di Yi Huang, Ugo Panizza e
Richard Varghese
The global financial crisis was followed by a massive increase in public sector borrowing.
Total outstanding public debt nearly doubled from $35 trillion in 2007 to $66 trillion
in 2017. Over the same period, public debt increased from 71 to 105 percent of GDP
in advanced economies and from 36 to 48 percent of GDP in emerging and developing
economies (International Monetary Fund, 2017).
This rapid increase in government debt sparked a large literature aimed at estimating
the effect of public sector borrowing on economic activity. Following the influential
contributions of Reinhart and Rogoff (2010), a large number of papers used countrylevel
data to establish the presence of a negative correlation between government debt
and each of economic growth and investment (e.g., Cecchetti, Mohanty and Zampolli,
2011, Checherita-Westphal and Rother, 2012, and Kumar and Woo, 2015), but
also highlighted the presence of substantial cross-country heterogeneity (Eberhardt
and Presbitero, 2015, and Kourtellos, Stengos, and Tan, 2013), and challenged the
presence of debt thresholds (Chudik, Mohaddes, Pesaran, and Raissi, 2017). However,
the cross-country literature has been less successful in establishing the presence of a
causal link going from pubic debt to economic growth (Panizza and Presbitero, 2013
and Panizza and Presbitero, 2014).
Reverse causality is a particularly important issue for the study of the link between
debt and growth. Traditional Keynesian policies and neoclassical models of optimal
fiscal policy (Barro, 1979) suggest that countries should run deficits, and hence accumulate
debt, in bad times and surpluses in good times. If shocks to growth are persistent
(Cerra and Saxena, 2008), the presence of a countercyclical fiscal policy can generate
a long-run negative correlation between debt and growth, where it is low growth that
causes high debt and not the other way around.
In this paper, we focus on corporate investment and provide a direct test for the
crowding out e§ect emphasized by the economic literature by showing that government
debt reduces investment by tightening the credit constraints faced by private firms.
Using data for nearly 550,000 firms in 69 countries over 1998-2014, we show that
higher levels of government debt are associated with lower private investment and with
an increase of the sensitivity of investment to internally generated funds. Our results are related to the findings of Greenwood, Hanson, and Stein (2010), Graham, Leary and
Roberts (2015), and Demirci, Huang, and Sialm (2017) who describe the relationship
between the structure and level of government debt and corporate leverage. While
these authors focus on firms capital structure, we study the behavior of corporate
investment and thus describe a channel through which public debt directly affects
economic activity
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