TABLE OF CONTENTS
DECLARATION…………………………………………………………………………………………………………….. i
ACCRONYMS……………………………………………………………………………………………………………… iv
ACKNOWLEDGEMENT……………………………………………………………………………………………….. v
ABSTRACT………………………………………………………………………………………………………………….. vi
BACKGROUND AND PROBLEM STATEMENT…………………………………………………………… 1
SOME DEBT CRISIS IN THE WORLD………………………………………………………………………….. 2
The Latin American Crisis…………………………………………………………………………………………….. 2
EUROZONE DEBT CRISIS………………………………………………………………………………………… 3
1.3 GHANA DEBT PROBLEM AND THE HIPC INITIATIVE………………………………………… 7
WAS THE HIPC PROGRAM NECESSARY FOR GHANA?………………………………………….. 10
THE TAX COLLECTION PROBLEM IN GHANA……………………………………………………….. 11
OBJECTIVES OF STUDY……………………………………………………………………………………………. 13
RESEARCH QUESTIONS……………………………………………………………………………………………. 13
RELEVANCE AND JUSTIFICATION FOR THE STUDY…………………………………………….. 13
CHAPTER 2: LITERATURE REVIEW…………………………………………………………………………. 15
THEORETICAL LITERATURE………………………………………………………………………………… 15
EMPIRICAL LITERATURE……………………………………………………………………………………… 17
THE LITERATURE ON GHANA………………………………………………………………………………. 18
CHAPTER 3: METHODOLOGY…………………………………………………………………………………… 20
CHOICE AND JUSTIFICATION OF THE EMPIRICAL MODEL………………………………….. 20
FREQUENCY, RANGE AND SOURCES OF DATA…………………………………………………….. 21
DESCRIPTION OF DATA PREPARATION, COLLATION AND ANALYSIS PROCEDURES………………………………………………………………………………………………………………………………… 21
CHAPTER 4: DATA ANALYSIS………………………………………………………………………………….. 23
CHAPTER 5: CONCLUSION AND RECOMMENDATION………………………………………….. 26
REFERENCES…………………………………………………………………………………………………………….. 29
Tables…………………………………………………………………………………………………………………………… 35
Table 1.0: OLS regression Estimates……………………………………………………………………………. 35
Table 1.1: Pairwise Granger Causality Test (1 lag)…………………………………………………………. 35
Table 1.2: Pairwise Granger Causality Tests (2 lags)………………………………………………………. 35
Table 1.3: Pairwise Granger Causality Tests (3 lags)………………………………………………………. 36
Table 1.4: Pairwise Granger Causality Tests (4 lags)………………………………………………………. 36
Table 1.6: Robust Least Squares Regression output……………………………………………………….. 37
Table 1.7: Wald Test of Coefficient Restriction…………………………………………………………….. 38
Table 1.8: Output for Breuch-Pagan-Godfrey Test for heteroskedasticity………………………… 38
Table 1.9: Wald Test of Coefficient Restriction…………………………………………………………….. 39
MDRI………………… Multilateral Debt Relief Initiative
HIPC………………….. Heavily Indebted Poor Countries
OLS……………………… Ordinary Least Squares
GDP……………………… Gross Domestic Product
IMF………………………. International Monetary Fund
VECM……………………. Vector Error Correction Model
First and foremost, I thank my research supervisor and lecturer, Stephen Emmanuel Armah (Ph.D.). Without his enormous assistance, the paper would not have been accomplished. I thank you so much for your support and constructive feedback that guided me to complete this paper. I would not be writing this paper without the enormous support of the MasterCard Foundation in awarding me a scholarship to study at Ashesi and supporting me throughout my education. To Mrs Araba Botwey and her team at the Scholarship and Admissions office, I say thank you.
My special thanks go to all my lecturers and faculty interns for their exceptional effort in ensuring that I had the best of education—may God bless them. I would like to also thank Ms Adeline Quaye-Foli, the faculty intern for B.A undergraduate thesis seminar. She has been helpful in providing us updates and reminders on deadlines and what is expected from us. That helped put me on my toes. I have to also thank my colleagues, especially Elvis Amponsah who proofread my work and offered me constructive feedback. You all made this journey a success and I am grateful to you.
Ghana’s public debt has been rising for the entire post-independence era. The only time Ghana’s public debt fell was when there were international interventions in the form of debt relief such as the Multilateral Debt Relief Initiative (MDRI) in the 1990s. Despite the continues rise in public debt, economic growth has been moderate. In fact, according to the IMF, although Ghana’s debt was at an all-time high in August 2019, Ghana was also one of the four fastest growing economies in Africa in October 2019.
This study investigated whether the surging public debt levels in Ghana is a credible challenge to growth similar to what occurred in Latin America and European countries. The study used an OLS regression model, the discrete threshold regression technique, and the Granger causality test to analyze the relationship between Ghana’s rising debt and its economic growth using data from 1970 to 2018. The discrete threshold regression technique was used to investigate nonlinear relationships between the variables.
The study revealed that debt granger-causes growth (unidirectional). At debt-to-GDP ratio below 25 percent, growth is negative (-1.348), but becomes insignificant at debt threshold between 25 percent and 45 percent. However, when debt is above 45 percent of GDP, growth is significantly positive. Between 45 and 60 percent of GDP, growth is 3.21 percent, whiles when debt supersedes 60 percent of GDP growth is significantly around 6 percent.
The study recommends prudent borrowing above 45 percent of GDP by the Ghanaian government to invest in productive sectors of the economy whiles ramping up efforts in formalizing the huge informal sector to spur growth.
BACKGROUND AND PROBLEM STATEMENT
African countries have experienced rapid increase in their public debt in recent years (Bernadini and Fomi, 2017). This requires much attention and knowledge for informed policy decisions. These debt surges are as a result of several situations. One reason is that Governments often lack the required funds to finance major investments projects, finance tax cuts, or even bail out financially distressed banks. The Increased public expenditure due to the urgency in which governments must tackle these problems has led to dramatic increases in demand for leverage which has resulted in high levels of accumulated public debt in recent times (Ncanywa & Masoga, 2018; Kouretas & Vlamis, 2010).
However, there is no consensus in the economics literature on the exact causal effect of debt on economic growth. For example, scholars such as Reinhart and Rogoff (2009), Shahor (2018), Mankiw (2014), Balassone (2011), and Barrow (1999) have found a negative relationship between the variables, greatly attributing the relationship to the crowding out of investment capital via public debt servicing.
Others such as Reinhart and Rogoff (2010, 2011) and Anning et al. (2016) found that the relationship is positive between public debt levels and economic growth. Contrary to the aforementioned findings, several other scholars found that there is no relationship at all between the variables (Cohen, 1993; Panizza and Presbitero, 2013).
More interestingly, some scholars have suggested that there is a ‘conditional relationship’ between the variables. For example, Yener, Stengos, and Yazgan (2017) argue that the macroeconomic fundamentals of a country are key in analyzing the relationship between public debt and economic growth. The authors explain that when the fundamentals are weak, there is no
need for policymakers to think about any debt policy that could spur growth because there is no such policy. But when the economic fundamentals are strong, then it is feasible to think of optimal debt policies that could spur growth. Similarly, Anning et al (2016) concludes that debt has no negative consequences on the Ghanaian economy, but the benefits of debt can only be realized when borrowed funds are put into productive use rather than diverted into private pockets.
In the 1980s, large shocks of oil prices led to current account deficits in most Latin American countries, notably Argentina, Peru, Chile, Brazil, Mexico, and Nicaragua. In comparison, the price shocks created current account surpluses in the oil exporting countries. As a fundamental investment principle, US banks, encouraged by the Bush administration, served as intermediaries in receiving large deposits from the gainers of the shocks and lending to the Latin American countries (Sims & Romero, 2013). By the end of 1970, outstanding debts for Latin American countries to foreign financial institutions totaled US$29 billion, but this amount skyrocketed by five folds to US$159 billion eight years later in 1978. By 1982, Latin American nations were owing an estimated amount of US$327 billion.
Following the recession of world economies in 1981, Europe and America tightened monetary policy. Commercial banks, in response, shortened repayment periods and charged higher interest rates on debts. As a result of the precautionary measures by the banks, Latin American countries soon found themselves with unsustainable debt burdens (Devlin and Ffrench-Davis, 1995).
Shockingly, by mid-1982, the Mexican government announced its decision to default on its debts repayment which stood at US$80 billion. Immediately after the Mexican government’s announcement of debt defaults, other countries quickly followed suit in defaulting their outstanding debts, whiles sixteen other Latin American countries rescheduled their debt repayments (Sims & Romero, 2013).
In response to the defaulting news, banks ceased lending to Latin American countries and the consequences became fatal. As countries suffered financial turbulence, Latin American countries’ last resort was borrowing, so lending cuts plunged most of them in severe recessions because they lacked access to investment capital to spur growth (FDIC, 1997).
Consequentially, output per head in 1990 was nine percent lower than in 1980, inflation was in double digits for most countries and even three to five digits for Brazil, Argentina, Nicaragua, and Peru. Unemployment levels surged and investment per worker massively fell (Felix,1990).
The Eurozone debt crisis, which was mainly triggered by the 2008/09 global financial crash, created a lot of macroeconomic imbalances within member countries. These imbalances were mainly current account deficits and rising external debt (Storm & Naastepad, 2015).
Following the European monetary and financial integration, people got more access to credit inflows from other countries which boosted demand domestically during the pre-crisis period.
Eventually, in 2008, private and public debts had reached unsustainable levels across the Euro area with Greece becoming the biggest victim. Fueled by the debt overhang problem, the
Euro area eventually entered a recession in 2008. By 2014, Greece, Spain, Portugal, and Italy’s GDP fell by 26.3, 5.7, 6.8, and 9.6 percent respectively (Storm & Naastepad, 2015).
Although, the debt crisis was, fueled by the monetary integration which saw the use of the Euro as a common currency, different policy implementations across the union led to varying outcomes in different countries.
According to Richard (2013), the Greece crisis erupted from policymakers’ goal of providing production-compromising social welfare and many other populist policies for citizens. Just like their European counterparts-in-debt, they socialized private debts by granting bailouts to financially distressed banks. Greek government increased its defense spending (due to the conflict with Turkey over Cyprus) and increased public sector employment. Coupled with revenue deficits, the increased spending led to budget deficits and the Greek government resorted to borrowing to sustain its policies, hence the genesis of the debt crisis (Dimitraki and Kartsaklas, 2017).
Prior to the crisis in 2008/09, the Greek economy after its reconstruction in the 1950s, became the fastest growing economy within the EU-15 and the OECD countries until the 1980s (Dimitraki & Kartsaklas, 2017). For the same period, the Greek debt to GDP ratio was around 17 percent in the1960s; 20 percent in the 1970s; 37 percent in the 1980s; 104 percent in the 1990s whilst it reached 157 percent of GDP in 2012 (IMF, 2012). As depicted in Figure 1.0 below, the debt ratio kept rising even after the crisis and reached about 180 percent of GDP in 2018. This continuous rise in debt levels compelled EU countries to grant Greece a debt relief of US$300 billion until 2032 where they will reassess the debt situation (CNBC, 2018).
Also, a look at Greece’s economic growth shows poor growth during the period of its debt crisis (which coincided with the global financial crisis in 2008/09) until 2014 when it started recovering, as reported by CNBC (2019).
