Growth without Governance

Abstract

Growth without Governance Daniel Kaufmann (bio) and Aart Kraay (bio) Per capita income and the quality of governance are strongly positively correlated across countries. We propose an empirical strategy that allows us to separate this correlation into two components: a strong positive causal effect running from better governance to higher per capita income and a weak and even negative causal effect running in the opposite direction from per capita income to governance. The first result confirms existing evidence on the importance of good governance for economic development. The second result is new and suggests the absence of virtuous circles in which higher incomes lead to further improvements in governance. This motivates our choice of title, "Growth without Governance." We document this evidence using a newly updated set of worldwide governance indicators covering 173 countries for the period 2000-01, and we use the results to interpret the relationship between incomes and governance in Latin America and the Caribbean region. Finally, we speculate as to the potential importance of elite influence and state capture in accounting for the surprising negative effects of per capita income on governance, present evidence on such capture in some Latin American countries, and suggest priorities for actions to improve governance when such pernicious elite influence shapes public policy. The starting point of the paper is the strong positive correlation between various measures of governance and per capita income. Figure 1 plots the relationship between governance (on the vertical axis) and log per capita [End Page 169] Click for larger view View full resolution Figure 1. Governance and per Capita Incomes in Latin America and the Caribbeana [End Page 170] Click for larger view View full resolution [End Page 171] Click for larger view View full resolution [End Page 172] income (on the horizontal axis) in a large sample of countries, for six different dimensions of governance. Per capita incomes are measured in 1995, in 1985 U.S. dollars adjusted for differences in purchasing power; the governance indicators refer to the period 2000-01. Since initial incomes in the distant past are not very different across countries, the current dispersion in per capita incomes on the vertical axis reflects differences in growth across countries in the very long run. Figure 1 can thus also be interpreted as illustrating the relationship between growth in the very long run and current institutional quality. Interestingly, the countries in the Latin American and Caribbean region display striking differences in performance on different measures of institutional quality relative to their per capita incomes. In terms of the institutions of political accountability, countries in Latin America and the Caribbean fare well relative to their per capita incomes, in the sense that a strong majority of countries in the region lie above the simple ordinary least squares (OLS) regression line of the voice and accountability measure on per capita income. In contrast, most countries in the region fare surprisingly poorly on three other dimensions of governance (namely, government effectiveness, rule of law, and control of corruption). Finally, for the last two dimensions of governance that we consider (political stability and regulatory quality), countries in Latin America and the Caribbean are fairly evenly distributed above and below the OLS regression line. Table 1 summarizes these patterns by indicating the proportion of the twenty-six countries in the region for which we have data that fall above and below the regression line. The last column also reports the p value associated with the null hypothesis of a sign test that countries in Latin America and the Caribbean are evenly distributed above and below the regression line for the entire sample. For the first four indicators we mention, the noted patterns are strongly statistically significant at conventional levels, with Latin America and the Caribbean faring well in the first indicator (political accountability), but poorly in the following three (government effectiveness, rule of law, and control of corruption). This paper provides an interpretation of the strong positive correlation between governance and per capita income shown in figure 1. The following section describes how we constructed the governance indicators for 2000-01 used in figure 1 as part of an ongoing project to measure governance worldwide, drawing on...