The Impact of External Debt On Economic Growth: A
The Impact of External Debt On Economic Growth: A
The Impact of External Debt On Economic Growth: A
3, 2008)
ISSN: 1520-5509
Clarion University of Pennsylvania, Clarion, Pennsylvania
Folorunso S. Ayadi
University of Lagos
Felix O. Ayadi
Texas Southern University
Abstract
This paper investigates the impact of the huge external debt, with its servicing requirements,
on economic growth of the Nigerian and South African economies. The external debts of
Nigeria and South Africa are analyzed in a new context utilizing traditional, but innovative,
models and econometric techniques. The Neoclassical growth model, which incorporates
external sector, debt indicators, and some macroeconomic variables, is employed in this
study to explore a linear, as well as non-linear, effect of debt on growth and investment.
Both ordinary least squares (OLS) and generalized least squares (GLS) are employed in the
analysis. Among other test results, the negative impact of debt (and its servicing
requirements) on growth is confirmed in Nigeria and South Africa. However, South Africa
performs better than Nigeria in the application of external loans to promote growth. In
addition, external debt contributes positively to growth up to a point after which its
contribution becomes negative in Nigeria (reflecting the presence of non-linearity effects).
Introduction
External debt is one of the sources of financing capital formation in any economy.
Adepoju et al. (2007) note that developing countries in Africa are characterized by
inadequate internal capital formation due to the vicious circle of low productivity, low
income, and low savings. Therefore, this situation calls for technical, managerial, and
financial support from Western countries to bridge the resource gap. On the other hand,
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external debt acts as a major constraint to capital formation in developing nations. The
burden and dynamics of external debt show that they do not contribute significantly to
because of the servicing requirements and the principal itself. In view of the above, external
Like most developing countries of the world, Nigeria relies substantially on external
funds for financing its development projects – iron and steel mills, roads, electricity
generation plants etc. Such external funding usually takes the form of external loans. In the
early years of political independence (i.e. 1960 through 1975), the size of such loans was
small, the rate of interest concessionary, the maturity was long-term, and the source was
usually bilateral or multilateral in nature. For instance, Nigeria’s external debt in 1960 was
about $150 million; however, beginning in the year 1978, the situation changed. Nigeria, at
the lure of the international financial centers, started to borrow huge sums from private
sources at floating rates and with shorter-term maturities. The 1978 “jumbo loan” alone was
estimated at some US $1 billion. By 1982, the value of Nigeria’s external indebtedness was
US $18.631 billion, which represented over 160% of Nigeria’s gross domestic product
(GDP) for that year. The situation precipitated a debt-crisis that progressively worsened over
time. By 1986, Nigeria had to adopt a World Bank/International Monetary Fund (IMF)
sponsored Structural Adjustment Program (SAP), with a view to revamping the economy and
Loan capital was readily available to South Africa during the 1970s, and both the
public and the private sectors borrowed heavily, often in the form of trade credits. However,
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in the early 1980s, foreign investments declined relative to the value of foreign loans needed
to finance economic growth. Equity finance declined as a proportion of foreign debt from
60% in the 1970s, to less than 30% in 1984. South Africa’s loan increased from 40% to 70%
of foreign debt. Its total foreign indebtedness increased steadily as loans were acquired from
the IMF, whenever the foreign bankers turn down its request for loan. In addition,
indebtedness was stabilized through gold swap. The debt problem became endemic in 1984,
as about two-thirds of its outstanding loans had a maturity of one year or less. The public
sector was responsible for the 16% of South Africa’s foreign debt; 44% of South Africa’s
foreign liabilities were incurred by the banking sector; the remaining 40% were private
liabilities. When Chase Manhattan withdrew substantial credit lines from South Africa in
The impact of credit freeze and refusal to roll credit over on South Africa led to a
drop in the value of rand (South African currency) and temporary closure of the financial and
foreign-exchange market. Liabilities not affected by the freeze include trade credits, credits
guaranteed by the Paris Club, member governments, and loans from IMF and Central Banks.
Also compounding South Africa’s debt problem was the large proportion of debt that was
denominated in hard non-dollar currencies, but appreciated in dollar terms as the dollar
weakened. Since then, South Africa’s external debt has been high and continued to follow a
predictable upward trend, exerting substantial negative impact on productivity and growth.
The Deutsche Bank (2008) showed the South African economic profile was better
when it observed that key economic indicators show that there is consistent negative trade
and current account balances. Current account balances, as proportion of GDP, is increasing
predictably and external debt is growing persistently. For instance, external debt as of 2003
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was put at US $38.1 and went up to US $68 billion by 2007 (about a 78% increase). Short
term debt for 2003 was US $9.2 billion and went up astronomically to US $24 billion in
2007. External debt, as percentage of GDP, was 22.9 in 2003, but moved up slightly to 23.2
in 2007. The significance of these is that the debt indicator may portray a manageable picture
of South Africa’s debt situation, but the reality is that the present external debt situation may
be unsustainable in the long run, especially if measures are not put in place for its
management.
According to Ayadi (1999) and Ayadi et al. (2003), external debt burden had
dramatically limited developing countries’ participation in the world economy and the
growth and development. Debt burden has led to a limited accumulation of capital (depletion
consolidate small and medium-sized firms. This indirectly affects employment, literacy, and
poverty. A cursory look at external debt profile and some debt indicators of Nigeria and
South Africa reveal the inherent serious nature of a debt burden (Tables 1 and 2).
Table 1: External Debt Stock for 1994 - 2007 (In Millions of US Dollars)
Year Nigeria South Africa
1994 33092.3 21671.0
1995 34092.5 25358.0
1996 31406.6 26050.0
1997 28454.8 25272.4
1998 30294.5 24752.8
1999 29127.6 23907.3
2000 31354.9 24860.7
2001 31041.6 24050.0
2002 30476.0 25099.1
2003 34700.2 27423.1
2004 37883.1 27112.4
2005 22178.3 31098.6
2006 7693.0 35548.8
2007 8590.0 38855.0
Source: Economist Intelligence Unit (2008) CountryData-Annual Time Series.
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A comparative view of the external debt stock of Nigeria and South Africa indicates
that the debt volume for Nigeria is significantly higher than that of South Africa. The debt
stock followed an upward trend in Nigeria until 2004, after which it nose-dived, especially
from 2006, when Nigeria took advantage of the debt relief to offset the substantial part of its
debt. The debt stock volume for South Africa has been stabilized over the years, until 2005
when debt stock started to record an upward pattern. On a casual view, the South Africa
external loan has been better managed than that of the Nigeria. For instance, South Africa has
not defaulted in servicing its debt obligation; the compounding effect of not servicing debt is
not taking a toll on its debt stock. In addition, South Africa has been able to offset some of its
external debt obligations, especially before the year 2005. The above comparison, however,
can be more meaningful if debt stock and its servicing requirements are compared with
Table 2: External Debt Indicators for Nigeria and South Africa (Percent)
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Table 2 contains popular, but traditional, external debt indicators which include the
ratio of debt stock to exports. This ratio peaked at over 317% in 1994 for Nigeria when
compared with its South African counterpart with about 70% for the same period. This
indicator began to decline after 1994 for Nigeria and South Africa. Prior to 2003, Nigeria’s
external debt was greater than its export capacity. As for South Africa, the story is different,
The ratio of debt stock to GDP is a traditional debt indicator that compares a
country’s debt stock with its productive capacities. By implication, the higher a country’s
debt stock is, compared with its output, the greater the debt burden or indebtedness of that
country. This ratio showed that debt stock was above the productive capacities of Nigeria in
the year 1995, whereas the South Africa indicator ranges between 12.53 and 22.59 from 1994
to 2007. Nigeria’s ratio did not decline substantially until the debt relief was granted by the
Paris club in 2006. The importance of this is that South Africa’s management of its debt, as
The above point is well supported when one observes the debt service payment as a
proportion of export, and as a proportion of GDP. South Africa had continued to honor its
external obligations regularly while Nigeria accumulated service arrears. This ratio is
identical for both South Africa and Nigeria, despite the huge disparity between debt stock to
exports of the two countries, because South Africa had been honoring its service obligations
as and when due. In Nigeria however, there is a wide disparity between service due and
payments, which further exerts substantial pressure on its debt stock due to recapitalization of
arrears.
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There are limitations to the aforementioned anecdotal comparative analysis because
they have not been able to ascertain existence of a debt trap facing either of the two
countries. Debt stock as well as debt service indicators, mostly serve as warnings of potential
danger of excessively large debt stock. Based on Van Der Merwe (1993) even though the
ratio of government debt to GDP has increased relatively sharply in South Africa, there is
still no “explosion” in the growth of debt. Whether or not the same argument holds water for
Nigeria prior to 2005 is a different story. From Tables 1 and 2, it is extremely difficult to
draw any definite conclusions alone from our international comparisons thus necessitating
for additional comparative analysis on the possible impact of huge debt on growth. The
thesis of this paper is to apply some econometric approaches to investigate the presence of
Literature Review
2007). Sachs (2002) argues that growth will not take-off until capital stock has risen to a
given threshold. As capital rises, and investment and output rise, in a virtuous circle, the
saving level will also continue to rise. After a given level, the rise in both capital and savings
will be sufficient to engender self-sustaining growth. The reason for opting for external
finance, as a means of ensuring sustained development rather than utilizing only domestic
resources, is provided by the ‘dual gap’ theory. The theory postulates that investment is a
function of savings, and that in developing countries, the level of domestic savings is not
sufficient to fund the needed investment to ensure economic development. Thus, it is logical
to seek the use of complementary external goods and services. The acquisition of external
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funds, however, depends on the relationship between domestic savings, foreign funds,
investment, and economic growth. A guiding principle on when to borrow is a simple one.
Borrow abroad so far as the funds acquired generates a rate of return that is higher than the
cost of borrowing the foreign funds (Ajayi & Khan, 2000). In essence, by following this
guiding principle, a borrowing country is increasing capacity and expanding output with the
External debt does not automatically transform into debt burden when funds are
optimally utilized. In an optimal condition, the marginal return on investment is greater than
or equal to the cost of borrowing. According to Edelman (1983), the critical factors affecting
debt service capacity are returns on investment, the cost of borrowing, and the rate of
savings. The benefits of external borrowing have been emphasized in the literature to the
neglect of the costs. Ubok-Udom (1978), enumerates the costs of external borrowing to
include debt service burden which incorporates costs implied by the term structure of
external loans, costs of resultant liquidity crisis, costs of the viciously cumulative debt, the
manageability of the debt, costs of debt rescheduling, and costs of import substitution among
others.
Colaco (1985) explains debt service vulnerability in developing countries using three
contexts. First, the size of external loans has reached a level that is much larger than equity
finance, resulting in an imbalance between debt and equity. Secondly, the proportion of debt
at floating interest rates has risen dramatically, so borrowers are hit directly when interest
rates rise. Thirdly, maturities have shortened considerably in large, part because of the
declining share of official flows. All the above factors are relevant to Nigeria and South
Africa. Mehran (1986) argues that adequate debt management is essential in an increasingly
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complex financial environment. Mehran also identifies the critical components of debt
analysis. The aforementioned is true since the effectiveness of measures to reach a balanced
level of debt supportive of development, depends on the debtor nation adopting fiscal
adjustment and structural reform. Other features are transparency and anticorruption
policies, creation and/or improvement of debt management structures, and decision making
sustainable level of debt. According to Ajayi and Khan (2000), sustainable foreign borrowing
is measured by several ratios, such as debt to export, debt service to export, debt to GDP (or
GNP), and external debt to Gross National Income among others. However, the
determination of the sustainable level of these ratios is indeterminable and their usefulness is
reduced to a warning of potential explosive growth in the stock of foreign debt. For instance,
if the acquisition of additional foreign debt increases the debt servicing burden more than it
increases the country’s capacity to bear the burden, such an acquisition becomes undesirable
and the situation must be reversed through export expansion. If export is not expanded, more
borrowing will be necessitated for servicing debt and external debt will pile up above the
According to Omotoye et al. (2006), Nigeria is the largest debtor nation in the Sub-
Saharan Africa. They also observe, in a comparative study with Argentina (Latin America’s
most severely indebted nation), that Nigeria’s external debt, as a percentage of gross national
income, has been continuously higher than that of Argentina since 1985 and continued to
follow an upward pattern, unlike that of Argentina. The problem is compounded, according
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to Greene (1989), by inability of the economy to generate the requisite resources to meet
repayment obligations, especially since the early 1980s. Fosu (2007) further shows the
severity of the debt burden brought about by the pile-up debt (debt arrears as proportion of
Cohen (1993) and Clements et al. (2003) corroborate the aforementioned impact of
debt, as they observe that the negative effect of debt on growth works not only through its
impact on the stock of debt, but also through the flow of service payments on debt, which are
likely to ‘crowd out’ public investment. This is so because service payments and repayments
on external debt soak up resources and reduce public investments. The damaging impact of
from debt-induced liquidity constraints (Taylor, 1993). Liquidity constraint, implied by the
debt-servicing requirements, may shift the budget away from the social sector or public
investment. This is important for consideration because public expenditures are likely to be a
major determinant of the economic activities in many functional sectors (Fosu, 2007).
effect (tax disincentive and macroeconomic instability). Tax disincentive means that a large
debt stock discourages investments because potential investors assume that there would be
taxes on future income in order to make debt repayments. The macroeconomic instability
relates to increases in fiscal deficit, uncertainty due to exceptional financing, exchange rate
depreciation, possible monetary expansion, and anticipated inflation (Claessens et. al. 1996).
The relevance of ‘debt overhang’ hypothesis was stressed by Audu (2004). According
to Audu, “the debt service burden has militated against Nigerian’s rapid economic
development and worsened the social problems. Service delivery by key institutions designed
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to mitigate the living conditions of vulnerable groups were hampered by decaying
infrastructure due to poor funding. By cutting down expenditure on social and economic
infrastructure, the government appears to have also constrained private sector investment and
growth through lost externalities. This has reduced total investment, since public investment
It is argued that external debt burden is among the factors that depressed private
investment in the Philippines after 1982. By utilizing data from Nigeria, Iyoha (1997) reports
results that confirm the ‘crowding out’ and the ‘debt overhang’ effects of debt servicing. He
concludes that these two effects apparently explain, to a large extent, the low level of
investment in the Nigerian economy. Another study by Ashinze and Onwioduokit (1996),
examines the relationship between external debt and growth in Nigeria using a macro-
economic model. The study reports a period of effective utilization of external finance, which
resulted in a significant level of economic growth. It also reports periods when external
funds were not judiciously utilized with a resultant effect of economic decline.
Edo (2002) analyzed the African external debt problem with reference to Nigeria and
Morocco. He concluded that external debt has affected investment severely. Other findings
include the fact that fiscal expenditure, balance of payments, and global interest rates are
major factors explaining debt accumulation in the studied countries. He, therefore, suggests
measures that could alleviate the above problems (privatization, sustained export promotion
Claessens et. al. (1996) also explained the cash flow impacts of debt as the “liquidity
constraint” (a reduction in current debt services increases the current level of investments, for
any given level of future indebtedness). Another effect identified is the reduction of moral
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hazard effect. Moral hazard effect implies debt reduction to countries with a record of sound
macro policies. According to Arnone et. al. (2005), “inflation tax reduces public investments
and uncertainty (option of waiting and misallocation of investments) are likely to occur with
a large debt stock. Additionally, large debt stocks lead to capital flights, higher tax rates and
Mutasa, the heavy debt burden and continual reliance on countries of the north for hard
currencies has been a major impediment to accelerated integration within and across regional
groupings in Africa. There is a growing concern over the amount of borrowing indulged in,
the servicing of such foreign debt, and the future strain on regional schemes and general
reduction in what can be devoted to regional schemes and economic development. Not only
is potential regional integration foregone but, also in many cases, previous development
achievements are being eroded. Debt repayments in the form of arrears have grown rapidly
giving rise to questions regarding the credit worthiness of many countries. On the other hand,
conditionality, associated with debt repayments and trade, has stood in the way of northern
creditors at the cost of intra-regional trade. Compounding this situation is the pattern of
existing trade. Existing trade patterns reflect strong vertical linkages (developed-developing
country) and weak horizontal linkages (between developing countries), which are
which external funds had been utilized and whether countries (especially South Africa) could
sustain its rapidly growing external debt profile with efficiency. This study specifically
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analyzes how annual growth rate of output (as measured by GDP growth) is affected by debt
stock and its service indicators. The effect of the external debt service burden on economic
performance and investment (the ‘crowding out’ effect) in Nigeria and South Africa is
analyzed. Moreover, the relationship between the debt Laffer curve and non-linearity in the
effect of debt can be better appreciated when we re-examine the debt Laffer curve’s
postulates. The curve, too, is non-linear and it relates the debt stock to the ability to repay
(expected value of repayment). The curve is inverted, U-shaped, indicating that as the debt
stock grows, repayment ability after a cumulative debt stock value declines. In other words,
efficient utilization of debt stock tends to decline beyond a level and further acquisition of
debt leads to a decline in productivity. This issue is examined comparatively for Nigeria and
South Africa. The choice of Nigeria and South Africa in this study is borne by the roles of
these countries in Africa’s development efforts and regional integration, which has great
The reason for opting for external finance, as a means of ensuring sustained
development, as against domestic borrowing is answered by the ‘dual gap’ analysis. This
theory postulates that investment is a function of savings and investment that requires
complementary external goods and services. According to Root (1978), the gross domestic
GDP = C + S (1)
Alternatively,
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GDP = C + I + ( X − M ) (2)
where,
C = Consumption
I = Investment
X = Exports
M = Imports
S = Saving
In this model, investment includes both private sector investment and government investment
I = I p + Ig
(3)
where,
Ig = G (government expenditures)
Since GDP equals domestic consumption plus the domestic saving, it follows from
equations (1) and (2) that the demand for domestic investment equals the sum of domestic
savings and the import balance on current accounts, which is financed by net borrowing from
abroad.
I = S + (M − X) (4)
Where,
To answer the question of why external debt tends to increase rapidly, we recall the
two-gap model described by Chenery and Strout (1966). In their model, net external
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between the net capital inflow (gross capital minus the amortization on past debt) and interest
BT = Dd − rD (4a)
Or
BT = (d − r ) D (4b)
where,
Equation (4b) shows losses or gains in foreign exchange from international capital
flows by a country in a given year. BT indicates gain if d > r and loss otherwise. Generally, if
borrowing is linked with productive use when rates of return exceeds r and BT is positive,
increasing the external debt will not hamper the economy of the recipient country in the long
run.
( Dt − Dt −1 ) = Yt − rDt − C t − I t − Gt (4c)
Where,
Ct = consumption in period t
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It = domestic investment in time t
In Equation (4c), the debt size in a given period can be reduced by an increase in a
expenditure. The failure of a country to do a period-to-period flow analysis and to reach the
level where the sum of output, consumption, domestic investment, and government
expenditure is less than the basic transfer, will lead to a debt crisis as shown below:
The regression models in this study take the Solow-type neoclassical growth model of
the following specific forms. Output growth is determined by domestic savings, debt burden,
Equation (5) analyzes the impact of debt indicators on output growth (‘debt overhang’
effect). Equations (6) and (7) capture the overhang effect and ‘crowding out’, respectively,
while also accounting for the non-linearity impact of debt (Krugman & Proot, 1989). The
Model 1
The first model explores a linear relationship between output and debt burden
Y g = Ω 0 + Ω 1 ΔEXPO
EXPO
+ Ω 2 RGDP
RGFI
+ Ω 3 DSERGD + Ω 4 DEBGDP + Ω 5 GCAP + μ t (5)
Where,
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(RGDPt-RGDPt-1)/RGDPt. RGFI/RGDP = total investment-output ratio
ΔEXPO
EXPO = annual growth rate of exports
Equation (5) represents the neoclassical growth model extended to exports and non-
export sectors. The common variables that enter the growth model are: growth rates of labor
(which is excluded because of data problem), exports and investment-GDP ratios (capital).
Gounder (2001) utilizes the Solow-type neoclassical growth model to analyze the impact of
incorporated into Solow’s model, the explanatory variables are; the official development
assistance to GDP ratio, (AID to GDP ratio) multilateral aid to GDP ratio, ratio of grant aid
to GDP, ratio of loan to GDP, and ratio of technical cooperation to GDP in separate
equations. It is relevant to include as explanatory variables in this analysis, the ratio of debt
stock to GDP and debt service to GDP, as shown in Equation (5) above.
The second model is based on variants of Elbadawi, Ndulu and Ndungu’s (1999)
model of external debt sustainability. This model has two versions, namely: (i) rate of
growth, external debt relationship (the debt Laffer curve, which investigates the ‘debt
overhang’), and financial constraint hypothesis; and (ii) private investment and external debt
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relationship (which investigates both demand side and the credit constraint). The Elbadawi et
al’s model investigates the impact of large external debt stock with its servicing requirements
and the resultant fiscal deficit on private investment (measured as private investment to
GDP). It is, however, true that external debt acts as constraint, not only to private investment
alone but on investment generally and as such we based our analysis on total investment. The
shortcoming of this model is that it considers only the public sector gap, and ignores the
external sector. Our re-formulated Elbadawi, Ndulu and Ndungu models are shown below:
(6)
And
RGFI
RGDP = β0 + β1 DEBGDP + β2 ( DEBGDP) 2 + β3 DSEREXP + β4 TOT + β5 GCAP + μit
(7)
Where,
In carrying out the analysis in this paper, the dependent and independent variables
chosen were based on their ability to portray the investigation in a meaningful and consistent
manner. Variables were included, excluded, or proxied based on theoretical and/or empirical
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justification. However, data availability and measurability acted as major constraints in terms
effects of foreign debt and economic growth in Nigeria and South Africa. However, since
foreign debt and the servicing requirements are not the only factors affecting output growth,
there is a need to capture other variables in order to avoid a model mis-specification error. In
order to capture the impact of domestic resource on growth, we utilized the total investment
to GDP ratio, as opposed to the savings to GDP ratio employed as a proxy for investment
(Mbaku, 1993; Islam, 1992). The use of total investment to GDP is in conformity with earlier
From (Gounder, 2001), the export coefficient in our model relates to the output
elasticity of exports and this variable reflects the degree of “openness” of the economy and
constitutes an “input” in the production function. Edwards (1998) observes that exports play
a positive role in the growth process by increasing total factor productivity after including
factor productivity and institutional factors. Aside from capital and export variables,
important variable input in a formalized input-output model. Our shortcomings in this study
include our inability to obtain an accurate labor data (a good proxy), therefore it was
excluded. Other variables used in our models include the ratio of debt stock to the country’s
output (measured as RGDP). This variable (new variable formed) is a traditional debt
indicator that compares a country’s debt stock with its productive capacities. By implication,
the higher a country’s debt stock is compared with its output, the greater the debt burden or
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Debt service ratio to GDP is another traditional indicator of indebtedness, which
compares an economy’s debt service expenditure to its level of productivity. Generally, the
higher the ratio of debt service to a nation’s productivity, the more serious the debt burden on
The data employed in this study are annual macroeconomic variables, including gross
investment, exports, foreign debt stock, debt service variables, debt service indicators, real
GDP (RGDP), and debt stock indicators. The sample period is from 1980 through 2007. All
data were directly obtained from the Economist Intelligence Unit [EIU] (2008) Country
Data-Annual time series. Data for debt service-to-export ratio (DSERVEXPO) for South
Africa were not directly available. As such, direct computation by the authors was done
having obtained the debt service data and export (fob) separately from the above source.
Model 1
Y g = Ω 0 + Ω 1 ΔEXPO
EXPO
+ Ω 2 RGDP
RGFI
+ Ω 3 DSERGD + Ω 4 DEBGDP + Ω 5 GCAP + μ t
Table 3: OLS Result of the Expanded Neoclassical Growth model for Nigeria and South Africa
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The results reported in Table 3 indicate that investment-output growth and gross
positive relationship with economic growth. However, in South Africa, export growth,
influence output growth. With an r-squared of 0.42, one can conclude that all independent
squared of 0.998 for South Africa indicates that all independent variables accounted for over
99 percent variability in output growth. In other words, the model explains that output growth
in South Africa is better than in Nigeria. The F-statistic validates the joint contributions of
the independent variables in explaining output growth in both Nigeria and South Africa. The
Durbin-Watson confirms the absence of serial autocorrelation in the Nigerian data series, but
not in the South African series. Taking cue from Greene (1997) who stresses the problem
posed by auto-correlated disturbances and suggests a way to deal with them. Accordingly,
because the ordinary least squares method becomes inefficient. Judge et al. (1985) also agree
on the loss of efficiency, but differ on the severity of the problem. In view of the above
argument, a generalized least squares (GLS) is fitted to the expanded neoclassical growth
The influence of export growth on GDP growth is confirmed by the results, even
though the coefficient is relatively small and statistically insignificant in Nigeria. In South
Africa, however, the relationship is not only positive, but fairly large in magnitude and is
statistically significant. The implication is that Edward’s (1998) observation, that exports
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play a positive role in the growth process by increasing total factor productivity, has been
confirmed in South Africa. Interestingly, the variable that captures the impact of domestic
growth in Nigeria and South Africa. As more domestic resources are committed to the
economy, the less is their effectiveness in generating a higher level of growth. Investment
stock, however, contributes significantly to the explanation of output growth in Nigeria and
South Africa. As gross investments grow, rate of output growth is accelerated in conformity
with the neoclassical. The positive (and significant) relationship between investments and
growth validates the neoclassical growth theory (Solow, 1956; Hunt, 2007).
The result, which relates debt service ratio to growth, produces mixed results in
Nigeria and South Africa. While debt service ratio aided output growth in Nigeria, it
compresses output growth in South Africa. The reason for this is not far fetched. South
Africa services her external debt conscientiously; debt service payments and debt service due
are the same. In Nigeria however, debt service payment is just a tiny proportion of the service
due over the years and that, of course, explains the steady build-up in Nigeria’s debt stock
over the years. In addition, the variable that relates the seriousness of debt burden
(EXDEBT/GDP) on productivity growth (Yg) indicates that the more serious the burden
(based on the stock of the debt), the more likely it is to compress output growth in Nigeria (a
partial validation of debt effects). Unlike Nigeria, South Africa utilizes the additional
external finance better, as it has contributed positively and significantly to output growth.
The extent to which it can sustain this beneficial impact of debt will be revealed in the next
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Model 2
*: indicates significant at 1% level; **: indicates significant at 5% level; ***: indicates significant at 10% level
Table 4 contains results of a non-linear test of the relationship between output growth
and some independent variables. In the Nigerian data, the size of external debt, terms of trade
variability and growth in fixed capital exert a significant impact on economic growth. As for
the South African data, only the terms of trade variability and growth in fixed capital exert a
significant impact on economic growth. The F-statistic confirms the existence of the
relationship for both countries. With the Durbin-Watson result of approximately 1.33, the
presence of serial correlation in both time series data is ruled out. The existence of
autoregressive unit within a unit bracket in the GLS estimate of South Africa is a pointer to a
stationary process.
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The results also show a non-linear impact of debt stock on growth in Nigeria.
External debt stock possibly contributed positively to growth in the early periods of loan
debt, and its cumulative impact took effect on Nigeria when the debt stock significantly
depressed output growth. In the case of South Africa, the non-linearity impact is not clearly
apparent as it is in Nigeria. Even though the non-linearity impact in the utilization of South
Africa’s external funding is present, it is not a significant factor affecting economic growth.
Debt service ratio also exerts a negative impact on productivity growth in conformity with
the ‘debt overhang’ theorists for both countries. Favorable terms of trade, which measure the
level of external shocks, are related positively to output growth in conformity with theory.
This variable is significant at the 10 percent significance level in Nigeria and at the five
percent level in South Africa. Lastly, investment growth exerts a positive and significant
Model 3
RGFI
RGDP = β0 + β1 DEBGDP + β2 ( DEBGDP) 2 + β3 DSEREXP + β4 TOT + β5 GCAP + μit
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Table 5, shows the results of a non-linear investment and the cash-constraint model.
This model captures the disincentive nature of debt and its servicing requirements on
investment. A cursory look at the results shows that the non-linearity impact of debt stock is
Nigeria. External debt service ratio also has a significant impact on growth in Nigeria. This is
a strong validation of the ‘debt overhang’ and ‘crowding out’ theory in Nigeria. Four out of
five variables significantly affect investment in Nigeria, while only one variable has
statistical significance in South Africa. In addition, the terms of trade variable is directly
related to domestic resources, which indicates that the presence of trade surplus increases the
size of investment in Nigeria. All the independent variables collectively capture about 99
percent variability in investment in Nigeria and South Africa. In addition, the F-statistic
validates the joint contributions of all independent variables in explaining investment in both
The results show that the terms of trade are important in the determination of
productivity. The reverse is the case in South Africa. Moreover, external debt as a proportion
of GDP is inversely related to growth in investment at an initial point. At some point the
relationship becomes reversed. The turning point is not ascertained in this study. The key
point is that the growth in debt stock relative to productivity discourages further growth in
investment in Nigeria and South Africa. This of course is the argument of the ‘debt
overhang’ proponents. However, at some other interval in time, debt contributed significantly
acquisition, because of its manageable size (and meaningful borrowing), external debt
258
significantly contributes to investment growth. Beyond a time frame, more indiscriminate
borrowing (and non-servicing of loans in Nigeria) become the order of the day and debt
clog on the wheel of investment in Nigeria and South Africa. This, of course, is expected as
the ‘crowding out’ theorists argue that external debt service crowds out investments.
Generally, the results in this paper support both the ‘debt overhang’ theory and ‘crowding
out’ theory in Nigeria and South Africa, but found the debt relief obtained by Nigeria as a
Conclusion
development and against domestic borrowing. The ‘dual gap’ theory postulates that
investment is a function of savings and that investment that requires domestic savings is not
goods and services. An important issue that needs investigation is whether or not external
borrowing drives economic development in debtor states. The thesis of this paper is to apply
Debt service to GDP ratio showed a negative relationship in conformity with theory
and expectation for South Africa. The debt stock, however, has a significantly strong positive
relationship with output growth confirming the beneficial impact of debt in South Africa. As
for Nigeria, debt service exerts a positive, but statistically insignificant, impact on output
259
growth. Capital growth exerts a positive and significant influence on output growth in
Nigeria and South Africa. The impact of debt size on growth is non-linear in Nigeria, but not
in South Africa. Debt stock contributes significantly to growth at the initial period of
In both countries, the terms of trade variability influences growth. When the terms of
trade are favorable, growth is accelerated. By the same token, capital pile-up contributes
positively to output growth in both countries. The contribution of capital growth to the
and South Africa. Debt service exerts a negative influence on the contributions of domestic
resource on growth in Nigeria and South Africa. The non-linearity impact of debt on the
Africa.
The logical implication of the foregoing is that external debt has been better utilized
in South Africa than in Nigeria. However, the current debt profile for Nigeria portrays a
better picture than for South Africa. Therefore, Nigeria needs to consolidate on the gains of
the debt relief recently granted her and the consequent reduction in its debt stock. One way to
A major implication is that South Africa requires a better management of its external
debt obligations. The government should place an embargo on further acquisition of external
finance, except for top priority projects. The marginal return on investment is greater than or
equal to the cost of borrowing for such priority projects. If the current rate of debt pile-up is
260
maintained, external debt will become South Africa’s major problem, threatening its
Finally, Nigeria, South Africa, and all indebted countries of the world should seek
external loans only for very high priority, well-appraised, and self-liquidating projects. Such
make fiscal adjustments through cuts in expenditures, as this could reduce the level of deficit
financing, which exerts pressure on foreign exchange. They should avoid short term
financing, especially when floating rates of interest are involved. A sound macroeconomic
261
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