An analysis of the relationship between external debt, institutional quality and economic growth in sub-Saharan African countries
Hassan, Adewale Samuel
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The need to attain robust growth and sustainable development has led most sub-Saharan African (SSA) countries to adopt different policies and strategies at various stages of their development since independence. However, owing to distortions in the economic, financial and institutional arrangements in this region in the 1960s, recourse to external debt to galvanise the economies towards a path of sustainable development became the norm from the 1970s. Indeed, in the past few decades, the external debt stock of SSA countries has increased significantly, thus, making the debate on its sustainability and role in financing the development process of these countries particularly important. Moreover, beyond the issue of sustainability or otherwise of foreign borrowing and the controversy over its effect on growth, the impact of institutions in the borrowing countries has also come to the fore in recent years. Thus, this thesis investigated the relationship between external debt, institutional quality and economic growth in SSA countries. The overarching aim of the study was subsequently divided into primary, theoretical and empirical objectives. To achieve the empirical objectives of the study, a quantitative research approach was adopted. Specifically, three major econometric models (one for each empirical objective) were estimated by means of panel autoregressive distributed lag (ARDL) technique. The first model examined the nonlinear effect of external debt on economic growth, while the second model investigated the channels of transmission between external debt and economic growth. The third model examined the role of institutional quality in the relationship between external debt and economic growth. Each model estimation was preceded by statistical tests: summary of descriptive statistics, correlation analysis and panel unit root tests. While both descriptive statistics and correlation analysis shed light on the various characteristics of the data, results from the panel unit root tests conducted showed that the variables employed in each of the models were of mixed stationarity, in which case some were stationary at level, while others became stationary, only at first difference. Furthermore, annual secondary data between 1985 and 2017 for thirty SSA countries were employed in the study. The data sets were obtained from different sources comprising the World Bank’s WDI and WGI, the International Monetary Fund (IMF)’s WEO, the World Penny Table (version 9.1) and the ICRG) database. Results from the panel ARDL regression for investigating the nonlinear effect of external debt on economic growth in SSA reported both long-run and short-run estimates. The long-run PMG estimates established that external debt exerts a nonlinear impact on economic growth in SSA over the study period. In particular, the relationship between the two variables was found to be hump-shaped, which indicates that external debt stock at moderate levels enhances economic growth before reaching a threshold, beyond which it begins to depress economic growth. This threshold was determined for different measures of external debt. On the other hand, the short run estimates established that external debt has no impact on economic growth in the short run. Moreover, these results were found to be robust to alternative measures of external debt. Furthermore, a second set of models were estimated to establish the channels of transmission in the relationship between external debt and economic growth. Results from the PMG estimators affirmed private investment, public investment and total factor productivity as the channels through which the nonlinear effect of external debt is transmitted to economic growth. Furthermore, the PMG estimates confirmed that interest rate is a channel transmitting linear and positive effect from external debt to economic growth. On the other hand, the results established that savings is not a channel of transmission between the two variables. The third model investigated the role of institutional quality in the relationship between external debt and economic growth. Results from the various regressions showed that while external debt exerts a negative effect on economic growth, institutional quality mitigates the adverse effect in countries with good institutions. Furthermore, the minimum level of institutional quality beyond which external debt becomes beneficial to economic growth was determined. The results of the sensitivity analysis conducted also showed that the estimates were robust to alternative measures of institutional quality. The study concludes that SSA countries should drastically reduce their reliance on external debt in their quest to fund their developmental efforts, through efficient use of existing accumulated debt, deepening of tax base, implementation of export-led growth strategy, strict adherence to external debt thresholds and greater emphasis on aids. Further, it is suggested that monetary authorities in SSA should endeavour to stimulate private investment by reducing interest rate, while the government should enhance total factor productivity by providing enabling environment and support for massive acquisition of productive equipment, investing in human capital and by stimulating international best-practice corporate governance. Lastly, the study concludes that there is urgent need for SSA countries to consciously pursue rapid improvement in governance infrastructure.