# 3.1. Benefits of debt

# 3.1.1 Promoting long-term growth

Government investment in physical and human capital can provide an important foundation for stronger growth over the long term and for achieving development goals. Sustained robust growth is the foundation of long-term poverty reduction. Since potential growth—the rate of growth an economy can sustain at full employment and capacity—is expected to slow further over the next decade, there is now greater urgency to deploy additional investment (World Bank 2018b). Investment can raise potential growth directly and indirectly. The direct channel is capital accumulation, which lifts labor productivity and potential output. Indirectly, investment can raise total factor productivity because of technological improvements embedded in investment.<sup>5</sup> EMDEs have large investment needs to meet development goals and improve living standards. Several studies estimate the cost of investment needed to achieve the Sustainable Development Goals (SDGs). Rozenberg and Fay (2019) find that low- and middle-income countries face aggregate investment needs of $1.5 trillion to $2.7 trillion per year—equivalent to 4.5 to 8.2 percent of GDP—between 2015 and 2030 to meet infrastructure-related SDGs. Their cost estimates depend on policy choices, highlighting the importance of spending efficiency (i.e., the quality of spending) in achieving such goals.<sup>6</sup> At the current juncture, debt accumulation may well be necessary to limit the long-term damage caused by the pandemic. The pandemic has disrupted the education of about 90 percent of the world’s children; it caused a plunge in investment that exceeded that during the global financial crisis; and it exposed severe underinvestment in health care systems in many countries (World Bank 2021). Years of sustained investment in education and health care systems as well as physical infrastructure will likely be needed to undo this damage.

# 3.1.2. Stabilizing short-term macroeconomic fluctuations

Temporary debt accumulation also plays an important role in stabilizing short-term macroeconomic fluctuations. During recessions, borrowing for government spending or tax cuts can provide the necessary fiscal stimulus to support activity (Yared 2019). However, the effectiveness of such stimulus policies depends on fiscal multipliers—the output effects of additional government spending or tax cuts (Huidrom et al. 2020; Ramey 2019).

A large literature estimates fiscal multipliers and documents that multipliers vary widely, depending on circumstances. They range from a 1.1-dollar output decline to a 3.8-dollar output increase for every dollar of additional government spending or reduced revenues. The

> 5 For example, using a panel of OECD countries, Fournier (2016) shows that a 1-percentage-point increase in the share of public investment in expenditure is associated with an increase in long-term output by 5 percent. The study also documents that public investment is more growth-enhancing in areas with large externalities, such as health and research and development. To the extent that debt-financed investment spending stems the slowdown in potential growth, it helps preserve the revenues required to service this debt (Fatas et al. 2019).

> 6 Infrastructure investment can have particularly large growth benefits if it connects isolated communities with input and output markets, allows companies to realize economies of scale by increasing market size, and increases competitive pressures (Calderón and Servén 2010; Égert, Kozluk, and Sutherland 2009).

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