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.