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External Debt, Adjustment, and Growth

Roberto Mariano () and Delano Villanueva ()

No 13-2006, Working Papers from Singapore Management University, School of Economics

Abstract: High ratios of external debt to GDP in selected Asian countries have contributed to the initiation, propagation, and severity of the financial and economic crises in recent years, reflecting runaway fiscal deficits and excessive foreign borrowing by the private sector. More importantly, the servicing of large debt stocks has diverted scarce resources from investment and long-term growth. Applying and calibrating the formal framework proposed by Villanueva (2003) to Philippine data, we explore the joint dynamics of external debt, capital accumulation, and growth. The relative simplicity of the model makes it convenient to analyze the links between domestic adjustment policies, foreign borrowing, and growth. We estimate the optimal domestic saving rate that is consistent with maximum real consumption per unit of effective labor in the long run. As a by-product, we estimate the steady-state ratio of net external debt to GDP that is associated with this optimal outcome. The framework is an extension of the standard neoclassical growth model that incorporates endogenous technical change and global capital markets. The major policy implications are that in the long run, fiscal adjustment and the promotion of private saving are critical; reliance on foreign saving in a globalized financial world has limits; and when risk spreads are highly and positively correlated with rising external debt levels, unabated foreign borrowing depresses long run welfare.

JEL-codes: F34 F43 O41 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2005-03, Revised 2006-05
New Economics Papers: this item is included in nep-fmk and nep-sea
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Published in SMU Economics and Statistics Working Paper Series

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Chapter: External Debt, Adjustment, and Growth (2008) Downloads
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