The relationship between sustainable public debt and economic growth in selected countries and polic.

The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.The relationship between sustainable public debt and economic growth in selected countries and polic.

MINISTRY OF EDUCATION AND TRAINING

FOREIGN TRADE UNIVERSITY

SUMMARY OF DOCTORAL THESIS

THE RELATIONSHIP BETWEEN PUBLIC DEBT SUSTAINABILITY AND ECONOMIC GROWTH IN SELECTED COUNTRIES AND POLICY IMPLICATIONS

The thesis is completed at: Foreign Trade University

Science instructor: 1 Assoc Prof, Dr Hoang Xuan Binh

2 Assoc Prof, Dr Nguyen Viet Dung

Reviewer 1:

Reviewer 2:

Reviewer 3:

The research will be protected in front of the council meeting at

The thesis could be read at National Library and Foreign Trade University Library

1.Rationale of the research

Public debt or government debt is a problem that all countries have toface Public debt by itself is not a bad thing The government with its functionneeds to spend on infrastructure, ensure the education system, health care,maintain national security and social order, which has been increasing duringthe development of economy, while it cannot raise taxes continously to offsetthese increases in spending As a result, the government has to borrow.However, the rate of public debt growth is higher than ever

In Vietnam, a developing country also experienced a similar situationwhen public debt increased from 54,5% of GDP in 2013 to 61,4% of GDP in

2017, this figure decreased slightly in 2018 at 58.4% Public debt per capitaincreased respectively from 23 million VND in 2013 to 32 million VND in

2018 (GSO, 2018) It is noteworthy that even the public debt decreased in 2018

at 58,4% of GDP, it was still 10% higher than the average level in the group ofdeveloping countries

As the scale of public debt is too high, accompanied with the increase inshort-term liquidity risks such as reduced tax revenue, high interest rates andforeign debt, public debt will fall into an unsustainable state Economists allagree that unsustainable public debt will create a negative macro-environmentfor the economy, causing economic growth to decline The public debt crisis inLatin America in the 1980s, the public debt crisis in Europe in the period 2009 -

2011 followed by an economic recession are clear examples In contrast, amoderate debt-to-GDP ratio, stable interest rates, and reasonable debt structure(domestic/foreign, short-term/long-term) will be the necessary conditions toreach the state of sustainability in public debt Strong public debt sustainability(PDS) will create a strong fiscal foundation to help the economy prosper andreach its potential The Nordic countries are good examples when they havemaintained strong PDS with a prosperous economy (Calmfors, 2020)

However, in developing countries, governments with a dominant role inthe economy will inevitably increase spending to promote growth According tothe Keynesian view, this would increase output in the short run In turn, due toincreased spending leading to higher debt scale and higher interest rates, publicdebt will become less sustainable Fast economic growth is thereforeaccompanied by less sustainable public debt The above fact shows that it isnecessary to have an overview study on the relationship between PDS andeconomic growth of countries in the world and especially by group of countries

to come to a unified conclusion on the relationship As a developing country,Vietnam needs to know the relationship in its group of countries in order tomake reasonable fiscal consolidation policies in the future

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In addition, most of the current empirical studies only focus onexploiting the relationship between public debt over GDP ratio, one aspect ofPDS and economic growth Meanwhile, PDS is a composite object thatincludes many components such as public debt structure or short-term debtsolvency (liquidity) expressed through indicators for instance foreign debt overtotal debt ratio, short- term public debt service over total tax revenue, foreigndebt over export ratio Quantifying the level of PDS from its components’value, thereby considering its correlation with economic growth becomes anecessary task in the study of public debt in particular and macroeconomicresearch in general.

Stemming from pratical problems and research gap, the author has

chosen the topic "The relationship between sustainable public debt and economic growth in selected countries and policy implications for Vietnam"

in which the degree of PDS is quantified through index method

2.Research objective và missions

2.1Research objective

Identify the relationship between PDS and economic growth in countries

in the world, thereby drawing policy implications related to the PDS inVietnam

- Developing an index method to measure the degree of PDS

-Determining the quantitative model to evaluate the relationshipbetween PDS and economic growth

- Proposing policies and some implementation solutions based on theresults from quantitative model and pratical situation to optimally solve therelationship between PDS and economic growth in Vietnam

3.Research subject and scope

+ Time: the thesis examines the relationship between PDS and economicgrowth in the period 2000 – 2018 since this is the duration that data of publicdebt of all available countries was fully collected by the World Bank (WB) andthe International Monetary Fund (IMF).

+ Content: the thesis only evaluates the economic relationship betweenPDS and economic growth That means only financial components of PDS aretaken into account, whereas political and geographical components are notconsidered In addition, the thesis will focus on the quantitative characteristics

of the two objects to evaluate the relationship between them in econometricmodels With PDS, it is the degree of public debt sustainability measured bydebt sustainability index and with economic growth, it is the economic growthrate

4.Research questions

Research results will answer the following questions:

-What is the theoretical background of the relationship between PDS and economic growth?

-How to measure the degree of PDS?

-What is the practical relationship between PDS and economic growth inoverall countries and in group of countries?

- What are the solutions that help Vietnam strengthen its PDS in

accordance with economic growth?

5.New contributions of the thesis

The thesis has theoretical and practical contributions through theconstruction of a composite index on PDS, thereby determining the relationshipbetween PDS and economic growth in each group of countries classified byincome by econometric models, based on that, drawing policy implications forVietnam, specifically as follows:

The thesis proposes a new method the index method using min max normalization to measure the degree of PDS The new method evaluatingmost of the important components of PDS can quantify the degree of PDS ofcountries and groups of countries by income at a given year

Based on the PDS index, the thesis finds out the relationship between itand economic growth rate This is a new finding Subsequent studies related toPDS can use the index to conduct other quantitative models, thereby enrichingthe practical knowledge of PDS

-The thesis uses VAR/VECM models to quantify the relationshipbetween PDS and economic growth, thereby indicating the specificity of therelationship in each group of countries

- Based on the relationship between PDS and economic growth in thegroup of lower middle-income countries, the thesis also draws some policy

implications to help Vietnam increase its PDS but still ensure a harmonious relationship with its economic growth.

6.Thesis structure

Besides introduction and conclusion, the thesis includes 5 chapters, as follows:

Chapter 1: Literature review on the relationship between public debt

sustainability and economic growth

Chapter 2: Theoretical background on the relationship between public

debt sustainability and economic growth

Chapter 3: Reserach method

Chapter 4: Empirical analysis on the relationship between public debt

sustainability and economic growth

Chapter 5: Policy implications for Vietnam

CHAPTER 1: LITERATURE REVIEW ON THE RELATIONSHIP BETWEEN PUBLIC DEBT SUSTAINABILITY AND ECONOMIC

GROWTH

1.1Studies on public debt sustainability

Researches on PDS focus on three topics: what is PDS, how to evaluatePDS and its impact on other variables in the economy

According to international financial institutions, public debt isconsidered sustainable when the debt is repaid without major adjustments in thebudget, the government does not need to declare default or renegotiate its loan(UNCTAD, 2016; IMF, 2013; ECB, 2012) In Vietnam, according to the Law

on Public Debt Management in 2017, public debt is considered sustainable ifpublic debt safety indicators are not violated This is also a view commonlyused by policy makers (Debrun, 2017) In general, the higher the scale ofpublic debt is, the more likely it is to fall into an unsustainable state

To assess whether public debt is sustainable, academic studies often usethe binary tree method of Manasse and Roubini (2005), the IMF's DebtSustainability Framework (DSF) and the method testing the stationarity of timeseries data on public debt proposed by Corsetti and Roubini (1991)

Regarding the impact of PDS on other macro variables, it can be saidthat the impact of PDS on economic growth is the topic that many studies focus

on and analyze However, due to the lack of a comprehensive measure of PDS,these studies often use one aspect of PDS for instance the size of public debt toGDP or the size of foreign debt to GDP and then consider the impact from theaspect on growth Typical studies evaluating the impact of public debt size oneconomic growth include Reinhart and Rogoff (2010), Checherita et al (2010),Imbs and Rancierce (2005) In addition, the size of public debt is alsoconsidered assumingly representing PDS in relation to other examined factorssuch as institutions, the development of financial markets and inflation

1.2Studies on the relationship between public debt sustainability and economic growth

1.2.1Studies on the impact of economic growth on public debt sustainabilityMost of the studies looking at the impact of economic growth on PDSare the studies that examine the criteria IRGD (Interest Rate-GrowthDifferential) Specifically, studies will try to find empirical evidences that asthe difference between interest rates and growth decreases, or equivalently, thedifference between growth and interest rates increases, the size of public debtwill tend to stabilize or decrease in the future, thereby indirectly showing thatthe country’s public debt becomes more sustainable Abbas et al (2011) usedthe data of 178 IMF member countries since 2001 to find out how much factorscontribute to the change of public debt size The results showed that in the case

of 60 countries with high public debt, with the initial debt size originating frommore than 60%

of GDP, the difference between interest rates and growth contributed the most

to the change in the public debt size with 18,1% compared to the initial budgetdeficit of 8,9%

In addition to many studies that have found a one-way effect as above,there are also a few studies that consider the opposite impact from PDS on thedifference between interest rates and economic growth Turner and Spinelli(2012) not only showed a unidirectional effect of the interest rate growthdifferential on the size of public debt, but also indicated the opposite effect inOECD member countries Turner and Spinelli (2012) showed that having avery low interest rate or in other words a small difference between interest ratesand growth rates had helped to keep the size of public debt in OECD countriesstable during the period 1995 – 2005

1.2.2Studies on the impacts of public debt sustainability on economic growth

The author has not found a study directly showing the relationship betweenPDS and economic growth due to the lack of a quantitative measure ofPDS However, there are many studies on the relationship between an aspect ofPDS and economic growth, specifically the component public debt/GDP ratio.There are three standpoints about the impact of this indicator on economicgrowth: the effect is linear (either positive or negative), the effect is notdetected and the effect is non-linear (both positive and negative) in which theeffect will reverse when the public debt/GDP ratio crosses a certain thresholdvalue In fact, most of the studies found a non-linear relationship

Table 1.1: Summary of empirical studies on the impact of public debt on

economic growth Nghiên cứu – Kết quả nghiên cứu

Elmendorf & Mankiw (1999), Gale & Orszag (2003),Baldaci & Kumar (2010): negative relationship in the longrun

Diamond (1965) Eisner (1984) Paul (1992): positiverelationship

Nguyễn & Trần (2014), Phạm (2018): positive relationship Abbas & Christensen (2007): positive relationship with conditions

Presbitero (2005): negative relationship in high-income country; positive relationship in low-income countryPatillo et al (2004): negative relationship in the short-run butreverse in the long-run

Calderon & Fuentes (2013): negative relationship and the degree depends on institutional quality

Reinhar & Rogoff (2010): 44 countries in 200 years, threshold of turning point is 90% GDP

Baum et al (2013): 20 European countries in 1990 – 2020, threshold of turning point from 67% to 95% GDP

Egert (2013): 44 countries in 200 years, threshold level from 20% to 60% GDP

Pattillo et al (2002): 93 developing countries from 1969 to

1998, threshold level from 35 to 40% GDP

Clements et al (2003): 55 low-income countries from 1970

to 1999, threshold level (regarding external debt) around 20– 25% GDP

Chang & Chiang (2006): all OECD countries from 1980 to

Checherita & Rother (2012): 12 European countries in 1990– 2008, threshold level from 90 to 100% GDP

Greeenidge & et al (2012): Caribbean region, threshold levelfrom 55 to 66% GDP

Lê & Thái (2015): 7 developing countries in South-East Asia

in 1995 – 2003, threshold level is 68% GDPCaner et al (2010), Kourtellos et al (2013), Teles &

Mussolini (2014), Ahlborn & Schweickert (2015), Imbs &Ranciere (2005): threshold levels are different due to different institutions

Phạm et al (2020): ASEAN + 3 (China, Japan, SouthKorea) in 2004 – 2015, there are two threshold levels29,96% and 72,53% for the region

Source: Compilation by author

Regarding the research method, because public debt data is usuallyannual, if only one country's data is used, the number of observations will not

be enough (except the case of some developed countries such as the UnitedKingdom, the United States having traditional and modern statistical system),especially with the existence of new variable such as foreign exchangereserves Therefore, studies often use panel data method covering manycountries over a given period to increase the number of observations

Regarding the scope of study, a small number of studies use data fromvarious countries with different levels of development and these studies havesubsequently received a lot of criticism (Reinhart & Rogoff, 2010) The rest ofthe studies choose specific group of countries with similar development levelsuch as the study of Clements et al (2003), Caner et al (2010) orgeographically close countries such as study of Le and Thai (2015), Checheritaand Rother (2010)

1.3Research gaps

Due to the limitation of quantifying PDS to a specific number, thestudies only take some common criteria in assessing the sustainability of publicdebt such as public debt/GDP ratio, external public debt/GDP ratio to examineits relationship with GDP growth, income per capita growth or real GDP Inother words, these studies only consider one component in PDS to evaluate therelationship between PDS and economic growth When there is a lack of amethod that can quantify the level of PDS, it is difficult for economists toexamine the object comprehensively and its relationship with economic growth.The thesis will fill the gap by building an index method, a method thatcan quantify the PDS in order to find out the relationship between PDS andeconomic growth at the world level as well as at the level of country groupdivided by income

CHAPTER 2: THEORETICAL BACKGROUND ON THE

RELATIONSHIP BETWEEN PUBLIC DEBT SUSTAINABILITY

AND ECONOMIC GROWTH

2.1Overview of public debt sustainability

Public debt

According to the IMF, public debt in a broad sense is the debt obligation

of the public sector, including the obligations of the central government, localgovernments, central banks, and other independent organizations withoperating capital funded by state budget or more than 50% of their capital isowned by the state and in case of debt default, the state has to pay the debtinstead In addition, public debt also includes debts of independentorganizations guaranteed by the government, such as debts of state-ownedenterprises (SOEs) (IMF, 2015a)

Within the scope of the thesis, public debt is understood as the definition

of IMF to ensure consistency with secondary data sources taken from IMF andWB

Public debt sustainability

According to managers’ view (Debrun, 2017), debt is said to besustainable if the debt ratio (to income, total assets, etc.) is expected to bestable or decrease in the future to a sufficiently low level Thus, debt isunsustainable when the debt ratio is expected to increase or remain high.Applying this view to public debt, it can be seen that public debt is sustainable

if the public debt over GDP ratio is expected to be stable or decrease in thefuture to a sufficiently low level The level of public debt at which public debtdoes not increase (maybe even decrease) is called as the benchmark level ofPDS

The views on PDS from the fiscal perspective of internationalorganizations are quite similar UNCTAD (2016) argues that public debt isconsidered sustainable when the borrowing country in the future does not need

to declare default or renegotiate to restructure its debt or resort to a majorchange in fiscal policy From the view of the IMF, the most rigorous publicdebt monitoring organization at a global scale, public debt is consideredsustainable when the initial budget balance necessary to maintain stable publicdebt in normal conditions as well as in the presence of shocks is economicallyand politically feasible

In summary, the above views on PDS have many differentinterpretations, but they all have one thing in common which is that a country'spublic debt is considered sustainable if the country has revenues which canhelp settle government debt obligations without any major adjustment to statebudget This is the concept of PDS used in the thesis, and also used byinternational organizations such as IMF, WB

Criteria to assess public debt sustainability

According to IMF (2013) and international studies on public debt (OIC,2012; Wyplosz et al., 2019), debt sustainability is assessed through the two criteria:

-Solvency: a country is considered to be solvent if its future fiscalsurplus is large enough to cover its debt obligations Debt repayment capacity

is expressed through indicators such as the difference between the economicgrowth rate and the real interest rate (IRGD standard), the ratio of public debt

to GDP, the ratio of public debt to total budget revenue, and the ratio ofexternal public debt service to export

- Liquidity: a country is considered to be liquid when its assets andavailable financial resources can ensure the payment or reversal of short-rundebt obligations as they come due, regardless of whether the country meets itstotal debt repayment capacity Liquidity is expressed through indicators such asthe ratio of short-term public debt to total public debt, the ratio of short-termexternal public debt to total short-term public debt, the ratio of short-termpublic debt to total budget revenue, the ratio of short-term external public debt

to foreign exchange reserves, the ratio of short-term external public debt toexports

Methods to assess public debt sustainability

Empirically, there are three methods being used by international debtmanagers, fiscal policy makers to assess PDS: using the rule of public debtceiling, using the binary tree method and finally the debt sustainabilityframework of IMF (Truong, 2020; Lan, 2017; IMF 2017b) The stationary test

of the public debt’s time series data presented in chapter 1 is often used inacademic research as an initial step before policymakers take a closer look atother criteria related to PDS

2.2Overview of economic growth

Economic growth is defined as the change in total output produced by acountry over time (Mankiw, 2016) With the goal to reflect more accurately theimprovement in people's living standards, economic growth could be measured

as the change in output per capita generated by economy over time To measurethe total output, economists use the concept of Gross Domestic Product (GDP).Economic growth in the short term is the change of real GDP inpercentage over year in which calculating formula based on real GDP data fortwo consecutive years (Yt and Yt-1) is given as follows:

gt = Y t − Y t-1 x100%

Yt-1Economic growth in the long run is the change in potential GDP (theGDP at full employment as all inputs are used in normal condition) PotentialGDP which reflects a country's production capacity is estimated by economists

In order to be consistent with the data of public debt taken annually inthe period 2000 - 2018, the thesis will use the growth rate calculated based onreal GDP year by year The calculation of GDP growth based on the realvariable, excluding the effect of inflation, is also consistent with the method oftaking the ratio of variables related to PDS, which will be presented in Chapter

3 when both the numerator and denominator are estimated by current price Asmaking the division to get the ratio, it naturally cancels out the effect of inflationfrom the ratio

2.3Theoretical background on the relationship between public debt

sustainability and economic growth

2.3.1The impact of economic growth on public debt sustainability

Theoretically, classical economists point out that in order to sustain debt

or not to default, the most important condition is that the increase in nationalincome must be greater than the amount of interest to be paid (Modigliani,1961; Diamond, 1965; Barro, 1974; Blanchard, 2019) In other words, theeconomic growth rate of the country must be greater than the interest rate when

it borrows

In addition to influencing PDS through the interest rate-growth criterion

of classical theory, economic growth also attracts investment for domestic andforeign private sector (Khan & Reihart, 1990) The higher the economic growthrate is, the larger the investment capital from the private sector is, therebyreducing the burden of public budget, especially since the public-privatepartnership (PPP) model is developed (Muhlenkamp, 2014) This willindirectly cause the government's debt to decrease, as the result, interest ratewill decrease Therefore, the government will also be easier to issue long-termdebt Economic growth also helps contribute to the development of thecountry's financial market, thereby creating many tools helping flexibly andeffectively handle public debts (Ragot & Pinois, 2019) All of the above factorscontribute to an increase in the degree of PDS

2.3.2The impact of pubic debt sustainability on economic growth

Public debt has a relatively complicated relationship with economicgrowth expressed through many channels of impact with different directions.Specifically, the impact of public debt on economic growth is transmittedthrough the following channels:

-Public debt and inflation: high public debt increases inflation, therebynegatively affecting economic growth

-Public debt and expectation: public debt also affects expectations Withincreasing public debt, there are various expectations that can be formedleading to opposite effects on economic growth

-Public debt and interest rate: the increase in public debt causescrowding out effect, in which increasing government spending raises interestrates in the capital market, thereby negatively impacting the economic growth