Institutional quality, income level, and debt sustainability: new evidence using dynamic panel threshold regression
Abstract
Most countries have suffered from prolonged budget deficits over the past two decades. This situation has made researchers and policymakers aware of the challenges to debt sustainability. This study investigates the threshold effect of institutional quality on debt sustainability in a panel of 82 countries, focussing on various threshold effects at different income levels. All the countries selected for this study fell under the categories of high income (HI), upper middle income (UMI), and lower-middle and low income (LMLI) based on the World Bank classifications. The dynamic threshold panel regression results indicate the presence of a threshold effect of institutional quality on the fiscal reaction function (including debt sustainability and cyclical fiscal policy) in all the countries with different income levels. In HI countries, fiscal adjustment weakens if institutional quality surpasses the threshold value of institutional quality. The fiscal adjustment in UMI countries is similar to that in HI countries but statistically insignificant. By contrast, governments in LMLI countries can promote sustainable debt if their institutional quality exceeds the threshold value. Thus, policymakers in LMLI countries need to prioritise their efforts to raise the level of institutional quality to promote debt sustainability.
Keyword : fiscal reaction function, institutional quality, debt sustainability, Income level, dynamic panel threshold regression
How to Cite
Lee, C. L., Ahmad, R., Karim, Z. A., & Khalid, N. (2023). Institutional quality, income level, and debt sustainability: new evidence using dynamic panel threshold regression. Technological and Economic Development of Economy, 29(5), 1520–1538. https://doi.org/10.3846/tede.2023.19247
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
Aidt, T. S. (2009). Corruption, institutions, and economic development. Oxford Review of Economic Policy, 25(2), 271–291. https://doi.org/10.1093/oxrep/grp012
Albu, A. C., & Albu, L. L. (2021). Public debt and economic growth in Euro area countries. A wavelet approach. Technological and Economic Development of Economy, 27(3), 602–625. https://doi.org/10.3846/tede.2021.14241
Alesina, A., & Perotti, R. (1995). The political economy of budget deficits. Staff Papers, 42(1), 1–31. https://doi.org/10.2307/3867338
Alesina, A., & Perotti, R. (1996). Income distribution, political instability, and investment. European Economic Review, 40(6), 1203–1228. https://doi.org/10.1016/0014-2921(95)00030-5
Alesina, A., & Perotti, R. (1999). Budget deficits and budget institutions. In J. Poterba, & J. v. Hagen, Fiscal institutions and fiscal performance (pp. 13–36). NBER/University of Chicago Press.
Alesina, A., & Rodrik, D. (1994). Distributive politics and economic growth. The Quarterly Journal of Economics, 109(2), 465–490. https://doi.org/10.2307/2118470
Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Journal of Economic Growth, 8(2), 155–194. https://doi.org/10.1023/A:1024471506938
Alonso, J. A., & Garcimartín, C. (2013). The determinants of institutional quality. More on the debate. Journal of International Development, 25(2), 206–226. https://doi.org/10.1002/jid.1710
Alonso, J. A., Garcimartin, C., & Kvedaras, V. (2020). Determinants of institutional quality: An empirical exploration. Journal of Economic Policy Reform, 23(2), 229–247.
Álvarez, I. C., Barbero, J., Rodríguez-Pose, A., & Zofío, J. L. (2018). Does institutional quality matter for trade? Institutional conditions in a sectoral trade framework. World Development, 103, 72–87. https://doi.org/10.1016/j.worlddev.2017.10.010
Amin, A. (1999). An institutionalist perspective on regional economic development. International Journal of Urban and Regional Research, 23(2), 365–378. https://doi.org/10.1111/1468-2427.00201
Aron, J. (2000). Growth and institutions: A review of the evidence. The World Bank Research Observer, 15(1), 99–135. https://doi.org/10.1093/wbro/15.1.99
Baharumshah, A. Z., Soon, S.-V., & Lau, E. (2017). Fiscal sustainability in an emerging market economy: When does public debt turn bad? Journal of Policy Modeling, 39(1), 99–113. https://doi.org/10.1016/j.jpolmod.2016.11.002
Barro, R. J. (1990). Government spending in a simple model of endogeneous growth. Journal of Political Economy, 98(5, Part 2), S103–S125. https://doi.org/10.1086/261726
Bernheim, B. D. (1989). A neoclassical perspective on budget deficits. Journal of Economic Perspectives, 3(2), 55–72. https://doi.org/10.1257/jep.3.2.55
Besley, T., & Persson, T. (2011). Pillars of prosperity. In Pillars of prosperity: The political economics of development clusters. Princeton University Press. https://doi.org/10.2307/j.ctt1d2dmcd
Bohn, H. (1995). The sustainability of budget deficits in a stochastic economy. Journal of Money, Credit and Banking, 27(1), 257–271. https://doi.org/10.2307/2077862
Bohn, H. (1998). The behavior of US public debt and deficits. The Quarterly Journal of Economics, 113(3), 949–963. https://doi.org/10.1162/003355398555793
Bohn, H. (2007). Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint? Journal of Monetary Economics, 54(7), 1837–1847. https://doi.org/10.1016/j.jmoneco.2006.12.012
Bologna, J. (2017). Corruption, product market competition, and institutional quality: Empirical evidence from the US states. Economic Inquiry, 55(1), 137–159. https://doi.org/10.1111/ecin.12378
Buchanan, J. M., & Wagner, R. E. (1977). Democracy in deficit: The political legacy of Lord Keynes. Academic Press.
Chang, H. (2011). Institutions and economic development: Theory, policy and history. Journal of Institutional Economics, 7(4), 473–498. https://doi.org/10.1017/S1744137410000378
Dabla-Norris, E., Allen, R., Zanna, L.-F., Prakash, T., Kvintradze, E., Lledo, V., Yackovlev, I., & Gollwitzer, S. (2010). Budget institutions and fiscal performance in low-income countries (IMF Working Papers, 10(080)). International Monetary Fund. https://doi.org/10.2139/ssrn.1583338
Dzhumashev, R. (2014). Corruption and growth: The role of governance, public spending, and economic development. Economic Modelling, 37, 202–215. https://doi.org/10.1016/j.econmod.2013.11.007
Eslava, M. (2011). The political economy of fiscal deficits: A survey. Journal of Economic Surveys, 25(4), 645–673. https://doi.org/10.1111/j.1467-6419.2010.00647.x
Everaert, G., & Jansen, S. (2018). On the estimation of panel fiscal reaction functions: Heterogeneity or fiscal fatigue? Economic Modelling, 70, 87–96. https://doi.org/10.1016/j.econmod.2017.10.014
Frankel, J. A., Vegh, C. A., & Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32–47. https://doi.org/10.1016/j.jdeveco.2012.07.001
Gagliardi, F. (2008). Institutions and economic change: A critical survey of the new institutional approaches and empirical evidence. The Journal of Socio-Economics, 37(1), 416–443. https://doi.org/10.1016/j.socec.2007.03.001
Gavin, M., & Perotti, R. (1997). Fiscal policy in Latin America. In B. Bernanke & J. Rotemberg, NBER macroeconomics annual (vol. 12, pp. 11–72). MIT Press.
Ghosh, A. R., Kim, J. I., Mendoza, E. G., Ostry, J. D., & Qureshi, M. S. (2013). Fiscal fatigue, fiscal space and debt sustainability in advanced economies. The Economic Journal, 123(566), F4–F30. https://doi.org/10.1111/ecoj.12010
Gradstein, M. (2003). Governance and economic growth (vol. 3098). World Bank Publications. https://doi.org/10.1596/1813-9450-3098
Gunter, B. G. (2011). Achieving the MDGs and ensuring debt sustainability. Third World Quarterly, 32(1), 45–63. https://doi.org/10.1080/01436597.2011.543813
Henisz, W. J. (2004). Political institutions and policy volatility. Economics & Politics, 16(1), 1–27. https://doi.org/10.1111/j.1468-0343.2004.00129.x
Hodgson, G. M. (2000). What is the essence of institutional economics? Journal of Economic Issues, 34(2), 317–329. https://doi.org/10.1080/00213624.2000.11506269
Islam, R., & Montenegro, C. E. (2002). What determines the quality of institutions? SSRN. https://ssrn.com/abstract=634477
Javid, A. Y., Arif, U., & Arif, A. (2011). Economic, political and institutional determinants of budget deficits volatility in selected Asian countries. The Pakistan Development Review, 50(4), 649–662. https://doi.org/10.30541/v50i4IIpp.649-662
Kapur, D., & Webb, R. (2000). Governance-related conditionalities of the international financial institutions (G-24 Discussion Paper Series). United Nations Publication.
Law, S. H., Kutan, A. M., & Naseem, N. A. (2018). The role of institutions in finance curse: Evidence from international data. Journal of Comparative Economics, 46(1), 174–191. https://doi.org/10.1016/j.jce.2017.04.001
Law, S. H., Ng, C. H., Kutan, A. M., & Law, Z. K. (2021). Public debt and economic growth in developing countries: Nonlinearity and threshold analysis. Economic Modelling, 98, 26–40. https://doi.org/10.1016/j.econmod.2021.02.004
Mawejje, J., & Odhiambo, N. M. (2020). The determinants of fiscal deficits: A survey of literature. International Review of Economics, 67(3), 403–417. https://doi.org/10.1007/s12232-020-00348-8
Melecky, M. (2012). Formulation of public debt management strategies: An empirical study of possible drivers. Economic Systems, 36(2), 218–234. https://doi.org/10.1016/j.ecosys.2011.08.001
Mendoza, E. G., & Ostry, J. D. (2008). International evidence on fiscal solvency: Is fiscal policy “responsible”? Journal of Monetary Economics, 55(6), 1081–1093. https://doi.org/10.1016/j.jmoneco.2008.06.003
Méon, P. G., & Weill, L. (2010). Is corruption an efficient grease? World Development, 38(3), 244–259. https://doi.org/10.1016/j.worlddev.2009.06.004
Mercan, M. (2014). Budget deficits sustainable? An empirical analysis for OECD countries. Procedia – Social and Behavioral Sciences, 131, 258–263. https://doi.org/10.1016/j.sbspro.2014.04.114
Nordhaus, W. D. (1975). The political business cycle. The Review of Economic Studies, 42(2), 169–190. https://doi.org/10.2307/2296528
Papageorgiou, T., Michaelides, P. G., & Tsionas, E. G. (2016). Business cycle determinants and fiscal policy: A Panel ARDL approach for EMU. The Journal of Economic Asymmetries, 13, 57–68. https://doi.org/10.1016/j.jeca.2015.12.001
Pelagidis, T., & Desli, E. (2004). Deficits, growth, and the current slowdown: What role for fiscal policy? Journal of Post Keynesian Economics, 26(3), 461–469.
Persson, T. (2002). Do political institutions shape economic policy? Econometrica, 70(3), 883–905. https://doi.org/10.1111/1468-0262.00313
Sen, K. (2013). The political dynamics of economic growth. World Development, 47, 71–86. https://doi.org/10.1016/j.worlddev.2013.02.015
Seo, M. H., & Shin, Y. (2016). Dynamic panels with threshold effect and endogeneity. Journal of Econometrics, 195(2), 169–186. https://doi.org/10.1016/j.jeconom.2016.03.005
Seo, M. H., Kim, S., & Kim, Y. J. (2019). Estimation of dynamic panel threshold model using Stata. The Stata Journal, 19(3), 685–697. https://doi.org/10.1177/1536867X19874243
Sevüktekin, M., Nargeleçekenler, M., & Giray, F. (2010). A cross-country comparison of corruption and public expenditures: A panel data approach. International Journal of Public Administration, 33(3), 140–150. https://doi.org/10.1080/01900690903304159
Spinesi, L. (2009). Rent-seeking bureaucracies, inequality, and growth. Journal of Development Economics, 90(2), 244–257. https://doi.org/10.1016/j.jdeveco.2008.09.009
Stein, E., Talvi, E., & Grisanti, A. (1999). Institutional arrangements and fiscal. In J. P. Hagen, Fiscal institutions and fiscal performance (pp. 103–104). NBER/University of Chicago.
Theofilakou, N., & Stournaras, Y. (2012). Government solvency and financial markets: Dynamic panel estimates for the European Monetary Union. Economics Letters, 115(1), 130–133. https://doi.org/10.1016/j.econlet.2011.12.024
Wu, H., Hao, Y., & Weng, J. H. (2019). How does energy consumption affect China’s urbanization? New evidence from dynamic threshold panel models. Energy Policy, 127, 24–38. https://doi.org/10.1016/j.enpol.2018.11.057
Yu, S., Liu, J., Hu, X., & Tian, P. (2022). Does development of renewable energy reduce energy intensity? Evidence from 82 countries. Technological Forecasting and Social Change, 174, 121254. https://doi.org/10.1016/j.techfore.2021.121254
Zhu, X., Asimakopoulos, S., & Kim, J. (2020). Financial development and innovation-led growth: Is too much finance better? Journal of International Money and Finance, 100, 102083. https://doi.org/10.1016/j.jimonfin.2019.102083
Albu, A. C., & Albu, L. L. (2021). Public debt and economic growth in Euro area countries. A wavelet approach. Technological and Economic Development of Economy, 27(3), 602–625. https://doi.org/10.3846/tede.2021.14241
Alesina, A., & Perotti, R. (1995). The political economy of budget deficits. Staff Papers, 42(1), 1–31. https://doi.org/10.2307/3867338
Alesina, A., & Perotti, R. (1996). Income distribution, political instability, and investment. European Economic Review, 40(6), 1203–1228. https://doi.org/10.1016/0014-2921(95)00030-5
Alesina, A., & Perotti, R. (1999). Budget deficits and budget institutions. In J. Poterba, & J. v. Hagen, Fiscal institutions and fiscal performance (pp. 13–36). NBER/University of Chicago Press.
Alesina, A., & Rodrik, D. (1994). Distributive politics and economic growth. The Quarterly Journal of Economics, 109(2), 465–490. https://doi.org/10.2307/2118470
Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Journal of Economic Growth, 8(2), 155–194. https://doi.org/10.1023/A:1024471506938
Alonso, J. A., & Garcimartín, C. (2013). The determinants of institutional quality. More on the debate. Journal of International Development, 25(2), 206–226. https://doi.org/10.1002/jid.1710
Alonso, J. A., Garcimartin, C., & Kvedaras, V. (2020). Determinants of institutional quality: An empirical exploration. Journal of Economic Policy Reform, 23(2), 229–247.
Álvarez, I. C., Barbero, J., Rodríguez-Pose, A., & Zofío, J. L. (2018). Does institutional quality matter for trade? Institutional conditions in a sectoral trade framework. World Development, 103, 72–87. https://doi.org/10.1016/j.worlddev.2017.10.010
Amin, A. (1999). An institutionalist perspective on regional economic development. International Journal of Urban and Regional Research, 23(2), 365–378. https://doi.org/10.1111/1468-2427.00201
Aron, J. (2000). Growth and institutions: A review of the evidence. The World Bank Research Observer, 15(1), 99–135. https://doi.org/10.1093/wbro/15.1.99
Baharumshah, A. Z., Soon, S.-V., & Lau, E. (2017). Fiscal sustainability in an emerging market economy: When does public debt turn bad? Journal of Policy Modeling, 39(1), 99–113. https://doi.org/10.1016/j.jpolmod.2016.11.002
Barro, R. J. (1990). Government spending in a simple model of endogeneous growth. Journal of Political Economy, 98(5, Part 2), S103–S125. https://doi.org/10.1086/261726
Bernheim, B. D. (1989). A neoclassical perspective on budget deficits. Journal of Economic Perspectives, 3(2), 55–72. https://doi.org/10.1257/jep.3.2.55
Besley, T., & Persson, T. (2011). Pillars of prosperity. In Pillars of prosperity: The political economics of development clusters. Princeton University Press. https://doi.org/10.2307/j.ctt1d2dmcd
Bohn, H. (1995). The sustainability of budget deficits in a stochastic economy. Journal of Money, Credit and Banking, 27(1), 257–271. https://doi.org/10.2307/2077862
Bohn, H. (1998). The behavior of US public debt and deficits. The Quarterly Journal of Economics, 113(3), 949–963. https://doi.org/10.1162/003355398555793
Bohn, H. (2007). Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint? Journal of Monetary Economics, 54(7), 1837–1847. https://doi.org/10.1016/j.jmoneco.2006.12.012
Bologna, J. (2017). Corruption, product market competition, and institutional quality: Empirical evidence from the US states. Economic Inquiry, 55(1), 137–159. https://doi.org/10.1111/ecin.12378
Buchanan, J. M., & Wagner, R. E. (1977). Democracy in deficit: The political legacy of Lord Keynes. Academic Press.
Chang, H. (2011). Institutions and economic development: Theory, policy and history. Journal of Institutional Economics, 7(4), 473–498. https://doi.org/10.1017/S1744137410000378
Dabla-Norris, E., Allen, R., Zanna, L.-F., Prakash, T., Kvintradze, E., Lledo, V., Yackovlev, I., & Gollwitzer, S. (2010). Budget institutions and fiscal performance in low-income countries (IMF Working Papers, 10(080)). International Monetary Fund. https://doi.org/10.2139/ssrn.1583338
Dzhumashev, R. (2014). Corruption and growth: The role of governance, public spending, and economic development. Economic Modelling, 37, 202–215. https://doi.org/10.1016/j.econmod.2013.11.007
Eslava, M. (2011). The political economy of fiscal deficits: A survey. Journal of Economic Surveys, 25(4), 645–673. https://doi.org/10.1111/j.1467-6419.2010.00647.x
Everaert, G., & Jansen, S. (2018). On the estimation of panel fiscal reaction functions: Heterogeneity or fiscal fatigue? Economic Modelling, 70, 87–96. https://doi.org/10.1016/j.econmod.2017.10.014
Frankel, J. A., Vegh, C. A., & Vuletin, G. (2013). On graduation from fiscal procyclicality. Journal of Development Economics, 100(1), 32–47. https://doi.org/10.1016/j.jdeveco.2012.07.001
Gagliardi, F. (2008). Institutions and economic change: A critical survey of the new institutional approaches and empirical evidence. The Journal of Socio-Economics, 37(1), 416–443. https://doi.org/10.1016/j.socec.2007.03.001
Gavin, M., & Perotti, R. (1997). Fiscal policy in Latin America. In B. Bernanke & J. Rotemberg, NBER macroeconomics annual (vol. 12, pp. 11–72). MIT Press.
Ghosh, A. R., Kim, J. I., Mendoza, E. G., Ostry, J. D., & Qureshi, M. S. (2013). Fiscal fatigue, fiscal space and debt sustainability in advanced economies. The Economic Journal, 123(566), F4–F30. https://doi.org/10.1111/ecoj.12010
Gradstein, M. (2003). Governance and economic growth (vol. 3098). World Bank Publications. https://doi.org/10.1596/1813-9450-3098
Gunter, B. G. (2011). Achieving the MDGs and ensuring debt sustainability. Third World Quarterly, 32(1), 45–63. https://doi.org/10.1080/01436597.2011.543813
Henisz, W. J. (2004). Political institutions and policy volatility. Economics & Politics, 16(1), 1–27. https://doi.org/10.1111/j.1468-0343.2004.00129.x
Hodgson, G. M. (2000). What is the essence of institutional economics? Journal of Economic Issues, 34(2), 317–329. https://doi.org/10.1080/00213624.2000.11506269
Islam, R., & Montenegro, C. E. (2002). What determines the quality of institutions? SSRN. https://ssrn.com/abstract=634477
Javid, A. Y., Arif, U., & Arif, A. (2011). Economic, political and institutional determinants of budget deficits volatility in selected Asian countries. The Pakistan Development Review, 50(4), 649–662. https://doi.org/10.30541/v50i4IIpp.649-662
Kapur, D., & Webb, R. (2000). Governance-related conditionalities of the international financial institutions (G-24 Discussion Paper Series). United Nations Publication.
Law, S. H., Kutan, A. M., & Naseem, N. A. (2018). The role of institutions in finance curse: Evidence from international data. Journal of Comparative Economics, 46(1), 174–191. https://doi.org/10.1016/j.jce.2017.04.001
Law, S. H., Ng, C. H., Kutan, A. M., & Law, Z. K. (2021). Public debt and economic growth in developing countries: Nonlinearity and threshold analysis. Economic Modelling, 98, 26–40. https://doi.org/10.1016/j.econmod.2021.02.004
Mawejje, J., & Odhiambo, N. M. (2020). The determinants of fiscal deficits: A survey of literature. International Review of Economics, 67(3), 403–417. https://doi.org/10.1007/s12232-020-00348-8
Melecky, M. (2012). Formulation of public debt management strategies: An empirical study of possible drivers. Economic Systems, 36(2), 218–234. https://doi.org/10.1016/j.ecosys.2011.08.001
Mendoza, E. G., & Ostry, J. D. (2008). International evidence on fiscal solvency: Is fiscal policy “responsible”? Journal of Monetary Economics, 55(6), 1081–1093. https://doi.org/10.1016/j.jmoneco.2008.06.003
Méon, P. G., & Weill, L. (2010). Is corruption an efficient grease? World Development, 38(3), 244–259. https://doi.org/10.1016/j.worlddev.2009.06.004
Mercan, M. (2014). Budget deficits sustainable? An empirical analysis for OECD countries. Procedia – Social and Behavioral Sciences, 131, 258–263. https://doi.org/10.1016/j.sbspro.2014.04.114
Nordhaus, W. D. (1975). The political business cycle. The Review of Economic Studies, 42(2), 169–190. https://doi.org/10.2307/2296528
Papageorgiou, T., Michaelides, P. G., & Tsionas, E. G. (2016). Business cycle determinants and fiscal policy: A Panel ARDL approach for EMU. The Journal of Economic Asymmetries, 13, 57–68. https://doi.org/10.1016/j.jeca.2015.12.001
Pelagidis, T., & Desli, E. (2004). Deficits, growth, and the current slowdown: What role for fiscal policy? Journal of Post Keynesian Economics, 26(3), 461–469.
Persson, T. (2002). Do political institutions shape economic policy? Econometrica, 70(3), 883–905. https://doi.org/10.1111/1468-0262.00313
Sen, K. (2013). The political dynamics of economic growth. World Development, 47, 71–86. https://doi.org/10.1016/j.worlddev.2013.02.015
Seo, M. H., & Shin, Y. (2016). Dynamic panels with threshold effect and endogeneity. Journal of Econometrics, 195(2), 169–186. https://doi.org/10.1016/j.jeconom.2016.03.005
Seo, M. H., Kim, S., & Kim, Y. J. (2019). Estimation of dynamic panel threshold model using Stata. The Stata Journal, 19(3), 685–697. https://doi.org/10.1177/1536867X19874243
Sevüktekin, M., Nargeleçekenler, M., & Giray, F. (2010). A cross-country comparison of corruption and public expenditures: A panel data approach. International Journal of Public Administration, 33(3), 140–150. https://doi.org/10.1080/01900690903304159
Spinesi, L. (2009). Rent-seeking bureaucracies, inequality, and growth. Journal of Development Economics, 90(2), 244–257. https://doi.org/10.1016/j.jdeveco.2008.09.009
Stein, E., Talvi, E., & Grisanti, A. (1999). Institutional arrangements and fiscal. In J. P. Hagen, Fiscal institutions and fiscal performance (pp. 103–104). NBER/University of Chicago.
Theofilakou, N., & Stournaras, Y. (2012). Government solvency and financial markets: Dynamic panel estimates for the European Monetary Union. Economics Letters, 115(1), 130–133. https://doi.org/10.1016/j.econlet.2011.12.024
Wu, H., Hao, Y., & Weng, J. H. (2019). How does energy consumption affect China’s urbanization? New evidence from dynamic threshold panel models. Energy Policy, 127, 24–38. https://doi.org/10.1016/j.enpol.2018.11.057
Yu, S., Liu, J., Hu, X., & Tian, P. (2022). Does development of renewable energy reduce energy intensity? Evidence from 82 countries. Technological Forecasting and Social Change, 174, 121254. https://doi.org/10.1016/j.techfore.2021.121254
Zhu, X., Asimakopoulos, S., & Kim, J. (2020). Financial development and innovation-led growth: Is too much finance better? Journal of International Money and Finance, 100, 102083. https://doi.org/10.1016/j.jimonfin.2019.102083