GOOD GOVERNANACE & ECONOMIC DEVELOPMENT 2018

Abstract

Good Governance has become an important subject in international

development since the end of the 1980s, and since this time in the context of
development studies, development policy as well as development cooperation
we are confronted with the issue of how to improve the governance systems.
Good Governance is a very broad theme, but the main issue is the relation
between the government and the civil society, or still broader, the relation
between the state and the private actors. In contrast to the 1960s and the 1970s
much deeper conclusions are drawn from this discussion. It is not enough to
improve the government machinery, or the public administration, or the civil
service. It is not enough to work on a better local government or for a better
provincial government, or even on a better economic policymaking process. The
term "good governance" basically implies a holistic concept, involving all
spheres of government, the private sector, and the civil society, and all the
interactions between these three poles are relevant. Principles of good
governance matter, as government based on the observance of human rights,
equality, justice, and equity, basic needs provision, effectiveness, and
subsidiary. Based on these principles adequate policies and instruments are
necessary at all government levels, and in the context of all segments of the
private community so as to reach the private actors. Numbers of economists of
development consider that good governance, defined as the quality management
and orientation of development policies has a positive influence on economic
performance. The question is what content the literature gives to the concept of
governance? According to the World Bank, good governance is evaluated by
the implementation capacity of governance principles of a country, providing a
framework for market development and economic growth. We focus on the
definition and the work on the concept of good governance made by the World
Bank and criticism formulated by Mushtaq Khan (2002.2004), who

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reconstructed the notion of governance in a broader sense, taking into account

the capacity of states to drive structural change in institutional, political,
economic and social fields, in order to ensure long-term economic growth.
Is good governance can explain economic performance? Or according to the
thesis of Mushtaq Khan (2002, 2004), reforms of economic structures and
government capabilities are the first step to improve economic performance of
developing countries, and in a second step to allow economic growth to enhance
good governance? Following several works of neo-institutionalist economists
on the relationship between economic growth and good governance (Kauffman
D. and al.1999, 2005, Knack S. and Keefer P. 1997, Hall, R. Jones, C.1999,
Clague, C. Keefer P., Knack S. and Olson M., 1997, Barro R., 1996, Rodrick
D., 1995, 1997, and 2002) emerged two divergent theories of ”state failure” in
developing countries.

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I. Introduction

Numerous economists of development consider that good governance, defined

as the quality management and orientation of development policies has a
positive influence on economic performance. The question is to understand
what content the literature gives to the concept of governance. According to the
World Bank, good governance is evaluated by the implementation capacity of
governance principles of a country, providing a framework for market
development and economic growth. Several econometric studies􀄷 tested the
relationship between good governance in the sense of "market-enhancing
governance" (stimulus institutions market) which showed a positive relationship
between good governance and economic growth. However, a good governance
policy allows developing countries to achieve minimum economic growth and
political reforms in order to reach a level of development similar to that of
industrialized countries? We focus on the definition and the work on the
concept of good governance made by the World Bank and criticism formulated
by Mushtaq Khan, who reconstructed the notion of governance in a broader
sense, taking into account the capacity of states to drive structural change in
institutional, political, economic and social fields, in order to ensure long-term
economic growth.

Can good governance explain economic performance? Or, according to

Mushtaq Khan􀄷 thesis, are reforms of economic structures and government
capabilities the first step to improve economic performance of developing
countries, and in a second step to allow economic growth to enhance good
governance?

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Following several works of neo-institutionalist economist’s on the relationship

between economic growth and good governance two divergent theories of “state
failure” in developing countries have emerged:

The first thesis (market Enhancing governance), defended by neo-institutionalist

authors, considers the state as having a sovereign role and being a welfare state.
Economically, the proper functioning of markets is correlated to the proper
functioning of institutions through efficient practice of state governance, what is
commonly called “good governance”. Therefore, underdevelopment and low
economic growth performance of countries could be explained by “state failure”
due to the increase in corruption, instability of property rights, market
distortions, and lack of democracy.

The second thesis (growth Enhancing governance) developed in particular by

Mushtaq Khan and partly by Dany Rodrik, concerns the ability of the state to
implement social change and pursue a voluntary policy of economic
development: The transition of developing countries towards a capitalist system
comparable to that of developed countries, cannot operate without the
establishment of efficient institutions in relation to distribution of political
power in such countries. Conversely, those countries would face state failure as
a result of a mismatch between institutions and an economic policy of
development.
Our research consists first to present our main results of an empirical study
based on a number of developing countries chosen by region (MENA, Latin
America, and Asia) and their natural resource endowment. The aim is to check
if growth rate may or may not be correlated with good governance indicators as
defined by the World Bank. The goal is to lead in a second time an analysis of
criticism made by Mushtaq Khan on the definition of governance, the causes of

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state failure and barriers to economic development. Our contribution is to

scrutinize the concept of good governance and the failure of states taking into
account the level of development and governance capacity based on a structure
and distribution of political power that evolves over time which may or may not
be positive for growth. The assumption we make here is that the so-called good
governance policies are relevant if countries reach an adequate level of
economic and social development that enable institutions of good governance to
boost growth.

II. Good Governance, State Failure and Economic Growth: The Level of
the Debate

2.1. The approach to institutions neo-institutional economists called good

governance positively affect economic growth.

Institutions are all formal rules (legal, economic, political) and informal rules
(social, behavioural norms, conventions) that structure social life. According to
Douglass North, a distinction should be made between formal and informal
institutions.
Good governance in the definition of the World Bank is the capacity of
management and institutional reforms conducted by state policy that improve
coordination and delivery of effective public services, accountability of political
actors and individual citizens in the driving of development policies. Good
governance, therefore, connects adequate political institutions and practices to
allow development. Several econometric studies tested the relationship between
good governance in the sense of "market-enhancing governance" (stimulus
institutions contract): a positive relationship has been obtained between good

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governance and economic growth. Then implementation of good governance

policies can promote economic development and ensure convergence towards
level of developed economies.

2.1.1 Indicators of Good Governance according to the World Bank:

Presentation and interpretation according to Douglass North thesis.􀄷

The World Bank built composite indicators summarized under six headings:
-“Voice and accountability”: measures tendencies of political process, civil
liberties, political rights and independence of the media. The responsibility is
that of citizens who participate in political life through elections, public
decisions.
-“Political instability and violence”: measures the perception of a possible
destabilization of the political regime through elections or violence.
-“Government effectiveness”: measures the perception of the quality of public
service or public administration. This index assesses the perception of the
government's credibility through the trust given to its administration.
-“Rule of Law”: measures the perception of citizens of the rules that structure
society and the degree of compliance with these rules. The indicator measures
the perception of the efficiency and fairness of the judicial system and respect
for binding contracts and agreements.
-“Quality control”: measures perceptions which are favourable or unfavourable
to a market economy, including anti-liberal interventionist policies, such as
price controls, imports and exports, and the banking system. This index allows
for the appraisal of the business climate for foreign investors, for example.
-“Control of corruption”: measures perceptions of the use of public power in the
pursuit of private gain. These indicators are rated on a scale as appropriate -2.5

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to +2.5 or on a scale from 0 to 100. The lowest indicator is considered as the

least favourable and above that figure the most favourable.
The purpose of the construction of these indicators is to measure the evolution
of good governance by country and implement a policy to improve these indices
in order to ensure that improving good governance could reduce the failure of
the state. Indeed, in the first argument, the state, seen in its functions as a public
services provider, is right but seems to be narrow if it assumes to reflect the
ability of the state to carry out economic development policies and policy and
social changes. The role of the state is certainly to create a set of institutions that
constitute the “rules of the game”, which offer people incentives, opportunities,
so that social coordination operates. The institutions included in the indices of
the World Bank include security of property rights through, for instance, the
“rule of law” indicator. Nevertheless, the improvement of this indicator needs to
take into account the notion of “enforcement”􀄷considered as efficiency or a
certain degree of enforcement. The state must be equipped with skills so that it
has capacity in the binding rules it has issued. Hence, the construction of
institutional indicators would include measuring the degree of respect, quality
and efficiency of the rules.
Institutions and evolution of institutions developed by North􀄷 have influenced
the definition of indicators of the World Bank. North diagnosed failure in
development of the economies of the Third World as due to their institutional
weakness, which causes historical stagnation and contemporary
underdevelopment. Specifically, North highlights the arguments of insecure
property rights, legal rules ambiguity and uncertainty in the behaviour of agents
of the economies of the Third World. From this institutional diagnosis the first
thesis, which puts in relation failure of states and “bad governance” of states
that could not provide an institutional framework conducive to growth and
economic?

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2.2 Empirical results of the work of the World Bank

Daniel Kaufmann􀄷 developed a set of six composite indicators covering nearly
190 measures perception of governance and agglomerates the collection of data
from 17 institutions, out of 170 countries. Kaufmann’s studies correlate the
quality of governance with the per capita income in all the countries studied.
Thus, their econometric studies show a positive relationship between income
per capita growth rates and improvement in the components of each indicator of
good governance.
Daniel Kaufmann concludes with the following assumptions:
- Better governance has a significantly positive effect on per capita income
- An improvement in income leads to better governance.

2.3 Critique of good governance by Mushtaq Khan and the theoretical

alternative to the relationship between institutions and growth in
developing countries.

As seen earlier, economists oppose two theses on the role of institutions in the
definition and establishment of good governance: the so-called theory of
“market enhancing governance” which attributes to the State strictly sovereign
functions of justice, police and compliance with market rules. The state would
be the actor that establishes and strengthens the institutional rules, so that the
market can operate more efficiently by ensuring the exchange contracts, private
property, establishing incentives and binding rules for the market.

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2.3.1 Discussion of Mushtaq Khan’s thesis about relationship between good

governance and economic growth.

Several econometric studies by Daniel Kaufmann and Aart Kraay􀄷, Stephen

Knack and Philip Keefer, Robert Barro, Hall and Jones􀄷 showed that the
variables of good governance, such as control of corruption, stability of
property rights or democracy are closely correlated with variables, such as GDP
growth rate per capita, investment or human capital development. These
empirical tests seek to support the first view already cited about the relationship
between market enhancing governance and economic performance of the
countries implementing it. The purpose of these studies is to show that
improved indices of “good governance” have positive effects on economic
growth and provide long-term convergence with the so called developed
countries.
Among the precautions taken by Mushtaq Khan to interpret the results of this
literature, the question of temporality is questioned: indeed, if we want to test
the effect of good governance mechanisms on economic growth, a reference
period of these institutional indicators should be measured in order to study the
effects on economic growth, for example a decade or two decades later (data
collected by Stephen Knack and IRIS began in 1984 and data collected by
Daniel Kaufmann and the World Bank began in1996). Thus, the authors took
the choice to study the relationship between good governance at the end of the
period of economic growth which began in 1984 for Stephen Knack’s data or in
1996 for Daniel Kaufmann’s data. In effect, the economic growth period studied
is the consequence of political and institutional capabilities developed since the
1950s and 1950s in Asian countries, for example. Good governance indicators
of the eighties and nineties are thus not correlated with economic growth which

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results in the same period. There is a gap period to take into account when
considering the effect of good governance on economic growth; otherwise there
is a methodological bias. So this means, according to Mushtaq Khan, that the
actual relationship studied and not assumed by authors is that of the effect of
economic growth on good governance. However, the dependent variable chosen
is that of economic growth! The second problem is to take into account a
threshold effect in the step reached by countries in their economic growth:
Underdeveloped countries could make efficient good governance policies only
after a period of learning in state capabilities and after reaching a level of
development, so that enhancing good governance indicators could generate
better economic growth rates.

2.3.2 Other theoretical difficulties highlighted by Mushtaq Khan (2007)

The series selected low and high economic growth to allow detection of the
possible correlation between good governance and growth. However, most so-
called emerging Asian countries which have successfully developed their
economies have experienced strong growth rates from the 1960s through 1980.
However, statistical series of good governance indicators start for Stephen
Knack in 1984 (the best) and for Daniel Kaufmann in 1996 (the worst). If we
assume a strong relationship between good governance and economic growth
for these rapidly developing countries, we have a lack of institutional indicators
in their early historic period of economic takeoff. The significance of the
correlation cannot be shown posterior with indicators of “good governance” for
a more recent period of economic growth.
Furthermore, the number of years observed in order to make a robust
econometric test is not sufficient to explain the performance in terms of
economic growth for emerging countries of the Asian region in particular and

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enable better understanding of the institutional mechanisms for their economic

success.
Another major obstacle is that the levels of the indicators of good governance,
although available over the recent period only, do not show a significant
difference between fast-growing countries and countries with slow growth. In
other words, good governance of fast developing countries does not differ
significantly from that of low developing countries. Although we can establish a
significant correlation between good governance and economic growth, the
level of fast-growing countries indicators does not converge with those of the
developed countries.
The empirical results of Stephen Knack and Daniel Kaufmann reveal a strong
correlation between good governance and GDP growth rate per capita, without
convincing that the level of institutional indicators of fast developing countries
can converge with that of developed countries. We can therefore conclude that
the enhancing of good governance cannot be a guarantee of GDP per capita
growth and vice versa, the GDP per capita growth can allow improving
governance without guaranteeing that its level may converge with that of
developed countries. So, it must be inferred that other factors may explain at
once the growth of GDP per capita and the improvement of good governance
indicators.

III. Empirical Study and Main Results

3.1 Content of our model

In this article, we will provide only the results of our previous empirical study􀄷
which aims to offer answers to the questions of the relationship between
economic performance and quality of institutions in 45 developing countries.

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Several models are estimated, first a panel with fixed effects on GDP growth
and GDP per head and finally the growth rate of deviation from the global
average over the period 1996-2011. We tried to explain the role of institutions
in economic performance of different regions studied (MENA, MENA oil, non-
oil MENA, Latin America, East Asia and South). The model chosen for the
study combines the determinants of economic performance (GDP growth rate
and the GDP per capita), Internal (institutional quality), and external
(commodity prices, index of risk perception of global finance and rates Growth
in the developed world)

3.2 Main results

We find that the explanatory variables growth rate of developed countries and
commodity prices are positive and highly significant with a t-stat and the
probability of rejecting H0 is less than 5% of error. Similarly, finance variable
is highly significant but with negative sign in the model of GDP growth rate as
the dependent variable. If the variable is of decomposed institutions, we observe
that the same non-institutional variables are highly significant, but in the
institutional variables, only two variables, namely “government effectiveness”
and “political stability and reducing violence” are very significant. These very
significant variables are the same as those of the model with growth rate of
GDP as an explanatory variable. For the MENA region as a whole, non-
institutional variables are highly significant with negative sign for finance. If we
break down the INSTIT variable, we also get a significance of non-institutional
variables, but for institutions, we retain only the variable “political stability” as
very significant.
We find for the other a negative sign and a lack of significance for “voice and
accountability”, “control of corruption”, “government effectiveness” and “rule
of law”. For the non-oil MENA, only the variable growth rate in developed

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countries is very significant. The price of raw materials is less significant. The
analysis of institutional variables shows that only “political stability” is
significant for non-oil countries. “Voice and Accountability”, “control of
corruption” and “government effectiveness” are not significant and even have a
negative sign.
For the oil MENA, we find that the growth rate of developed countries is very
significant, unlike all other variables. If we analyze effects of institutions, we
find that “political stability” is the most significant. This finding is the same as
that of the non-oil MENA, about the role of institutions on GDP per head.
In Latin America, the decomposition of institutions variable does not change the
significance of non-institutional variables and highlights only the variable
“political stability” as very significant. We note that the variable “voice and
accountability” is positive and weakly significant and the variable “rule of law”
and not meaningful with negative sign.
In Asia, only the variables growth in the developed countries and commodities
are very significant. We find that non-institutional variables, as growth in
developed countries, finance and commodities, are not significant. On the other
hand, we see that three institutional variables are very significant: “voice and
accountability”, “government effectiveness” that are a positive sign and “control
of corruption” that has a negative sign.

3.3 Interpretation of the negative sign of the variable good governance

The presence of institutional variables negative sign leads us to ask ourselves
the inverse relationship between governance and economic growth: it is in fact
admitted in the studies done on “good governance” that improved indices are
positively correlated with the growth of GDP per capita. But how could we
explain the positive effect of these negative institutional indicators on economic
growth? Scholars such as Paul Bardhan􀄷 and Bibel Ben Nahia􀄷 show the

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possibility of a positive effect on FDI in the degradation of institutional

variables as the “quality control” and “control of corruption”. Indeed, the
arguments show that corruption can be favourable to companies wishing to
finance investment projects but come up against bureaucratic obstacles due to
excessive government regulations. These companies are willing to pay a bribe
to speed up administrative procedures. Paul Bardhan􀄷 believes that corruption
in this form generates a time saver since it plays the role of facilitator in
administrative proceedings. According Bibel Ben Nahia􀄷 corruption can have
a paradoxical effect since it can be beneficial to foreign direct investment (FDI).
Kaufmann also discusses this ambiguous effect of corruption which “lubricates
the mechanism” or “greases the wheels”. Other empirical works, such as Peter
Egger and Hannes Winner’s􀄷 support the view of a positive effect of
corruption on direct investments flows: their panel includes 73 developed and
developing countries which capture 90% of direct investments flows worldwide
over the period 1995-1999, using the data on corruption from Transparency
International and the World Bank. The study shows that corruption can have a
short-term positive effect on the entry of direct investment flows. Overall, this
literature can help to provide explanatory elements of the negative signs of
institutional variables such as corruption. The negative sign was notably found
in our estimates for Asia: the experience of Asia in terms of foreign investment
showed that foreign direct investment flows have been enhanced by high levels
of corruption.

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Conclusion:
The work of descriptive and econometric analysis above is a contribution to the
debate on institutional conditions for economic take off in developing countries.
The results of our studies based on a sample of 45 developing countries, do not
permit us to conclude as Kauffman and Knack on high significance in the
relationship between "good governance" and economic growth: in fact, on the
one hand all countries from all regions do not know the significance even on the
same indicators: Asia and Latin America regions converge regardless of the
model tested for the huge significance of the "voice and accountability"
indicator.
Nevertheless the two regions diverge for all models tested on other indicators.
Latin America has a very strong significance of the "political stability and
reducing violence" indicator (all models) and the "Rule of Law" indicator (for
GDP per capital model). In the MENA region only non-oil MENA countries
converge with Latin America for indicators of "political stability" in all models,
and for indicator "rule of law" only in GDP growth per capita model. The oil
MENA region differs in the sense that most of the institutional indicators are
not significant. Otherwise, non-oil MENA and Latin America have a very
significant result for "political stability" indicator for all models. Asian
countries know singular way with a very strong significance of three indicators:
"voice and accountability", "control of corruption" and "government
effectiveness".
The indicator that emerges in our estimates for its strong significance and this
for all models and virtually all regions (excluding Asia) is the "political stability
and reducing violence": the transversal application of this indicator allows us to
conclude that improved political stability is a major institutional factor of
growth and economic catch in developing countries. The argument of the neo-
institutional economists is that improving indicators of 'good governance' is a

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necessary condition for creating the institutional conditions of lowering

transaction costs and thus a competitive market is conducive to increasing the
efficiency in the allocation of resources and the pace of economic growth.
However, this thesis supported by econometric work of Daniel Kaufmann and
Stephen Knack was criticized by Mushtaq Khan especially since the good
governance of fast-growing developing countries indicators are not significantly
different from those of low-growth countries. The thesis of economic catch-up
in developing countries by improving good governance index is weakened by
this. The thesis is more efficient when it comes to carry out economic reforms
and improve governance indices and to improve the operation of an existing
market economy as in the specific case of developed countries.
Nevertheless, this occults in developing countries, structural and institutional
conditions incretion of a market economy and a capitalist economic system
which implies a major social transformation and the emerging of formal and
informal institutional framework. In this issue, the role of the state is crucial in
order to drive economic development: state must acquire skills to orient capital
into economic sectors with high added value and increase productivity.
Khan developed for this purpose the concept of "political settlement" that is
stable and consistent relationship between the distribution of political power, an
institutional framework and economic growth in a country. Instead of "good
governance" as a condition for economic growth, Khan replaces it by the notion
of governance seen as redistribution of power to a stable political coalition
whose interests coincide with those of the reform and restructuring of
the economy, sources of growth and economic and human development.
Our work allows supporting the criticism of Mr Khan on the correlation
between good governance and economic growth to the extent that our empirical
results do not support the huge significance of the correlation nor its
generalization to all developing country regions.

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So, economic growth and take off in developing countries can not only be
explained by good governance indicators as given by institutional authors.
Taking into account the complexity of the issues, including search and
economic rent seeking in the relations between political power and coalitions
functioning of the economy requires to develop a broader analysis of the
concept of good governance to better understand the role of political and
institutional factor in economic development.

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