The Role of Policy Fundamentals in Fostering Economic Growth in Developing Countries

Abstract

This paper examines the role of policy fundamentals in fostering economic growth in developing countries. Based on data from the World Bank for the 2000-2011 period and a sample of sixty-two developing economies we find that the growth rate of per capita GDP is dependent on a country’s investments in human capital as measured by the share of the public sector in total health expenditure and by the relative size of public education in the government’s budget, on an enabling business environment as measured by two Doing Business indicators, namely the cost of starting a business as a percent of per capita income and the number of days required to enforce contracts, and by the share of losses due to theft, robbery, vandalism, and arson in sales as reported in the enterprise surveys, on the depth of the credit information index and the share of domestic credit provided by the banking sector in the GDP, on the initial level of per capita GDP, and on the share of the net inflow of foreign direct investment (FDI) in the GDP. We observe that the coefficient estimates of two explanatory variables, namely, the share of the public sector in total health expenditure and by the relative size of public education in the government’s budget, do not have their expected sign, possibly to the collinearity between these variables and the cost of starting a business as a percent of per capita income as well as with the initial level of per capita GDP. In addition, the share of the public sector in total health expenditure is not significant via using the t-test. We suspect that this is also due to the collinearity between this variable and the cost of starting a business as a percent of per capita income as well as with the initial level of per capita GDP. Statistical results of such empirical examination will assist governments in developing countries and focus on appropriate policy fundamentals in order to foster economic growth.