This document discusses the importance of good governance for economic growth and well-being. It summarizes research finding that improving governance can significantly increase GDP growth rates over time by enabling greater physical and human capital accumulation. At the firm level, less corruption is associated with higher sales growth and productivity gains. The document also finds that better governance has a direct, positive impact on life satisfaction, above and beyond its effects on income levels. Residents in countries with weaker governance are also more likely to express an intention to emigrate. While governance has strengthened over time in many regions, significant gaps remain compared to advanced economies.

1. Alexander Plekhanov
Office of the Chief Economist
Governance and
economic development

2. Governance concerns authority, decision-making
and accountability in all domains
2
https://www.aeaweb.org/articles?id=10.1257/app.20130170
Governance is about the quality of institutions and the processes that they support
Institutions = broad rules of the game in a society (North, 1990)
• National-level governance
• Governance in regions and municipalities
• Governance in firms
• Green governance of firms

3. Examining views of firms using Enterprise Surveys
3
Source: Enterprise Surveys and authors’ calculations.
Enterprise surveys: Average percentage of sales diverted to informal payments
Building on data on 18,000+ firms surveyed as part of Enterprise surveys 2018-19 in EBRD regions, previous
rounds 2008-09 & 2011-14
Senior managers evaluate 15+ aspects of the business environment + questions about firms’ performance
Special modules on the green economy, management practices and the use of CEO time

4. And looking at residents’ perceptions of governance
and quality of public services using Gallup World Poll
4
Source: Gallup World Poll and authors’ calculations.
Gallup World Poll: Global coverage since 2006, measures of life satisfaction
How much life satisfactions do higher incomes buy?
How much does the quality of governance matter?

5. Use Worldwide Governance Indicators
to measure country-level governance
5Source: World Bank, IMF and authors’ calculations. Simple average of the Worldwide Governance Indicators of control of
corruption, rule of law, regulatory quality and government effectiveness.
Worldwide governance indicators at a glance, 2017
Control of corruption, rule of law, regulatory quality and government effectiveness scaled -2.5 to 2.5
[also voice and accountability and political stability and absence of violence]
Results are similar for other measures as shown in TR 2013

6. The governance dividend

7. EBRD regions had weak governance in the mid-1990s
relative to advanced economies and many EMs
7Source: World Bank, IMF and authors’ calculations. Simple average of the Worldwide Governance Indicators of control of
corruption, rule of law, regulatory quality and government effectiveness.
Economies in the EBRD regions had relatively weak governance in the mid-1990s
In contrast with relatively strong skills

8. Countries’ progress was somewhat faster than in
other EMs with comparable per capita income levels
8
Source: World Bank, IMF and authors’ calculations. Average of the Worldwide Governance Indicators of control of corruption, rule of law, regulatory
quality and government effectiveness. Low-income = income below Tajikistan at market exchange rates in 2017, high-income = above Slovenia.
Economies in the EBRD regions have strengthened the quality of institutions faster
than other EMs with comparable income level
Transition reforms, EU accession played an important role (see TR 2013); most progress in regulatory quality
For emerging markets in general, governance gap with respect to advanced economies has been widening
even as the income gap has (slightly) narrowed

9. In the end, the governance gap with respect to
advanced economies remains large
9
Source: World Bank, IMF and authors’ calculations. Quality of economic institutions is captured by the average of the Worldwide
Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness. 2017 or latest available.
Governance gap with respect to advanced economies remains large
Most advanced economies are well above the linear trend line – governance becomes particularly important as
growth models rely on innovation, entrepreneurship vs import of technology and economies of scale

10. Enterprise surveys also show that constraints
on business have become less severe over time
10
Source: Enterprise surveys and authors’ calculations. Averages on a 0-4 scale (“no obstacle” to “severe”). Comparator economies are those with
similar per capita incomes and where surveys were conducted both in 2006-10 (diamonds) and in 2016-19 (bars). Israel: 2013, Sweden: 2014.
Constraints on business have become less severe over time
Improvements in the EBRD regions are larger than among comparators with similar per capita income
(mainly in Latin America – due to survey coverage) – but levels remain higher than in advanced economies

11. And corruption is no longer in top 3 constraints
as seen by firms
11
Source: Enterprise surveys and authors’ calculations. Averages on a 0-4 scale (“no obstacle” to “severe”). Comparators are economies with similar
per capita incomes and where surveys were conducted both in 2006-10 (diamonds) and in 2016-19 (bars). Sweden/Israel surveyed in 2013-14.
Corruption no longer features among the top 3 constraints to doing business
In contrast with 2008-09 when, with the exception of Central Europe, it consistently featured in the top 3
Among comparators, perception of corruption improved but it remains in top 3 – also in Russia and SE Europe

12. Improvements in regulations in Doing Business –
firms’ experiences often differ significantly
12
Source: World Bank Doing Business, Enterprise Surveys and authors’ calculations. Values for Enterprise Surveys are estimated for a firm
approximating Doing Business case studies based on a linear regression of firms’ answers (log number of days) on firm characteristics.
Improvements in regulations in Doing Business surveys and based on firms’ experiences
Doing Business measures days it takes to eg get a permit based on laws on the books and expert opinions;
enterprise surveys provide a snapshot based on enterprises’ experiences – which take into account
enforcement of rules and use of alternative channels so actual length of time tends to be shorter than in DB
The number of days it takes to obtain construction permit, 2008 → 2019

13. Improvements in the quality of institutions
relative to global average have slowed down
13
Source: World Bank, IMF and authors’ calculations. Quality of economic institutions is captured by the average of the Worldwide
Governance Indicators of control of corruption, rule of law, regulatory quality and government effectiveness.
Improvements in the quality of economic institutions in Central and SE Europe have slowed down
In Central and SE Europe the Worldwide Governance Indicators peaked in 2014, as EU accession
momentum subsided, populism gained momentum in a number of economies

14. And a widening governance gap as seen by residents
in the Gallup World Polls
14
Source: Gallup World Poll and authors’ calculations. Index is based on 6 questions covering trust in corruption not being widespread throughout
the government or business, confidence in the national government, the judicial system and courts, honesty of elections and freedom of media.
A widening governance gap as perceived by residents

15. High growth dividend from improving institutions –
mainly through building physical and human capital
15Source: IMF, World Bank, Penn World Table 9.0 and authors’ calculations. An “improved-governance” scenario assumes that countries close
half of the gap between the levels of their economic and political institutions and those in the G-7 economies.
https://www.aeaweb.org/articles?id=10.1257/app.20130170
Scenario: Closing half-gap in economic institutions between Ukraine and G7 (to today’s Croatia) over 10 years
Calibrated based on past experiences of large improvements governance; conservative assumptions
Similar conclusion when looking at the aftermaths of closely-fought elections
In a scenario with improved governance, income per capita growth in Ukraine is at least 1.2% per annum higher

16. At firm level, less corruption is associated
with higher growth of sales and productivity
16
Source: Enterprise surveys and authors’ calculations. Firm’s informal payments are instrumented using the average value for the region and sector
where the firm operates. “Kvetch” = firm’s perception of transport, electricity access to land minus country average perception. 95% conf. intervals.
A one standard deviation improvement in governance is associated with a 1.4% per annum faster sales growth
Firms that grow faster may have to deal with a larger number of regulations such as getting new licenses --
firm’s exposure to corruption is instrumented with average answer for region-sector (excluding the firm)
Control for a firm’s tendency to complain (“Kvetch factor”, Kaufmann and Wei, 2000)

17. The dividend adds up over time – difference of a
generation in duration of income convergence
17Source: IMF and authors’ calculations. Based on income levels measured at PPP. Where data are missing, no convergence is expected on the
basis of observed growth rates.
Income convergence is now forecast to take longer – unless governance improves

18. Poor governance affects well-being directly,
in addition to being a constraint on growth
18Source: Gallup World Poll and authors’ calculations. Perception of governance is instrumented using average of randomly selected subsample
of observations in the same region (1/2 of total number), which are excluded from the main sample. Controlling for propensity to complain.
In Ukraine, 1 sd improvement in governance has the same impact on life satisfaction as +US$270 per month;
closing half-gap in governance to G7 is associated with closing 15% of happiness gap ( 8pp direct effect)
People are likelier to state intention to emigrate if they are dissatisfied with governance
Life satisfaction is significantly higher where governance is stronger

19. People are likelier to state intention to emigrate
if they are dissatisfied with governance
19Source: Gallup World Poll and authors’ calculations. Calculated by regressing intentions to emigrate on each governance indicator in turn,
using a linear probability model with survey-weighted observations. All regressions take account of demographic characteristics. 95% intervals
In Albania, having confidence in government fighting corruption reduced intention to emigrate by as much as
extra US$ 400 per month
People with low levels of confidence in public institutions are more likely to report an intention to emigrate

20. Source: EBRD. Close to 200 reformers are supporting reform delivery
Strengthening country-level institutions is difficult
but possible: Evidence from Ukraine
State capacity relies on developing local expertise, not simply importing foreign know-how
Nurturing reform coalitions is key to effecting real change
Built-in flexibility encourages local ownership and long-term sustainability
20

21. Advance of (uncensored) internet fosters
transparency, especially in weak-governance
countries
21Source: Guriev et al. (2019). The dots show the means of the outcome variable net of all controls by equal-size bins, with polynomial trend
lines. The confidence intervals are constructed by performing a block bootstrap at the level of clusters.
Look at rollout of 3G (data) internet across Europe post-2008
It strengthens link between perceptions of corruption in Gallup World Poll and corruption (as covered in
EIU), as long as internet is not censored
Government approval is lower where increases in 3G coverage were greatest – if internet is uncensored

22. National level: The governance gap remains large.
It matters
22
EBRD regions entered the 1990s with stronger skills than comparators with similar per capita
income but governance somewhat weaker than comparators, much weaker than advanced
economies
Considerable improvements in governance can be tracked in country indicators, Gallup
Surveys and the latest enterprise surveys
Yet evidence of slower progress (or even reversals) in the last decade – in a way that the
“governance gap” with respect to advanced economies is almost as large as it was
Yet this is more problematic than before: As economies develop, deficit of governance
becomes more problematic
Closing (half) the gap yields a sizable growth dividend for firms’ sales and economies, largely
through greater investment in human and physical capital – and it makes residents happier
and less likely to emigrate
Strengthening country-level institutions is difficult but not impossible

23. Governance in regions and
municipalities

24. Quality of governance varies significantly not just
across countries, but also within them
24
Source: European Quality of Government Survey and authors’ calculations. Higher values of the index (on the 0-100 scale) correspond to
better governance
The quality of governance varies significantly within countries
As countries become richer, public spending and decision making tends to become more decentralized

25. In Enterprise Surveys, much regional variation in
terms of most binding constraint on growth of
business
25
Source: EBRD-EIB-WB Enterprise Surveys and authors’ calculations.
Within-country variation in most important obstacles to firms’ operations
Reflects differences in implementation and enforcement of national-level regulations
And also growing areas that are direct responsibilities of municipalities and regions

26. In EBRD regions, municipalities primarily responsible
for waste, waste water, water, pre-school education
26Source: EBRD Capital Expenditure and Investment by Municipalities Survey and authors’ calculations.
Tiers of government with legal responsibility for service delivery, by area
Based on a survey of municipal governance arrangements conducted by the EBRD

27. Importance of regional factors in explaining
perceptions of governance has been growing steadily
27
Source: Gallup World Poll and authors’ calculations. Gallup World Poll is a representative annual household survey , 140+
economies, 1,000+ respondents per economy in up to 50 locations
% of variance in perception of governance explained by regional differences has been growing in the EBRD regions
In part, reflects increased devolution of decision-making authority to lower levels of government
As well as growing regional inequality that comes with technological change and urbanisation: weak
governance, slow growth and outmigration of the skilled can reinforce each other in regions lagging behind

28. Quality of governance varies more within countries
with weaker average governance
28
Source: European Quality of Government Survey and authors’ calculations. Logarithmic trend line.
The quality of governance varies more within countries with worse governance
And larger disparities in governance are associated with higher regional income inequality

29. Large effects on regional growth – using borders of
former empires to establish causal links
29
Source: Diercke International Atlas World Political Map 1900 and Grosjean (2011). Based on the NUTS 2013 classification.
Boundaries of former empires cut across today’s countries in several instances
Former empires have significant impacts on institutions
Imperial past is unlikely to have direct effects on growth / well-being today
Nor would they be affected by economic activity today, making them plausible instruments in regressions.

30. Growth dividend of improvements in regional
governance actually seen in EQI 2010-17 is 0.9% pa
30
Source: EBRD-EIB-WB Enterprise Surveys, Eurostat, EQI, OECD, World Bank and authors’ calculations. Based on regressions of regional growth
on the quality of regional governance instrumented using dummy variables based on the boundaries of former empires in Europe.
Regional governance has large effects on regional growth
Improving governance from Romania’s worst-scoring region (the south-east), to best (Sud-Muntenia,
surrounding Bucharest) is associated with 1.7% per annum in growth
Over an individual’s working life, per capita income-wise this means Hungary → Spain or Serbia → Poland
Also large impact on employment, life satisfaction (beyond the income effect)

31. Incentives to improve regional governance:
Competition for capital and skilled labour
31
Source: FDi Intelligence, Financial Times Ltd 2019 and authors’ calculations. Based on the locations of the latest 500 projects in Croatia, Bulgaria,
Greece, Hungary, Poland, Romania and the Slovak Republic.
Locations of greenfield FDI projects
Look at locations of greenfield foreign direct investment projects

32. Quality of regional governance matters for FDI, in
particular with large capex (hard to relocate)
32
Source: Eurostat, fDi Intelligence, Financial Times Ltd 2019 and authors’ calculations. Regressions of log(number+1) of greenfield FDI projects per
NUTS2 region on EQI institutional quality, controls and country fixed effects. Dark = significant at 5%.
Regions with better governance attract more greenfield FDI projects
People also report lower intention to emigrate if they reside in better-governed regions

33. Regional level: Benefits of improving subantional
governance, with unchanged national governance
33
The quality of governance varies significantly not just across countries, but also within them
Countries with lower levels of subnational spending and those with weaker governance on
average tend to have larger within-country disparities in the quality of governance
Within-country disparities in governance have been increasing; vicious circle of low quality of
governance, weaker economic growth and outmigration of the skilled
Improving regional or municipal governance could add ≈ 1pp per annum to per capita regional
income growth via better firm performance + improve well-being of individuals
In the interregional competition for resources, better-governed regions attract more greenfield
FDI projects and individuals are less likely to emigrate
Way forward: Benchmarking performance + disseminating best practices + stakeholder
participation + coordination across municipalities + ensuring that municipal investment projects
with high economic rate of return can secure financing.

34. Governance in firms

35. Governance in firm = rules/practices re relationship
between shareholders, directors, managers, employees
35
Source: EBRD Corporate Governance Sector Assessment. conducted by EBRD Legal Transition Team. Range 1-5, average of 2.8.
Corporate Governance Sector Assessment scores in the EBRD region
Aims to minimise the conflict of interest between shareholders and managers – as managers have better
information but not necessarily the same interests as shareholders
Corporate Governance Assessment scores are higher where management practices are also stronger

36. Higher-income economies tend to have better
management, yet much variation is within economies
36Source: Enterprise surveys and authors’ calculations. Explained share of variance refers to the share of variation in firm-level
management scores explained by different combinations of country, sector, and size fixed effects.
Management and senior manager time use scores vary greatly across firms within countries

37. Better managed firms are more productive
37
Source: Enterprise surveys and authors’ calculations. Regressions control for firm age, listed status, foreign ownership status, and include 2-digit ISIC
industry and country fixed effects. Standardised beta-coefficients *, ** and *** denote values that are statistically significant at the 10, 5 and 1% level.
Better management practices are associated with higher output per worker

38. Foreign firms tend to be better managed
38
Source: Enterprise surveys and authors’ calculations.
Foreign-owned firms have best management practices
Scoring is based in Enterprise Survey questions on management practices capture a firm’s core business
practices relating to operations, monitoring, targets and incentives

39. Firms that face strong competition, those in regions
with better business environment are better managed
39
Source: Enterprise surveys and authors’ calculations. Based on regressions, results are significant at 5%. Regions with high competition are those
where % of firms reporting having 10+ competitors > median; similarly for regions where labour market regulations are less of an obstacle.
Firms operating in regions with stronger competition and better business environment are better managed

40. Weak national-level governance impedes delegation
to professional managers
40
Source: Enterprise surveys and authors’ calculations. Regressions control for logarithm employment, log-age, 2-digit industry and country effects.
High-trust and low-trust subnational regions based on % of Gallup respondents who believe others can be trusted. Standard errors in parentheses.
Family-owned companies are more likely to higher professional managers in regions with high levels of trust
Firms run by professional managers score more highly in on management quality and use of CEO time
But national-level governance / trust is weak delegation is risky; only 17% delegate to professionals

41. Weak contract enforcement results in
suboptimal use of production inputs
41
Source: World Bank, Enterprise Surveys and authors’ calculations. Share of input materials in total costs on the vertical axis represents residuals
after taking into account firm size, sector and other observable characteristics in the regression analysis. 95 per cent confidence intervals shown.
Where contract enforcement is costly firms’ use of material inputs is lower

42. Firms: Strengthening corporate governance
and management in firms
42
Various aspects of firm governance are closely related: For instance, businesses have better
management practices, on average, in countries that score higher in terms of the EBRD’s
Corporate Governance Sector Assessment
Differences in firm performance are to a significant extent driven by differences in firm
governance: Better corporate governance and management practices enable firms to combine
human capital, physical capital and material inputs more efficiently
Foreign firms, firms in markets with stronger competition (including those with international
operations), firms operating in regions with less onerous labour regulations are better
managed
Firms with professional managers are better run but few family owners delegate – to a large
extent due to weaknesses of national-level governance and deficit of trust
Recent thinking around corporate governance emphasise that firms should explicitly elevate
broader interests such as those of employees and customers, for instance emissions (see
Chapter 4)

43. The green governance of firms

44. Quality of green management varies across economies:
Based on Enterprise Surveys green economy module
44
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations.
Green management practices vary considerably across economies
Strategic objectives that mention environmental or climate change issues, manager responsible for
environmental and climate change issues, monitoring and targets

45. Country factors matter yet 90%+ of variation in green
management practices is within economies
45
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Cross-country differences in sectoral composition of the sample are
controlled for. Density = the number of values that fall into each class divided by the number of observations in the set and the width of the class.
Green and general management scores vary considerably across firms
Country factors explain 10% of variation (1/3 of the explained total) – reflecting regulations and standards
Large mass of firms with just-below-average green management scores (to the left of zero) and a long tail
of firms with good green management scores; same pattern within countries

46. Firms in “dirty” sectors have greener management
in response to regulatory, customer pressures
46
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. Dirty sectors include paper products, printing and publishing, coke, petroleum,
chemicals, rubber and plastics, non-metallic mineral products, basic metals and transport.
Firms in “dirty” sectors have on average better green management practices

47. Older, larger firms; foreign firms, exporters
also have better green management practices
47
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. SMEs have fewer than 100 employees; young firms are less than five years
old.
Older, larger firms; foreign firms, exporters have better green management practices

48. Exposure to extreme weather, pollution by others
prompt firms to step up green management
48
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations.
Positive correlation between the average quality of green and general management practices
Overall, 10% of firms in the EBRD regions reported experiencing monetary losses due to extreme
weather events over the last three years

49. Firms that face customer pressure, higher energy costs
are more likely to make green investments
49
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations.
Customer pressure, energy taxes boost green investments
Examples of pure green investments: Green energy generation on site, energy management, waste
minimisation, recycling and waste management, pollution control measures, water

50. Firms that do not invest in energy efficiency say “not a
priority”, only 13% cite non-profitability
50
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations.
Reasons for not adopting energy efficiency measures vary
SMEs are more likely not to invest due to credit constraints than large firms
Need for awareness campaigns – and policies delivering “a nudge”

51. Where firms are credit-constrained they invest less in
green measures
51
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. The first-stage instruments are the branch-weighted average wholesale
funding dependence in 5km radius and dummies for having experienced extreme weather or pollution caused by others
Credit constraints, green management, and green investments
But the quality of green management has a greater bearing on green investments
Credit constraints are instrumented by the extent to which banks in a locality relied on wholesale funding
before the 2008-09 crisis (and thus had to deleverage more in the aftermath)

52. And in credit-constrained localities pollution from
industrial facilities declined more slowly
52
Source: European Pollutant Release and Transfer Register. Based on locations of 1,819 industrial facilities across Bulgaria, Czech R., Estonia,
Hungary, Lithuania, Romania, Poland, Slovak R. and Slovenia during 2007-2017.
Geographical distribution of industrial facilities across Emerging Europe
Average industrial facility reduced its greenhouse gas emissions by 88% during 2008-2017 (in localities
where banks had an average funding structure)

53. In credit-constrained localities annual emissions
were around 4.6% higher than in other localities
53
Source: EBRD-EIB-WBG Enterprise Surveys and authors’ calculations. 95% confidence intervals shown.
Impact of local credit supply shocks on facility-level GHG emissions, by year
The delayed impact of the 2008-09 crisis reflects project implementation lags

54. Green firms: Emissions in the EBRD regions have fallen
since 1990s yet more progress is needed
54
Evidence from Enterprise Surveys: there are firms with excellent green management practices
in the region, yet the majority lag behind
Credit constraints slow down firms’ investments, including those with environmental benefits.
Yet whether firms undertake improved energy management, green-energy generation, air-
pollution controls and other purely green investments depends primarily on green management
practices
Firms tend to prioritise green management and investments when faced with extreme weather
/ pollution or in response to customer pressure
To give firms a “nudge”, governments may have to use environmental standards, other
regulation, subsidies that are contingent on the use of specific green technologies, support
targeted green credit lines
An important precondition for success is effective enforcement in a corruption-free
environment
Voluntary environmental standards may help to leverage the power of peer pressure and
consumer awareness to reduce firms’ environmental footprint further

55. Structural reform

56. Updated assessment of transition qualities
56
Source: EBRD.
Sustainable market economy as Competitive, Well-governed, inclusive, green, integrated and resilient