Debt and Private Investment: Does the EU Suffer from a Debt Overhang? Open Economies Review, 1-31.
36. World Bank. Worldwide Governance Indicators, 2021. https://info.worldbank.org/governance/wgi/
37. Zhou, S. “The impact of debt service costs and public debt on private capital formation in South Africa.” African Journal of Economic and Management Studies 12(No.3 2021): 453-469.