Without fixed effects, the kernel estimates point to a significantly negative coefficient when debt face value ranges between 30 and 250 percent of GDP.<sup>27</sup> We focus on the subsample formed by this range of indebtedness, and ask what institutional controls best mimic the inclusion of fixed effects in Figure 2, i.e. act to weaken the estimated coefficient on debt. We consider the benchmark OLS regression and augment it with a single institutional variable at a time. As most of the institutional variables are not available for the early part of the sample, we take a timeless perspective and use country means for all the institutional indicators. This approach, consistent with the objective of uncovering specific fixed effects, is valid under the assumption of a high degree of persistence in institutional variables. Formally, we estimate where Ii is a time-invariant institutional variable.

Results are reported on Table 4 for the Kaufmann, Kraay and Mastruzzi (2004) synthetic institutional indexes, which include voice and accountability, political rights, corruption, government effectiveness and rule of law. A striking result appears. Government effectiveness and rule of law knock all significance out of the coefficient on debt. The same is however not true of any time invariant control, as introducing the other three KK institutional variables leaves the link between debt and growth virtually unchanged. These findings are consistent with theory. Debt overhang is less likely to occur with more effective governments and within a better legal and contractual environment. It might still happen, but will do so at higher levels of indebtedness.

Table 5 reports similar results with ICRG average indexes. An index of bureaucratic quality is the only variable that affects significantly the debt and growth relationship. Neither the level of democratic rights, nor the occurrence of conflicts or ethnic tensions alter the negative link between debt and growth.

# 5 Debt Overhang: An Event Study

We use the non-parametric results to identify country-years where an overhang episode is estimated to have happened in sample. In other words, we isolate a panel of countryyears where we know the link between debt and growth to be negative. If the mechanisms underpinning debt overhang are to be observed anywhere in available data, it is bound to be in this sample where we know debt has within-country deleterious effects on growth. In choosing these samples, we opt for prudence. We investigate the possibility of overhang as soon as one of our estimator points to a negative and significant debt-growth relation, rather than dismissing the argument if and when the estimates are not unanimous. In fact, since the “double residuals” estimator tends to lack efficiency, we focus on the thresholds implied by the simple rolling window, lest we mistakenly reject overhang phenomena. (Fixed effects) kernel estimation results imply the following threshold levels for our various measures of indebtedness:

> 27 This excludes the nine country-observations year with highest debt to GDP ratio in our sample. Inclusion of these extreme values results in insignificant coefficient estimates in Figure 1. Chances are these are outliers, with ratios of debt in excess of 500 percent of GDP, or even sometimes 1,000 as Nicaragua in the late 90s.

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