loan agreements contracted by either private or official creditors, as well as the average rate at which they are contracted.<sup>12</sup> Finally, several institutional factors can affect the relationship between external debt and growth, as well as the onset of an overhang episode. We seek to characterize the institutional arrangements likely to result in both high indebtedness and low growth. We investigate the role of government efficiency, as institutions prone to tolerate the official squandering of resources are likely to hamper growth while they also facilitate debt buildup. We use the measure of bureaucratic quality constructed in the International Country Risk Guide (ICRG), as well as government effectiveness, one of the Kaufmann, Kraay and Mastruzzi (2004) (KK) indicators.

# 4 A Debt Curve

We first revisit the role of debt as implied by standard growth regressions, paying particular attention to timing issues. We then introduce our kernel estimator to characterize a debt Laffer curve with as little parametric assumptions as possible. Finally, we discuss the discrepancies that arise when comparing between- and within-countries estimates. We relate these differences to the role of institutions, and investigate which tend to result simultaneously in high debt and low growth

## 4.1 Debt and Growth Regressions

Debt overhang should prevail only for high enough levels of indebtedness. Below that, the relation between debt and growth is theoretically ambiguous. For instance Barro and Sala-iMartin (1995) show, in an augmented Solow growth model, that access to foreign borrowing leads to a faster rate of convergence. In that context however the role of external debt should be entirely reflected in the rate of investment and should not have an independent effect of growth. Debt finances investment, and thus fosters growth, but no direct effect is discernible. For this reason, we omit investment from the set of control variables in what follows. We want to allow for a possible channel that works via investment, since this is one of the prominent theoretical possibilities.<sup>13</sup> For purposes of comparison with the existing empirical literature, we first briefly reassess the link between debt and growth in the context of a linear panel approach using nonoverlapping windows of three- and five-year.<sup>14</sup> We consider the general growth specification where yit is the log of per capita GDP, Dit a debt ratio, Xit a vector of control variables and ηi and ζt are country and time fixed effects, respectively. There are six measures of

> 12 These data include new money lent as part of restructuring deals, and thus does not strictly focus on the terms of purely new contracted debt.

> 13 In fact, including investment yields overall similar results, with perhaps slightly higher estimated overhang thresholds. This indicates that investment is a relevant channel for overhang effects, but not the only one, which is confirmed later in the paper.

> 14 With three-year windows, the dataset includes up to eleven time units from 1969-1972 to 1999-2002. With five-year windows, the dataset includes up to seven times unit from 1971-1975 to 1976-2000.

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