Measuring Bad Governance

One of the most compelling features of postwar economic history is the continued prevalence of global poverty. Its intransigence is striking given the fact that development has been one of the main items on the international agenda since the end of World War II. The United Nations has numerous branches devoted entirely to reducing poverty, and both the World Bank and the International Monetary Fund have spent billions of dollars to promote development. Many wealthy nations also have government departments devoted to development assistance, and the amount of cash and in-kind transfers these countries have disbursed over the years is substantial. After over half a century of such efforts, success has been scattered and slow, especially given the optimism that was so prevalent in the 1950s. If a dollar a day or less in income is used as the standard of poverty, the United Nations (2002) reports that the percentage of poor people in all developing countries fell between 1987 and 1999 from 28 to 24 percent, but very unevenly. A recent estimate suggested that almost half the world's population lives on less than two dollars a day (Duraippah 2000), and progress has varied tremendously by region. East Asia, particularly China, has showed dramatic progress, and India has advanced modestly since the early 1990s. But much of Latin America and sub-Saharan Africa has shown very little improvement. In addition, many nations that were once thought to be potential stars of development, such as Argentina and Brazil, have struggled mightily during most of the postwar period, even as other nations such as Singapore, Mauritius, and Chile have had unexpected success. What might account for this pattern of long-term, widespread failure combined with isolated but dramatic success? While the 1990s saw the emergence of the "Washington consensus," the belief that good economic policy was essential to growth, there is still a widespread belief that the failure to grow is often due to factors partially or substantially out of control of developing-country governments. Geography and biology (Diamond 1997), political and social instability (Chen and Feng 1996), and harmful cultural norms (Lal 1988) are among the contrary explanations offered for poor economic performance. But these variables are difficult to change unless they do so endogenously as a result of growth, and so a fatalistic attitude toward poverty alleviation suggests itself when they are emphasized as causes of poverty. But if bad economic policy--more broadly thought of as bad governance--is largely to blame, there is room for hope. This article investigates the effects of government policy on growth. Its goal is to see whether a prima facie case can be established that bad policy is responsible for much of the poor economic performance in the developing world in the post-colonial period. The findings provide a contrast to Easterly (1993), who argued that luck is more important than policy in determining who grows and who does not. Easterly (2001) also contends that good policy has had disappointing effects on growth, while Klein and Luu (2003) and Burnside and Dollar (2000) argue that sound policy is critical. The literature that diminishes the role of policy does not try to estimate its full effect on growth, an omission this article remedies. Obtaining Estimates of the Determinants of Growth The approach taken here is similar to that of Barro (1991, 1997), who adopts the neoclassical growth model as his starting point and argues that at any moment an economy has potential as well as actual output. Potential output is defined by the available production technology, including the ability of human capital to augment the productivity of physical capital, by government policy choices, and by factors beyond any government's control. A government that provides the most productive public goods, enforces property rights, and controls externalities--while avoiding distortions and the costly disincentives of excessive or inappropriate taxation--will have a higher level of potential output, as will a country that can trade with others on favorable terms. …