Case Study Research: Design & Methods: Applied Social Research Methods Series

Debt Overhang— Debt and Economic Growth

The debt overhang represents a situation where rate of growth of any economy suffers because of payments of debt services. As because interest payments of debt, rather than debt, not only private investment is reduced but the components of govt. expenditures also change. It is explained as: Because of higher debt service payments government interest payments increase. As a result, the govt. budget deficit payments increase leading to reduce public savings and increasing rate of interest. This in turn will lead to crowd-out private investment.

Then the income and employment will decrease and rate of economic growth will be affected. Moreover, due to higher interest payments the composition of govt. expenditures will charge, as govt. expenditures for infra-structure, health and education will decrease. Prof Sachs came to this conclusion in 1989 that all above situation will have a negative effect on economic growth. Thus it means to say that whenever govt. payments against debt service charges increase, govt. expenditures on human resource development decrease, and because of increase in rate of interest the private investment is also crowded‑out leading to decrease GDP.

It also means that there exists a negative relationship between interest payments and national income. This is the philosophy of Debt Overhang.

Some economists have also observed this thing that if due to public debt the consumption activities flourish instead of increase in exports, it will also have a negative effect on economic growth. In the same way, Prof Serletes has come to this conclusion in 1996 that external debt can play a better role in economic development if the debtor countries use these debts in the capital goods importation (resource: Symulator Forex). He says that during 1970′s that debt crisis rose because they used their external debt to remove deficit in their BOPs. While the democratic governemnts used external debt to please their voters.

In 1998, Prof Krugman ascribed debt-over hang a situation where the debt level of a country exceeds its capability to pay the expected interest payments. As the interest payments are the increasing function of the output of a country. In such situation, the revenues raised through investing by the creditors are taxed away. This leads to discourage local and foreign investors, then rate of growth is also affected.

Thus according to Krugman, Debt overhang comes into being due to external debt burden, as it leads to slower down of investment, and then has a negative effect on rate of economic growth.

In 2002 Prof. Pattillo came to this result that external debt has a positive effect on investment and growth up to a specific limit. After wards, this effect starts proving negative.

Therefore he has identified a non linear Laffer curve between external debt and growth. In 1993, Prof. Cunningham came to this result that in order to know the relationship between debt and growth we will have to see whether due to debt the productivities of labor and capital of debtors have increased or those of creditors. Therefore, if due to external debt the labor and capital productivitics of debtors decrease, this will have a negative effect on economic growth, other wise not.

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