International Journal of

Financial Studies

Article
Public Debt, Public Investment and Economic
Growth in Mexico
Isaac Sánchez-Juárez * and Rosa García-Almada
Department of Social Sciences, Universidad Autónoma de Ciudad Juárez, 32310 Chihuahua, Mexico;
[email protected]
* Correspondence: [email protected]; Tel.: +52-656-688-2100 (ext. 3759)

Academic Editor: Nicholas Apergis

Received: 12 December 2015; Accepted: 21 March 2016; Published: 30 March 2016

Abstract: The primary objective of this article is to answer the following two research questions: has
the growing public debt of state governments promoted increased public investment? If the answer is
yes, then does any increase in public investment lead to more growth in the Mexican states? Dynamic
Models of panel data and the Generalized Method of Moments, with information for 32 states from
1993 to 2012, were used for this purpose. The econometric results confirmed that public debt is
positively correlated with public investment and that this in turn generates economic growth. This
does not mean that a good economic policy strategy has been followed, since the marginal positive
impact of public investment, and therefore the public debt on the production per person, is reduced
(1% increase in the interaction between public investment and public debt variable causes a 0.0005%
increase in economic growth). This suggests deviations from the debt contracted for purposes other
than production, which could lead to a situation of unsustainability of state public finances in the
medium term.

Keywords: Mexico; economic growth; public finance; development

JEL Classification: H72; H74; O40

1. Introduction
The Mexican economy is underdeveloped and the authorities have not found a way to overcome
this; it faces problems as diverse as poverty, informality, low productivity, insecurity, unemployment
and a chronic phase of economic stagnation. Of all indicated problems, the one that gives most concern
relates to the low rates of economic growth. Attempts have been made to fix this and various strategies
proposed, the most common being the increase in public spending, particularly concerning investment.
There are at least three sources to finance government spending: printing money, taxes and public
debt. The first source has not been used recently as a financing mechanism, at least officially, while
the second has remained on a path of low stability; in fact, with information provided by Robles and
Huesca [1] (p. 68), it is known that the collection in Mexico as a proportion of GDP is 18%, taking
into account oil revenues, and 14.25% without considering them, when the average of the OECD
(Organization for Economic Co-operation and Development) was 25.81% in 2012.
The third source of funding is the public debt, which has grown at the federal level, but this does
not represent a problem, since the gross debt represented 27% of GDP to December 2012, and 80.3% of
domestic debt and other external debt [2]. The total gross public debt of the USA for the same year
was 106.5%, with 84.1% in Spain and 68.5% in Brazil [3].
The problem is the debt of the states or sub-national, which has grown significantly from 2% of
GDP in 1994 to 3.1% in 2013. In some states such as Chiapas, Chihuahua, Coahuila, Nayarit, Quintana
Roo and Veracruz, the debt has grown in the same period by a factor greater than five [4]. According

Int. J. Financial Stud. 2016, 4, 6; doi:10.3390/ijfs4020006 www.mdpi.com/journal/ijfs

Int. J. Financial Stud. 2016, 4, 6 2 of 14

to current regulations, at least in theory, the public debt of the states means more income and income
transfers from the federation to be used for multi-year projects of investment that will translate into
economic growth and jobs, which ultimately result in greater well-being for the citizens.
From the above, this paper provides evidence of the relationship between public debt and public
investment, as well as between public investment and economic growth. The central objective is
to answer the following two questions of research: has the growing public debt of sub-national
governments promoted an increase in public investment? If the answer is yes, then does any increase
in public investment translate into greater growth of the Mexican states? In essence, it is considered
that public investment complements private investment and thus promotes growth [5,6].
Thus, there are two hypotheses. The first is called “golden rule” [7], which states that there is a
positive relationship between the public debt and public investment of sub-national governments in
Mexico for the period 1993–2012. It is assumed that debt is prudently used only to finance socially
profitable investment spending that “brings its own source of payment in the form of direct generation
of resources... the rule marked it implies that current spending be paid only out of current income,
never with debt ...” [8].
The second hypothesis is that public investment is the main determinant of economic growth of
sub-national governments [9]. It assumes that there is complementarity between public investment
and private investment, thus both promote increases in the production of goods and services. Thus,
when an entity is in debt, it is because the retrieved money is channeled into public investment and
this promotes economic growth.
The article has six sections, including this introduction. The second part is devoted to the review
of the literature in an effort to highlight the contribution made by this article. The third presents the
data used, source and characteristics. The fourth is a brief description of the data and presents the
econometric method. In the fifth, the results of the estimates are presented. Finally, the findings are
discussed and some policy recommendations presented.

2. Literature Review
This work establishes that sub-national governments hire debt for the purpose of financing
public investment projects that complement private investment to translate into greater economic
growth, from which contracted debt becomes sustainable and there is no risk for their finances (on the
determinants of debt, see [10]). According to orthodox principles, maintaining healthy public finances
is a necessary condition for growth, which implies maintaining an appropriate public deficit and debt
level. The following criteria are defined to make it happen [11] (pp. 347–348):

(1) Comparison between revenue and public expenditure by means of a definition of public deficit,
where it tends to zero at the optimal level

DtPN “ pGt ´ Tt q ` It , It “ it B0,t´1 , (1)

where DtPN is the nominal budget deficit, Gt is public spending, Tt is the public income, It is the
volume of interest paid, it is the nominal effective rate of interest, and B0,t´ 1 is the total value of
domestic public debt from the period 0 to period t ´ 1.
(2) Compliance with the intertemporal budget constraint
ż 8 ´r p t q
D0 ď e pTs ´ Gs q ds. (2)
0

Equation (2) says that the sum of the present value of each of the expected primary surpluses must
be greater than or equal to the value of the initial debt D0 (r is the interest rate). Thus, if the primary
deficit is zero, then it should not be public debt. Growing surpluses in each period are required to
maintain a positive or increasing public debt.
 Int. J. Financial Stud. 2016, 4, 6 3 of 14

(3) Following Blanchard et al. [12] (p. 12) the comparison between the rate of economic growth and
the interest rate that is paid by the debt should be considered:
ż8
´ d0 “ e´pr´θ q pg ´ tqs ds, (3)
0

where d0 is the original debt, g is government spending and t tax revenues expressed as proportion
of the actual product, r is the interest rate and θ is the rate of growth of the economy. Thus, fiscal
policy is sustainable if the present value of the primary deficit is equal to the negative of the
initial value of the debt, which means you can keep any level of debt and primary deficit if and
only if the growth rate of the economy exceeds the rate of interest paid on the debt. With this
framework, we tried to reaffirm the idea according to which the contracted debt goes to public
investment and the latter translates into higher economic growth, completing a virtuous circle.
Alternatively, the work relies on Minsky [13] and its financial instability hypothesis transferred to
sub-national public finance, according to which increases in investment in the current period encourage
expectations of higher profits in the future, which improves the price of capital assets and increases the
confidence of companies and financial intermediaries, which is reflected in lower perception of risk
and greater indebtedness [11] (p. 349). However, causality would be in a different sense as it would be
on investment to growth and this to indebtedness. This is a different situation to that raised in this
article, where we want to verify if indeed debt contracted by sub-national governments translates into
public investment and hence to higher growth.
Prior to the review of empirical works on the relationships between variables proposed in this
article, the theoretical considerations raised by Rubio et al. [14] should be noted, in particular the
debt overhang hypothesis and the Laffer curve for the debt. Regarding the first point, it is noted that
foreign and national private sector agents conceive the debt as a future tax on the return on capital;
additionally, they perceive that a growing debt service increases the likelihood that the government
brings inflationary financing policies. Higher borrowing creates expectations that lead to a reduction in
private investment, which in turn is detrimental to economic growth [14] (p. 13). In addition, Obstfeld
and Rogoff [15] warn that increasing the stock of debt increases the probability of non-payment, and
therefore the country (in this case the state) should decrease the investment so that, given a lesser
product, it reduces the cost of credit.
Regarding the Laffer curve applied to the study of debt by Rubio et al. [14], it is suggested that
if the amount of debt in relation to GDP is put in the axis of abscissa, with the contribution of the
debt to the GDP growth on the y-axis, it will be observed that, between these two series, there is a
non-linear relationship, and instead an inverted u-shaped curve appears, so the debt contracted at the
beginning generates growth, but then stops it. This is explained by the likelihood of non-compliance
in the payment from certain considered high levels of indebtedness and the consequent detrimental
effect on both public and private investment (see [16]).
Regarding the relationship between public debt and economic growth, there is an abundant
amount of literature, particularly using comparisons between countries. Patillo et al. [17] studied the
non-linear impact of debt on economic growth using a panel of 93 countries for the period 1969–1998,
and found that from a certain debt threshold (160% to 170% of the exports or 35% to 40% of GDP),
growth shrinks since it reduces the efficiency of the investment more than its volume, which favors
the hypothesis of over-indebtedness previously exposed. Salamanca and Monroy [18], in the case
of an emerging economy such as that of Colombia, provide similar information to find that private
investment is reduced each time the external public debt increases. In Mexico, Diaz [19] found the
public debt of the federal government is used predominantly for the financing of the government
deficit, which represents an obstacle to investment and, therefore, a brake on economic growth.
A much-cited work in the study of the relationship between debt and growth is Reinhart and
Rogoff [20] who, using historical series of more than 200 years, found two situations: (1) that the
relationship between government debt and the GDP growth is weak for debt-to-GDP rate below a
Int. J. Financial Stud. 2016, 4, 6 4 of 14

threshold of 90% of GDP, and above 90%, the average growth rates fall 1%; (2) the markets of emerging
economies face lower external debt (public and private) thresholds, when external debt reaches 60% of
GDP, and annual growth is reduced to about 2%, and if debt levels are higher, growth is reduced by
almost half. In essence, this work recommends being careful not to reach a level of debt that impairs
economic growth.
However, the above-mentioned work suffers from severe flaws that were exposed by authors
such as Irons and Bivens [21], but particularly Herndon et al. [22]. For the first set of authors, the
most serious failure of the work of Reinhart and Rogoff [20] is that they analyze correlation between
public debt and growth, but not causation, particularly to demonstrate that there is a causal link
between these variables and the relationship running from low economic growth to public borrowing.
Herndon et al. [22] completely discredit the work of Reinhart and Rogoff [20] to demonstrate that
these authors made mistakes in coding, the selective exclusion of the evidence, and weighting in
a non-conventional form their summary statistics, so it is not confirmed that there is a threshold
of debt from which economic growth is reduced; in fact, it can be considered that the relationship
between these variables depends on the period and analyzed country (also see Pescatori et al. [23] and
Ostry et al. [24]).
Rito et al. [25] evaluated the effect of debt on economic growth using data for 13 countries—Greece,
Italy, Portugal, Belgium, France, Germany, Spain, Finland, Estonia, Hungary, Denmark, Lithuania and
Sweden—from the first quarter of 2000 to the third quarter of 2011. What they found is that public
debt has a positive effect on growth up to a certain level, after which it must comply with its cost and
its effect on growth is negative. This agrees with Kellerman [26], who shows that in the long term, the
opportunity cost of social public investment financed with debt is superior to the public investment
financed with taxes.
For the Mexican case, Ramírez and Erquizio [27] evaluated the public debt contracted by the
state’s impact on public spending on investment, a model whose main purpose was not this but
proves that the governments of the states spend more coming up to elections. They used in their
estimates information from 31 federal entities for the period 1993–2006, grouped in a panel that
was estimated using instrumental variables and the Generalized Method of Moments. The result is
that there is a negative relationship between the new debt contracted by sub-national governments
and spending on public investment; in contrast, the estimate of the relationship between the total
expenditure, administrative expenditure and public debt is positive, which serves as background for
this article (in relation to the way in which public spending of sub-national governments is influenced
by the political business cycle—see also the work of Gámez and Ybarra-Yunez [28] and Sánchez [29],
who found for the Asturian municipalities in Spain that debt is contracted to respond to scheduled
public spending and to achieve financial autonomy).
Romp and de Haan [30] studied a long list of theoretical and empirical works that have studied
the relationship between public investment (or public capital) and economic growth, and conclude
that although not all studies find that the growth is being encouraged by the public investment, there
is always greater consensus on the importance of having public capital for productive promotion.
Sánchez-Juárez and García [31] found with data of the Mexican economy for the period 2003–2011 that
the relationship between production and public investment made by sub-national governments of the
northern border is negative, which they attributed to the effect of displacement of private investment
or that had a short temporary sample (on this last point, see the work of Castillo and Garcia [32]).
Shrithongrung and Kriz [33] show with sub-national data of the American economy and the method
of Panel Vector Autoregression, that public capital has a positive effect on growth in the short and the
medium term. On the other hand, Shrithongrung and Sánchez-Juárez [9], with data of sub-national
governments of Mexico, confirm that public investment has positive effects on the production in both
the short and the long term. Based on the review, it can be said that public investment or public capital
promotes growth considering developing and developed economies.
Int. J. Financial Stud. 2016, 4, 6 5 of 14

With reference to the study of the relationship between public debt, public investment and
economic growth, very few studies were found in the search carried out in digital databases for one
period no longer than ten years. The work of Boris [34] is highlighted, with data from 20 European
countries for the period 1985–2010, and who applied the method of fixed effect panel controlling for
potential bias of endogeneity and causality test, and found that economic growth is what determines
public debt and that public debt negatively affects total investment. According to his work, when an
economy ceases to grow, public borrowing is used and this harms investment and is detrimental for
growth, plunging the economies into stagnation. Its results favor the paradigm of austerity in public
finance as a stabilization mechanism and the hypothesis of crowding-out of private investment.
Rodríguez and Azamar [11] conducted the first job encountered that links sub-national public
debt, public investment and economic growth in the case of the Mexican economy; they used data
from the 32 federal entities for the period 2005–2009 and estimated models of simple linear regression
with the OLS (Ordinary Least Square) method for panel data. In one of their estimates, they found
that the lower the level of indebtedness and greater state investment, the greater the economic growth
of the state. In a second estimate, they found that increased state debt and total public investment
negatively affect economic growth. Regarding when the data description was performed, an element
to be highlighted is that, during the analyzed period, the growth of public debt was greater than public
investment, which suggests that part of the debt is used for other purposes. The work suffers from
several problems: (1) in their estimates, they obtained positive and negative signs in what refers to
the impact of debt on economic growth; (2) for the first of their estimates, although the debt has a
negative sign, the t test reveals that it is not statistically significant; (3) as noted in his paper, his work
has a reduced temporary sample; (4) it does not estimate the effect of debt on public investment and
therefore assumes that the impact of the debt on growth should always be negative; (5) its estimates
do not consider control variables.
This article considers the works cited as a precedent to determine whether contracted
debt—associated with sub-national governments—is positively related to public investment and
this with the growth of the product, in order to expand the knowledge we have on this important issue
for Mexican public finances.

3. Origin and Characteristics of the Data

We built a database with information from 1993 to 2012 for the 32 states that make up the Mexican
Republic. These are: (1) Aguascalientes; (2) Baja California; (3) Baja California Sur; (4) Campeche;
(5) Coahuila; (6) Colima; (7) Chiapas; (8) Chihuahua; (9) Distrito Federal; (10) Durango; (11) Guanajuato;
(12) Guerrero; (13) Hidalgo; (14) Jalisco; (15) México; (16) Michoacán; (17) Morelos; (18) Nayarit;
(19) Nuevo León; (20) Oaxaca; (21) Puebla; (22) Querétaro; (23) Quintana Roo; (24) San Luis Potosí;
(25) Sinaloa; (26) Sonora; (27) Tabasco; (28) Tamaulipas; (29) Tlaxcala; (30) Veracruz; (31) Yucatán; and
(32) Zacatecas.
It has eight variables: population (pop), total output (pib), output per person (pibpc), public
investment (inver), current government spending (corriente), average years of schooling (edu), foreign
direct investment (ied), and public debt (deuda). The population was obtained from the Consejo
Nacional de Población and is an estimate of the population each year. Total production was obtained
from the Instituto Nacional de Estadística y Geografía (INEGI) and its Banco de Información Económica;
data were deflated using a base year of 1993. The output per person is obtained by dividing the
previous two series. Public investment and current expenditure were taken from the Sistema Municipal
de Bases de Datos from INEGI, deflated based 1993. Schooling by entity data were obtained from Sistema
Nacional de Información Estadística Educativa of the Ministry of Education. Foreign direct investment
data came from the Center for the Study of Public Finance of the House of Representatives, deflated
base 1993.
Finally, public debt data were obtained from the Secretaría de Hacienda y Crédito Público (SHCP),
deflated base 1993. Two caveats must be carried out with respect to this series: the first is that in the
Int. J. Financial Stud. 2016, 4, 6 6 of 14

case of the state of Hidalgo for 1999, Campeche 2003, 2006 and 2009, and Tlaxcala 1996–2004 and
2008–2010, debt reported value was zero, so we proceeded to assign a value of one peso, since for the
econometric analysis logarithms were used. The second warning is that the debt reported by the SHCP
only includes registered bank debt and equity instruments emissions, but does not include all of the
short-term debt, since only states are required to report the debt that compromises the entries received
from the federal government [8].

4. Description of Data and Econometric Method

Description of data is presented in the tables and charts that follow. The variables of interest are
public debt, public investment, and production per person. The production per person increased by
little more than 4000 pesos between 1993 and 2012, a modest increase in 20 years (42%); inequalities
between states with more and less income reported increased, which can be seen when analyzing the
positive change in the standard deviation. The main feature of the behavior of output per person is its
meager growth and geographic concentration. As for public investment, in the period, an increase of
150% was observed, and distances between states that had more and less investment decreased, hence
the reduction in the standard deviation in the two periods was observed. Aggregated data confirms
that there is a correlation between increases in output per person and public investment, clarifying that
this last grows much more. In terms of public debt, this increased 313% and shows a great inequality
between states that borrow more and those which borrow less. The available statistics are clear: three
indicated series are positively correlated, but it is surprising that the magnitude of the growth does
not correspond between them (see Table 1).

Table 1. Description of the database built, 32 states, Mexico, 1993–2012.

pob pib pibpc

1993 2012 1993 2012 1993 2012
Mean 2,773,500 3,438,205 36,097,881 61,155,975 12,702 16,978
Median 2,097,378 2,617,777 20,538,029 35,798,136 11,029 15,658
Max 11,040,075 15,408,294 274,667,008 392,208,211 32,386 44,305
Min 353,348 606,545 5,859,721 10,273,317 5826 7079
SD 2,400,337 2,990,185 49,756,805 74,779,241 6015 7740
inver corriente ied
1993 2012 1993 2012 1993 2012
Mean 289,534,124 463,443,058 924,820,677 2,194,580,746 477,076,067 1,231,759,769
Median 142,885,658 357,176,663 409,476,770 1,655,109,435 71,025,506 658,897,140
Max 2,355,390,500 1,871,759,340 8,332,723,300 7,284,889,015 9,622,367,375 15,231,373,178
Min 6,511,000 20,481,574 107,500,030 188,021,815 311,515 ´123,214,538
SD 441,885,358 407,973,457 1,564,591,466 2,005,536,099 1,690,156,048 2,682,549,554
edu deuda
1993 2012 1993 2012
Mean 6.60 8.81 571,193,750 2,306,647,763
Median 6.67 8.98 281,950,000 1,166,103,681
Max 9.02 10.70 2,728,500,000 9,978,480,210
Min 4.53 6.90 30,000,000 7,323,227
SD 0.98 0.83 751,271,880 2,581,294,466
pob in persons; pib in miles of pesos (1993); pibpc in pesos of 1993; inver in pesos of 1993; corriente in pesos of
1993; ied in pesos of 1993; edu in average years of schooling and deuda in pesos of 1993. SD: standard deviation.
Source: Own elaboration.

Average annual growth of the public debt and public investment rates are presented in the
Figure 1. For some states, it seems to show a slight positive relationship. Regarding the relationship
between public investment and production per person, there is not a relationship in accordance with
 As far as the state public debt is concerned, only two states observed negative rates of growth
(Querétaro and Tlaxcala). In eight states, the growth of public debt was between 12% and 18% on
annual average, whereas in 12, debt grew by between 5% and 10%. On the other hand, the
production was what increased less; only in the state of Zacatecas was it higher than 3%. In Quintana
Int. J. Financial Stud. 2016, 4, 6 7 of 14
Roo and Campeche, growth was even negative, although in these states public investment grew
significantly, as well as public debt. In 10 states (Guanajuato, Aguascalientes, San Luis Potosí,
Coahuila, Querétaro,
the established Sonora,
hypothesis, Nuevo
which León,
leads Michoacán,
directly Durangoofand
to the realization Puebla), the analysis
an econometric growth within output
panel
per
dataperson was between
that makes use of all2% and 2.6%.
available In the remaining
information 18 states,
and to obtain growth
a more robustwas greatly reduced.
conclusion. In relationThe to
conclusion here is that for the whole country,
public investment, nine states presented a negative rate ofthe regional growth in output per person is reduced,
(Nuevo León, Tabasco, Querétaro,
while debt and
Tamaulipas, public
Jalisco, investment
Guanajuato, in mostYucatan
Morelos, of the states growsFederal).
and Distrito significantly,
In sixsuggesting that other
states, the growth rate
factors
of public must collaborate
investment was more with
positive andeconomic
two-digit growth;
(betweentherefore, in the
14% and 21%) study, itBaja
(Hidalgo, was decided Sur,
California to
include
Nayarit,control variables such
Aguascalientes, as education
Guerrero and foreign direct investment.
and Oaxaca).

30 30

Public investment
Public investment

20 20

10 10

0 0
-20 -10 0 10 20 30 -2 0 2 4
-10 -10
Public debt GDP per head

Figure 1. Average annual growth rate of the public debt, public investment, and per capita GDP,
32 states, Mexico, 1993-2012. Source: Own elaboration.
Figure 1. Average annual growth rate of the public debt, public investment, and per capita GDP,
32 states, Mexico, 1993-2012. Source: Own elaboration.
As far as the state public debt is concerned, only two states observed negative rates of growth
(Querétaro and Tlaxcala).
To conclude this part, In eight states, the
a classification growth
of the statesofwith
publicmajordebtand
wasminor
between 12%
levels of and 18%per
output on
annual public
person, average, whereas inand
investment, 12, debt grew
public debtbyfor
between
the last5% andof10%.
year On the other
the sample hand, the
is presented in production
Table 2. It
was what
points out increased
that two of less;
theonly
mostin heavily
the stateindebted
of Zacatecas was
states areitalso
higher than
those who3%.have
In Quintana Roo and
higher levels of
Campeche,
output growth was
per person, eveninnegative,
but not regards although
to publicininvestment
these states(Distrito
public investment
Federal and grew significantly,
Nuevo León).
as well asand
Coahuila public debt. In are
Chihuahua 10 states
other(Guanajuato,
states that drawAguascalientes,
attention, as SantheyLuis
havePotosí,
a highCoahuila, Querétaro,
level of output per
Sonora, Nuevo León, Michoacán, Durango and Puebla), the growth in output per person
person and debt; Sonora, Quintana Roo, Baja California and Tamaulipas are similar cases. In relative was between
2% and
terms, 2.6%.
this In the remaining
highlights the central18region
states, and
growth was greatly
northern borderreduced. The conclusion
region, which have highhere is that
levels of
for the whole
production percountry,
person andthe public
regional growth
debt, as wellin as
output per person
moderate public is reduced, while debt and public
investment.
investment in most of the states grows significantly, suggesting that other factors must collaborate
more with economic growth; therefore, in the study, it was decided to include control variables such as
education and foreign direct investment.
To conclude this part, a classification of the states with major and minor levels of output per
person, public investment, and public debt for the last year of the sample is presented in Table 2.
It points out that two of the most heavily indebted states are also those who have higher levels of
output per person, but not in regards to public investment (Distrito Federal and Nuevo León). Coahuila
and Chihuahua are other states that draw attention, as they have a high level of output per person and
debt; Sonora, Quintana Roo, Baja California and Tamaulipas are similar cases. In relative terms, this
highlights the central region and northern border region, which have high levels of production per
person and public debt, as well as moderate public investment.
The investigation made use of dynamic models to study the relationship between public debt and
economic growth. Thus, before presenting the results, we define what is meant by a dynamic model
and the different versions to be estimated.
Dynamic models are characterized by the presence of one or more lagged endogenous variables
as part of the explanatory variables. They try to explain a variable based on its behavior in the past,
which is quite adequate, in a context where history matters. In particular, a dynamic model has the
following structure:
yit “ αyit´1 ` β i Xit ` ε it , (4)

where y is the endogenous variable, X is a vector with the exogenous variables of control, while α and
β are parameters to be estimated and ε is the random disturbance term.
Int. J. Financial Stud. 2016, 4, 6 8 of 14

Table 2. Ranking of production, public investment and public indebtedness, 2012, pesos 1993 = 100.

pibpc inver deuda

1 Distrito Federal 44,305 México 1,871,759,340 Distrito Federal 9,978,480,210
2 Nuevo León 33,511 Oaxaca 1,606,488,654 Nuevo León 7,971,556,605
3 Coahuila 25,877 Sonora 964,582,289 Veracruz 6,796,018,878
4 Chihuahua 24,202 Veracruz 855,378,661 México 6,779,103,510
5 Sonora 23,381 Michoacán 729,412,411 Coahuila 6,183,585,802
6 Aguascalientes 22,756 Guerrero 680,683,530 Jalisco 4,416,811,924
7 Quintana Roo 22,003 Sinaloa 658,709,015 Chihuahua 3,953,241,187
8 Querétaro 21,899 Aguascalientes 610,637,198 Chiapas 2,786,548,495
9 Baja California Sur 20,612 Hidalgo 536,518,065 Michoacán 2,636,318,344
10 Baja California 17,921 Chiapas 511,032,704 Sonora 2,564,623,536
11 Tamaulipas 17,902 Quintana Roo 487,578,853 Quintana Roo 2,547,775,085
12 Colima 17,729 Nuevo León 480,397,970 Baja California 2,166,729,727
13 Jalisco 16,979 Puebla 477,227,756 Tamaulipas 1,854,670,862
14 Morelos 16,607 Coahuila 466,006,690 Puebla 1,547,514,972
15 Campeche 16,352 Distrito Federal 458,659,939 Guanajuato 1,370,804,871
16 Durango 15,917 Chihuahua 384,517,647 Sinaloa 1,259,199,019
17 San Luis Potosí 15,400 Baja California 329,835,680 Nayarit 1,073,008,343
18 Guanajuato 14,581 Tamaulipas 277,287,654 Oaxaca 961,014,167
19 Sinaloa 14,565 Tlaxcala 239,480,925 Zacatecas 903,518,374
20 Yucatán 13,865 Baja Cal. Sur 216,073,411 Tabasco 818,970,244
21 México 13,814 Colima 214,802,735 San Luis Potosí 795,950,418
22 Zacatecas 13,352 Durango 214,617,022 Durango 723,864,222
23 Puebla 12,308 Tabasco 205,484,506 Hidalgo 618,475,714
24 Tabasco 11,678 Zacatecas 204,290,962 Aguascalientes 535,803,867
25 Veracruz 11,007 Jalisco 204,225,123 Guerrero 516,063,147
26 Nayarit 10,969 Nayarit 203,419,733 Morelos 487,440,279
27 Michoacán 10,671 Campeche 178,089,613 Yucatán 411,873,372
28 Hidalgo 10,582 Querétaro 174,950,555 Colima 363,108,415
29 Guerrero 9139 Guanajuato 165,388,813 Querétaro 307,477,831
30 Tlaxcala 8716 San Luis Potosí 145,678,244 Baja California Sur 286,527,363
31 Oaxaca 7620 Morelos 56,480,582 Campeche 189,326,409
32 Chiapas 7079 Yucatán 20,481,574 Tlaxcala 7,323,227
Source: Own elaboration.

To clarify this, we estimate three equations with information grouped on a panel with
640 observations, and 32 cross-sections from 1993 to 2012, this with the Generalized Method of
Moments (GMM). This method was chosen because it eliminates any bias associated with the individual
heterogeneity not observed, which consequently provides more efficient results (see Arellano and
Bond [35]). We estimate a first equation in which output per capita is determined by its lagged value
(yit ´1 ), public investment, schooling, foreign direct investment (Xit ) and the extent of government debt,
both in absolute values and in logarithms.

yit “ α1 yit´1 ` β i Xit ` µi deudait ` ε it . (5)

According to established assumptions, it is expected that economic growth is positively

determined by public debt, since it is assumed that it is used mostly to finance public investments.
The correlation is also expected to be positive in the case of schooling and foreign direct investment.
The second estimated equation explains the public investment itself lagged (inverit ´1 ), the current
expenditure of the government, the population of each entity, foreign direct investment (Xit ), and of
course the public debt, both in their absolute values as logarithms.

inverit “ α1 inverit´1 ` β i Xit ` µi deudait ` ε it . (6)

It is expected that for higher current expenditure there is less public investment, while foreign
direct investment is complementary to public investment. Finally, an equation was estimated involving
an interaction factor (inver*deudait ), which, it is expected, will correlate positively with growth to
show that public debt is heading for more public investment, and the latter to complement private
Int. J. Financial Stud. 2016, 4, 6 9 of 14

investment takes the form of higher economic growth in Mexican states. The control variables used
were foreign direct investment and schooling.

yit “ α1 yit´1 ` β i Xit ` µi pinver ˚ deudait q ` ε it . (7)

5. Results
The estimation of Equation (5), with the absolute values of the variables, gave the following
results (see Table 3):
1. The first lag of GDP per capita was statistically significant at 0.01.
2. Public investment lagged three periods has a positive effect on output per person, with a
significance level of 0.01—although marginal effects, as measured by the coefficient, indicate that
its impact is reduced.
3. The public debt is positively correlated with output per person, with a significance level of 0.01.
As in the case of public investment, marginal effects are reduced.
4. In this way, part of the hypothesis of research seems to be confirmed; it is possible to say that
public investment is a determinant of economic growth, as well as public debt. However, the
marginal effect is negligible.
5. In addition, it was found that the average years of schooling, proxy variable of education and
human capital are positive determinants of economic growth.
6. Foreign direct investment is negatively related to production, with a statistical significance of 0.01.
7. As a measure of the goodness of the estimates, the J statistic and its probability value were
calculated. A rejection of the null hypothesis means that instruments do not satisfy the
orthogonality conditions required for its use. This may be because they are not really exogenous
or because they have been incorrectly excluded from the regression (Baum et al. [36] (p. 16)). The
estimated statistical was 30.50 with a value of probability of 0.33, which does not reject the null
hypothesis, the model was specified correctly.

Table 3. Results of the estimation of Equation (5) with the Generalized Method of Moments GMM.

Independent Variables Dependent Variable pibpc Independent Variables Dependent Variable logpibpc
0.824900 * 0.750674 *
pibpc(´1) logpibpc(´1)
(54.85) (39.50)

inver(´3) 2.78 ˆ 10´7 * loginver(´3)

0.000380
(5.11) (0.364)
73.01667 ** 0.211917 *
edu logedu
(2.01) (7.50)
´2.42 ˆ 10´8 * 0.000227
ied logied
(´5.20) (0.942)
1.54 ˆ 10´7 * logdeuda(´1)
0.001533 *
deuda (3.75) (2.65)
J-statistic 30.5066 J-statistic 38.97
Probability 0.339415 Probability 0.081389
@DYN(pibpc,´2 ) inver(´3) edu @DYN(logpibpc,´2 ) loginver
Instruments Instruments
ied deuda logedu logied logdeuda
** Significance at 5%; * Significance at 1%, values of t-statistic in parentheses. Source: Own elaboration.

The estimate with logarithms also indicated that the first lag of the endogenous variable was
statistically significant, the third lag of public investment and the first public debt have a positive
impact on economic growth, but the coefficient of public investment was not statistically significant.
With regards to the control variables, education has a positive impact on economic growth and is
statistically significant. Foreign direct investment has the expected positive sign, but its coefficient is
not statistically significant. The J statistic indicates that the null hypothesis of correct specification must
be rejected. The estimate included dummy variables, for periods without transforming a better overall
Int. J. Financial Stud. 2016, 4, 6 10 of 14

estimate, was obtained, with signs expected in public investment and debt variables, but the problem
remained that individually their coefficients were not statistically significant (results not reported here,
but are available on request).
The estimation of Equation (6) produces the following results (see Table 4):

1. The first lag of public investment was statistically significant at 0.01, both in absolute values as
estimated in logarithms.
2. The current expenditure on the estimation in absolute values was a positive sign, indicating that it
is complemented with public investment. In the estimation of logarithms, the expected negative
sign was obtained, but the associated coefficient was not statistically significant. Authors such as
Vivanco and Solís [37], using similar data for the period 1993–2006, found that the relationship
between public investment and current expenditure is negative but, as in this study, the coefficient
was not statistically significant.
3. The total population, both in absolute values and in logarithms, is shown correlated positively
with public investment, with the result significant at 0.01.
4. The foreign direct investment in absolute values presented the expected positive sign and is
statistically significant at 0.01. However, in logarithms, the correlation is negative, although the
estimated coefficient is not significant.
5. The increases in public debt reduce public investment, if the results are considered in absolute
values, but in logarithms have the expected positive sign, although the coefficient is not significant.
It was decided to consider the relationship is positive as Kinto [38] and Vivanco and Solis [37]
report in the Mexican case. With the estimation of Equation (7), this will become clear.

Table 4. Results of the estimation of Equation (6) with the GMM.

Independent Variables Dependent Variable inver Independent Variables Dependent Variable loginver
0.528249 * 0.438549 *
inver(´1) loginver(´1)
(376.32) (7.37)
0.049889 * ´0.012266
corriente logcorriente
(30.98) (´0.09)
191.3417 * 3.418949 *
pob logpob
(23.94) (5.45)
0.006541 * ´0.006209
ied logied
(65.62) (´1.12)
´0.059481 * 0.002043
deuda logdeuda(´2)
(´35.28) (0.21)
J-statistic 30.08 J-statistic 19.77
Probability 0.359115 Probability 0.839896
@DYN(inver,´2 ) corriente pob @DYN(loginver,´ 2 ) logcorriente
Instruments Instruments
ied deuda logpob logied logdeuda(´2)
* Significance at 1%, values of t-statistic in parentheses. Source: Own elaboration.

Finally, we present the results of estimate Equation (7) in absolute values and logarithms
(see Table 5):

1. The variable output per capita lagged one period was significant in the estimation with absolute
values and logarithms.
2. The variable interaction between public investment and public debt was statistically significant at
0.01, using absolute values and logarithms. In the case of the logarithms, the interaction variable
was lagged three periods. This confirms the two proposed hypotheses, according to which
the debt which is channeled for public investment collaborates to observe a greater economic
growth. However, the marginal contribution of increases in public debt and public investment on
growth are small, since for every 1% increase in this interaction variable, output per capita rises
0.0000508 per cent.
Int. J. Financial Stud. 2016, 4, 6 11 of 14

3. Education is a variable that persistently shows as statistically significant and implies that the
greater degree of schooling of the population of a state, the greater the chance of increased
production per person.
4. Finally, foreign direct investment, if logarithms are used, is statistically significant at 0.01 and
has the expected positive sign. In absolute terms, it is statistically significant, but with a negative
sign; it presents a negative correlation with output per person, so it is not possible to reach a
conclusion about its effect on economic growth.

Table 5. Results of the estimation of Equation (7) with the GMM.

Independent Variables Dependent Variable pibpc Independent Variables Dependent Variable logpibpc
0.830284 * 0.750485 *
pibpc(´1) logpibpc(´1)
(167.05) (532.6)
422.8647 * 0.219623 *
edu logedu
(18.33) (43.10)

ied(´1) ´3.49 ˆ 10´8 * 0.000306 *

logied
(´10.54) (2.81)
4.91 ˆ 10´17 * loginver*logdeuda(´3) 5.08 ˆ 10´5 *
inver*deuda (4.53) (3.15)
J-statistic 30.68 J-statistic 38.41
Probability 0.331425 Probability 0.139409
@DYN(pibpc,´2 ) edu ied( ´1) @DYN(logpibpc,´2 ) logedu
Instruments Instruments
inver*deuda logied loginver*logdeuda(´3)
* Significance at 1%, values of t-statistic in parentheses. Source: Own elaboration.

6. Discussion
In this article, using Dynamic Models with panel data and the GMM, there has been evidence
to confirm that between public investment and public debt of the Mexican states, there is a positive
correlation, which is in line with the findings of other researchers. Moreover, it has been shown that
public investment is a positive determinant of economic growth, with which it can be stated that the
debt that has been hiring does have a relatively favorable impact on state economies. However, there
are some points that need to be made.
The first and most important is that the rate of average annual growth of the public debt (7.4%) is
higher than the public investment (5.04%) and this in turn is several times higher than the production
per person. Thus, it is possible to conclude that the contracted debt is not sustainable, which adds that
it does not meet a basic rule for the recruitment of debt—that observed economic growth rate is higher
than the interest rate that you pay on the loan received. From 1993 to 2012, state economies grew 1.5%
on average while the interbank interest rate of reference in 2015 averaged 4.7%.
Although the absolute amount of the debt of states remains low (3.1% of GDP), its trajectory is of
concern because it may occur that at some point in time, the debt, far from contributing to growth,
is detrimental to it, as is explained in the section reviewing the international literature. In addition,
it should be remembered that in this study, public debt that the state governments have contracted
was not considered at all, and it only worked with published information which includes registered
bank debt and equity instruments emissions, leaving out the debt that does not compromise federal
contributions to states that do not have the obligation to report to the federation.
From the study, we can reflect on the true destination of public debt that is contracted by the
state governments. It is very likely that it is channeling other than public investment expenditures,
particularly to cover the operating expenditure of governments. Indeed, Ramírez and Erquizio [27]
demonstrate that there is a positive correlation between public debt and total government spending.
In addition, the debt may be the result of an imbalance of funds from operations in which current
expenses exceed the current funds, because there is no ability to raise what it takes or there are simply
no incentives to do so within the framework of a federation. In any case, this matter may be considered
for further research in this direction.
Int. J. Financial Stud. 2016, 4, 6 12 of 14

The public debt and its relationship with public investment is a matter that leads directly to issues
such as transparency and accountability. It is likely, although it cannot be proved, that spending on
public works is in fact less than that officially reported, and so its effect on the statistical exercise cannot
be strongly identified as positive on economic growth. Government corruption is a widespread
problem in Mexico; the citizens do not believe in the information published by the authorities,
particularly if it has to do with one of its main obligations, such as public investment. According to
Transparency International, this country was classified 103 out of 175 nations in 2014 in the field of
fighting corruption. Remember that the estimation that we perform with absolute values of the ratio
between public debt and public investment was observed in a negative sign, which establishes an
additional element to study more deeply in future research.
Part of the research agenda is to incorporate the most recent information, including the variable
of private investment, and, as stated before, to assess the relationship between public debt and
current expenditure. The public debt should be a priority for the authorities and analysts, since
when a government is into debt, it is taking an important intertemporal choice using resources of the
administrations of the future in order to meet current needs. By virtue of this, the hiring of new debt
must be fully justified; it is particularly relevant to verify that it complies with the “golden rule” and
that there is a positive impact over short-term economic growth.
In light of the results presented, it is recommended to increase public investment and monitor the
effectiveness of multiplier effects; it is not only quantity, but as in many other areas of the economy, it
is a matter of quality. It is also recommended that its funding comes from taxes and not exclusively
from debt, an issue long debated in Mexico, since states are highly dependent on resources received
via the federation: today, of every 100 pesos received by states, 97 pesos come from the federation and
only three pesos are collected internally. Tax reforms should aim at giving the states greater tax powers
and strengthen the legal framework to ensure that public finances are handled more transparently and
citizens may have total certainty over the government’s use of its resources.

7. Conclusions
In summary, the main conclusion of this work is that the public debt may be an option to finance
public investment, as long as it is intended fully for this area and not diverted for other purposes, which
is always likely due to the configuration of the incentives of the political class in power. The current
legal framework should be reformed to expressly state that debt contracted under any circumstances
must not be used in areas other than investment in public works with productive character, introducing
severe penalties for those who do not act in this way. If a reform is not achieved in this direction, in the
next 20 years, we will be speaking about the way in which the sub-national government debt grew
and how it has become an obstacle to economic growth and regional development in Mexico.

Acknowledgments: The authors would like to thank Universidad Autonoma de Ciudad Juarez; Consejo Nacional
de Ciencia y Tecnologia; Programa de Desarrollo del Profesorado de la Secretaría de Educacion Publica.
Author Contributions: These authors contributed equally to this work.
Conflicts of Interest: The authors declare no conflict of interest.

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