Does Tunisia Need More Economic Freedom to Reduce its Public External Debt?

Abstract This study tests the effect of economic freedom on Tunisian external debt. This empirical study is based on the three-gap model of Bacha (1990) extended by economic freedom indices. To estimate the long-run effect of economic freedom on debt, I use the fully modified ordinary least square (FMOLS) model by Philips and Hansen (1990). From 1980 to 2020, I find that: a one-unit increase in the Fraser Institute and a 10-unit increase in the Heritage Foundation indices reduce the external debt ratio by 0.77 and 0.38 percentage points; economic freedom indirectly affects the external debt accumulation through macroeconomic variables. More economic freedom enhances investment and reduces the negative effect of trade deficit and government expenditure on the Tunisian economy; and finally, to reduce the demand for external borrowing, Tunisia must liberalise its economy and build a good institutional environment that generates additional financial resources.