Examnng the dmensons of governance that are relevant for prvate nvestment BEH, Aprl, 21 Peer-revewed & Open access journal ISSN: 184-125 www.peb.cz BEH - Busness and Economc Horzons Volume 1 Issue 1 Aprl 21 pp. 3-7 Examnng the dmensons of governance that are relevant for prvate nvestment Quan Vu Le Department of Economcs, Albers School of Busness and Economcs, Seattle Unversty, USA, e-mal: lequ@seattleu.edu Meenaksh Rsh Department of Economcs, Albers School of Busness and Economcs, Seattle Unversty, USA, e-mal: rshm@seattleu.edu Whch types of governance ndcators matter the most for prvate nvestment? Ths short paper answers the queston by examnng the mpact of specfc governance ndcators on prvate nvestment n a cross-secton of developng economes. Results ndcate that an effectve government that ncludes competent and ndependent cvl servce and credble governmental polces are postvely assocated wth prvate nvestment. Far and predctable rules of the game that determne the extent to whch property rghts are protected also facltate greater prvate nvestment. Based on ths the paper concludes that snce some ndcators of governance matter more than others, targeted nsttutonal reform that focuses frst on the sgnfcant dmensons may be key to facltatng prvate nvestment n developng areas. JEL Classfcatons: E2, E22, 16 Keywords: Prvate nvestment, governance, developng economes. Introducton Governance matters! Good nsttutons are mportant for economc growth and economc development (North, 199; Rodrk, 21; Kaufmann et al., 2; La Porta et al., 1999). Whle emprcal lterature on the channels by whch weak nsttutons mpact economc growth s stll nascent, the postve mpact of prvate nvestment on economc growth has been well documented (Khan and Renhart, 199). What determnes the prvate nvestment decson? Although research has manly focused on economc polces, market sze ssues, and the rsk envronment as man determnants of gross nvestment behavor (Salahuddn and Islam, 28), there s some consensus on the sgnfcance of nsttutonal qualty n creatng a salutary for prvate nvestment. Indeed, prvate nvestment has surfaced n lterature as a medatng channel between good governance and economc growth (Mauro, 1998). Ths emphass on prvate nvestment motvates our nvestgaton of the lnkages between governance and captal formaton n the prvate sector. The research queston asked by ths paper, smply stated, s - whch types of governance ndcators are sgnfcant for prvate nvestment n developng economes? To ths end, the paper examnes the mpact of dfferent dmensons of nsttutonal qualty on prvate nvestment n a sample of 47 developng economes. The emprcal analyss utlzes a multdmensonal vew of governance as proposed by the Worldwde Governance Indcators (WGI) that reports governance ndcators for several countres over 1996 27, for sx dmensons of governance, vz., Voce and Accountablty, Poltcal stablty and Absence of Volence, Government Effectveness, Regulatory Qualty, Rule of law, and Control of Corrupton (Kaufmann et al., 27). An examnaton of whch types of governance ndcators matter for prvate nvestment has mplcatons for polcy. Much of the current polcy thrust n developng economes s on the expanson of prvate nvestment and on nsttutonal reform as a prerequste for a prvate nvestment-led growth strategy (Rodrk, 21). However, there has been no agreement on the ngredents of governance that encourage prvate nvestment n developng economes. As a matter of practcalty, broad-based nsttutonal reform may not be feasble for such economes gven ther resource constrants. Perhaps, examnng the dmensons of governance that matter the most for prvate nvestment n these countres wll help prortze an nsttutonal reform agenda for polcymakers. The paper s organzed as follows. The next secton surveys pertnent lterature on governance and prvate nvestment and motvates the paper s focus. Research methodology and data employed n the analyss are dscussed n the followng secton. The rest sectons present the econometrc results and conclusons. 21 Prague Development Center - 3 -
Examnng the dmensons of governance that are relevant for prvate nvestment BEH, Aprl, 21 Governance and prvate nvestment Poor nsttutonal qualty vtates the nvestment clmate and ncreases the rsk assocated wth the nvestment decson. Such rsks can n effect staunch the wllngness of the prvate sector to nvest (Johnson et al., 2). The mportance of nvestment to economc growth has prompted research on the sgnfcance of governance on prvate captal accumulaton. However, most studes have concentrated on examnng the mpact of partcular governance ndcators on prvate nvestment. Noteworthy among these are studes that are focused on the connectons between securty of property rghts and prvate nvestment, especally n the context of developng economes (Mauro, 1995; Knack and Keefer, 1995). Other specfc dmensons of governance and ther sgnfcance for prvate nvestment have also been explored n the lterature. Emprcal and poneerng work by Barro (1991) posts a negatve assocaton between poltcal volence and prvate nvestment as a share of GDP. Pastor and Hlt (1993) emprcally document the postve mpact of democracy (voce) and poltcal openness on prvate nvestment. The qualty of publc servce provson, bureaucratc qualty, and polcy credblty also seem to matter for prvate nvestment as has been underscored n Jacobs (22, p.1) who asserts that the underperformance of prvate nvestment n Asa s utlty sectors may by related to nvestor doubts about the qualty of the regulatory envronment. Fnally, there s a growng body of lterature that partcularly focuses on the corrupton dmenson of governance and examnes ts effect on prvate nvestment. Mauro (1995) and Pellgrn and Gerlagh (24) examne corrupton and ts consequences for prvate nvestment and growth. Smlarly, Wedeman (1997) contends that the level of corrupton can vtate the domestc nvestment clmate by contrbutng to uncertanty and nsecurty. In sum, the extant lterature on governance and prvate nvestment has only establshed the sgnfcance of nsttutonal qualty by studyng the mpact of partcular ndcators of governance. There has been no study that fully explots the multdmensonal nature of governance by consderng the mpact of several markers of nsttutonal qualty. In ths regard, our analyss seeks to add to the lterature on governance by econometrcally examnng the relevance of a cluster of ndcators on the prvate nvestment decson. Such an nvestgaton, as dscussed above, s mportant n the context of prortzng nsttutonal reform for resource constraned developng economes. Data and model Our emprcal nvestgaton conssts of an econometrc analyss of a sample of 47 developng economes over the 199s. The sample and tme-perod were determned by data avalablty. The key source of governance data, vz. the WGI, provdes data for 1996, 1998, 2, and 22-26. However, the IFC dataset supples prvate nvestment data only from 197 to 1998. There are also many gaps n the seres, whch further restrct the sample sze and study perod. Fgure 1 llustrates the smple relatonshps between sx governance ndcators and prvate nvestment. A postve correlaton s ndcated whch warrants further study. The followng econometrc model provdes a framework of analyss. PRIVINV α + βx + ηz + µ =, (1) where, PRIVINV s the share of prvate nvestment n GDP and X s a vector of control varables. Z represents the sx dmensons of governance. Data on the dependent varable, PRIVINV, were obtaned from Bouton and Sumlnsk (2). The control varables employed are: the log of real GDP per capta n 199 (LNGDPPC) - a proxy for country sze; the annual growth of real GDP per capta n the 199s (GROWTH), and the amount of credt avalable to the prvate sector (CREDPRIV). Data on these varables were acqured from the World Development Indcators and ther coeffcents are expected to be postve per economc theory. Another control varable s the share of publc nvestment n GDP (PUBINV) taken from Bouton and Sumlnsk (2). The sgn on PUBINV s ambguous - t depends on the relatve strength of crowdng out versus crowdng n (Khan and Renhart, 199; Pastor and Hlt, 1993, Ramrez, 26). Data on governance are obtaned from the WGI research project whch computes aggregate perceptons about sx ndcators of nsttutonal qualty from 31 data sources provded by 25 organzatons. These are: voce and accountablty, VOICE, poltcal stablty and lack of volence, POLSTAB, governance effectveness, GOVEFF, regulatory qualty, REGQUAL, rule of law, RULE, and control of corrupton, CONTLCORR. Descrptve statstcs of the varables are presented n Table 1. 21 Prague Development Center - 4 -
Examnng the dmensons of governance that are relevant for prvate nvestment BEH, Aprl, 21 Alternatve measures of governance, such as those compled by the Internatonal Country Rsk Gude (ICRG) are extremely broad and therefore too nosy for our analyss. Salahuddn and Islam (28) employ ICRG as a proxy for uncertanty and fnd an nsgnfcant mpact on nvestment. FIGURE 1. PRIVATE INVMENT AND GOVERNANCE INDICATORS 4 4 3 2 1 TUR CHN MEX ECU POL CRI 3 2 1 LBY EGY CRI POL MWI - -1. -. 1. -2. - -1. -. 1. Voce and Accountablty Poltcal Stablty and Absence of Volence 4 4 3 2 1 DOM PAN TUN EGY BEN 3 2 1 LBY GNB SLV - -1. -. 1. -3-2 -1 1 2 Government Effectveness Regulatory Qualty 4 4 3 2 1 GNB KEN MEX ZAF CHN 3 2 DOM UZB 1 VEN BOL BRA ZAF -2. - -1. -. 1. -1. -. 1. Rule of Law Control of Corrupton 21 Prague Development Center - 5 -
Examnng the dmensons of governance that are relevant for prvate nvestment BEH, Aprl, 21 TABLE 1. DESCRIPTIVE STATISTICS Mnmum Maxmum Mean Std. Devaton PRIVINV 3.771 3.25 13.718 5.953 LNGDPPC 671 9.435 8.198.729 GROWH -2.95 5.76 1.348 1.78 PUBINV 1.96 2.757 7.799 4.143 CREPRIV 4.71 12992 3557 29.17 VOICE -1.346 1.345 -.137.7 POLSTAB -1.79 1.144 -.178.642 GOVEFF -1.322 1.166 -.231 37 REGQUAL -2.376 1.233.116.675 RULE -1.615 1.279 -.218.686 CONTLCORR -.963 1.29 -.285.478 Results Table 2 contans econometrc results. The postve and sgnfcant sgns on the control varables LNGDPPC and GROWTH as dsplayed n the table are per expectaton. PUBINV s negatve but nsgnfcant. The postve and sgnfcant sgn on CREDPRIV s agan per expectaton. Regardng our varables of nterest, Table 2 ndcates that only two dmensons of governance, vz., GOVEFF and RULE matter for prvate nvestment across the sample. The Adjusted R2 statstcs are qute hgh for each regresson, as the regressors explan close to 5 percent of the varaton. Despte the lmtatons of cross-sectonal regressons, the analyss s suggestve. Our results demonstrate that an effectve government that ncludes competent and ndependent cvl servce and credble governmental polces s postvely assocated wth prvate domestc nvestment across the sample. Far and predctable rules of the game that determne the extent to whch property rghts are protected also contrbute to greater prvate nvestment n the same sample. TABLE 2. OLS REGRESSIONS FOR PRIVATE INVMENT AND GOVERNANCE INDICATORS (1) (2) (3) (4) (5) (6) CONSTANT -8.342 (9.653) -4.428 (1.296) -3.931 (9.293) -9.821 (934) -.89 (1.45) -6.931 (9.337) INITIAL LNGDPPC 2.455** (1.165) 2* (1.21) 2.32* (1.88) 2.647** (1.174) 77 (1.29) 2.359** (1.91) GROWTH.873** (.438).862** (.428).88** (.42).851** (.437).753* (.424).86** (.429) PUBINV -.224 (.191) -.273 (.194) -.229 (.185) -.23 (.21) -.276 (.187) -.229 (.189) CREDPRIV.69** (.28).68*** (.28) 6* (.29).69** (.28).65** (.28).63** (.29) VOICE.392 (1.16) POLSTAB 1.169 (1.194) GOVEFF 2.424* (1.476) REGQUAL 5 (62) RULE 1.989* (1.211) CONTLCORR 1.355 (35) Adjusted R 2.476.486 6.474 6.484 No. of Obs. 47 47 47 47 47 47 Notes: Whte heteroskedastcty-constant standard errors n parentheses. *** Sgnfcant at 1%; ** sgnfcant at 5%; * sgnfcant at 1%. 21 Prague Development Center - 6 -
Conclusons Examnng the dmensons of governance that are relevant for prvate nvestment BEH, Aprl, 21 Ths artcle adopts a multdmensonal vew of governance and tests the mpact of sx specfc governance ndcators on prvate nvestment across a sample of developng economes. Our results suggest that some ndcators of governance matter more than others. In partcular, effectve enforcement of the rule of law and mprovng the effcency of government n delverng servces, matter the most for the prvate nvestment decson. Insttutonal reform that focuses frst on these dmensons s vtal to encouragng prvate nvestment n our sample of developng economes. References Barro, R., 1991. Economc growth n a cross secton of countres, Quarterly Journal of Economcs, Vol. 16, pp. 47-443. Bouton, L., Sumlnsk, M., 2. Trends n prvate nvestment n developng countres: Statstcs for 197-1998, Dscusson Paper 41, World Bank, Washngton, D.C. Jacobs, S., 22. Better regulatory governance: Can t stmulate prvate nvestment n Asa s nfrastructure?, Vol. 34, Asan Development Bank, Manla. Johnson, S., Kaufmann, D., McMllan, J., Woodruff, C., 2. Why do frms hde? Brbes and unoffcal actvty after communsm, Journal of Pubc Economcs, Vol. 76, pp. 495-53. Kaufmann D., Kraay, A., Mastruzz, M., 27. Governance Matters VI: Governance Indcators for 1996-26, World Bank Polcy Research Workng Paper No. 428, World Bank, Washngton D.C. Khan, S., Renhart, C., 199. Prvate nvestment and economc growth n developng countres, World Development, Vol. 18, pp. 19-27. Knack, S., Keefer, P., 1995. Insttutons and economc performance: Cross-country tests usng alternatve nsttutonal measures, Economcs and Poltcs, Vol. 7, pp. 27-227. La Porta, R., López-de-Slanes, F., Shlefer, A., Vshny, R., 1999. The Qualty of Government, Journal of Law, Economcs, and Organzaton, Vol. 15, pp. 222-279. Mauro, P., 1998. Corrupton and the composton of government expendture growth, Journal of Publc Economcs, Vol. 69, pp. 263-279. Mauro, P., 1995. Corrupton and economc growth, Quarterly Journal of Economcs,Vol. 11, pp. 681-712. North, D., 199. Insttutons, nsttutonal change and economc performance, Cambrdge Unversty Press, Cambrdge. Pastor, M., Hlt, E., 1993. Prvate nvestment and democracy n Latn Amerca, World Development, Vol. 21, pp. 489-57. Pellgrn, L., Gerlagh, R., 24. Corrupton s effect on growth and ts transmsson channels, Kyklos, Vol. 57, pp. 429-456. Ramrez, Mguel D., 26. Does foregn drect nvestment enhance prvate captal formaton n Latn Amerca? A pooled analyss for the 1981-2 perod, Journal of Development Areas, Vol. 4, pp. 81-97. Rodrk, D., 21. Tradng n llusons, Foregn Affars, Vol. 123, pp. 55-62. Salahuddn, M., Islam, M., 28. Factors affectng nvestment n developng countres: A panel data study, Journal of Development Areas, Vol. 42, pp. 2-37. Wedeman, A., 1997. Looters, rent-scrapers, and dvdend collectors: Corrupton and growth n Zare, South Korea, and the Phlppnes, Journal of Developng Areas, Vol. 31, pp. 457-478. World Development Indcators 29, World Bank, Washngton, D.C. 21 Prague Development Center - 7 -