External debt and growth of developing countries.

Abstract

This dissertation is an exploratory study of the effect of external debt on growth of (debtor) developing countries. The model developed for estimation is based on neoclassical growth theory. In particular, the Solow-Swan-Ramsey model for credit-constrained open economy is used. One of the important features of the model is its prediction of the occurrence of absolute and/or conditional convergence.

The important finding that external debt tends to have an inverse relationship with growth suggests that relying on external debt to boost economic growth is not a good policy. Instead, developing countries may be better off by trying to reduce their external debt and supplement their lack of domestic saving with other forms of foreign capital such as foreign direct investment. (Abstract shortened by UMI.)

Driven by optimal control theory, the empirical model relates to two types of explanatory variables, i.e. the state variables and control variables. Using Barro-type regression, the state variables take the form of initial values of each variable during certain sub-periods. Control or environmental variables, on the other hand, are represented by the average values of the variables over relevant sub-periods.

The idea of a 'financing gap' which is based on the Harrod-Domar theory has prompted developing countries to accumulate external debt since the 1960s. Unfortunately, debt repayment has to be financed by hard earned foreign exchange reserve. Therefore, a likely result of reliance on external debt would be to deplete domestic investment and slow economic growth.