Implications of Public Debt on Economic Growth and Development. A European perspective

Abstract

This paper takes an ambitious look at long-run economic growth and investigates the relationship between debt, investments and economic development in a European context. The novelty of the approach is that it includes public debt as an independent variable in the augmented Solow model. The analysis is based on fixed effects models on a panel consisting of 12 European countries, observed across more than 30 years (1980-2012). Various estimation and validity issues are raised, including endogeneity and reverse causality. The general findings of this research are that economic growth has a significant negative effect on public debt accumulation. As economic growth slows down it leads to an increase in the budget deficit through reduced public revenue, leading to new debt issuance. The specific analyses for Italy and Portugal show that they have been on an unsustainable path in the last decades, accompanied by huge fiscal deficits, negative net exports, and rising interest rates on their debt.