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Jurnal Ekonomi & Studi Pembangunan Volume 21 Nomor 1, April 2020
Article Type: Research Paper
The Relationship between Public Debt,

Budget Deficit, and Sustainable Economic
Development in Developing Countries: The
Role of Corruption Control
Vo Thi Thuy Van1, Nguyen Tran Thai Ha*1, Phan Gia Quyen2, Le Thi Hong
Anh3, and Do Thanh Loi4
Abstract: This study investigates the effects of public debt and budget deficits on
the sustainable economic development of developing countries, taking into
account the role of control of corruption. The two-step GMM method was
AFFILIATION: applied for unbalanced panel data of 59 developing countries from 2004 to 2015.
1Saigon University, Ho Chi Minh
The study found that public debt and the budget deficit had negative effects on
City, Vietnam.
sustainable development, while the effect of control of corruption was positive.
2Universityof Economics and Law, Moreover, using interaction terms between control of corruption and public debt
Vietnam National University, Ho and budget deficit, respectively, empirical results showed that controlling
Chi Minh City. Vietnam. corruption limited these adverse effects. Thus, if the objective is to achieve
3Military
sustainable economic development, developing countries should not see raising
Commercial Joint Stock
public debt or maintaining budget deficits as a strategy for economic
Bank, Thong Nhat Branch,
development. The study contributes empirical evidence to the theory of debt
Vietnam.
overhang, crowded effects, and institutional theory in the context of developing
4Van An Phat Real Estate Joint countries. The implications are also discussed in this paper.
Stock Company, Vietnam. Keywords: Public debt; Budget deficit; Sustainable economic development;
Corruption; Developing countries.
*CORRESPONDENCE: JEL Classification: H0; H62; H63; H83.
[email protected]
THIS ARTICLE IS AVALILABLE IN:

http://journal.umy.ac.id/index.php/esp
Introduction
DOI: 10.18196/jesp.21.1.5033
CITATION: The phenomenon of sustainable development of the economy receives

Van, V. T. T., Ha, N. T. T., Quyen, P. much attention because it focuses on meeting the needs of the present
G., Anh, L. T. H., & Loi, D. T. (2020). time without impacting on future needs, according to the Report of the
The Relationship Between Public
World Commission on Environment and Development in 1987. It can be
Debt, Budget Deficit, and
Sustainable Economic understood that sustained development of the economy is defined as
Development in Developing economic growth with sustainability in the long-term, and it does not
Countries: The Role of Corruption focus on high growth rates but only on growth in a manner that sustains
Control. Jurnal Ekonomi & Studi
natural resources and the environment for future generations. It has been
Pembangunan, 21(1), 84-104.
one of the prerequisite goals of government and thus received interests
ARTICLE HISTORY from researchers in looking into factors that affect sustainable
Received: development in various economies.
5 February 2020
Reviewed:
4 March 2020
Revised:
31 March 2020
Accepted:
19 April 2020
Van, Ha, Quyen, Anh, & Loi
The Relationship Between Public Debt, Budget Deficit, and Sustainable Economic Development …
The role of public debt is one crucial aspect that is very prominent in the process of
economic development. Its impact on economic development continuously causes
debate between scholars and policy-makers due to its inconclusive results. Indeed, public
debt can promote or limit the economic growth (Eberhardt & Presbitero, 2015; Égert,
2015; Bal & Rath, 2014; Panizza & Presbitero, 2014; Abbas & Christensen, 2009). Harcourt
and Coddington (1984) claim that public debt in Keynesian theory stimulates economic
growth because it supplies more resources for government spending to promote
infrastructure, construction, education, and health care to enhance the productive
capacity of an economy. It also increases consumption as well as aggregate demand for
goods, services, and employment of the economy at that time. However, prior studies
show that the adverse effects of public debt on economic growth are noticeable (Hussain,
Haque, & Igwike, 2015; Anita, Ana, & Martina, 2014; Zouhaier & Fatma, 2014; Calderón &
Fuentes, 2013; Šimić & Vinko, 2012). An exceed rate of public debt is a primary result of
low savings rates of a nation, and it leads to a reversal effect, which is called the debt-
overhang effect (Reinhart, Reinhart, & Rogoff, 2012). This effect occurs when the
proportion of public debt is higher than a country’s ability to repay its debt. Consequently,
the nation’s costs associated with debt’s borrowing become relatively expensive, so it
puts pressure on domestic and foreign investment shortly.
Moreover, crowding-out effects are seen as a cause of the negative effect of public debt
on economic growth (Gochoco, 1990; Liaqat, 2019). According to Elmendorf and Mankiw
(1999), a high ratio of public debt is the result of a prolonged situation of a budget deficit.
The government continuously borrows to spend or invest, and it has the intention to
increase interest rates that lead to a reduction in private investment spending, thus
creating the crowding-out effect (Buiter, 1977; Morrissey & Udomkerdmongkol, 2012).
Therefore, public debt is considered as an indirect reason to reduce the economic growth
of countries due to the exceed spending of government. Recently, Pattillo, Poirson, & Ricci
(2011) developed a theory on the relationship between public debt and economic growth
through the proposal of a model of endogenous growth. The authors argued that public
debt could have positive or negative effects on economic growth depending on the public
debt proportion, and it is supported by the studies by Wright and Grenade (2014) and
Afonso and Alves (2014) in recent years.
Meanwhile, caution in implementing fiscal policy is one of the essential pillars for
economic development. However, the state budget deficit has become a common
phenomenon in most countries, including developing countries and developed countries
(Tung, 2018). Rodrik (2005) emphasizes that both financial solvency and well-established
property rights are considered as a prerequisite for achieving significant and stable
economic growth. However, the budget deficit and its role in economic development are
still controversial. On the one hand, Okelo, Momanyi, Othuon, and Fredrick (2013)
showed that budget deficits could help economic growth because it helped to increase
the efficiency of restructuring, education, and social welfare, thereby promoting
economic growth. Moreover, a low budget deficit could help to reduce the occurrence of
economic crisis and future risks of high and inconsistent public debt levels (Clements,
Gupta, & Inchauste, 2004; Baldacci, Cui, Clements, & Gupta, 2004). One the other hand,
Jurnal Ekonomi & Studi Pembangunan, 2020 | 85

the budget deficit could cause an increase in the cost of financial debt, thereby leading to
financial burdens and loss of competitiveness of the economy (Gaber, 2010).
Moreover, Cohen, Hawawini, Maier, Schwartz, & Whitcomb (1983) indicated that
institutional quality plays a vital role in the growth, and it is measured by bureaucracy,
corruption, property rights, and laws and regulations. Some studies suggest that
corruption can be considered as the main factor in explaining the difference in the
influences of public debt and budget deficit, which is found by previous studies (Madni &
Chaudhary, 2017; Barişik & Baris, 2017; Kim, Ha, & Kim, 2017). The authors argued that
corruption could cause an increase in public debt, but the negative effect of public debt
on economic growth became stronger in the countries where the corruption level was
high with low transparency (Cooray, Dzhumashev, & Schneider, 2017). The authors found
that the improvement in institutional conditions promotes higher effectiveness of the
fiscal policy. The author suggested that the good institutional aspects, such as government
effectiveness, regulatory quality, and control of corruption, enhance the positive impacts
of government expenditure on economic growth. Similarly, other studies showed that
corruption reduced economic investment (Mauro, 1995; Campos, Lien, & Pradhan, 1999),
foreign direct investment (Abed & Davoodi, 2000), tax revenue (Wei, 2000), labor
productivity (Lambsdorff, 2003), and increase the inflation (Al-Marhubi, 2000; Blackburn,
Bose, & Emranul Haque, 2006), as well as shadow economy (Schneider Buehn, &
Montenegro, 2010). It claims that the effects of corruption are presented in various
aspects of the economy, and they need to be considered in more detail.
However, previous studies have left significant academic gaps in research on sustainable
economic development in two aspects: (1) There have been many studies conducted on
both theoretical and empirical analysis to find the influences of public debt or budget
deficit to economic growth in short-term, but the results have been inconsistent; (2) There
has been a significant shortage of studies on the relationship among public debt, budget
deficit, and sustainable economic growth in long-term, especially in developing countries.
Moreover, most previous studies focused on explaining the relationship among public
debt, budget deficit, and economic growth while ignoring the role of corruption as a
critical factor in explaining the differences in their results of these studies. The role of
corruption control, budget deficit, and public debt for sustainable economic development
have not been fully mentioned in previous studies. Thus, this study makes new
contribution to the literature by directly addresses the aforementioned research gaps.
The study also contributes to the theory and practice of determining the effects of public
debt on sustainable economic development in the context of developing countries. This
study is organized into five sections: Section one presents an overview of the study;
Section two discusses the relevant theories and prior studies; Section three describes the
variables, empirical models and methods; Section four presents and discusses the results;
Finally, section five provides main summaries and implications.
Economic growth, which is measured as a percentage change of the gross domestic

product (GDP) or gross national product (GNP), may be positive or negative in different
periods. Negative economic growth reflects the recession, whereas positive economic
growth reflects the expansion of an economy. It can be seen that economic growth occurs

when resources are exploited most effectively and reasonably (Matiti, 2013). However,
Malthus and Ricardo (in Wrigley, 1998) argued that the scarcity of national resources
could create limits to economic development, population growth, and personal income.
Therefore, the concept of sustainable economic development, referring to the optimal
management of renewable resources, has received much attention from many leaders
and researchers in the world (Figuières, Masclet, & Willinger, 2012). In 1987, the
Brundtland Report entitled “Our Future” defined sustainable economic development as
meeting the needs of the present time without any harmful effect on future needs
(Commission World of Environment and Development, 1987). It can be noted that
sustained economic development can be defined as an economic growth connecting with
sustainable aspects in the long-term (Pezzey, 1992). It is not focused on a high rate of
economic growth but instead maintains sustainable growth by sustaining natural
resources and the environment for future generations. In empirical studies, sustainable
economic development can be measured as an increase in GDP at present compared to a
given year in the past, such as a percentage change in GDP at the current year compared
to GDP in four years ago (Kim et al., 2017).
Sustainable economic development and public debt
Public debt is one of the critical aspects of economic development due to its ability to
make financial resources for the economy. However, the Keynesian model argues that no
real burden is associated with public debt and that it has no significant impact on
economic growth (Metwally & Tamaschke, 1994). The real burden happens at the time
government spending is made when real resources are used up. Public debt is a debt that
the government owes to its economic sectors; it within the country does not complement
its real resources. Meanwhile, the public debt of external sectors is different because
external public debt can supplement the nation’s real resources, and they must be
returned within a particular time. The replacement of the current tax by public debt brings
a macroeconomic expansion immediately because an increase in government spending
financed by tax increases will create a different and low multiplier than financed by public
debt. Thus, public debt can boost the nation's economic growth. According to the
Keynesian model, public debt is not a factor in narrowing the fiscal policy (Savvides, 1992).
However, the opposite effect of public debt on economic growth can be explained by
using the theory of debt overhang effect. Krugman (1988) identifies that public debt as a
situation in which investment is reduced or delayed because the private’s profits from its
investments will be considered to use for paying public debt. It implies that future public
debt is expected to increase with the nation’s output. As a result, the level of public debt
will increase uncertainty behavior among investors regarding the policies that the
government applies to pay its debt obligations. In this view, he argues that most potential
investors would assume that the government would finance their debt obligations
through increasing tax rates in the economy in the near future, and it leads to the dilemma
of private investors. These investors will wait or delay to observe how their investment
and economic growth will be affected by an increase in public debt. Consequently, a
higher proportion of public debt will have a negative effect on macroeconomic stability in
the economy in the next years. It is illustrated by a limitation of capital flows while

occurring the capital flight in the economy (Alesina, Mirrlees, & Neumann, 1989; Cerra,
Rishi, & Saxena, 2008). It makes economic development to become unstable. Empirical
evidence supporting the debt overhang effect is given, such as Reinhart et al. (2012);
Hwang, Chung, and Wang (2010); Sen, Kasibhatla, and Stewart (2007); and Chowdhury
(2001).
In addition, the crowded-out effect is seen as another approach to investigate the effect
of public debt on economic growth (Heutel, 2012; Liaqat, 2019). According to Elmendorf
and Mankiw (1999), public debt is often used by countries to offset the deficit of state
budget, and it often crowds out for private investments. It is claimed that loans will often
lead to a rise in the interest rates when the government wants to increase the ratio of
public debt. As soon as there is an increase in interest rates, it may reduce or put the
private sectors to ignore their investments in the economy. The decline in private
investment means that the whole economy will have low available capital for its
operation, and it will reduce future economic growth. Therefore, it can be seen that the
higher public debt, the greater the crowded-out effect is created for private investment.
Consequently, the economic fluctuation will be created, and the high public debt will
hinder the sustainable economic development of nations due to uncertainties in the
future.
H1: Public debt has a negative effect on sustainable economic development
Sustainable economic development and budget deficit
The impact of budget deficits can be explored from two different sides: positive or
negative, long-term or short-term. On the positive side, the budget deficit is considered
as an expanded fiscal policy to alleviate economic fluctuations related to external shocks,
coping with economic recession (Clements et al., 2004; Baldacci et al., 2004). Okelo et al.
(2013) imply that budget deficits can help economic growth because it helps increase the
efficiency of economic restructuring, providing more resources to invest in education,
infrastructure, and social welfare. The Keynes model also shows that by increasing the
budget deficit, the government can expand spending and increase the aggregate demand
of the economy, thus increasing the economy. However, the impact of budget deficits on
economic growth is only significant in the short-term (Karras, 1994). Moreover, the use
of budget deficits to stimulate growth can only be effective in the context of declining
aggregate demand (for example, in the case of recession or crisis). When the economy is
operating at full employment (there is no excess of production factors), increasing the
budget deficit will not only affect aggregate demand but also threaten to increase of
inflation for the economy (Van & Sudhipongpracha, 2015). In turn, a high inflation rate
reduces aggregate demand, increases unemployment, it causes instability in the socio-
economic environment, the stability of macroeconomic growth is significantly affected
(Barro, 1995; Bruno & Easterly, 1998).
Besides, budget deficits can cause an increase in the cost of financial debt, thereby
threatening the sustainability of fiscal policy as it leads to an increase in public debt

(Agnello & Sousa, 2013). Woo (2003) argues that these fiscal policy results are in the
presence of income inequality. It leads to strong effects that impede fiscal policies to show
at a lower level of capital accumulation, and thus growth to collapse. Policymakers use
budget deficits to meet their short-term goals, and they conflict with maintaining long-
term macroeconomic stability. It happens because policymakers may disagree with
government spending components that will ultimately lead to distribution failures and
determine government spending levels. In addition, shocks related to the level of
government revenue will lead to many changes in government spending and, in turn,
cause fiscal fluctuations next year. Khan, Khan, & Zaman (2012) found that both
government spending and budget deficits had adverse impacts on economic growth in
Pakistan between 1980 and 2010. Earlier, Fatima, Ahmed, & Rehman (2012) used time-
series data from 1978-2009 to examine the effects of budget deficits on economic growth
in Pakistan; they found evidence of an inverse relationship between these two indicators.
Therefore, the budget deficit is said to have a negative relationship with the sustainable
development of the economy in the long-term.
H2: Budget deficit has a negative effect on sustainable economic development
Sustainable economic development and corruption
Institutional theory has recently been integrated to explain economic relations more
clearly (Cooray et al., 2017; Ha et al., 2019; Phung, Van, Thuong, & Ha, 2019). North (1990)
implies that institutional perspectives are the rules or regulations for the functioning of
society, which are the foundation for interaction among residents and organizations. Kim
et al. (2017) suggest that a better institutional environment can promote higher levels of
investment, and it can lead to sustained economic growth. Moreover, a good institutional
environment can also reduce the instability of the economic decision of policymakers and
encourage more creative and productive activities. Égert (2016) showed that regulations
and institutional quality could affect the productivity of OECD countries. Dort, Méon, &
Sekkat (2014) provide empirical evidence to confirm that national investment promotes
economic growth in countries with good institutional quality. Bergeen et al. (2015) found
that institutional quality was positively correlated with the economic growth of 35
countries in Europe. Phung et al. (2019) investigate a decisive intermediate role for
institutional quality in promoting the relationship between innovation and economic
growth. At the enterprise level, Ha et al. (2019) revealed that the institutional
environment would enhance firm profitability because it creates a comparative and
transparent environment.
The role of institutional quality is essential in the functioning of the economy and society.
However, the measurement of institutional quality is a controversial issue. One of the
widely applied measurements of institutional quality is the level of corruption (Kim et al.,
2017). A high level of corruption will have a significant opposite effect on sustainable
economic development, through causing adverse effects to other macroeconomic factors.
Many previous studies have explained the impact of corruption on economic growth, and
most studies have found a negative correlation between these two indicators, for

example, Mauro (1995); Tanzi and Davoodi (2001). A country with low corruption will be
able to increase investment, reduce inflation, increase national productivity, leading
economic growth. For example, prior studies find that corruption will reduce investment
(Mauro, 1995; Campos et al., 1999; Brunetti & Weder, 2003) and foreign direct
investment as well as tax revenue (Abed & Davoodi, 2000; Wei, 2000). Lambsdorff (2003)
argues that corruption would reduce labor productivity. High corruption is a testament to
the disadvantage of the economy through higher inflation (Al-Marhubi, 2000; Blackburn
et al., 2006). Corruption has the potential to significantly damage economic efficiency
through the allocation of resources in the market system, disrupting competition, leading
to innovation and brain drain in a country and beyond. It leads to an uncomfortable
business environment, lower growth rate with lower tax revenue and higher public debt,
so preventing economic development (Tarek & Ahmed, 2017). Therefore, this study
proposes that corruption control plays an active role in reducing the negative effects of
corruption, thereby promoting sustainable economic development.
H3: Corruption control has a positive impact on sustainable economic development.
Sustainable economic development, public debt, budget deficit, and corruption
Studies on budget deficits and budget deficits and their determinants have focused on
macroeconomic indicators and ignored the intermediate impact of institutional quality.
Alesina et al. (1989) support the idea that macroeconomic indicators are not only
sufficient to explain budget deficits, concerns for the impact of institutional factors on the
budget deficit. By emphasizing the importance of the institutional framework of the
economy, it helps ensure the sustainability of good macroeconomic policies. However,
budget overspending will have a major impact if accompanied by high levels of corruption
because the revenue and expenditure aspects of government budgets are strongly
affected by corruption. In terms of revenue, less revenue is due to bribes by public
officials, while government spending is misleading or misrepresented for their
composition (Chowdhury & Michael Geringer, 2001). Corruption leads to budget deficits
when public revenue decreases, while public spending simultaneously increases. The
inefficiency of this system exacerbates the implementation of sound fiscal policy
(Lambsdorff, 2003; Tanzi & Zee, 1997). It creates a vicious cycle of corruption and
borrowing in the near future and causes unstable economic growth. Therefore,
controlling corruption will reduce the adverse effects of the budget deficit on sustainable
economic development.
H4: The interaction between budget deficit and corruption control has a positive impact on
sustainable economic growth.
In addition, a high deficit leads to an increase in public debt, while the resources allocated
to repaying public debt become a constraint on productivity growth and will create a
crowded effect (Heutel, 2012; Liaqat, 2019). Existing literature indicates that corruption
distorts public spending and leads to suboptimal government spending (Cooray et al.,

2017; Tanzi & Davoodi, 2001). Kaufman (2010) argues that a government finances its
spending by increasing debt, in the case of corruption, which means that, once again, a
higher debt is required, leading to a higher debt servicing cost. This practice of corruption
increases public debt and future repayment costs, thereby reducing the positive results
of sustainable economic development. Therefore, controlling corruption will limit the
inefficiency of public debt on sustainable economic development.
H5: The interaction between public debt and corruption control has a positive impact on
sustainable economic growth.
Research Method
In order to estimate the effects of public debt on sustainable economic development, this
study developed empirical models for panel data that was used by Woo and Kumar (2015)
and Kim et al. (2017). Then, the study improved Equation (1) to Equation (2) to check the
influence of corruption control to sustainable economic development, as follows:
𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗

𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 + 𝛾 ∗ 𝑋𝑖𝑡−4 + 𝜀𝑖𝑡 (1)
Where i and t illustrate the countries and the time periods, respectively (i = 1, ..., 59 and
t = 2004, ..., 2015). According to Kim et al. (2017), 𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 is a dependent variable, and
it is represented by the sustainable economic development of country i at t time. It is
defined by the average growth rate of real GDP per capita of country i over a period of
four years. Then, it is as follow:
1 𝐺𝐷𝑃𝑃𝐶𝑖𝑡 −𝐺𝐷𝑃𝑃𝐶𝑖𝑡−4
𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = ∗ (2)
4 𝐺𝐷𝑃𝑃𝐶𝑖𝑡−4
The initial GDP per capita is controlled for with log(𝑦𝑖𝑡−4 ). Moreover, 𝑑𝑒𝑏𝑡𝑖𝑡−4 and
𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 are the public debt ratio and the difference between spending and revenue
ratio of country i at the beginning of the period. 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 is the level of corruption
at the t-4 time ago of country i. 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 is corruption level of country i at the
beginning of the period, represented by two indicators: (1) the level of corruption control
which is collected from the World Governance Indicator (WGI) of Worldbank, and (2) the
corruption index comes from the International Country Risk Guide (ICRG). An increase in
these two variables implies a low level of national corruption. 𝑋𝑖𝑡−4 is a vector of other
control variables, and 𝛾 is a vector of coefficients for those control variables (see more at
Table 1). They are often used by many studies in economic growth, such as Phung et al.
(2019), Kim et al. (2017), Ha and Quyen (2018), Barro and Lee (2013), and Blackburn et al.
(2006). The last term, 𝜀𝑖𝑡 is the idiosyncratic error term.

Table 1 Description of variables

Variables Abbreviation Measurement Database
Dependent variable
Sustainable economic 1 𝐺𝐷𝑃𝑃𝐶𝑖𝑡 − 𝐺𝐷𝑃𝑃𝐶𝑖𝑡−4
Growth ∗ World bank
development 4 𝐺𝐷𝑃𝑃𝐶𝑖𝑡−4
Independent variables
The ratio between public debt and
Public debt Debt IMF
GDP.
The ratio between the difference
Budget deficit Deficit from spending to revenue of World Bank
government with GDP.
Corruption index from The
Corruption 1 Corr1 ICRG
International Country Risk Guide.
The indicator of control of
Corruption 2 Corr2 corruption from the World World Bank
Governance Indicator.
Control variables
The human capital index is collected Barro and
Human capital Human
from the database of Barro and Lee. Lee
The ratio between government
Government size Govsize World Bank
spending and GDP.
The ratio is calculated by the total of
Trade openness Trade World Bank
export and import on GDP.
The ratio in the change in price
Inflation Infl World Bank
consumption.
Source: Author, 2020
In order to estimate the interactive effects of corruption and public debt on sustainable
economic development, this study improved Equation (1) to Equation (3). The model was
developed with the interaction term among public debt and control of corruption, as
follows:
𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 ∗

𝑑𝑒𝑏𝑡𝑖𝑡−4 ∗ 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 is an interaction variable between the public debt ratio and
the level of corruption at the beginning of the period of country i. From Equation (3), it
can be seen that the marginal effect of public debt on sustainable economic development
would be determined as a function of the dependent variable of corruption. Particularly,
the equation of dependent corruption is as follows:
𝜕(𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 )
= 𝛽1 + 𝛽3 ∗ 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 (4)
𝜕(𝑑𝑒𝑏𝑡𝑖𝑡−4 )
Based on Equation (4), it can be seen that if the corruption indicator at the t-4 time is
−𝛽1
smaller ⁄𝛽 of public debt, it will hinder the sustainable economic development.
3
−𝛽1
However, if the corruption indicator at t-4 time is greater ⁄𝛽 of public debt, it will be
3

able to boost sustainable economic development. We note that the corruption indicator
has a negative relation with the level of national corruption.
In order to estimate the interactive effects of corruption and budget deficit on sustainable
economic development, this study transformed Equation (1) to Equation (5). The model
was developed with the interaction term among public debt and control of corruption, as
follows:
𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 ∗

𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 ∗ 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 is an interaction variable between the budget deficit ratio

and the level of corruption at the t-4 time of country i. From Equation (5), it can be seen
that the marginal effect of budget deficit on sustainable economic development would be
determined as a function of the dependent variable of corruption. Mainly, the equation
of dependent corruption is as follows:
𝜕(𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 )
= 𝛽1 + 𝛽3 ∗ 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 (6)
𝜕(𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 )
Based on Equation (6), it can be seen that if the corruption indicator at the t-4 time is
−𝛽1
smaller ⁄𝛽 of the budget deficit, it will hinder the sustainable economic
3
−𝛽1
development. However, if the corruption indicator at the t-4 time is greater ⁄𝛽 of
3
the budget deficit, it will be able to boost sustainable economic development. We note
that the corruption indicator has a negative relation with the level of national corruption
Methodology
Prior growth models’ predictions were somewhat inconsistent with observations from
reality because factors such as human capital and government spending, which have
become endogenous factors behind economic development. Empirical analysis using
Ordinary least squares (OLS) did not bring valid and reliable results due to bias and
inconsistent regression. Therefore, this study applied the two-step system Generalized
Method of Moments (two-step sys-GMM) to deal with heterogeneity, serial correlation,
and endogenous issues (Kim et al., 2017). The study used the lags of the dependent
variable and control variables as instrument variables for GMM estimations because of
their endogenous effect in models. The Hansen test was employed for the validity and
robustness of estimations, while the Arellano-Bond test AR (2) showed the
autocorrelation for residual (Roodman, 2009).
Result and Discussion

Macro data for this study were collected from the databases of World bank, International
Monetary Fund (IMF), as well as Barro and Lee’s database, while corruption indices were

Table 2 Descriptive Statistics

Variables Mean St. Deviation Min Median Max
Gdppcgr 0.1104 0.0698 -0.0028 0.0965 0.6868
Debt 0.5349 0.3688 0.0587 0.4339 2.3618
Corr1 2.1233 0.7292 0.0000 2.0000 5.0000
Corr2 0.4224 0.1805 0.0000 0.4084 1.0000
infl 10.293 19.733 -7.714 6.933 418.019
Gsize 12.910 5.196 0.000 13.200 31.527
Trade 70.946 34.587 0.000 66.499 220.407
Human 2.0896 0.5803 1.0695 2.0738 3.3016
Deficit -0.658 4.769 -17.302 -0.767 40.340
Log(yit-4) 11.005 2.361 4.965 10.652 17.277
obtained from The International Country Risk Guide and Worldwide Governance
Indicators. We note that this study attempted to collect data as much as possible, but
some primary data were limited (for example, debt ratio by IMF and corruption index by
ICRG). Thus, the collected data covered 59 developing countries from 2004 to 2015 after
excluding lacked data (see the list of selected countries in Appendix 1). They were
organized into unbalanced panel data for GMM estimations.
It can be seen that sustainable economic development represented by GDPPCGR had an

average value of 0.1104 and a standard deviation of 0.0698. These results imply that GDP
per capita of countries generally increased by 11.04% during the previous four years, and
there was a significant difference in the sustainable economic development of countries.
Similarly, the public debt of countries four years ago had an average value of 0.5349,
showing the proportion of public debt in national GDP four years ago. Kazakhstan in 2011
had the lowest public debt ratio with 0.05874 of LDEBT, while Nicaragua in 2007 with
2,3618 LDEBT was a country with the highest public debt ratio in the four years ago.
Moreover, based on the largest and smallest values of corruption indicators, it can be
seen that there was a significant deviation between countries in the research sample with
2.1233 mean and 0.7292 standard deviations (ICRG). The average value was 0.4224, and
the standard deviation was 0.0698 when considering with WGI.
First, the study estimated the impact of corruption and public debt on countries'
sustainable economic growth, in which corruption was represented by the level of control
of corruption from WGI. An increase in this index implies a low level of corruption. The
results are presented in Table 3 and Table 4. It can be seen that both AR (2) and Hansen
tests produced a p-value of 10% higher than statistical significance. It implies that
autocorrelation in the research model did not occur when using GMM estimates, while
the instrument variables were not correlated with residuals. Thus, our findings were
robust and reliable, and they could be used to interpret and discuss implications.

Table 3 The relationship between public debt, budget deficit, and sustainable economic
development
Independent Model (2)
variable: Model (1) Corruption indicator 1: Corruption indicator 2: WGI
GDPPCGR ICRG (1) (2)
-0.09598*** -0.09084*** 0.08347***
Log(Gdppc)
[-54.20] [-50.22] [-31.96]
-0.05271*** -0.04816*** -0.04935***
Debt
[-15.26] [-15.62] [-12.81]
-0.00108*** -0.00095*** -0.00072***
Deficit
[-21.50] [-26.56] [-16.01]
0.00310*
Corr1
[1.77]
0.02570*
Corr2
[1.83]
0.00180*** 0.00182*** 0.00138***
Gsize
[14.71] [10.26] [10.67]
0.00058*** 0.00062*** 0.00078***
Infl
[52.65] [23.07] [26.45]
0.00043*** 0.00065*** 0.00079***
Trade
[10.17] [19.83] [15.96]
0.13398*** 0.08857*** 0.04605***
Human
[9.72] [6.79] [3.25]
0.85645*** 0.87546*** 0.86668***
Const.
[39.13] [33.05] [32.93]
AR(1) 0.542 0.517 0.276
AR(2) 0.853 0.844 0.993
Hansen 0.259 0.209 0.236
Num. group 59 59 59
Num. IV 59 59 59
Obs 677 677 677
Note: (*), (**), and (***) are 10%, 5%, and 1%, respectively, z-statistic in [ ]
The results presented in Table 3 show that the coefficients of Debt in the model (1) and
(2) are from -0.04817 to -0.05271, and both coefficients are statistically significant at level
1%. These findings showed that a 1% increase in public debt in the previous four years
would reduce from 0.04817% to 0.05271% in sustainable economic development. In other
words, public debt will impede the sustainable economic growth of nations. Our results
are similar to the previous findings of DiPeitro and Anoruo (2012), Šimić and Vinko (2012),
and Panizza and Presbitero (2013). It can be interpreted in terms of overhang-debt and
crowding-out effects. According to the overhang debt theory, high public debt is an
uncertain situation in which domestic investment is reduced or delayed because potential
investors would assume that the government would finance their debt obligations
through increasing tax rates in the economy, and they think that their profits will be used
to pay the public debt (Krugman, 1988). Moreover, a high ratio of public debt implies that
the interest rate will be raised when the government wants to borrow more debt. In turn,
the high-interest rate causes a reduction in private investment, and the usable capital of
the economy will fall to a low level. Besides that, according to the crowding-out effect,

public debt is often used by countries to offset the state budget deficit, and the expansion
of government spending is also the main factor that eliminates out private investment
(Elmendorf & Mankiw, 1999). Consequently, sustainable economic development will be
influenced by the increase of uncertainty among investors regarding the policies that the
government applies to pay its debt obligations.
The budget deficit was found as an inverse correlation with sustainable economic growth
with a statistical significance of 1%. Deficit coefficients ranged from -0,00072 to 0.00108,
suggesting that countries with high deficits were more constrained by sustainable
economic growth. Our results confirmed that the budget deficit could lead to an increase
in public debt in the long term. It could also lead to inefficient resource allocation. In the
future, the government must prioritize resources when allocated to pay public debt.
Besides, the budget deficit brings limitations to the productivity of the economy and will
create a crowded effect. On the one hand, the budget deficit threatens the stability of the
economy in the future as the problem of external debt and debt service has continued to
increase over time (Ali & Mustafa, 2012). On the other hand, it leads to a negative impact
on investment. Private investment is negatively affected by internal and external debt
service, total debt stock, and tax burden. Public borrowing after a prolonged fiscal deficit
leads to a financial outburst because it accounts for savings that can be used for private
investment (Ali & Mustafa, 2012; Chowdhury, 2001). As a result, long-term sustainable
growth of the economy is significantly reduced when the budget deficit is prolonged.
The regression coefficients of the variables represented for control of corruption ranged
from 0.00310 to 0.02570, respectively, with a statistical significance of 10%. They showed
that if corruption were well controlled, represented by an increase in the value of Corr1
(ICRG) and Corr2 (WGI), sustainable economic growth would increase from 0.00310 to
0.002570. Our results illustrate the critical role of control of corruption in economic
development. Controlling corruption will minimize conflicts in the distribution of national
resources, reduce the loss of government revenue, increase the competitiveness and
transparency of the business environment. As a result, investment activities will be
promoted; trust in the business environment will be improved. In turn, they will promote
stable economic development in the long term (Mauro, 1995; Tanzi & Davoodi, 2001; Kim
et al., 2017).
The role of control of corruption is also reflected in the ability to control the negative
impact of budget deficits and public debt, which are shown in Table 5. The coefficients of
the interaction variable between public debt and corruption, Interact1 and Interact2,
received 0.01681 and 0.08541, respectively. Our findings suggested that countries with
low levels of corruption would restrict the negative impact of public debt on sustainable
economic growth. In other words, countries with low levels of corruption would have
higher levels of sustainable economic development when increasing their public debt
than countries with high levels of corruption. Our results are similar to the findings of Kim
et al. (2017). Based on Equation (4), we also found that the threshold value of control of
corruption was 4.92 and 0.93 in Equation (3), respectively. It implies that control of
corruption had to be higher than 4.92 (ICRG) and 0.93 (WGI) to bring overwhelm to the
negative impacts of public debt totally. Meanwhile, the coefficients of the interaction

variable between budget deficit and corruption, Interact3, and Interact4, got 0.00131 and
0.00397, respectively. Based on Equation (6), we found that the threshold value of control
of corruption was 2.81 (ICRG) and 0.62 (WGI) for Equation (4). Enhancing the control of
corruption will promote both sustainable economic development and reducing the
negative impacts of public debt as well as the budget deficit.
Table 4 The relationship between public debt, budget deficit, and sustainable economic
development
Model (3) Model (4)
Independent Corruption Corruption
Corruption Corruption
variable: indicator 1: indicator 2:
indicator 1: ICRG indicator 2: WGI
GDPPCGR ICRG WGI
(1) (2)
(1) (2)
-0.09459*** -0.94108*** -0.99057*** -0.09641***
Log(Gdppc)
[-31.61] [-46.40] [-47.62] [-46.52]
-0.08283*** -0.07980*** -0.05668*** -0.48075***
Debt
[-16.37] [-21.09] [-13.73] [-17.70]
-0.00113*** -0.00106*** -0.00368*** -0.00247***
Deficit
[-38.19] [-22.31] [-10.27] [-18.23]
0.01681***
Debt*Corr1
[6.87]
0.08541***
Debt*Corr2
[6.80]
0.00131***
Deficit*Corr1
[7.29]
0.00397***
Deficit*Corr2
[6.37]
0.00223*** 0.00201*** 0.00234*** 0.00279***
Gsize
[13.14] [13.34] [12.93] [22.65]
0.00059*** 0.00064*** 0.00059*** 0.00057***
Infl
[15.34] [26.03] [27.28] [16.81]
0.00070*** 0.00071*** 0.00030*** 0.00066***
Trade
[5.73] [10.92] [5.70] [9.77]
0.11383*** 0.11068*** 0.16311*** 0.13627***
Human
[5.73] [5.83] [13.33] [8.20]
0.85558*** 0.86175*** 0.83467*** 0.82346***
Const.
[28.75] [27.45] [33.09] [31.63]
AR(1) 0.531 0.450 0.411 .595
AR(2) 0.887 0.950 0.935 0.932
Hansen 0.242 0.238 0.179 0.229
Num. group 59 59 59 59
Num. IV 58 58 58 58
Obs 677 677 677 677
Threshold 4.92 0.93 2.81 0.62
Note: (*), (**), and (***) are 10%, 5%, and 1%, respectively, z-statistic in [ ]

The regression coefficients of Gsize in Table 3 and Table 4 range from 0.00138 to 0.00279,
and they are statistically significant at 1%. This result showed that when the size of
governments in the previous four years increased, it would enhance sustainable economic
development in the long-term. The more government spending is, the more infrastructure
will be created. Thus, they will reduce production costs, input costs of business activities,
thereby increasing the income of the economy as well as promoting economic growth.
Moreover, government spending on health and education will improve the human health,
knowledge sharing, and skills of the workforce, thereby boosting the productivity of
national labor. As a result, the output of the economy will be enhanced. Our result is
similar to previous studies by Chowdhury (2001), Wahab and Holland (2012), and
Alshahrani and Alsadiq (2014).
The coefficients of Inf in Table 3 and Table 4 fluctuate from 0.00058 to 0.00078, and they
are statistically significant at 1%. This result revealed that inflation could boost sustainable
economic development when its rate in the previous four years increased. It reflects the
theory of the Philips curve because inflation will be able to stimulate economic growth by
minimizing the nation's unemployment rate. Our findings are similar to the findings of
Cho wdhury (2001); Rapach (2003); and Benhabib and Spiegel (2009).
In Table 3 and Table 4, Trade has regression coefficients, which range from 0.00030 to
0.00079, and they are both statistically significant at the 1% level. It illustrates that the
trade openness of the previous four years improved the countries' sustainable economic
growth statistically. It can be explained that a country with a high degree of integration
with the world can increase its exports and imports. On the one hand, it can boost
domestic production productivity for export. On the other hand, it creates an opportunity
to import technology and knowledge from the outside. As a result, it can improve the
productivity of the economy and lead to a higher level of sustainable economic growth.
Our findings are similar to the findings of Baum, Checherita-Westphal, & Rother (2013),
Kim et al. (2017), and Phung et al. (2019).
Lastly, Human receives coefficients which were from 0.04605 to 0.16311, and they were
statistically significant at the 1% level. They showed that high human capital had a positive
impact on sustainable economic development. The improvement of human capital will be
to attract foreign investors as well as promote innovation activities in the country
(Grossman, 2000). In turn, innovation will promote sustainable economic growth (Phung
et al., 2019). Our results are similar to the findings of previous authors, such as Woo and
Kumar (2015); and Kim Kim et al. (2017).
Conclusion
This study investigates the effects of public debt and budget deficits on sustainable
economic development of developing countries, meanwhile expanding to explore the role
of control of corruption in these relations. By using the two-step GMM method for
unbalanced panel data of 59 developing countries from 2004 to 2015, the study found
that public debt and budget deficits had negative influences on sustainable economic

development while controlling corruption had a positive impact on sustainable economic

development. Countries with high public debt will create situations in which it reduces
investment, creates crowding-out effects of private investment and potential economic
uncertainty. As a result, public debt impedes the sustainable economic growth of nations.
Similarly, budget deficits cause an increase in the cost of financial debt, thus threatening
the sustainability of fiscal policy as it leads to an increase in public debt and a failure to
allocate national resources. Consequently, budget deficits also hinder the process of
sustainable economic growth. However, using, in turn, an interactive variable between
controlling corruption and public debt or budget deficits, the study found that countries
with good levels of control of corruption limited the negative impacts of public debt and
budget deficit on sustainable economic growth. In other words, for countries with high
levels of control of corruption, an increase in public debt or budget deficits will lead to
higher sustainable economic growth than countries with low levels of control of
corruption. Low corruption will be able to increase investment, reduce inflation, increase
national productivity, pushing economic growth. Good control of corruption brings the
chance for improving competition and innovation, leading to a comfortable business
environment. Moreover, good control of corruption also reduces the stress of budget
deficit as well as a public debt due to a good allocation of resources and transparency of
government expenditure. Consequently, it leads to sustainable growth and plays an active
role in reducing the negative effects of corruption, thereby promoting sustainable
economic development.
Based on the results, this study provides some policy implications. First, developing
countries should not consider to raise public debt or maintain budget deficits as keys for
economic development if the government's goal is to aim for sustainable economic
growth. Instead of that, developing countries need to increase the quality of control of
corruption to create a competitive and transparent of the business environment, promote
private investment, and reduce instability of the economy in cases of wanting to use
budget deficits as an expansionary fiscal policy to boost economic spending, investment,
and consumption. Control of corruption also encourages more creative and productive
social activities. In addition, for countries with good levels of control of corruption, the
use of public debt can be considered as a solution to complement the nation's resources.
Finally, the government can implement policies that aim to increase consumption, open
greater integration, and invest heavily in human capital so they can improve sustainable
economic development in the long-term.
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Jurnal Ekonomi & Studi Pembangunan Volume 21 Nomor 1, April 2020

Article Type: Research Paper

The Relationship between Public Debt,

THIS ARTICLE IS AVALILABLE IN:

CITATION: The phenomenon of sustainable development of the economy receives

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Economic growth, which is measured as a percentage change of the gross domestic

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Sustainable economic development and public debt

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H1: Public debt has a negative effect on sustainable economic development

Sustainable economic development and budget deficit

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H2: Budget deficit has a negative effect on sustainable economic development

Sustainable economic development and corruption

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H3: Corruption control has a positive impact on sustainable economic development.

Sustainable economic development, public debt, budget deficit, and corruption

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𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗

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Table 1 Description of variables

𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 ∗

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𝑔𝑟𝑜𝑤𝑡ℎ𝑖𝑡 = 𝛽0 ∗ log(𝑦𝑖𝑡−4 ) + 𝛽1 ∗ 𝑑𝑒𝑏𝑡𝑖𝑡−4 + 𝛽2 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 + 𝛽3 ∗ 𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 ∗

𝑑𝑒𝑓𝑖𝑐𝑖𝑡𝑖𝑡−4 ∗ 𝑐𝑜𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛𝑖𝑡−4 is an interaction variable between the budget deficit ratio

Result and Discussion

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Table 2 Descriptive Statistics

It can be seen that sustainable economic development represented by GDPPCGR had an

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development while controlling corruption had a positive impact on sustainable economic

Jurnal Ekonomi & Studi Pembangunan, 2020 | 99

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