Public Debt, Economic Growth, and Public Sector Management in Developing Countries: Is There a Link?

AuthorKelbesa Megersa,Danny Cassimon
DOIhttp://doi.org/10.1002/pad.1733
Date01 December 2015
Published date01 December 2015
PUBLIC DEBT, ECONOMIC GROWTH, AND PUBLIC SECTOR
MANAGEMENT IN DEVELOPING COUNTRIES: IS THERE A LINK?
KELBESA MEGERSA
1,2
*AND DANNY CASSIMON
1
1
University of Antwerp, Institute of Development Policy and Management (IOB), Belgium
2
University of Namur, Centre of Research in the Economics of Development (CRED), Belgium
SUMMARY
The article investigates whether differences in public sector management quality affect the link between public debt and eco-
nomic growth in developing countries. For this purpose, we primarily use the World Banks institutional indices of public sector
management (PSM). Using PSM thresholds, we split our panel into country clusters and make comparisons. Our linear baseline
regressions reveal a signif‌icant negative relationship between public debt and growth. The various robustness exercises that we
perform also conf‌irm these results. When we dissect our data set into weakand strongcounty clusters using public sector
management scores, however, we f‌ind different results. While public debt still displayed a negative relationship with growth
in countries with weakpublic sector management quality, it generally displayed a positive relationship in the latter group.
The tests for non-linearity shows evidence of an inverse-U-shape relationship between public debt and economic growth. How-
ever, we fail to see a similar signif‌icant relationship on country clusters that account for PSM quality. Yet, countries with well-
managed public sectors demonstrate a higher public debt sustainability threshold. Copyright © 2015 John Wiley & Sons, Ltd.
key wordspublic debt; economic growth; public sector management; developing countries
INTRODUCTION
Although there is an increasing focus on debt sustainability, one noticeable weakness of the current line of research is the
failure to account for cross-country heterogeneity in the public debt versus growth dynamics (Kourtellos et al., 2013).
1
In
an effort to close this literature gap and also supplement the existing empirical works that account for country heteroge-
neity, this article will study the debtgrowth relationship while focusing on a specif‌ic set of institutional measures of pub-
lic sector management (PSM) quality. In this regard, this work tries to complement existing studies of public debt
sustainability that utilize aggregate institutional measures. As a further contribution, the article will use robust tests of
non-linearity and check if non-linearity prevails in a similar fashion between countries with different institutional scores
for PSM. The main interest of this article will be to f‌ind out if differences in the quality of the public sector, other things
remaining constant, bear differences in the debtgrowth nexus in developing countries.
The quality of PSM, for example, property rights, budget management, and transparency, has been shown to
positively affect growth (Duvanova, 2014). However, the special interest of this article is to analyze if country dif-
ferences in PSM result in differential outcome in the debtgrowth relationship. There are different channels through
which the quality of the public sector might have an impact on the debtgrowth nexus. For instance, countries with
lower public sector quality (say those with lower rate of revenue mobilization, poor budget management, and low
transparency) are more prone to higher public debt levels as they tend to borrow more (Heylen et al., 2013;
Fernandez and Velasco, 2014). Shleifer and Vishny (1993) also state that ineff‌icient and corrupt governments
*Correspondence to: K. Megersa,Institute of DevelopmentPolicy and Management(IOB), University of Antwerp,Prinsstraat 13, 2000Antwerpen,
Belgium. E-mail:kelbesa.megersa@uantwerpen.be
1
For the issues behind rising concerns of debt-sustainability, see, for example, Michel and Von Thadden (2010), Helm (2011), Jogiste et al.
(2012), DellErba et al. (2013), Panizza and Presbitero (2013).
public administration and development
Public Admin. Dev. 35, 329346 (2015)
Published online 20 October 2015 in Wiley Online Library
(wileyonlinelibrary.com) DOI: 10.1002/pad.1733
Copyright © 2015 John Wiley & Sons, Ltd.
and public sectors have the tendency to redirect funds from high-value investment areas such as education and
health to less productive sectors like defense and superf‌luous infrastructure projects.
However, there might also be counterintuitive arguments. That is, even public sectors with good governance
quality may sometimes behave in a less eff‌icient manner. Jalles (2011), for instance, notes that a democratically
elected government may not be very enthusiastic about budget sustainability or public debt levels because their pri-
mary concern is fulf‌illing the demands of their voters in the short term, that is, while they are in off‌ice. Financing
short-run consumption with debt is argued to yield positive growth (Elmendorf and Mankiw, 1999). However, un-
restrained and unsustainable consumption level will push sovereign debt levels higher and higher, which may on
the longer term lead to negative growth rates.
Furthermore, in countries with weaker PSM, we would expect a lower level of investment compared with coun-
tries where good institutions exist. Weaker institutions bring uncertainties to the investment atmosphere. Public
funds would also be redirected to ineff‌icient sectors that are more conducive to misappropriation rather than
productivity. Scully (1988) argues that the presence of freer institutions, such as business freedom and personal
liberties, yield higher economic growth rates.
With the foregoing brief introduction into the importance of institutions in the analysis of public debt and its re-
lationship with growth, we will proceed to the discussion of a specif‌ic aspect of institutional quality (i.e., PSM) and
its possible effects up on the debtgrowth nexus.
PUBLIC SECTOR MANAGEMENT QUALITY
The focus of most studies on PSM and public spending has been examining the eff‌iciencyof the public sector
(Gupta and Verhoeven, 2001; Afonso et al., 2005; Hauner, 2008). In doing so, such studies often dwell on partic-
ular socio-economic projects and sectors towards which public spending f‌lows. They measure eff‌iciencyby
linking public expenditure to specif‌ic socio-economic gains. For instance, school enrollment (relative to public ex-
penditure) is often used to measure the eff‌iciency in the education sector while infant mortality is used for the
health sector. Apart from the estimations of respective scientif‌ic papers, it is often diff‌icult to f‌ind databases that
are dedicated to measuring public sector eff‌iciency or quality at the aggregate level and even more so to compare
multiple countries.
One reliable measure of PSM quality for developing countries has been the Country Policy and Institutional
Assessment (CPIA) database of the World Bank (WB). Various empirical papers dealing with cross-country insti-
tutional differences have been adopting this measure in their analysis (Knack et al., 2011; Dabla-Norris and
Gunduz, 2014).
2
As its name implies, CPIA evaluates the quality of policy and institutional frameworks in develop-
ing countries. To make sure that there is consistency in the process of applying the criteria for various coun-
tries, the WB follows a rigorous internal review process (IDA, 2004; GTZ, 2008). CPIA is widely used to
gauge the allocation of resources to developing countries. The International Development Association of the
WB and various other institutions (both private and public) are dependent on this rating for their operational
decisions. The increasing attention given to the CPIA by WB and other development partners emanates from
their belief that aid and concessional lending are effectively utilized in countries with a good policy and insti-
tutional environment.
The CPIA ranks countries on the scale of 1 to 6, where higher is better. The WB uses a median score of 3.5 as a
threshold. Countries with policy scores above 3.5 will be treated as strongperformers and countries scoring be-
low that will be treated as weak(IDA, 2004; Eifert and Gelb, 2007). The index also has 16 specif‌ic indicators.
The 16 individual criteria within the overall CPIA index are grouped into four categories, namely, economic man-
agement, structural policies, policies of social inclusion and equity, and also public sector management and
2
The Country Policy and Institutional Assessment (CPIA) index is compiled by the World Bank (WB) annually (WB, 2011). In order to direct
the International Development Association lending process, the WB kicked-off country assessment programs in the late 1970s (GTZ, 2008).The
assessment criteria have evolved to assume its current version in 2004. The revisions have also been made with the intention of facilitating in-
ternational comparability in performance across countries.
330 K. MEGERSA AND D. CASSIMON
Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 329346 (2015)
DOI: 10.1002/pad

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