Government debt and economic growth in Malaysia: the role of institutional quality

Abstract

We examine the role of economic freedom in the debt-growth model. There is evidence of the contingency effect of institutional quality on the relationship between government debt and economic growth.

Keywords:

• government debt
• economic growth
• institutional quality
• economic freedom

JEL Classification:

• E62
• E69
• H63

Notes

¹ There are two debatable views on this issue. The first one firmly believes that there should be a tipping point for government debt, which was found to be at around 64% to 100% of GDP depending on the size and the development stage of the economy. The second view is not concerned with the level of debt as long as interest rates and inflation remain low and there is no downward pressure on public investment.

² Barro’s (1979) theory predicts that debt only reacts to temporary variations in income or government expenditure and, thus, debt levels are irrelevant for the current debt issue. Meanwhile, Melecky (2012) agreed that good public debt management will reduce borrowing costs, contain financial risks, develop domestic markets, give confidence to investors and reduce the lending spread.

³ A preliminary study on the pattern of growth in government debt and economic growth has depicted a negative correlation (−0.62), as attached in Appendix. The scatter diagram shows that the plot clustered at the bottom-right quadrant (positive growth in GDP-negative growth in government debt) followed by the upper right quadrant (positive growth in GDP-positive growth in government debt). In addition, about six dots represent the upper left quadrant (negative growth in GDP-positive growth in government debt), and there are none in the lower left quadrant. Thus, the negative correlation (−0.62) has been explained by the positive economic growth and negative growth in government debt.

⁴ Following Burnside and Dollar’s (2000) approach to analysing the effect of foreign aid on growth, the article used per capita income as the dependent variable.

⁵ Political rights and civil liberties are measured on a one-to-seven scale, with one representing the highest degree of freedom and seven the lowest. The political rights are derived from three subcategories: electoral process, political pluralism and participation and functioning of government. Meanwhile, the civil liberties are derived from four subcategories: freedom of expression and belief, associational and organizational rights, rule of law and personal autonomy and individual rights.

⁶ The EF index is measured on a one-to-ten scale, with one representing the lowest degree of freedom and ten the highest. The data is available in 5-years interval over the period of 1970–2000 and on a yearly basis thereafter. Thus, we perform linear interpolation at missing datapoints.

⁷ Countries and territories with a PR rating of 2 have slightly weaker political rights than those with a rating of 1 because of factors such as some political corruption, limits on the functioning of political parties and opposition groups and foreign or military influence on politics. For detailed explanation of characteristics of the rating, please refer to http://www.freedomhouse.org

⁸ Countries and territories with a rating of 3, 4 or 5 include those that moderately protect almost all civil liberties to those that more strongly protect some civil liberties while less strongly protecting others.

⁹ For specification 3, we use the overall EF world index. Meanwhile, for specifications 4–7, the subcomponents of the EF index, namely LEGAL, MONEY, FTRADE and REGULATE, respectively, have been used in this article.

¹⁰ High EF for international trade is defined as low tariffs, easy clearance and efficient administration of customs, a freely convertible currency and few controls on the movement of physical and human capital. Meanwhile, high EF for regulation is defined as existing in countries that use a private banking system to allocate credit to private parties and refrain from controlling interest rates, allow market forces to determine wages and establish the conditions of hiring and firing, refrain from the use of conscription, allow markets to determine prices and refrain from regulatory activities.