THE EFFECT OF EXTERNAL DEBT ON ECONOMIC GROWTH IN SUB – SAHARAN AFRICA MAHLET KASSAYE A THESIS SUBMITTED TO THE CENTER FOR AFRICAN AND ORIENTAL STUDIES SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ARTS IN AFRICAN STUDIES (HUMAN AND ECONOMIC DEVELOPMENT IN AFRICA) ADDIS ABABA UNIVERSITY ADDIS ABABA, ETHIOPIA JULY, 2017 i Addis Ababa University School of Graduate Studies This is to certify that the thesis prepared by Mahlet Kassaye, entitled: The Effect of External Debt on Economic Growth in Sub – Saharan Africa and submitted in partial fulfillment of the requirements for the Degree of Master of Arts in African Studies (Human and Economic Development in Africa) complies with the regulations of the University and meets the accepted standards with respect to originality and quality Signed by the Examining Committee: Examiner Signature _ Date Examiner Signature _ Date Advisor Signature _ Date Chair of Department or Graduate Program Coordinator ii ACKNOWLEDGEMENTS First and above all, glory to be for the Almighty God for making me complete this thesis successfully and for all the blessings in my life My heartfelt thanks and gratitude goes to my advisor, Dr Kidist Gebreselasie, for her guidance, constructive and timely comments, unlimited support and welcoming approach in undertaking this study I am also very grateful to my family, thank you for being very much supportive throughout my life My sincerest thanks go to my friends and classmates for their encouragement and support Thank you all! i Table of Contents Contents Pages Acknowledgements i Table of Contents ii List of Tables iv List of Figures v List of Acronyms vi Abstract viii Chapter One Introduction 1.1 Background of the Study 1.2 Statement of the Problem 1.3 Objective of the study 1.4 Significance of the study 1.5 Delimitation of the Study 1.6 Organization of the thesis Chapter Two 10 Review of the Literature on External Debt and Economic Growth 10 2.1 Theoretical Literature 10 2.1.1 Conceptualizing External Debt, Debt Servicing, Economic Growth and Convergence 10 2.1.2 Historical Roots of SSA‗s External Debt 12 2.1.3 Theories on the External Debt and Growth nexus 13 2.1.4 Theories on the negative effect of excessive debt on growth 19 2.1.5 The Heavily Indebted Poor Countries Initiative 24 2.2 Empirical Literatures 26 Chapter Three 32 Research Method 32 3.1 Model Specification 32 3.1.1 Theoretical Model 32 3.1.2 Empirical Model 37 ii 3.2 Variables Included in the Model 38 3.2.1 Variables and their expected signs 45 3.3 Data description and source of data 46 3.4 Estimation Method 46 3.4.1 The General Method of Moments (GMM) 46 3.4.2 Testing for Stationarity 50 3.4.3 Testing for Consistency 51 3.4.4 Testing for Multicollinearity 52 3.4.5 Testing for Heteroskedasticity 52 Chapter Four 53 Results and Discussion 53 4.1 Descriptive Statistics and trends in per capita GDP growth and Debt 53 4.1.1 Trends in Per capita GDP growth across the HIPCs SSA 54 4.1.2 Trends in External Debt Stock across the HIPC, SSA 56 4.1.3 Trends in debt servicing across the HIPC of SSA 58 4.2 Test Results 60 4.2.1 Levin-Lin-Chu test for Stationarity 60 4.2.2 Arellano - Bond test for Autocorrelation 61 4.2.3 Pairwise test for Multicollinearity 62 3.2.4 Test for Heteroskedasticity 63 4.3 Econometric Results 63 4.3.1 The Effect of Debt Stock on Growth across the HIPC of SSA 65 4.3.2 The Effect of Debt Servicing on Growth across the HIPC of SSA 66 4.3.3 Evidence of Convergence/Divergence in Growth across the HIPC of SSA 68 4.3.4 Other variables affecting growth across the HIPC of SSA 68 Chapter Five 70 Conclusion 70 References 72 Appendices 79 iii List of Tables Table 3.1 Variable description and their expected signs 45 Table 4.1 Descriptive statistics of the variables included in the estimation (1996-2015) 53 Table 4.2 unit root test result for Levin-Lin-Chu (LLC) test 61 Table 4.3 Arellano –Bond test for autocorrelation 62 Table 4.4 Pairwise test for multicollinearity 62 Table 4.5: dynamic panel –data estimation, two - step GMM results 64 iv List of Figures Figure 2.1.The Debt Laffer curve 21 Figure 4.1 Average per capita GDP growth rate during 1996-2015 55 Figure 4.2 Average per capita GDP growth rate among HIPC-SSA (1996-2015) 56 Figure 4.3 External debt stocks (% of GNI) for HIPC of SSA during 1996-2015 57 Figure 4.4 External debt stocks (% of GNI) among HIPC-SSA during (1996-2015) 58 Figure 4.5 Total debt servicing (% of GNI) for HIPC of SSA during (1996-2015) 59 Figure 4.6 Total debt servicing (% of GNI) among HIPC-SSA during (1996-2015) 60 v ACRONYMS AND ABBREVIATIONS ADF African Development Fund BOP Balance of Payment COC Control of Corruption DEDH Direct Effect of Debt Hypothesis DPD Dynamic Panel Data FONDAD Forum on Debt and Development GDP Gross Domestic Product GMM General Method of Moments GNI Gross National Income GNP Gross National Product HIPC Heavily Indebted Poor Countries ICOR Incremental Capital - Output Ratio IDA International Development Agency IFIs International Financial Institutions IMF International Monetary Fund LDCs Least Developed Countries LLC Levin-Lin-Chu MDGs Millennium Development Goals MDRI Multilateral Debt Relief Initiatives OLS Ordinary Least Square OPEC Organization of Petroleum Exporting Countries PRGF Poverty Reduction and Growth Facility vi PRSP Poverty Reduction Strategy Paper SAPs Structural Adjustment Programs SOEs State Owned Enterprises SSA Sub - Saharan African USD United States Dollar WB World Bank WDI World Development Indicators WGI Worldwide Governance Indicators vii ABSTRACT The Effect of External Debt on Economic Growth in Sub – Saharan Africa Mahlet Kassaye Addis Ababa University, 2017 The effect of external debt on economic growth continuous to be a debatable issue among scholars, policy makers and advocates This study examines the impact of excessive debt accumulation on economic growth in the heavily indebted poor countries (HIPC) found in Sub – Saharan Africa (SSA) during the period (1996 – 2015) using two – step GMM estimation technique It also assesses weather the debt cancellations under the HIPC initiative contributes for growth in SSA Results show that excessive external debt accumulation is adversely affecting the growth rate of per capita GDP possibly through its overhang and crowding out effects, whereas debt forgiveness under the HIPC initiative is found to have a significant and positive effect on the growth rate of per capita GDP in SSA Debt coming as a package with a relief initiative can positively contribute to growth in HIPC - 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22,Niger 23,Rwanda 24,Senegal 25,Sierra Leone 26,Tanzania 27,Togo 28,Uganda 29,Zambia 79 Appendix II Data used in the study year drgdp growth externaldebtstockstotal Debt service/GNI investmentprimary trade populationgrowth coc governmenteffectivenessestimate timedummy 1996 0.001079 133.8466 4.639477 16.15621 76.38069 60.16964 2.894499 -0.97977 -0.73442 1997 0.002786 113.6948 4.190215 17.26327 77.56158 58.49225 2.832382 -0.85998 -0.64812 1998 -0.0015 132.9902 4.247591 17.24866 78.42072 57.92197 2.802062 -0.74019 -0.56183 1999 0.00311 119.6535 3.631807 21.9049 77.49538 62.21877 2.811513 -0.70638 -0.56201 2000 0.002893 111.7278 4.221004 20.60979 78.94474 58.18958 2.846449 -0.67258 -0.56218 2001 0.00343 106.3388 3.259962 22.14953 82.93687 60.9721 2.884077 -0.76866 -0.57879 2002 0.002317 109.1144 3.726035 20.45985 87.20658 58.20038 2.911003 -0.86474 -0.5954 2003 0.00307 91.44001 6.37053 20.85753 93.74736 55.5176 2.931732 -0.66435 -0.57696 2004 0.003816 82.73438 4.477942 21.83875 100.4072 58.59167 2.943816 -0.58676 -0.58892 2005 0.001921 51.67059 2.344847 19.85668 104.5661 54.00842 2.949594 -0.87636 -0.77891 2006 0.003994 16.59049 1.030143 21.15032 105.5175 52.35435 2.955663 -0.67547 -0.69298 2007 0.005734 18.82648 0.803123 24.4974 109.0498 61.78821 2.960821 -0.52172 -0.6178 2008 0.004549 16.16615 0.944303 23.49358 112.5317 57.97641 2.957996 -0.49995 -0.58776 2009 0.003593 21.98029 0.94764 24.61225 111.8584 54.41096 2.9458 -0.59269 -0.67398 2010 0.004115 23.15697 0.802702 26.5053 111.9433 64.44696 2.927311 -0.65074 -0.70406 2011 0.001739 23.47055 0.94876 28.88781 113.8126 65.8958 2.905531 -0.55512 -0.57999 2012 0.004412 24.41137 0.98523 27.15523 115.9901 69.38457 2.884806 -0.64269 -0.48991 2013 0.004491 21.9931 1.085783 30.92576 114.0005 77.0294 2.867541 -0.60562 -0.48763 2014 0.003667 25.12021 1.189071 31.30835 114.2151 78.2972 2.855359 -0.59726 -0.47521 2015 -0.00054 34.71174 1.719689 34.38186 115.5868 76.1668 2.845893 -0.50962 -0.58624 80 Appendix III Result for the descriptive Statistics Variable Per capita (PRGDPG ) real GDP Mean Std.Dev Min 0.002801 0.010707 -0.08089 growth overall between within External debt stock (DEBT) overall between within Total debt service(SERV) overall between within HIPC overall between within Human Capital (HK) overall between within Population growth (POP) overall between within Openness (OPEN) overall between within Gross capital formation (INV) overall between within Government effectiveness overall (GOVEFT between within Control of corruption (COC) overall between within Debt after HIPC overall between within Debt servicing after HIPC overall between within 81 Max C.V 0.126915 382 0.003683 0.010076 138.877 102.1305 95.90865 9.836594 3.933756 9.04389 0.500432 0.500432 25.17843 19.84723 15.90494 0.726844 0.431023 0.590439 34.56223 28.08861 20.7718 9.495601 6.307906 7.189052 0.47171 -0.0026 -0.07802 10.72205 35.19566 -467.924 0.06151 0.953352 -14.2577 0.5 29.0764 49.9516 39.03718 -0.12395 1.922833 0.123094 20.96405 35.79312 -40.6474 0.29287 8.902392 -1.02109 -1.98201 0.01583 0.113886 1380.766 592.4017 881.2736 135.3757 19.81855 125.7537 0.5 149.9517 136.2533 136.524 7.988684 3.862556 7.46046 321.6317 156.307 230.8453 61.46868 35.43448 51.92593 0.129632 0.426524 0.215773 -0.73672 0.412473 0.343214 0.237073 1.744008 1.80183 0.229897 1.787589 0.044422 0.677951 0.327486 0.596565 -1.71159 -1.61618 -2.05746 -1.47137 -1.51951 1.367222 -0.56831 -2.78856 -0.44227 -2.58084 -0.08219 -0.05065 0.829802 -56 -0.12326 0.241028 6.832307 103 2.312315 6.264 4.908054 153 0.751831 4.622311 92.90937 3.251918 0.5 92.42006 2.845407 65.52058 20.44184 -0.88412 149 302 100 27 26 53 46 -53 Appendix IV Test Results Table A4 Levin-Lin-Chu (LLC) unit root test result Variable LLC(Level) Growth rate of Per -2.4459 capita GDP 0.0201 Investment -5.7028 -1.0250 Primary -8.5975 enrollment -5.4574 Trade -7.2749 -2.0076 Population Growth -19.9361 -17.7701 External debt -5.2135 stock -0.8395 debt servicing -7.5093 -2.8762 GOVEFT -9.1781 -3.2449 COC -8.3185 -2.5258 HIPC -5.5413 -1.6481 Debt after HIPC -5.4435 -1.5567 Debt Servicing -4.8688 after HIPC -0.7077 LLC(First Difference) -16.7006 -9.1417 -20.1634 -10.2776 -13.0528 -5.1951 -19.5130 -10.3876 -27.7749 -21.7297 -14.1719 -5.7301 -17.4674 -8.1180 -17.6860 -9.5947 -18.8241 -10.7070 -17.3009 -9.5938 -18.1785 -10.6703 -19.7706 -11.9172 82 LLC(P-Value) Level 0.5080 LLC(P-Value) First Difference 0.0000 0.1527 0.0000 0.0000 0.0000 0.0223 0.0000 0.0000 0.0000 0.2006 0.0000 0.0020 0.0000 0.0006 0.0000 0.0058 0.0000 0.0497 0.0000 0.0598 0.0000 0.2396 0.0000 Table A4 Pairwise test result for Multicollinearity corr drgdpgrowth lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary > ntrade populationgrowth governmenteffectivenessestimate coc (obs=580) drgdpg~h lnexte~l lndebt~i timedu~y dummy~bt dummys~g lninve~t lnprim~y drgdpgrowth lnexternal~l lndebtserv~i timedummy dummydebt dummyservi~g lninvestment lnprimary lntrade population~h government~e coc 1.0000 -0.0130 -0.1588 0.0133 -0.0010 -0.0332 0.0795 0.0317 0.0728 0.3588 0.0571 0.0005 1.0000 0.4016 -0.6888 -0.5391 0.2307 -0.3732 -0.3007 0.0966 0.0178 -0.2761 -0.2045 1.0000 -0.3618 -0.2638 0.6283 -0.0610 -0.2709 0.1597 -0.1323 0.1812 0.1492 1.0000 0.9687 0.0656 0.3168 0.4306 0.2732 -0.0083 -0.0239 0.0164 1.0000 0.1959 0.2763 0.3987 0.3412 -0.0097 -0.0816 -0.0123 1.0000 0.0158 -0.1036 0.2823 0.0070 -0.0815 -0.0801 1.0000 0.1686 0.3137 0.1406 0.3838 0.2976 coc coc 1.0000 Table A4 Arellano – Bond test result for Autocorrelation estat abond Arellano-Bond test for zero autocorrelation in first-differenced errors Order z Prob > z -2.3915 0.0168 1.0588 0.2897 Table A4 LR test result for Heteroskedasticity 83 1.0000 0.2836 -0.0190 0.1042 0.0965 lntrade popula~h govern~e 1.0000 -0.0094 -0.0479 0.0338 1.0000 0.0288 -0.0628 1.0000 0.7619 l xtgls drgdpgrowth lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary > lntrade populationgrowth governmenteffectivenessestimate coc , igls panels (heteroskedastic) Iteration 1: tolerance = 00122507 Iteration 2: tolerance = 00031856 Iteration 3: tolerance = 00009305 Iteration 4: tolerance = 00003271 Iteration 5: tolerance = 00001302 Iteration 6: tolerance = 5.461e-06 Iteration 7: tolerance = 2.560e-06 Iteration 8: tolerance = 1.300e-06 Iteration 9: tolerance = 6.276e-07 Iteration 10: tolerance = 2.932e-07 Iteration 11: tolerance = 1.338e-07 Iteration 12: tolerance = 6.006e-08 Cross-sectional time-series FGLS regression Coefficients: Panels: Correlation: generalized least squares heteroskedastic no autocorrelation Estimated covariances = Estimated autocorrelations = Estimated coefficients = Log likelihood = 29 12 Number of obs Number of groups Time periods Wald chi2(11) Prob > chi2 2216.773 drgdpgrowth Coef lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary lntrade populationgrowth governmenteffectivenessestimate coc _cons -.0014908 -.0005408 -.0081845 001684 -.000386 0026225 0008367 -.0004288 -.0001773 0019109 0001816 0023431 Std Err .0006339 0002802 0030187 0007478 0003863 0005531 0007106 000615 0003814 0005934 0005678 0041464 z -2.35 -1.93 -2.71 2.25 -1.00 4.74 1.18 -0.70 -0.46 3.22 0.32 0.57 = = = = = 580 29 20 142.37 0.0000 P>|z| 0.019 0.054 0.007 0.024 0.318 0.000 0.239 0.486 0.642 0.001 0.749 0.572 [95% Conf Interval] -.0027332 -.0010899 -.014101 0002184 -.0011431 0015384 -.000556 -.0016341 -.0009248 0007479 -.0009311 -.0057836 -.0002484 8.31e-06 -.002268 0031496 0003711 0037066 0022294 0007766 0005702 0030738 0012944 0104698 estimates store hetero xtgls drgdpgrowth lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary > lntrade populationgrowth governmenteffectivenessestimate coc , igls Iteration 1: tolerance = Cross-sectional time-series FGLS regression Coefficients: Panels: Correlation: generalized least squares homoskedastic no autocorrelation Estimated covariances = Estimated autocorrelations = Estimated coefficients = Log likelihood = 12 Number of obs Number of groups Time periods Wald chi2(11) Prob > chi2 1863.979 drgdpgrowth Coef lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary lntrade populationgrowth governmenteffectivenessestimate coc _cons 0006071 -.0029424 0050191 -.0018703 0022551 -.0009003 -.0012168 0039025 0047021 0035594 -.0007914 -.0163624 Std Err .0010492 0006614 0059235 0014261 0009572 0009156 0016017 0012653 0005848 0015171 0015528 008454 z 0.58 -4.45 0.85 -1.31 2.36 -0.98 -0.76 3.08 8.04 2.35 -0.51 -1.94 = = = = = 580 29 20 121.33 0.0000 P>|z| 0.563 0.000 0.397 0.190 0.018 0.325 0.447 0.002 0.000 0.019 0.610 0.053 [95% Conf Interval] -.0014493 -.0042387 -.0065908 -.0046654 000379 -.0026948 -.0043561 0014226 0035559 0005858 -.0038349 -.032932 local df = e(N_g) - lrtest hetero ,df(568) Likelihood-ratio test (Assumption: nested in hetero) LR chi2(568)= Prob > chi2 = 84 705.59 0.0001 0026635 -.0016461 016629 0009247 0041313 0008941 0019225 0063824 0058483 0065329 0022521 0002072 Appendix V Regression Result Table A5 Two – step GMM estimation result xtdpdsys drgdpgrowth lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimar > y lntrade populationgrowth governmenteffectivenessestimate coc , lags(3) maxldep(1) maxlags(1) twostep vce(robust) > artests (2) System dynamic panel-data estimation Group variable: id Time variable: year Number of obs Number of groups Obs per group: Number of instruments = 45 = = 493 29 = avg = max = 17 17 17 = = 97.29 0.0000 Wald chi2(14) Prob > chi2 Two-step results WC-Robust Std Err drgdpgrowth Coef z P>|z| [95% Conf Interval] drgdpgrowth L1 L2 L3 -.0792808 -.0632575 1698798 1062341 1073196 1084002 -0.75 -0.59 1.57 0.455 0.556 0.117 -.2874959 -.2736001 -.0425806 1289343 1470851 3823403 lnexternaldebttotal lndebtservicinggni timedummy dummydebt dummyservicing lninvestment lnprimary lntrade populationgrowth governmenteffectivenessestimate coc _cons -.0072659 0010345 -.0241571 0049553 -.0017271 -.0042382 0129182 016962 0037831 -.0004455 001083 -.0909143 0027221 0008257 0118396 0026484 001015 0032558 0062797 0050982 003018 0030802 0031253 0264994 -2.67 1.25 -2.04 1.87 -1.70 -1.30 2.06 3.33 1.25 -0.14 0.35 -3.43 0.008 0.210 0.041 0.061 0.089 0.193 0.040 0.001 0.210 0.885 0.729 0.001 -.012601 -.0005839 -.0473623 -.0002354 -.0037164 -.0106195 0006102 0069697 -.0021322 -.0064825 -.0050426 -.1428522 -.0019307 0026528 -.000952 010146 0002622 0021431 0252262 0269544 0096983 0055915 0072085 -.0389765 Instruments for differenced equation GMM-type: L(2/2).drgdpgrowth Standard: D.lnexternaldebttotal D.lndebtservicinggni D.timedummy D.dummydebt D.dummyservicing D.lninvestment D.lnprimary D.lntrade D.populationgrowth D.governmenteffectivenessestimate D.coc Instruments for level equation GMM-type: LD.drgdpgrowth Standard: _cons 85 DECLARATION I, the undersigned, declare that this is my original work and has not been presented for a degree in any other university and that all sources of materials used for the thesis have been duly acknowledged The examiners‘ comments have been duly incorporated Declared by:Name: Mahlet Kassaye Signature: Date: Confirmed by Advisor: Name: Kidist Gebreselassie(Ph.D) Signature: Date: Place and Date of submission 86 ... examines the impact of excessive debt accumulation on economic growth in the heavily indebted poor countries (HIPC) found in Sub – Saharan Africa (SSA) during the period (1996 – 2015) using two –. .. trends of external debt stock and debt servicing for SSA  analyze the effect of indebtedness on the economic growth performance of SSA  assess the role of HIPC initiative for economic growth in. .. assessing the contributions of debt treatments done under the HIPC initiatives for HIPC of SSA 1.3 Objective of the study The objective of this study is to examine the effect of external debt on economic