Institutional Quality and Real Sector Economy: Evidence from Belt and Road Economies

Abstract

Purpose: The aim of this study is to investigate the role of institutional quality (IQ) in developing the real sector economy of a country.
Rationale of the study: Institutional quality (IQ) works as a trust symbol for the entire socio-economic culture of a nation. If an economy achieves high trust from domestic and cross-border investors and business entrepreneurs—in terms of citizen security, investor rights protection, a rational and straightforward bureaucratic system, fewer internal and border tensions, and a shared willingness to follow law and order—they are more likely to select that country as their investment destination. Based upon these theoretical assertions, this study examines the relationship under consideration.
Methodology: This study considers data from 79 Belt and Road Initiative (BRI) partner countries over the 1999–2019 period. The study utilizes Principal Component Analysis (PCA) to combine each set of indicators into one while capturing the maximum variance of the data. The dependent variable in this research is economic growth, measured by GDP at constant prices. The model controls for FDI, financial development, human capital, inflation, domestic investment, trade openness, infrastructure, and population. Finally, the study deploys pooled OLS, fixed-effect, and random-effect modeling to reveal the relationship.
Findings: The research finds that IQ has a highly positive and significant effect on the economic growth of a country, especially in the BRI partner countries. A highly significant coefficient of 0.156 (p<0.01) is found for the IQ variable when considering the combined index of six different IQ indicators. Moreover, each of the six IQ indicators is analyzed separately to check the robustness of the study, and all indicators exhibit highly significant and positive coefficients. Additionally, using alternative methodologies, the results are found to be consistent and robust in terms of both sign and significance.
Originality: This research pioneers the investigation into the impacts of IQ on economic growth, specifically for the BRI country groups. It conducts a detailed analysis utilizing World Governance Indicators and political risk indicators as alternative IQ measures. Moreover, it combines each set of IQ measures into a single index utilizing PCA, which establishes a comprehensive consideration of all IQ measures.