Public debt and economic growth: does institutional quality matter?

Abstract

The main aim of this research was to assess the public debt and economic growth nexus in the presence of institutional quality in 15 economies that are in the SADC region. The study made use of the POLS model, two-stage least squares and SGMM for the period spanning from 1996 to 2015. The results obtained from the one-step system GMM and Two-Stage Least Squares reveal an adverse connection between public debt and economic growth in two models although not significant. Similarly, the pooled OLS revealed a negative relation between public debt and economic growth. Institutional quality was proxied using six governance indicators and we used the principle components analysis to construct a composite index and found that institutional quality yields a favourable impact on growth. Specifically, a 1% improvement in quality institutions will boost economic growth by approximately 15%. We also found that public debt has a threshold boundary that ranges from 48 to 72% for the region. We failed to obtain any statistically significant mechanism through which public debt exhibits an impact on economic growth. This study explored whether the connection between public debt and economic growth is conditional on quality of institutions using interaction term of public debt and institutions, and we established that the relationship is indeed dependent on institutions as the interaction term of institutions and public debt has a positive impact on the debt-growth relationship. Corruption, government effectiveness and rule of law have an adverse effect on economic growth in the region and we therefore suggest that the countries work on a comprehensive improvement of institutional quality to minimize the negative impact that public debt presents on economic for them to reap the benefits of borrowing. The SADC countries should have stringent policies to assist with the reduction of debt. Our research was restricted by the unavailability of reliable data on public debt for some countries in the SADC region and some missing observations.