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Governance, Incentives and Elections as Determinants of Economic Performance, Aid and Investment Flows

19 September 2012
Publication Type: Working Paper

Scholars have focused their efforts to explain poor growth and development in regions such as Sub-Saharan Africa, and parts of Asia, Eastern Europe, and Latin America, using arguments based on quality of institutions and geography and the structure and process of resource allocation and endowment. This paper presents a different argument based on an incentive compatibility and asymmetric information framework. We characterize the decision-making problem in government and public sector as being fraught with mis-information about the true state of economic performance. Misinformation can also result in a legal liability which may depend on probability of losing elections, income, and attitude to risk. The agency conflicts between the elected politicians and career-bureaucrats contribute to the mis-information problem, resulting in poor policy choices that may lead to poor economic performance. The role of international financial aid flows is examined and the paper argues that such aid flows may only serve to subsidize the inefficiencies of political leaders and reduce the economic gap created by poor policy choices. More financial aid flows may not be a panacea for poor economic growth and its insurance characteristics may cause recipient governments to choose even riskier policies. We also examine why Foreign Direct Investment (FDI) flows to poor regions, such as Sub-Saharan Africa, are low. We show that the risky policy choices create conditions that increase the value of the option-to-wait on investment decisions, thus reducing the flow of FDI. We undertake empirical analysis on some African Countries and show that the quality of governance influences GDP growth, Employment Creation, and Poverty Reduction in Africa.

Series title: Working Paper 025
1 September 2006
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