Structural origins of debt-sustainability in mature and transition economies: Domar, Balassa–Samuelson and Maastricht

• A two-sector model with endogenous industrial structure shows the effect of structural change on debt sustainability.
• The core driver of structural change is shown to be differences in productivity growth across sectors.
• Under some conditions transition economies perform better on debt sustainability than mature market economies.
• Structural flexibility, structural status quo and composition of GDP matter for debt sustainability.
• The results cast doubt on the appropriateness of the one-size-fits-all approach of the Maastricht Criterion on debt.

This paper analyses the relation between the structure of GDP and a country's debt sustainability. A two-sector model with endogenous relative sector sizes is developed to formally show that under certain conditions the debt sustainability, measured as the limiting value of the debt-to-GDP ratio, of transition economies exceeds that of mature market economies. This ‘advantage’ comes from structural factors: sectoral imbalances of growth and shifts in sectoral composition of GDP. Furthermore, among transition economies those with relatively higher structural flexibility can sustain relatively higher debt-to-GDP ratios. How much debt relative to GDP a country can sustain is shown to be highly context specific and depends on the economic structure, composition of growth, structural flexibility, and the prevailing incentives for restructuring. But should a country carry a high debt level relative to GDP just because it can? The paper answers this question by distinguishing between two categories of transition economies: Those that could and should and those that could but should not exploit their capacity to sustain high debt levels.