Regional Growth, Debt Thresholds and Subnational Sustainability

Abstract

Aim: To examine the nexus between subnational debt sustainability and regional economic growth. Method: The study employs dynamic panels by Arellano-Bond and the kink model to estimate debt thresholds by Seo and Shin. Results: The study finds a positive association between subnational debt and regional GDP growth, which differs by type of debt. The fiscal intergovernmental architecture of federal system in Mexico results in lower debt thresholds compared to national thresholds. Recommendations: Fiscal, regulatory and normative rules on bank debt should aim to provide the right incentives to encourage regional growth. Limitations: Results from a small sample are a first approximation to the regional debt-growth nexus in Mexico. The lack of updated and consistent data for longer horizons on subnational public finance limits the generalization of the findings. Originality: The study helps to understand the effect of increasing debt on regional GDP growth in centralized fiscal systems and the differential effect by type of financing. Conclusions: Highly centrally regulated fiscal models with limited revenue autonomy could engender soft budget problems and create financial management inefficiencies.