The Impact of Governance Environment on Economic Growth: The Case of Middle Eastern and North African Countries

Abstract

The main goal of this paper is to evaluate the impact of governance on economic growth using a group of 188 countries. Although our main focus is on the 21 Middle Eastern and North African (MENA) countries, our findings can be applied to the other countries as well. There are two main contributions in this paper. The first contribution is we are able to create a “composite governance index” (CGI) that summarizes the existing six governance measurements; the Worldwide Governance Indicators (WGI), using the Principal Components Analysis (PCA) method. The first principal component derived from the WGIs explains as large as 81% of the variations in the original six WGI measurements, which indicates that it can be used as a strong indicator for evaluating government’s managerial ability and effectiveness. Following the creation of CGI, the second contribution is we are able to quantify the marginal contribution of improvement in governance to economic performance using PPP adjusted constant per capita GDP data. We find that the per capita GDP would rise by about 2% if the CGI increases by one unit. Using the Rule of 70, the marginal estimate further indicates a mere five-unit improvement in CGI would double the country’s per capita GDP in seven years. Nonetheless, the effect of improvement of governance can not account for the higher than expected per capita GDP in most of the oil rich MENA countries. In other words, the majority of the MENA countries have achieved fragile levels of economic growth that does not depend on sound governance.

Keywords: MENA, Governance, Composite Governance Index, Economic Growth.

JEL Classification: O16, O43, N20.