THE DEBT OVERHANG HYPOTHESIS: EVIDENCE FROM PAKISTAN

Muhammad Imran Shah, Irfan Ullah, Zia Ur Rahman and Nadeem Jan
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Muhammad Imran Shah: Wuhan University, China
Irfan Ullah: Zhongnan University of Economics and Law, China
Zia Ur Rahman: Gomal University, D.I.Khan, Pakistan
Nadeem Jan: Gomal University, D.I.Khan, Pakistan

Studies in Business and Economics, 2016, vol. 11, issue 1, 140-151

Abstract: This study investigates the debt overhang hypothesis for Pakistan in the period 1960-2007. The study examines empirically the dynamic behaviour of GDP, debt services, the employed labour force and investment using the time series concepts of unit roots, cointegration, error correlation and causality. Our findings suggest that debt-servicing has a negative impact on the productivity of both labour and capital, and that in turn has adversely affected economic growth. By severely constraining the ability of the country to service debt, this lends support to the debt-overhang hypothesis in Pakistan. The long run relation between debt services and economic growth implies that future increases in output will drain away in form of high debt service payments to lender country as external debt acts like a tax on output. More specifically, foreign creditors will benefit more from the rise in productivity than will domestic producers and labour. This suggests that domestic labour and capital are the ultimate losers from this heavy debt burden.

Keywords: debt overhang; GDP; ECM; Pakistan (search for similar items in EconPapers)
Date: 2016
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