Does good governance matter for post-pandemic economic growth recovery?

Post-COVID economic recovery could be delayed in countries with poor track records on governance.

Many researchers have examined the effects of good governance on economic growth using different methodologies and data sets, and the findings have been contradictory. In our research, we added a new dimension by asking the question: does good governance matter for recovery in growth after a mega external shock like the pandemic?

We found that the perception about the quality of public services and the ability of the government to design and implement the right policies, free of political pressure, and in full compliance with the rules of the society could lead to higher growth recovery. In short, good governance is indeed a path to recovery during a pandemic. The relationship between a composite governance indicator for 170 countries, using the World Bank governance indicators, and growth forecast for 2021 from the World Economic Outlook turns out to be positive and robust.

What explains this result? We offer three possible explanations. First, an investor or a banker cannot make the right decision if there is high probability of policy reversals or doubts about its implementation. For example, the banker might think that the government could waive all loans to small businesses soon for publicity. Therefore, the banks will not lend to the SME sector. Similarly, an entrepreneur might think that the government could put an end to some tax incentives prematurely. Thus, clear, and credible signaling of sound policies is critical for growth recovery.

The COVID-19 crisis has disproportionately affected poor and vulnerable individuals, adding to the already existing social gaps in many countries of the region. Reviving demand for mass consumption items critically depends on the renewed spending by this segment of the population. Thus, our second explanation focuses on a demand side argument. Targeted, and transparent (free from any patronage) implementation of various government policies, especially those that are designed to strengthen the social safety nets, is important for recovery in growth.

The third plausible explanation draws its genesis from the theory of precautionary savings due to income uncertainty and generally ineffective governance. Consumers are less inclined to spend on durable consumer goods, entertainment, tourism etc. more, with many expecting their household post-tax income could fall in the near future.

Precautionary saving increases if there is rising uncertainty about the future path of disposable income. The problem of ineffective governance and associated uncertainties could be aggravated by the fact that almost all governments increased public expenditure for various reasons during the COVID-19 pandemic – financed primarily by new borrowings.

If the consumers feel that the government will follow the easy route of raising taxes to pay off debt instead of undertaking serious reforms in public financial management, including domestic resource mobilization, then they will tend to save rather than spend and stimulate the economy. In other words, domestic demand may continue to be subdued over a longer period.

The message of our research is clear: convincing policies with sincere intent are needed for economies to enjoy a sustained economic recovery from the pandemic.

This blog post is part of a series by the Asian Development Bank and Thinking Machines Data Science, Inc.