The Impact of Covid-19 and Trade Openness on Government Debt: Case of Low and Lower-Middle Income Countries (2010-2020)

Abstract

Drawing on the vast literature on trade openness impact on government debt, the research project is aimed to investigate the relationship between trade openness and external debt in countries with commodity exports and service exports. Thereafter, ways through which COVID 19 and trade openness aggravates the debt. The study analyzed a panel of 72 low- and lower-middle-income countries over the period from 2010-2020. The main research question is “What Effect does trade openness have on external debt in countries with commodity export and service export?” And sub- questions are: Does Trade openness effect external debt positively in countries where trade is more oriented toward Commodity exports? Does Trade Openness effect external debt negatively in countries where trade is more oriented toward Service exports? And lastly whether Covid-19 aggravates the effect on the external debt? A key observation highlighted in the literature review is the absence of studies of whether opening up trade has a similar impact on countries dependent on services exports compared with countries dependent on commodities exports. This gap in the empirical literature, together with the impacts of COVID-19 on government debt of low- and lower-middle-income countries, was a major motivating factor in initiating this study. Ordinary least square is used for conducting a variance inflation factor (VIF) test in order to make sure that data is free of multicollinearity. To address the endogeneity of regressor and heterogeneity, the Fixed Effect Method dynamic panel data estimator was employed. The results of the analysis found that economic growth, investment, trade openness, foreign direct investment, remittances, and dependency ratio all had a significant impact on external debt. The direction of the relationship between these variables and external debt was consistent with previous literature, with positive relationships found between trade openness in commodity export countries, remittances, and external debt, and negative relationships found between economic growth, investment, FDI, trade openness in service export countries, and dependency ratio and external debt. The study also found that COVID-19 has exacerbated the effects of trade openness on external debt, particularly in low- and lower-middle-income countries. These findings have important implications for policymakers seeking to understand the trade-related determinants of external debt and to mitigate the negative effects of the COVID-19 pandemic on government debt.