Electronic copy available at: http:ssrn.comabstract1527466 1 [616529]

Electronic copy available at: http://ssrn.com/abstract=1527466 1
GOVERNMENT DEBT AND ECONOMIC GROWTH. SOME COMMENTS.
A PANEL DATA ANALYSIS FOR WESTERN EUROPE (1988 – 2006).

Miltiades N Georgiou PhD

ABSTRACT
In the present paper it is pointed out that government debt is an obstacle to economic
growth. To my belief, the remedy to this problem is to encourage consumption and
not to impose taxes onto the consumers. Because, any decrease in their wages and
salaries for temporary budgetary purposes, will further shrink consumption and will
cause unemployment in the long run. Panel da ta covering western European countries
during the period 1988 – 2006 are elaborated by means of Eviews software package.
This paper is an extension of Georgiou (2009a, 2009b, 2009c and 2009d).

Keywords : Government Debt, Economic grow th, Interest Rates, Inflation,
Consumption, Consumption-led-growt h, Taxation, Banking loans, Financial
Deepening, Economic Policy, Unemployment, Econometric Models with Panel Data.
JEL classification : H6, O4, E43, E31, E21, H2, E51, E6, E24, C23.

Dr. M. N. Georgiou has an M.Sc. (Econom ics) from Stirling University, and a
Ph.D. (Economics) from the University of Thessaly in Greece. He left in July 2008
Emporiki Bank as a Department Head on Mark et Analysis. He has contributed papers
to: “Hellenic Bank Association”, “Econom ic Review of Commercial Bank of
Greece”, “Applied Research Review” , “Applied Financial Economics Letters”,
“Max Planck Institute of Economics” (4) and “Social Science Research Network
(SSRN)” (19). He is familiar with Eviews software package

Author confirms that this article has never been published by any other journal.
Further, this article expresses only author’s personal ideas and of nobody else.

Home address: M. N. Georgiou, 69 Ep tanisou Street, Athens 11257, Greece.
E-mail: [anonimizat]

Electronic copy available at: http://ssrn.com/abstract=1527466 2
PART 1. THEORY

As claimed by (Feldstein, 1982); (Hoe lscher, 1986); (Abell, 1990); (Miller and
Russek, 1991); (Raynold, 1994); (Tanzi and Fanizza, 1995); (Cebula, 1993 and 1997);
(Svensson, 1997); (Mitra, 1997); (Vam voukas, 1997) and (Georgiou, 2009b)
government debt increases interest rates, and it is therefore an obstacle to
entrepreneurial activities (Georgiou, 2009b). It should be mentioned however the
opposite view of (Wang, forthcoming) that government deficit does not result in
higher interest rates.
Thus, based on Georgiou (2009a), that any obstacle to entrepreneurship is also
an obstacle to economic growth, we recall some important works dealing with types
of obstacles faced by entrepreneurship, me ntioned in (Georgiou, 2009a). According to
the work of (Georgellis and Wall, 2002) government legislation concerning taxation
affects entrepreneurial activities. Furthe rmore, there are various obstacles on
entrepreneurship that differ among countri es. These, following (Berthold and Fehn,
2003), are due to external factors like bur eaucracy. Besides, according to Andersson
(2000) there are other types of obstacles lime market segmentation, inadequate information in technological progress, labour market, as well as money market. Moreover, (Bonini and Alka, 2006) assert that inflation is a barrier to
entrepreneurship. Besides, according to th e research of (Thurik and Grilo, 2005, p14),
in the case of the opening of a new business, European entrepreneurs face fewer obstacles compared with their counterparts in the United States. However, in the case
of keeping running an existing business the opposite takes place. It is worth
mentioning that a business entry into the market faces various barriers depending on
the plans of the existing most important co mpanies within this market (Broadway and

3
Trembley, 2005). Finally, the cost to start-up a company as well as the related
regulations and legislation are off-putting (Djankov et al., 2002). Hence, since
entrepreneurship faces various obstacles , eventually economic growth will be
hindered. Therefore, keeping in mind that a hi gher level in interest rates is also an
obstacle, it is expected to cause a decline in economic growth.
Further, since government debt pushes up interest rates, the cost of capital
increases and this is off-putting for investment decisions. From the banking point of
view, corporate credit, as well as retail credit will ceteris paribus go down. This will
lead to lower investment as well as to lower consumer loans and lower housing loans.
In turn, since higher interest rates will lower consumption (since prices will go
up too) then economic growth will be hi ndered, according to the consumption-led
growth theory, mentioned in: (Aoki a nd Yoshikawa, 1999); (Giarli et al., 2008);
(Georgiou, 2009c).
In short, it is concluded from the above analysis that government debt has a
negative impact on economic growth. In part 2 this conclusion will be examined with
an econometric model.
.

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PART 2. THE MODEL

The econometric model is given by equation (1):
rgdpgr it = c 0 + c 1 debtgdp it + error it (1)
Ex-ante c1 < 0
Variable [ rgdpgr ] stands for the real GDP growth. It is defined as grow th rate of GDP
volume – percentage change on previous year. GDP is a measure of the results of
economic activity. It is the value of all goods and services produced less the value of
any goods or services used in producing th em. The calculation of the annual growth
rate of GDP volume allows comparisons of economic development both over time
and between economies of different sizes, irre spective of changes in prices. Growth of
GDP volume is calculated using data at previous year's prices. Variable [ debtgdp]
stands for the government debt as a percen tage of GDP. The subscript (i) stands for
the country, while (t) for the year. Data are annual and are taken from Eurostat.
The method of GLS will be used to handle heteroskedasticity, since, according
to Yaffee (2003, p.10) for large samples the methods of “fixed effect” as well as
“random effect” are not efficient when there is heteroskedasticity (either between time
periods, or between cross sections). For e quation (1) there are basically two types of
model, the “fixed” and “random” effects. The appropriate choice depends on whether
one treats constant terms αi’s as some fixed numbers or ‘random drawings’ from a
specific distribution. As the correlation struct ure of the error term is ignored, a more
efficient estimation method would be the Generalized Least Squares (GLS) provided
that there is no correlation between the x’s and the α ’s. GLS requires weighting the
observations of y and x by Σ –(1/2):

5
2 22΄2/1
where1 1
ασσσθϑ
σ
TiiTIT
+=






−−=∑−

First one obtains an estim ate θ by estim ating the equation:
) () (. .΄
. i it i it i it uu xx y y −+−=−β (2)
Once the com ponent variances have been es timated, one form s an estim ator of the
composite residual covariance and GLS transform s the dependent and regressor data
(Baltagi, 2001; Davis, 2002) . In this paper GLS period SUR weights m ethod will be
preferred, because, contrary to the GL S cross section m ethod, it has no serial
correlation (see table 1). The panel data analys is is m ade feasible by m eans of Eviews
software package.
Panel data are annual, cover western European countries during the period
1988 – 2006, and have 126 observations (see table 3). The detailed results are shown
in table 1 and diagnostic tests (based on Halkos (2003)) in table 2. It can be seen that
model (1) as estim ated m eets the three required criteria of heteroskedasticity,
specif ication and norm ality. Further, there is no serial correlation. Hence, m odel (1) is
robust. It can be seen that (at 95%) the coefficient of [ debtgdp ] is negative and
statistically signif icant.

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PART 3. CONCLUSIONS

In the present paper it is pointed out th at government debt is an obstacle to
economic growth. To my belief, the remedy to this problem is to encourage
consumption and not to impose taxes onto the consumers. Because, any decrease in
their wages and salaries for temporar y budgetary purposes, will further shrink
consumption and will cause unemployment in the long run.
During recent period it is well known that all economies experience a
consumption decline (either due to consump tion saturation, or (even worse) due the
very recent world financial crisis). Hence, any measure to control government debt
should not reduce consumption. If debt is financed through taxation the effect will be
temporary (revenue wise), because consumption will decline in the l ong run. If debt is
financed through finance, this will further increase the debt for the future generations
and will lead to a further decline in economic growth.
Instead, consumption should be trigge red to generate economic growth
according to the theory of “consumption led growth”. It should also be noted that
consumers (in order to increase their consumption) should not resort (or rely too much
on) to consumer loans, since an excessive financial deepening will cause unemployment (Georgiou, 2009d).

7
REFERENCES

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3. Aoki, M. and Yoshikawa, H. 1999. Demand Creation and Economic
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Available at: www.stlouisfed.org .
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Empirical Analysis for Western European Countries and the United States 1990-2004.
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http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1478903

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16. Georgiou, M. N. 2009b. Government debt impacts on interest rates as well
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Economic Growth. A Panel Data Analysis For Western Europe. Social Science
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APPENDIX
Table 1. Results
Method GLS Period SUR weights GLS Cross section weights
c0 3,798 3,506
(9,84) (10,40)
c1 -0,013 -0,012
(-2,19) (-4,44)
Adjusted R2 0,028 0,045
Durbin Watson 1,986 0,936
Notes :
1. For n = 126 (at 95% ) dL = 1,693 and d U = 1,725
2. As for the above mentioned term “SUR ”, it does not refer at all to the term
“seemingly unrelated regressions”, but according to the manual of Eviews
the term “SUR” is used only because it applies for the covariance estimation
the same formula as for the estim ation of “seemingly unrelated
regressions”.

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Table 2. Diagnostic Tests1
TESTS GLS Period
SUR weights GLS Cross
section w eights Critical values
(at 95% )
Heteroskedasticity 1,639 … 3,928
Heteroskedasticity 0,329 … 3,928
Heteroskedasticity 1,643 … 3,841
Heteroskedasticity 1,936 … 5,991
Heteroskedasticity 0,767 … 7,815
RESET 1 0,438 … 3,841
RESET 2 0,670 … 5,991
RESET 3 0,957 … 7,815
Norm ality 1,027 5,260 5,991
Notes:
Test 1: Regression of the squared residuals on X. That is, t,1 1t2
t vγx u+′=
Test 2: Regression of absolute residuals on X. That is, |t,2 2t t vγx|u+′= (a Glejser test)
Test 3: Regression of the squared residuals on Yˆ
Test 4: Regression of the squared residuals on and Yˆ2Yˆ
Test 5: Regression of the log of squared residuals on X (a Harvey test)
Test 6: Regression of residuals on Y2ˆ
Test 7: Regression of residuals on Y 3ˆ
Test 8: Regression of residuals on Y4ˆ
Test 9: Norm ality test (Jarque Bera)

1 The di agnost ic tests are based on Hal kos (2003)

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Table 3. Data
Country Period
Austria 1988 – 2006
Belgium 1988 – 2006
Denmark 1988 – 2006
Finland 1988 – 2006
France 1988 – 2006
Germany 1988 – 2006
Greece 1988 – 2006
Ireland 1988 – 2006
Italy 1988 – 2006
Netherlands 1988 – 2006
Portugal 1988 – 2006
Spain 1988 – 2006
Sweden 1988 – 2006
UK 1988 – 2006
Source: Eurostat