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Debt and Growth: Different Evidence from the Western African Countries

Article · January 2019

DOI: 10.15604/carep.2019.01.02.002

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 Central Asian Review of Economics & Policy, 1(2), 2019, 19-26
https://doi.org/10.15604/carep.2019.01.02.002

CAREP
Central Asian Review of Economics & Policy
http://journalcarep.org/

Debt and Growth: Different Evidence from the Western African Countries

Ebrima K. Ceesay
(Corresponding Author)
The University of the Gambia, the Gambia
Email: ceesayebrimak@utg.edu.gm

Joseph B.M. Tsenkwo

University of Jos, Nigeria
Email: tsenkwoj@gmail.com

Momodou Mustapha Fanneh

The University of the Gambia, the Gambia
Email: mmfanneh@utg.edu.gm

Abstract

This paper examines the testing of the effect of debt and growth differences by following the work
of Reinhart-Rogoff Propositions in the Western African Countries from 1970-2017. The objective
of the study is to contribute to the literature on debt and growth relationship in the Western Africa
countries by dividing the region of Western African countries into French-speaking and English
speaking countries, respectively. According to the results, the log of the lag of the gross domestic
product (GDP) is significant in both regions and positive sign. The debt ratio that is the debt to
GDP is also substantial in both areas and negative coefficients in all the regions. External debt as
a percentage of Gross National Income is not statistically significant and positive sign in the
Francophone Western African Countries and negative in the Anglophone Western African
Countries. To sum up, the Western African sub-region should do more in other to control their
debt ratios.

Keywords: Reinhart-Rogoff Proposition; Economic Growth; External Debt, Growth-Debt Nexus;

Fixed-effects Estimations

JEL Classification Codes: F32; F14; D81; C33

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 Ceesay et al. / Central Asian Review of Economics & Policy, 1(2), 2019, 19-26

1. Introduction

Domestic debt is accumulated through domestic borrowing, for example, selling of treasury bills.
Certificate and bond depending on the length of the developmental strategy adopted. Sustainable
economic growth is a paramount concern for all countries, especially developing economies that
frequently face burgeoning fiscal deficits mainly driven by higher levels of debt service,
particularly external debt servicing and widening current account deficits (Reinhart et al., 2012).
Deficits are created when government spending is higher than government revenue. One way of
financing the deficit is through borrowing (domestic and external).

External debt of middle and low-income countries has been increasing over the years. The stock
of external debt owed by low-income and middle-income countries reached the US $6.7 trillion
in 2015 (World Bank, 2017). In 2015, foreign debt accounted for 26 percent of the Gross National
Income (GNI) of the low- and middle-income countries and 98 percent of their export receipts.
There are a plethora of studies, particularly on debt and growth nexus and recently on the debate
of the debt threshold effects on growth. This debate was hinged on the aftermath of Reinhart and
Rogoff (2010) expositions and led to an outpour of studies testing for the threshold effect in the
link between public debt and GDP growth. Notable studies like Kumar and Woo (2010), Cecchetti
et al. (2011), Checherita-Westphal and Rother (2012) and Baum et al. (2013) obtained evidence
supporting the proposed 90 percent debt threshold. Minea and Parent (2012) estimated a higher
debt threshold, around 115 percent of GDP. However, Hansen (2017) detected the regression kink
around 40 percent. Baglan and Yoldas (2016) and Egert (2015) suggested that the threshold maybe
even lower, around 20 percent. However, substantial studies have found mixed and non-linearity
results in the threshold effects of the relationship between debt and growth, mostly in advanced
economies. Some of the reasons noted in Lee et al. (2017) indicate that the impact could be
different between short and long run, higher public debt could stimulate aggregate demand in
the short term which might in turn crowd out private spending, in the long run, resulting in
reduced output. Another possibility is that the level of debt may have a higher non-linear effect
on growth (Mauro and Zilinsky, 2016).

Furthermore, the literature on public debt emphasized on the issue of sustainability in this case
related to the African case- namely debt- overhang in Krugman (1988) and fiscal fatigue in Ghosh
et al. (2013). The continent of Africa and particularly the West African sub-region are heavily
indebted, and thus the debt-to-GDP growth is equally high example Zambian debt case is still
fresh. Studies in this area are very scanty on the African continent. Therefore, this paper sets the
stage for further discussion. To the best of our knowledge, our article is the first to focus on the
median real GDP growth. This paper proposed to test of the validity of Reinhart and Rogoff (2010)
findings using West African cross country data and on the premise that Reinhart-Rogoff debt
threshold might not be tenable in the West African sub-region situation.

The remainder of the paper is organized as follows. In Section 2, we review related literature. In
Section 3, we explain the methodology adopted to address the study’s question. In Section 4, we

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present the main testing results, and summary, conclusion, and recommendation will be
presented in Section 5.

2.1. Review of Related Literature

2.1.1. Conceptual and Theoretical Review

On a theoretical basis, it is a truism that debt is necessary to augment domestic resources at an
early stage of development in developing countries. However, the magnitude or size of the debt
and the fiscal fatigue of repayment is the aspect that should occupy the minds of policymakers.
It is usually worrisome where the ratio of debt-to-GDP is out of the golden rule. Once the debt
has outgrown the threshold, the expected positive effect of public debt because negative. The
conventional, neoclassical view on public debt is that regardless of any short-term positive impact
on demand and output, an increase in public debt has a negative long-term impact on economic
growth as it crowds out investments. Thus, the relationship between public debt and economic
growth is negative. Under this paradigm, fiscal deficits and subsequent increase in public debt
could have a positive impact on output if and only if there is excess capacity in an economy
(Cecchetti et al., 2011). This conventional view, however, has been criticized for its neglect of case-
specific economic conditions and context. In particular, they said the paradigm ignores the issue
of the quality of debt spending. For instance, Checherita-Westphal and Rother (2012) argue that
debt has a growth-enhancing effect when debt is issued to finance public investments. DeLong
and Summers (2012) say that in the case of protracted recessions, fiscal deficits and public debt
might have a positive effect both in the short and long term.

2.1.2. Debt and Growth: Empirical Literature

Empirical evidence on the debt-growth nexus is mixed. Were (2001) conducted a time-series
analysis on Kenya, and found external debt is negatively associated with growth. Reinhart and
Rogoff (2010) employed panel regression analysis on a sample of 20 developed countries and
found that for GDP to debt ratios below 90 percent, the relationship between debt and growth
was insignificant while for rates above 90 percent external debt worsened the median increase by
1 percent and considerably more to the significant rise. This finding is consistent with Kumar and
Woo (2010), who also found that external debt is harmful to economic growth in developed
countries. Various papers found others that established a negative relationship between external
debt and economic growth (e.g., Chudik et al., 2017; Fosu, 1996 and 1999; Senadza et al., 2017).
Others showed a positive relationship (Jayaraman et al., 2008). A few studies, including Afxentiou
and Serletis (1996), Frimpong and Oteng-Abaye (2003), have found no clear relationship between
external debt and growth.

There is scarce literature on Debt-growth nexus about Africa. The paper intends to contribute to
the literature on debt and growth relationship in Western Africa. Senadza et al. (2017) studied
debt-growth in Africa using annual data for 39 SSA countries from 1990 to 2013 and employs the
System Generalized Methods of Moments (GMM) estimation technique and finds that external
debt negatively affects economic growth in SSA. Classification of the countries in the sample into
low-income and middle-income economies had no significant effect on the debt-growth

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relationship. The paper did not confirm a non-linear relationship between external debt and
growth. Fosu (1996) tested the relationship between economic growth and external debt in the
sub-Saharan African countries over the period 1970-1986 using the Ordinary Least Squares (OLS)
method. The study examined the direct and indirect effect of debt hypothesis. Using the debt-
burden measure, the study reveals that the immediate impact of debt hypothesis shows that GDP
is negatively influenced via diminishing marginal productivity of capital. The study also finds
that on the average a high debt country faces about one percent reductions in GDP growth
annually. Fosu (1999) also employed an augmented production function to conclude that external
debt has a negative growth in the sub-Saharan African countries for the period 1980-1990.

This paper contributes to the literature in the following ways. First, we address the non-linearity
in the Debt-Growth nexus. Secondly, we explain the debt-growth relationship using econometric
techniques such as the Panel Threshold Regression (PTR) model. Thirdly, we disaggregate debt
into domestic and external debt and can separately analyze their effects on economic growth in
developing countries and this the first study to disaggregate debt into internal and foreign debts
in Sub-Saharan African economies.

3. Econometric Methodology and Empirical Model

Most of the dynamic panel specifications are estimated using several different estimators: OLS;
two-stage least squares (using instrumental variables to correct for endogeneity). The fixed-
effects to allow countries to have different intercepts (that may be correlated with the regressors).
However, the differenced and system GMM can correct for the endogeneity of debt and other
control variables, and the bias introduced by the lagged income variable in the presence of fixed
effects.

In the presence of variables that are correlated with both debt and growth, the model may suffer
from an omitted variable bias. Starting with Kumar and Woo (2010), Cecchetti et al. (2011), and
Checherita-Westphal and Rother (2012), the literature has tried to address this issue by estimating
alternative versions of the dynamic growth model. An alternative approach consists of fitting a
spline regression, allowing for one or more knots. Kumar and Woo (2010) follow this
methodology and explore the presence of non-linearity in their sample of advanced and emerging
economies. Minea and Parent (2012) study the relationship between debt and growth by using
the Panel Smooth Threshold Regressions, which allows for a gradual change in the regression
coefficient when moving from one regime to the other. Cecchetti et al. (2011) used Panel
Threshold regression (PTR) models. In here, we follow Cecchetti et al. (2011) and use the PTR
model.

The equation to be estimated is a fundamental growth model, including the main variables
suggested by the Solow (1956) model plus some other standard controls and augmented with the
measure of debt as follow:

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∆log GDPi,t = α log GDPi,t−1 + γ log DDEBTi,t + δ log EDEBTi,t + δDEBT 2 i,t + X i,t β′ +
ηi + τt + εi,t (1)

where the lagged value of the log of GDP (GDPt−1 ) measures log of conditional convergence
(endogenous regressor) and X is a vector of standard control variables including: the log of the
investment rate (INVESTMENT), the log of the gross primary enrollment rate as a measure of
human capital accumulation (HUMAN CAPITAL), the sum of imports and exports of goods and
services over GDP as a measure of openness (OPENNESS), inflation (INFLATION), log of
Domestic Debt,log DDEBTi,t is the domestic debt of country i at a given time, t. Domestic Debt,
External Debt, logEDEBTi,t is the external debt of country i at a given time, t and DEBT 2 i,t Is the
total debt square of country i at a given time, t ((captures nonlinearity in the debt-growth
relationship). Finally, ηi and τt capture respectively the country and time fixed effects,
measured by geographic and time dummies, and εi,t is the classical spherical error term.

The dataset covers the panel dataset of 13 Western African Countries (The English-Speaking
Countries: The Gambia, Ghana, Nigeria, and Sierra Leone) and the French-Speaking Countries:
Benin, Burkina Faso, Cote d'Ivoire, Guinea, Mali, Mauritania, Niger, Senegal, and Togo) for the
period from 1970 to 2017.

4. Empirical Results and Discussion of Findings

The results of Panel Threshold Regression (PTR) that includes nonlinearity model as quadratic
model estimation are summarized in Table 1. The estimation was performed using Stata 13. The
panel data techniques were used over the period 1970-2017.

4.1. Results of the Anglophone Western African Countries

We started the analysis by West African English speaking countries. There is a positive correlation
between the dependent variable, the natural logarithm of the GDP and natural logarithm of the
lag of GDP and it is statistically significant 1%, 5 and 10% level of alpha respectively. Meaning an
increase in one unit in the log of the lag of the GDP will increase the log of GDP as the dependent
variable. There is a negative relationship between the log of GDP and log of debt ratios, i.e., Debt
to GDP but is statistically significant at 1%. The percentage of the external debt stock and debt
square have a negative and positive sign, respectively. The intercept term is highly significant, if
all other variables remained constant, the natural logarithm of the Gross domestic product of the
selected Anglophone West African countries is a highly significant and positive sign.

The results demonstrated that in English speaking West African countries, in the long-run their
expected a reduction in debt. This evidence conforms with a prior expectation. The other result
that complies with the correct hypothesis theory is that debt ratio (debt to GDP), which is a
negative relationship with the natural logarithm of GDP, and it is statistically significant. The
results give a sense because countries with high debt tend to grow slowly. Example the Gambia
is called debtor countries in macroeconomics perspective because they borrow or accumulated
more debt to sustain its economics, which causes the total expenditure of the government to be

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the lower and the import of the country to be more substantial and total investment to be smaller
and overall Gross domestic product to debt will be negative. The result for the external debt of
the Anglophone Western African Countries region is not statistically significant and also have a
negative sign. It points out that a country with high foreign debt will be associated with lower
economic growth. The results for R-squared and F-statistics, which are 99% and chi-squared value
of 0.000, which approved the model is adequate.

Table 1.
Results of the Panel Threshold Regression (PTR) for the Western African Countries
Independent Variables Anglophone Western African Countries Francophone Western African Countries

Coefficient Std. Error t-ratio p-value Coefficient Std. Error t-ratio p-value

Log GDPt−1 0.903358 (0.0229) 39.41 0.000*** 0.93354 (0.0125) 74.93 0.000***

Log (Debt Ratio) -0.085669 (0.02231) -3.84 0.000*** -0.0523 (0.0115) -4.601 0.000***

Log (External Debt of GNI) -0.003538 0.0221) -0.16 0.873 0 .0105 (0.0115) 0.912 0.362

Debt Square 0.000524 (0.0004) 1.30 0.194 0.0002 (0.0001) 1.561 0.118

Diagnostics N= 191 N= 415

F ( 4, 186) = 7087.25 F ( 4, 410) = 8092.49
Prob. > F = 0.0000 Prob. > F = 0.0000
R2= 0.9935 R-squared = 0.9875
Adj. R2= 0.9933 Adj. R-squared = 0.9874

Notes: Dependent variable is the growth rate of GDP. The Standard errors between parentheses 𝑑𝑒𝑏𝑡max
– the maximum value of the quadratic model * p<0.10, ** p<0.05, *** p<0.01.

4.2. Results of Francophone Western African Countries

In French-speaking Western African countries, the results of the analysis are as follows; natural
logarithm of the lag of the GDP is highly significant and associated with a positive coefficient.
Meaning the rate of change or slope of the natural logarithm of the log of the lag of the GDP from
1970-2017 is significant and positive coefficient. With increases in GDP, it's lag values also rise.
The result for external debt is not substantial as do the English speaking countries, except the
sign, is positive. In contrast, the results for the natural logarithm of debt to GDP ratios is a highly
significant and negative sign. Negative sign meaning percentage change in debt ratios will lower
the percentage change in the gross domestic product of the French-speaking countries. Debt
squared is not significant and positive. It counts the nonlinearity of debt to growth. The constant
term is a highly statistically significant and positive sign. The R-squared and F- statistics made
the model more accurate or adequate for our analysis.

4.3. Comparing the Results of Francophone and Anglophone Western African Countries
We could notice that debt to GDP is significant in all the regions and negative sign. This evidence
means that whether the countries are colonized by French or English, whatever debt the countries
consumed, does not impact on the debt it's accumulated. The log of the lag of GDP is significant

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 Ceesay et al. / Central Asian Review of Economics & Policy, 1(2), 2019, 19-26

in both regions. The external debt as a percentage of GNI is not statistically significant is all the
regions, but had a positive sign in French-speaking West Africa and negative sign in English
speaking West African countries. This evidence means that French-speaking countries external
debt improve growth while the opposite in the case of English speaking countries. The squared
of debt is not significant in all the regions and contain a positive coefficient. The autonomous of
the variables under study are highly significant and positive coefficients.

5. Conclusion

The results for the two regions in terms of statistically and economically significant is almost
similar, except external debt which is not significant in all areas and positive coefficient in French-
speaking West Africa and contrary in English speaking West Africa countries respectively, which
means in francophone countries high external debt, high growth and Anglophone countries,
higher debt lower growth. The recommendation of the future researchers on debt and growth
testing for nonlinearity should focus on different types of external debts, add control variables
fixed effect, individual and time such as population, investment in human capital like education,
research, and development, learning by doing, inequality, poverty reduction, secondary
enrollment, etc. and create jobs for youth. Finally, the policymakers should also add technical,
soft skills interpersonal skills, discipline in workplaces, communication skills into the model, and
even add digital skills such as computer skills.

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