External Debt and Economic Growth in Nigeria: Is there a Debt Laffer Curve?

Abstract

The primary objective of this paper is to test the hypothesis that a debt Laffer curve exists for the Nigerian economy. A debt Laffer curve is a smooth inverted U shaped parabolic function showing a non-linear relationship between the rate of growth of real GDP and the stock of external debt. Basically, the debt Laffer curve shows that economic growth first rises with debt and later falls as the debt stock continues to grow. Clearly, the existence of a debt Laffer curve suggests that a high and rising external debt stock is inimical to economic growth. A second objective of the paper is to empirically test the validity of the debt overhang hypothesis for the Nigerian economy. “Debt overhang” may be defined as a situation in which the expected repayment on external debt falls short of the contractual value of debt, and therefore, the expected debt service is likely to be an increasing function of the country's output level. Thus, a debt overhang effect demonstrates the potential deleterious effect of external debt on an economy as rising debt militates against economic growth. Using quarterly data for the years 1981 through 2015, this study finds strong empirical evidence for the existence of both a debt overhang effect and a debt Laffer curve for Nigeria. Given these empirical results, the lesson that policymakers should take away is that every effort should be made to reduce Nigeria’s external debt in order to promote rapid and sustainable economic growth in the years ahead.