The Interactions between Governance Quality and Economic Development

Abstract

In this chapter, we investigate the interactions between governance quality and economic development. More specifically, we analyze how the institutions through which state authority is exercised influence the level of economic development. In that respect, governance could be considered as a quasi-factor of production which affects the country's economic growth and development, an issue that lies in the heart of institutional economics. The effect of governance on economic development is mainly played out via two channels. Namely, the quality of democracy, distinguished in political rights and civil liberties, and the level of corruption, associated with the exercise of state authority. Good governance is in principle associated with a high quality of democracy and a low level of corruption. Both generate positive effects on the level of economic growth and development, mainly due to their impact on state effectiveness and private and public investment. At the same time, there also exists an inverse causality: the level of economic development affects positively the quality of democracy and negatively the level of corruption which in turn tend to improve the quality of democracy. These coexistent mechanisms are associated with crucial policy issues which are largely neglected by the traditional theory of economic growth.