Governance, Growth, and Aid Effectiveness

Abstract: This essay examines the relationship between governance, aid effectiveness and economic growth using a newly developed governance index consisting of a variable for institutional quality from the Fraser Institute and three policy variables. The governance index is an extension to the policy index developed by Burnside & Dollar (2000). As earlier research has predicted, the author finds that aid alone has no significant positive effects on growth. However, aid interacted with governance has a significant positive effect on growth. These results are especially strong in low income countries. More importantly is that the essay reaffirms the importance of good policies and good governance on growth controlling for endogeneity problems in the variable for institutional quality and the governance, and policy indices. Good governance by itself is found to be very important for economic growth.