External Debt and Economic Growth: Case of A Small Island Nation based on Solow Growth Model

This paper formulates an augmented Solow Growth Model using standardized indicators most applicable to the Pacific Island nation of Tonga. The article explored how external debt can affect Tonga's economic growth, centred on the crowding-out effect and debt overhang theory. A time series data based on 32 years ranging from 1985 to 2016 was used for the analysis. The results showed that Tonga's external debt significantly and positively impacted economic growth. Official development assistance harmed the economic growth of Tonga, which may be due to the mismanagement of external debt. The crowding effect in the form of debt servicing negatively affects Tonga's economy. However, loan repayments under the theory of a debt overhang had a positive relationship with economic development. Additional findings suggested that the distribution of technology grants to the island nation appeared to improve economic growth.