Federal government debt and economic growth: Evidence from Malaysia

Abstract

This article conducts an investigation into the effect of federal government debt on Malaysia’s economic growth with the application of threshold regression. The result reveals that, beyond the government debt threshold level, the country is experiencing a positive effect on economic growth.

Keywords

government debt economic growth Malaysia threshold regression

I Introduction

The world economy was hit by the debt crisis, which initially affected some of the developed economies, although some developing economies now seem to be sounding the alarm.¹ It became a topical and debatable issue, and many researchers have been investigating the level of government debt with concerns about the effect of debt on growth. Several empirical works have focused on investigating the impact of public debt on a country’s economic growth, while proposing a non-linear analysis (Baum et al., 2012; Cecchetti et al., 2011; Checherita and Rother, 2010; Caner et al., 2010; Reinhart and Rogoff, 2010; Pattillo et al., 2004; Presbitero, 2010; Schclarek, 2004). Most of the literature has found that the tipping point of government debt should be held at around 64 per cent to 100 per cent of the gross domestic product (GDP) depending on the size and the development stage of the economy. This suggests a positive effect of government debt on economic growth, up to certain level. Above that level, additional government debt is associated with an adverse effect on growth. However, no consensus has emerged among economists on this issue.² On the other hand, Malaysia, an open economy, has recorded a fiscal deficit position since its independence in 1957, except for the period 1993–97; this has led to Malaysia accumulating a high stock of indebtedness. As at the end of 2011, the total federal government debt was recorded at RM 455,745 million, which is equivalent to 53.8 per cent of the GDP (Malaysia Economic Planning Unit, 2012). This raises the question of whether the government debt has played some role in Malaysia’s economic growth. In principle, if borrowing is allocated efficiently, a country will benefit from it since debt financing of public spending can make a positive contribution to productive investment and, ultimately, to economic growth (Miller and Foster, 2012).

II Data and Methodology

A standard basic growth model has been estimated where real GDP per capita is a proxy of economic growth, while the independent variables, including population growth and the investment ratio, represent the rates of growth of factor inputs in the production function. Openness, government deficits and federal government debt variables represent country-specific policy. To determine the existence of threshold level and the slope coefficient of the federal government debt and other independent variables, we employ a test proposed by Hansen (2000) that tests the null hypothesis of a linear regression against a threshold regression analysis. In the form of the thresholds model,

E c o n o m i c G r o w t h_{t} = {β^{'}}_{1} ​ x_{t} + μ_{t} d e b t_{t} \leq γ

(1)

E c o n o m i c G r o w t h_{t} = {β^{'}}_{2} ​ x_{t} + μ_{t i} d e b t_{t} > γ

(2)

Debt is used to split the sample into two groups or regimes, and it could be part of the regressors. The null hypothesis of linearity against a threshold specification can be expressed as:

H_{0} : β_{1} = β_{2}

(3)

Hansen (2000) has developed a threshold model estimator that considers the least-squares estimations. Furthermore, by providing an asymptotic simulation test of the null of linearity against the alternative of a threshold, this method also computed a confidence interval by inverting the likelihood ratio statistics. Hansen (2000) also proposes an F-test bootstrap (heteroscedasticity-consistent) procedure to test the null of linearity. Since the threshold value γ is not identified under the null, the p-values are computed by a fixed bootstrap method. The independent variables are supposed to be fixed and the dependent variable is generated by a bootstrap from distribution $N {(0, \hat{μ})}_{i}, w h e r e {\hat{μ}}_{i}$ is the ordinary least squares (OLS) residual from the estimated thresholds model. Data are collected from the World Development Indicator (WDI) and the Global Development Financial (GDF) indicator from the World Bank (WB) database and Monthly Bulletin, Central Bank of Malaysia.

III Results and Discussion

Figure 1 shows a scatter plot of federal government debt growth and GDP growth over the period of study. Descriptively, it depicts a negative bivariate association between the government debt and Malaysia’s economic growth over more than 30 years. Close observation reveals that the concentrations are within the area of a 10 per cent to 20 per cent growth in debt holding associated with a growth rate within 5 per cent to 12 per cent of economic growth, implying that the growth of debt is higher than the growth of the economy. On the other hand, it shows that, during 1973 and the period 1988–97, the Malaysian economy was growing more than the growth in government debt.

Figure 1

Source: Author’s estimation.

Results on the threshold regression of debt–growth estimates are shown in Table 1. All the control variables carry the expected sign and are significant at a 5 per cent significance level. Additionally, the magnitude of the coefficient of these variables is fairly robust across two specifications. Meanwhile, the estimated threshold levels are about 50.528 (Equation 1) and 50.790 (Equation 2) under the null of a no-threshold effect and is strongly rejected at least at a 5 per cent significant level. This also indicates that the bootstrap p-value could reject the null of the no-threshold effect. During the period when the government holds debt below 50.528 per cent of GDP (Equation 1) and 50.790 per cent of GDP (Equation 2), the effect of debt on the Malaysian economy is insignificant. This could be due to the fact that there are insufficient borrowing resources to boost investment and, to a lesser extent, economic growth. Beyond that level, Malaysia is found to be enjoying a positive effect on growth for Equation 1 (β₂ = 0.011; se = 0.002).³ Thus, an increase in government debt to GDP above the threshold level leads to higher additional growth.

Table 1

Threshold regression (dependent variable: Real GDP per capita)

	Equation 1	Equation 2
Constant	11.747(0.170)*	11.536(0.160)*
Investment/GDP	0.018(0.003)*	0.019(0.004)*
Population growth	−1.170(0.063)*	−1.139(0.006)*
Openness	0.013(0.004)*	0.013(0.000)*
Fiscal deficits/GDP	0.012(0.004)*
Government debt Low debt (debt_t≤ γ)	0.002(0.005)	−0.005(0.006)
High debt (debt_t > γ)	0.011(0.002)*	0.003(0.000)*
Threshold estimate	50.528	50.790
LM-test for no threshold	88.812	45.275
Bootstrap p-value	0.000	0.002

Source: Author’s estimation.

Notes: * indicate significance levels of 5 per cent. Bootstrapped p-value was performed with 1,000 replications and 10 per cent trimming.

Thus, our results suggest that, at a lower level of debt, the stock of government debt does not seem to benefit the Malaysian economy.⁴ In addition, the country has experienced around 17 occasions when the government debt was higher than the threshold estimates (1981–93, 2004 and 2009–11), which indicates that the country experienced a positive growth effect from the government debt. This scenario might be supported by the notion that, as long as interest rates and inflation remain low, and there is no downward pressure on public investment, the extra debt issued by a government can be highly prized as a store of value. This helps savers sleep more easily and provides a boost to the economy because it assists with deleveraging and raises the velocity of spending (DeLong, 2013). As at the end of 2012, the inflation rate and unemployment rate remain low at 1.6 and 3.0, respectively, while private and public investment both recorded double-digit growth in 2012.⁵

IV Conclusion

This article investigates the linkages between government debt and economic growth for Malaysia. Results indicated that there is a threshold effect on the relationship between government debt and economic growth. In addition, the results reveal that an accumulation of government debt has a positive effect on Malaysia’s economic growth beyond the threshold level.

Footnotes

Notes

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