Is the relationship between external debt and human development non-linear? A PSTR approach for developing countries

This paper examines the relationship between external debt and human development for a panel data set of 95 developing countries observed during the period 2002 – 2015. By performing a Panel Smooth Threshold Regression (PSTR) model developed by Gonzà lez et al. (2005), estimation results show that this relationship is non-linear and characterized by the presence of an optimal threshold of external debt equals to 41.7775%. Below this debt threshold, external debt has a positive effect on human development. Any 1% increase in the external debt ratio induces an increase in the HDI of 0.02%. However, above the debt threshold, external debt becomes detrimental to human development since HDI decreases by 0.01% when external debt ratio increases by 1%. In a low external debt regime, countries are encouraged not to exceed this threshold to benefit from the leverage effect, and to modify the structure of imports while avoiding unnecessary ones. In a high external debt regime, countries are complelled to reduce their external debt ratio to reach the optimal threshold, avoid the waste of highly remunerated foreign resources and know how to allocate them to the most productive sectors, and control their demographic growth.