Rethinking public debt, governance and economic growth in transition countries: A PSTR framework

In the aftermath of the international financial crisis of 2008, the amount of public debt to gross domestic product (GDP) is a very important question for policy makers. This situation leads to a deterioration of public finances and to a higher levels of budgetary deficits in many developed and developing countries. Increases in budget deficits, trade and payment balances mainly result from the rapid increase in public expenditure. Tax revenues fall as a consequence of production slowdowns. Exports of goods and services fall, tax evasion, and informal activities and smuggling occur. Many countries have a high rate of public debt (i.e public external debt and domestic debt), insufficient capital and very low saving rates. Facing this difficult economic climate, several practitioners and economists started fueling theoretical and empirical debates on the consequences of public debt on economic growth in different countries. Many researchers empirically analyzed the effects of public debt on the economy, showing negative results in terms of economic growth. This research surveys the recent empirical literature on the effect of public debt on growth by focusing on the role of governance. This literature yields mixed results. We investigate this relationship over the period 1990-2013 on a sample of 36 countries using the Panel Smooth Transition Regression (PSTR) framework. The results show that public debt has a negative impact on growth. Results confirm the idea that good institutions (for example those respecting rules of law and with a low level of corruption and a stable government) are considered one of the main factors for outcome maximization for all countries. It is pointed out that high quality institutions influence the level of public debt and consequently growth. Overall, regardless of the level of governance, economic growth is always higher with better institutions.