Sound governance and economic growth

Physical capital, human capital and technology progress are factor inputs commonly used to explain how an economy grows over time. We consider an additional factor input, governance, as another pivotal factor that accounts for economic growth. The main goal of this paper is to evaluate how the governance factor contributes to economic growth using a sample of 189 countries. Based on a modified Solow Growth model, the empirical approach takes two steps: First, a “composite governance index” (CGI) is created to summarize the existing six governance measurements; the Worldwide Governance Indicators (WGI), using the principal components analysis (PCA) method. The reason for using PCA is due to the high collinearity problem in the original measurements. The PCA method helps reduce the problem and retain their explanatory power for governance as much as possible at the same time.  Secondly, the quantile regression technique is applied to examine various marginal effects of CGI on per capita GDP. The advantage of using quantile regression enables us to observe how the CGI affects economic growth at different per capita GDP levels, which cannot be obtained using the traditional linear regression model where only the marginal effect on conditional mean is focused.

This research contributes to the economic growth literature on two fronts. (1) A unique and representative composite governance index is created that reduces the dimension of the original measurements. (2) The main findings not only indicate that sound governance is indispensable to economic growth but the effects of CGI on economic growth are different between under-developed and developed economies.