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The impact of public debt on economic growth in Jordan

Feb 01,2020 - Last updated at Feb 01,2020

A clear phenomenon has prevailed in Jordan during the past two decades, which is the continuous growth of public debt at rates exceeding 9 per cent annually during the period 2001-2019, reaching nearly 11 per cent for the period 2006-2019 and 11.8 per cent during the last decade. This was accompanied by a decline in the GDP growth rate from rates that ranged around 4.5 per cent and decreased to an average of 3.8 per cent and to an average of 2.7 per cent during the same periods.

Did the rise in debt has a negative impact on the GDP growth rates in Jordan? And to what degree was the high indebtedness responsible for part of the decline in GDP growth rates?

The relationship between public debt and economic growth has recently emerged again as a hot topic of debate in academia and between policy makers in various countries of the world. The questions raised were whether the relationship between public debt and economic growth is largely negative in the long run, and whether there are specific thresholds at which public debt levels have negative effects on GDP growth rates.

The study I conducted on Jordan for the period 2001-2019 using simple statistical analysis showed that there is a clear negative relationship between the ratio of public debt to GDP and the economic growth rate during the first period of the study, and this relationship became more clear during the period 2006-2019, and this negative relationship became strong when public debt to GDP ratio exceeded the 80 per cent threshold.

The average GDP growth rate was about 5.3 per cent during the periods when the public debt to GDP ratio was less than 80 per cent, compared to 3.8 per cent in the periods when the debt ratio to GDP exceeded 80 per cent.

The results of this study coincided with the results of the most influential paper by Reinhart and Rogoff (2010), which analyses the impact of different levels of government debt on real GDP growth rate in the long-term by considering a sample of 20 advanced and 24 emerging countries over a period of nearly 200 years (1790–2009). They obtained similar results with simple correlation statistics as previous studies, namely that below a threshold of 90 per cent of GDP debt has a positive but weak impact on the long-term GDP growth rate, whereas the effect of debt above 90 per cent is negative and significant. Our study shows different threshold, 80 per cent of GDP, for Jordan.

Simple regression models reinforced the presence of a negative impact of public debt on the rate of economic growth in Jordan, where it was found that an increase in the ratio of public debt to GDP by about 9.4 per cent reduces the GDP growth rate by one per cent. In other words, if the public debt ratio increases from 80 per cent to 89.4 per cent, the GDP growth rate decreases from 3 per cent to 2 per cent. The analysis of data of the ratio of public debt to GDP with GDP growth rates showed that the relationship between the two variables is linear during the 2001-2008 and 2009-2019 study periods, with some shocks inflicted by external factors on the Jordanian economy.

Multiple regression models also reinforced the presence of a negative impact of public debt on economic growth in Jordan, where these models showed that an 8.1 per cent rise in debt reduces GDP by 1 per cent.

Mechanisms of transmission of the impact of public debt to economic growth rates are through the negative effect of public debt on savings and capital accumulation, and through distortions that occur on the tax that limit new private investment, and also through the contractionary policy of government spending practiced by governments to reduce deficits in the budget.

The most prominent recommendations that can be made to address the high indebtedness and the decline in economic growth rates are; first, priority of economic policies should be given to stimulate economic growth, and secondly, public debt law should be amended so that the ceiling of the public debt to GDP ratio, which is currently inactive, should be raised to a maximum of 80 per cent, which is the per centage where public debt is still sustainable.

Third, limit or even stop borrowing as much as possible for budget purposes and rely more on grants and aid for a period of no less than two or three years to give an opportunity for GDP to grow by a clear and large difference beyond the public debt.

Fourth, put more pressure on the international community, governments and financial institutions, to write off part of the debts, especially foreign ones, as a reward for Jordan to enable it bear the consequences of the political crises in the region, as Jordan has no role in.

Fifth, capitalise part of the debt by utilising various methods and financial instruments. Sixth, restructure public debt which can be carried out by reducing the interest rates on loans or by extending the dates when debt is due.

 

The writer is director general of the Association of Banks in Jordan. He contributed this article to The Jordan Times

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