Impact of Institutional Quality On Economic Performance of Eastern Africa: A Panel Data Analysis

Jurnal Perspektif Pembiayaan dan Pembangunan Daerah Vol. 7 No.
2, September - October 2019 ISSN: 2338-4603 (print); 2355-8520 (online)
Impact of institutional quality on economic performance of

Eastern Africa: a panel data analysis
Fikadu Abera; Wondaferahu Mulugeta; Tesfaye Melaku*
Department of Economics, Jimma University, Ethiopia
*To whom correspondence should be addressed. Email: [email protected]
Abstract
Nowadays, studies argued that international difference in prosperity across a country is
the matter institutional quality. Thus, the poor economic performance of African’s is
linked to their weak institutional quality. The aim of this study is to examine the extent
to which institutional quality affect economic performance of 14 selected East African
Countries; Burundi, Comoros, Djibouti, Ethiopia, Kenya, Madagascar, Malawi,
Mozambique, Mauritius, Rwanda, Tanzania, Uganda, Zambia and Zimbabwe, over the
period 2005-2016, using fixed effect and System GMM methods. The finding of this
study confirms with the existing empirical study that economic institutions matter for
economic performance among which control of corruption and government
effectiveness has positive impact on economic performance, while rule of law has
adverse impact. The finding of this study implies that that Eastern Africa with better
institutions has a higher economic performance. Therefore, the Eastern Africa countries
should improve those institutions that have positive impact, and promote and change
those institutions that have adverse effect in way that it can promote economic
development.
Key words: Eastern African, Economic performance, Institutional quality, Panel data
analysis, System GMM
JEL Classifications: E02, O11, O55
INTRODUCTION
The cause of international difference in economic growth and development is the
most important concern in social sciences. Many years ago, economist recognized that
capital accumulation and exogenous technical progress are the main reason behind
cross-country difference in international economic development. Subsequently, the
debate was extended to the quality of policy and incentive structure that enable a county
to accumulate more capital and innovate. In the recent time, institutional frame works
affecting these policies and incentives was found to be the root cause behind difference
in economic growth and development (Acemoglu & Robinson, 2010).”Institutions are
the rules of the game in a society or, more formally, are the humanly devised constraints
that shape human interaction and in consequence they structure incentives in human
exchange, whether political, social, or economic” (North, 1990).
Today, the role of institution in economic performance attracted the attention of
many researchers, policy makers and development practitioners. A growing body of the
literatures established that Institutions are fundamental determinant of the welfare of
nations, because they affect organization performance by fostering better policy choice.
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Jurnal Perspektif Pembiayaan dan Pembangunan Daerah Vol. 7 No. 2, September - October 2019 ISSN: 2338-4603 (print); 2355-8520 (online)
They are created to establish incentive structure that help to reduce transaction cost,
minimize uncertainty and promote efficiency, maintain social harmony, hence
contribution to strong economic performance of a nations. When they weak uncertainty,
unpredictability, instability, corruption and transaction costs increase (Wiggins &
Davis, 2006; Tadic, 2006; Acemoglu & Robinson, 2010; Vītola & Senfelde, 2012).
An enormous empirical studies emerged to examine the impact of institution on
economic performance (Jalilian et al., 2003; Rodrik, Subramanian & Trebbi, 2004;
Acemoglu et al., 2005; Habtamu, 2008; Fabro & Aixalá, 2009; Batuo & Fabro, 2009;
Commander & Nikoloski, 2010; Osman, Alexiou & Tsaliki, 2011; Fayissa & Nsiah,
2013; Kilishi, Mobolaji & Yaru, 2013; Han, Khan & Zhuang, 2014; Iqbal & Daly,
2014; Nawaz, 2015; Effiong, 2015; Valipoor & Bakke, 2016).Most of the these studies
establishes positive relationship between institution and economic performance. In
addition, the above studies conclude that institutions are the fundamental cause of
economic growth and development differences across countries and hence poor quality
of institution is the root cause of economic problem of third world countries. Thus, the
poor economic performance of the SSA has been linked to intuitional quality. However,
studies are ambiguous on the channel through which institutional quality affect
economic performance due the existence of various measure institutional qualities and
the methodological applied. Most of the existing literatures assume homogenous
relationships across the country included in the analysis which is not always the
case(Chang, 2011; Eicher & Leukert, 2006; Luiz, 2009).In addition, Most of the above
studies incorporate larger number of countries in their analysis, hence failed to address
the unexpected shocks that are specific to one country and one period.
To this end, the main objective of this study is to investigate institutional quality
and economic performance relationships in 14 selected Eastern Africa countries by
employing fixed effect and SYS-GMM over 2005-20016 periods.
LITERATURE REVIEW
The question of what makes societies economically successful remains the
concern of many social scientists for a long periods. Especially, economists have
developed different theoretical framework to explain the cause of cross-country
difference in economic growth and development. Until 1980s, human capital, physical
capital, technology advancement remain the driving factors behind economic growth
and development of a country. Post 1980s, the new institutional economics integrated
the theory of institution into the mainstream economic (Sardadvar, 2011). The
Institutional economics stresses the crucial role of institutions in economic performance
of a Country. It provides a framework for understanding the interaction of government
structures, firm organization, and individual decisions, emphasizing transaction costs as
a central component of economic activity (Wajda, 2015).
The most widely used definition of institutions which based on Douglas North
framework is that the formal rules (a constitution, laws and regulations, a political
system, property rights, etc.) and informal rules (a system of values and beliefs,
customs, ideas, social norms, etc.) that govern the behavior of individuals and
organizations (Hodgson, 2006). On the other hand, Vitola & Senfelde (2015) define
institutions as socially approved behavior models that restrict the rationality of an
individual and constrain or encourage specific behavior, and assume that high quality
institutions encourage an efficient use of limited production resources in order to fulfill
the needs of society.
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Today, Empirical literatures are exponentially increasing in searching for what

explain larger difference in property across a country. Jalilian, Kirkpatrick & Parker
(2003) explored the impact of the quality of regulatory governance on economic growth
.Using the World wide governance Indicators(WGI) and applying the OLS and fixed
effect estimation techniques ; regulatory quality found to have positive impact on
economic growth of developing countries. Habtamu (2008),using System GMM over
1996-2005 for 35 Sub-Saharan Africa (SSA), found that institutional qualities such as
Rule of law, government effectiveness, regulatory quality, political instability, and
voice and accountability were found to influence the growth of SSA, while control over
corruption has no relation to growth in the region. Fabro & Aixalá (2009), using
dynamic panel and Instrumental variable estimation techniques for 145 rich and poor
countries, found that for the total sample of countries institutional arrangement is a
fundamental factor for explaining the level of economic development. However, when
countries divided up based on income level, they found no evidence that institutional
qualities are important in poor countries.
Osman, Alexiou & Tsalik (2011) examined the link between institutional quality
and economic performance in 27 Sub-Saharan Africa (SSA) countries during the period
1984-2003.Using ICRG index of institutional quality and static and dynamic panel
estimation techniques, the study found that institutional variables assume a key role in
the process of economic development whereas the control variables display a limited
effect. Kilishi, Mobolaji, Yaru, (2013), using the World wide governance data over
1996-2010 for 36 SSA and employing System Generalized Method of Moment (GMM)
estimators, found that institution really matter for Sub-Saharan Africa’s economic
performance, among which regulatory quality appeared to be the most important. Fayisa
& Nsiah (2013), using a panel of data for 39 Sub-Sahara African countries and
employing a dynamic and static panel data destination, found that good quality of
institutions has a positive and significant impact on growth.
Most of these studies establish positive relationship between institution and
economic performance. In addition, the above studies conclude that institutions are the
fundamental cause of economic growth and development differences across countries
and hence poor quality of institution is the root cause of economic problem of third
world countries. Thus, the poor economic performance of the SSA has been linked to
intuitional quality. However, studies are ambiguous on the channel through which
institutional quality affect economic due the existence of various measures institutional
qualities and the methodological applied. Most of the existing literatures assume
homogenous relationships across the country included in the analysis which is not
always the case (Eicher & Leukert, 2006; Luiz, 2009; Chang, 2011).In addition, Most of
the above studies incorporate larger number of countries in their analysis, hence failed
to address the unexpected shocks that are specific to one country and over period.
Docquier (2014) stated that instead of comparing a larger number of countries having
heterogeneous characteristics, it might be interesting to focus on a smaller sample of
counties that are likely similar and experienced institutions change at different period.
To this extent, this study selected the Eastern Africa countries.
The Eastern Africa Countries, especially the Horn Africa are known for the most
conflict area in the World. For instance, today countries such as Ethiopia and Kenya are
experiencing the fasted growing economy in the area. Evidence shows that , Despite
increasing economic growth in the region, on average than other regions, institutional
quality in East African is weakening (UNODC, 2013; Solomon, 2014).Thus, there is
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need to investigate the extent to which the institutional quality affect the economic
performance of countries in this region.
METHODS
Data type and source
This study has used Panel dataset of 14 selected Eastern Africa countries such as
the East African countries investigated in this study are; Burundi, Comoros, Djibouti,
Ethiopia, Kenya, Madagascar, Malawi, Mozambique, Mauritius, Rwanda, Tanzania,
Uganda, Zambia and Zimbabwe ,which is a 12 year records between the years of 2005-
2016 period. The data are obtained from different sources, such as Worldwide
Governance Indicators (WGI), Center for Systematic peace (CSP), World Development
Indicators (WDI), IMF and UNCATD databases.
Data on quality of economic institutions indicators has been obtained from WGI
database which produced by Kaufmann et al. (2011) and compiled at the World Bank
annually. These indicators are based public opinion and perception-based surveys of
various governance measures from investors, consulting firms, non-government
organizations, governments, and multilateral agencies; and classified into six clusters.
According to Kaufmann, Kraay & Mastruzzi (2010), these indicators are conceptually
defined as follows:
Government effectiveness (GEE): It captures perceptions of the quality of public
services, the quality of the civil service and the degree of its independence from
political pressures, the quality of policy formulation and implementation, and the
credibility of the government's commitment to such policies.
Regulatory quality (RQE): It captures perceptions of the ability of the government
to formulate and implement sound policies and regulations that permit and promote
private sector development.
Rule of law (RLE): It captures perceptions of the extent to which agents have
confidence in and abide by the rules of society, and in particular the quality of contract
enforcement, property rights, the police, and the courts, as well as the likelihood of
crime and violence.
Control of corruption (CCE): It captures perceptions of the extent to which public
power is exercised for private gain, including both petty and grand forms of corruption,
as well as the "capture" of the state by elites and private interests.
To measure quality of Political institution; the study used polity2 variable from
polity4 project of CSP.Polity2 is a scale measurement ranging from ranges from +10
(strongly democratic) to-10 (strongly autocratic), which is computed by subtracting the
indicator of Autocracy score from the indicator of Democracy score (Marshal, Gurr, &
Jaggers, 2016).
GDP per capita at 2010 $US constant price has used as dependent variable in the
analysis. Data on GDP per capita has been obtained from WDI. In addition, data on
annual population growth rate, total investment and trade openness sourced from World
Development Indicators, IMF and UNCATD respectively.
Econometrics model specification
In order to explore the impact institutional quality of economic performance
Eastern African (EA), the study employed panel data analysis approach. Following the
study specifies the log linear economic growth model augmented with institutional
variables as the following:
lnGDPpc 𝑖𝑡 = β0 + β1 I𝑖𝑡 + β2 polity2𝑖𝑡 + β3 topen𝑖𝑡 + β4 inv𝑖𝑡 + β5 popg 𝑖𝑡 +ℱ𝑖 + εit ..........(1)
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Where,
i = 1, 2..., N is the number of countries; t = 1, 2, …, T is time period, a K1 vector which
is slopes of independent variables i, is the unobserved heterogeneity and is the error.is
logarithm of level of GDP per capita, “I” is the indicators of quality of economic
institutions (such as, CCE, GEE, RQE and RLE), topen is trade openness which is the
sum of exports and imports of goods and services measured as a share of gross domestic
product,polity2 is the proxy measure of quality of political institution, “inv” is
Investment as a percentage of GDP is calculated at market prices, “popg” represents
annual population growth rate.
With the equation of the model (1), due high correlation between the four
measures of quality of economic institutions it is impossible to regress all of them at the
same time. . For this reason, the method of principal component analysis is used to deal
with the possible multi-collinearity problem. Principal component analysis (PCA) is a
statistical technique used for dimension reduction.
Depending on this problem, the study has been designed on two analytical
methods. First, the composite indicator for all quality of economic institution has
computed by PCA. In this manner, the four measures of quality of economic institutions
namely: CCE, GEE, RQE and RLE were aggregated as one indicator of institutional
quality. The Second method of analysis applies disaggregated analysis. In this case, the
impact of each of the individual indicators on economic performance examined
separately.
Estimation techniques
The most popular method to estimate equation (1) is the static panel estimation
method. It commonly known that Static panel data estimation involves the fixed effect
(FE) and random effect (RE) estimation. This study has chosen fixed effect estimation
over random effect due to its advantage in controlling of unobserved county and time
fixed effect. The random effect assume that unobserved country fixed effect are
uncorrelated with error term which impossible in this study. For instance geography,
culture, history and distance to equator and many other fixed factors exists to be
correlated with institutional variables which cannot be controlled in random effect.
In fact, the FE employed in this involves the method of LSDV which take into
accountant country and time fixed effect. This technique is sensitive to
heteroscedasticity problem. The Brush pagan test is used to test this problem which has
the null hypothesis of there is a constant variance. The larger probability value is
required to accept to these hypotheses. When this null hypotheses rejected the Feasible
Generalized Least squares (FGLS) is employed in order to improve the efficiency of the
FE. With FGLS we can estimate the Fixed effect regression model of equations (3.34)
and (3.4) under the assumptions of homoscedastic and no autocorrelation. In addition,
FGLS allows estimation in the presence of first order autocorrelation, AR (1), within
panels and cross-sectional correlation and heteroscedasticity across panels (Greene,
2012).
However, economic relationships usually involve dynamic adjustment processes
and dataset are panel data with small time period there has been often problem of
inference, such as sample bias in coefficients and hypothesis tests. Therefore, neither FE
nor the RE is unbiased and consistent. Thus, under such problem the appropriate model
is dynamic panel data modeling. Such model is appropriate when the outcome variable
of interests depend past realization. In this approach equation (1) can be specified as in
the following:
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lnGDPcit = β0 + β1 lnGDPcit−1 + β2 I𝑖𝑡 + β3 polity2𝑖𝑡 + β4 popg 𝑖𝑡 + β5 topenit +

β6 𝑖𝑛𝑣it + ℱi +εit .......................................................................................(2)
The popular method to estimate equation (2) is called Generalized Method of
Moments (GMM). It is the extension of Instrumental Variable (IV) approach in order to
form the instrument for endogenous variables from its own past lag value. The most
important reason of choosing GMM estimation techniques over IV estimation is that it’s
not appropriate techniques when there is more instrument than endogenous variables,
which happen in the case of these study variables of institutional quality. In addition,
with GMM estimation there no needs to be worry about homoscedastic and stationary
(Hansen, 1982).
In fact, GMM estimation has two types: the first difference GMM (Diff-GMM)
and System GMM (SYS-GMM). The Diff-GMM is estimation technique which apply
first differencing to the original model and use moment condition to generate internal
instrument for variable that are endogenous (Arellano & Bond (1991).This approach
does not provide good estimator under heteroscedasticity and for time invariant
repressors. To address this problem, Arellano & Bover (1995) as well as Blundell &
Bond (1998) proposed the SYS-GMM as an alternative. Because of this reason
SYS_GMM estimation has been employed in this study. The System GMM estimators
involve two step processes. In steps one the System GMM not robust. Therefore, the
“two step” SYS- GMM should be performed in order to improve the efficiency of the
estimation result.
In order to generate internal instrument, the SYS-GMM form two systems of
equations: one equation in level form and one other in differenced form. Using the
moment condition, it generates two kinds of instruments; one group of instrument the
lagged level and the other group are the first differenced instruments. Finally, equations
in level forms are instrumented with differenced instruments while equations in first
difference are instrumented with instrument in lagged level (Roadman, 2009). In order
to be valid
Therefore, the validity of SYS-GMM estimation results depends on the validity of
these instruments. These instruments should not be greater than number of observations
and strictly exogenous. The formal test statistics for this is called Hansen J-statistics.
This test has two null hypotheses:
H01: Instruments as group are valid
H02: Instruments are valid exclusively
Therefore, the higher the P-value of the Hansen J-statistics is better to accept this
hypothesis
In addition, the estimated result of SYS-GMM is consistent if there is no evidence
of significant second order serial autocorrelation. The Arellano and Bond (AR) Test
have been used to test the null hypothesis of no autocorrelations. Similarly, the higher
the P-value of AR (2) is better to accept this hypothesis to retail this hypothesis.
RESULTS AND DISCUSSION

As discussed in methodology section, the result of this study has been based the
Fixed Effect and System GMM estimation techniques. The fixed effect has been
employed to deal with heterogeneity among the individual country and the system
GMM estimation is to deal with the endogeneity problem. Since the Fixed estimation
results suffer from heteroscedasticity problem, the method of Feasible Generalized
Least square estimation (FGLS) technique was used. Through this study, robust
estimation result of fixed effect estimation mean that FGLS.
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Table 1 shows the diagnostics test results for SYS-GMM .In this study, five
models were estimated as indicated table 2-6 below and the diagnostics tests for these
results are presented in table 1 through column 2- 6. As indicate clearly in the table the
number of instrument in each regression is smaller than the number of observations
(N=153), which pretty what is desirable. On the other hand, the minimum of 1 and
maximum of 4 lag values was imposed on the predetermined variable, since one period
lag of predetermined variables are not assumed to be correlated with current shocks. For
this study, one period lagged dependent variable (l. lnGDPpc) is treated as
predetermined variable meaning that it’s not strictly endogenous. In addition, The
minimum and maximum lag limit imposed on endogenous variables, that is all
independent variables except lagged value of GDPpc, is 2 which can be written as lag
(2 2) (Roadman, 2009).
Table1. Model diagnostic test results for system GMM
Evaluation criteria Table 2 Table 3 Table 4 Table 5 Table 6
Observations 153 153 153 153 153
Number of Instruments 16 14 16 14 42
Lag limit (min/max) (1/4) (1/2) (1/4) (1/2) (1/2)
Second order Autocorrelation( AR2) :p-value 0.422 0.095 0.417 0.065 0.544
Hansen test of Overid. restrictions: p-vale 0.939 0.605 0.939 0.730 1.00
Testing the validity of instruments in subsets of equations
GMM(endogenous var.) type instruments
Hansen test excluding group: p-value 0.986 0.607 0.986 0.744 1.00
GMM(predetermined var.) type instrument
Hansen test excluding group: p-value 0.971 0.305 0.976 0.318 1.00
Source: Own estimate using Stata 13.
Note: The term in parenthesis “(min/max)”used with lag limit means minimum and maximum
lag imposed on variables used as instrument, here on predetermined variables
Moreover, as clearly depicted in the table1there is no second order
autocorrelation. The p-value for Arellano – Bond test -AR (2) is 1 which cannot reject
the null hypothesis of no autocorrelation at 0.05 levels. Furthermore, Hansen test for
instrument over identification and instrument in subset of equation are valid and the null
hypotheses of instruments are valid cannot be rejected at 1% convectional level.
Table 2 shows the result of the aggregate impact of institutional quality on
economic performance of the Eastern African. From the table it is clear that the
aggregate indicator of quality of economic (Einst) has positive significant on economic
performance at 1% convectional level under the robust FE estimation. The result is
consistent under the SYS-GMM at 5% level. Using the SSY-GMM results, we can infer
that one unit increase in institutional quality would leads to 3.6% increase economic
performance. In addition, the result implies that improvement in quality of economic
institutions would have huge contribution for economic welfare and country with better
quality of institution would have better economic performance. In fact, this finding is in
accordance with (Kilishi, Mobolaji & Yaru, 201; Fayisa & Nsiah, 2013; Batuo & Fabro,
2009). On the other hand, the robust estimation result of fixed effect shows that Polity2
has positive relationships with GDPpc per capita. The result implies that each individual
country has its own and time fixed effect that affects quality of economic institution
which in turn impacted on economic performance. However, the results of SYS-GMM
indicate that polity2 has insignificant impact on economic performance. This result does
not mean that polity2is not important, rather the deteriorations quality of political
institution. This result is in line with Commander & Nikoloski (2010).
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The other control variable, total investment (inv) has positive country and time
effect on economic performance. However, after controlling for endogeneity,
investment has insignificant impact on GDP per capita. This shows that keeping
institutional constant, the impact of investment on economic performance is limited in
Eastern African. PO Finally, the SYS-GMM results indicate that one period lag of GDP
per capita (l. lnGDPpc) has positive significant effect on economic performance. The
result implies that Eastern Africa Economic performance depends on its own past
performance than other factors.
Table 2.The impact of aggregate quality of economic institutions on economic performance
Dependent variable is GDP per capita (lnGDPpc)
Independent FE FGLS SYS-GMM
variables C C &T C C &T
Einst 0.140*** 0.124*** 0.140*** 0.124*** 0.036**
(0.0348) (0.0228) (0.0327) (0.0207) (0.015)
polity2 0.0197*** 0.00740 0.0197*** 0.00740* 0.006
(0.00699) (0.00466) (0.00658) (0.00422) (0.008)
Topen 0.00000 -0.00013 0.00000 -0.00013 0.00000
(0.000851) (0.000601) (0.000801) (0.000544) (0.001)
Inv 0.00560*** 0.00284*** 0.00560*** 0.00284*** 0.000
(0.00126) (0.000842) (0.00119) (0.000763) (0.001)
Popg -0.168** -0.0696 -0.168** -0.0696 -0.069*
(0.0724) (0.0485) (0.0681) (0.0439) (0.036)
L.lnGDPpc 0.894***
(0.047)
Constant 7.113*** 6.756*** 7.113*** 6.756*** 0.942**
(0.228) (0.152) (0.214) (0.137) (0.417)
Observations 167 167 167 167 153
R-squared 0.979 0.992
Number of Countries 14 14 14
Source: Own estimates using Stata 13.
Note: Standard errors in parentheses, *** p<0.01 means significant at 1%, ** p<0.05 means
significant at 5%, * p<0.1means significant at 10% level.Whereas, C indicate country fixed
effect and C & T indicate country and Time effect.
Table 3 shows that the estimated results of control of corruption (CCE) on Eastern
African economic performance. The result indicates that CCE has positive effect on
GDP per capita (GDPpc).The result implies that this positive impact depend on country
and time fixed effect. This confirm with (Batuo & Fabro, 2009; Han, Khan & Zhuang,
2014; Valipoor & Bakke, 2016) which stated that in country where control of corruption
is high their economic growth and development better. Similar to in case of Einst, the
robust estimation result of fixed effect shows that Polity2 has positive relationships with
GDPpc per capita, when CCE and other variables kept constant. The result implies that
each individual country has its own and time fixed effect that affects quality of
economic institution which in turn impacted on economic performance. However, the
results of SYS-GMM indicate that polity2 has insignificant impact on economic
performance. This result does not mean that quality of political institution not
important, rather the deteriorations quality of political institution. This result is in line
with Commander & Nikoloski (2010).
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Table 3. Estimated impact of Control of corruption on economic performance

Variables C C &T C C &T
CCE 0.159*** 0.212*** 0.159*** 0.159*** 0.054*
(0.0575) (0.0363) (0.0541) (0.0541) (0.030)
polity2 0.0245*** 0.0119** 0.0245*** 0.0245*** 0.001
(0.00725) (0.00462) (0.00683) (0.00683) (0.003)
Topen -0.00009 -0.00020 -0.00009 -0.00009 0.001**
(0.000875) (0.000591) (0.000824) (0.000824) (0.001)
Inv 0.00551*** 0.00228*** 0.00551*** 0.00551*** 0.001
(0.00131) (0.000844) (0.00123) (0.00123) (0.001)
Popg -0.183** -0.103** -0.183** -0.183** -0.038
(0.0769) (0.0489) (0.0724) (0.0724) (0.043)
L.lnGDPpc 0.977***
(0.024)
Constant 7.214*** 6.992*** 7.214*** 7.214*** 0.222
(0.261) (0.165) (0.246) (0.246) (0.230)
Observations 167 167 167 167 153
R-squared 0.978 0.992
Source: Own Estimates using Stata 13.
Note: Standard errors in parentheses, *** p<0.01 means significant at 1%, ** p<0.05 means significant
at 5%, * p<0.1 means significant at 10% level. Whereas, C indicate country fixed effect and C & T
indicate country & Time effect.
The control variables; investment (inv), and population growth (popg) has
positive and negative significant country and time fixed effect respectively .But, the
SYS-GMM result revealed that the standard economic variables has no relation with the
Eastern African economic performance. This confirms with (Fayisa & Nsiah, 2013;
Kilishi, Mobolaji & Yaru, 2013) which argued that standard economic variable has
limited impact on economic performance once institution s are control for. Finally, the
results of SYS-GMM indicate that trade openness and lagged value of GDP per capita
has positive significant impact on economic performance. But, the magnitude of lagged
value of GDP per capita is high indicating that economic performance depends on it
past performance than the other factors.
Table4shows the estimated impact of government effectiveness (GEE) on
economic performance of the Eastern Africa. The robust estimation of FE indicates that
GEE has positive impact on GDP per capita (l.lnGDPpc) at 5% under SYS-GMM. The
possible impact of GEE implies that each country has unique and time effect
government effectiveness. This finding also confirm with the hypothesis of this research
and the previous studies (Development, 2009; Effiong, 2015; Habtamu, 2008; (Fayisa &
Nsiah, 2013; Kilishi, Mobolaji & Yaru, 2013).Therefore, using the SYS-GMM
estimation we can infer that one unit improvement in government effectiveness would
leads to 6.3% increase in GDP per capita. Keeping GEE and other variables at
constant, polity have positive impact on GDP per capita under the fixed effect
estimation. However, this results loss its consistency after dealing with endogeniety
which show that deterioration of quality of political institutions in the Eastern Africa.
This result confirms with(Commander & Nikoloski, n.d.).
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Table 4. Estimated impact of government effectiveness on economic performance

Dependent Variable is GDP per capita(lnGDPpc)
Independent FE FGLS SYS-DGMM
Variables C C&T C C&T
GEE 0.239*** 0.211*** 0.239*** 0.211*** 0.063**
(0.0592) (0.0389) (0.0557) (0.0352) (0.026)
polity2 0.0197*** 0.00740 0.0197*** 0.00740* 0.005
(0.00699) (0.00466) (0.00658) (0.00422) (0.008)
Topen 0.000001 -0.000131 0.000001 -0.000131 0.000000
(0.000851) (0.000601) (0.000801) (0.000544) (0.001)
Inv 0.00560*** 0.00284*** 0.00560*** 0.00284*** 0.000
(0.00126) (0.000842) (0.00119) (0.000763) (0.001)
Popg -0.168** -0.0696 -0.168** -0.0696 -0.067*
(0.0724) (0.0485) (0.0681) (0.0439) (0.036)
L.lnGDPpc 0.896***
(0.048)
Constant 7.272*** 6.897*** 7.272*** 6.897*** 0.962**
(0.242) (0.161) (0.228) (0.146) (0.415)
Observations 167 167 167 167 153
R-squared 0.979 0.992
indicate country & Time effect.
The standard economic variables: investment and annual pollution growth rate
(popg), which are used as control variables has positive and negative significant impact
on the region economic performance under the FE robust estimation at 1% and 5% level
respectively. After dealing with endogeneity problem, the negative impact of pogg is
inconsistent and inv has negative impact at 10% which is almost negligible. Finally, one
period lag of GDP per capita has significant on current economic performance of the
Eastern African. The SYS-GMM estimation result of table 4.8 shows that l. lnGDPpc
statistically significant at 1% level, with positive sing of 0. 896. This indicates that the
Eastern African Economic Performance depends on its past performance than GEE and
other factors.
Table 5 shows the impact of regulatory quality (RQE) on Easter African economic
performance. The robust estimation result of FE indicates that RQE has significant
impact on GDP per capita at 1% level, which implies that RQE depends on country
fixed effect. However, the result was not consistent under the SYS-GMM implying the
absence of RQE relation to economic performance in Eastern Africa. This result
confirms with WB (2002).
In addition, robust estimation result of FE in the table 5 show that Polity2 and
investment (inv) has positive impact on the Eastern African economic performance at
1% level. However, this result is inconsistent when endogeneity problem was dealt
with. The result indicates the deterioration of political institutions and weak investment
environment in the Eastern African. Annual population growth has negative significant
impact on GDP per capita at 5% and 10% convectional level under the FGLS and SYS-
GMM respectively. The result implies that annual population growth rate depend on
country fixed effect and as population grow decrease by one unit, economic
performance would increase by 3.9%.The result of SYS-GMM shows that Trade
178
openness (Topen) and lagged value of GDP per capita (L.lnGDPpc) has positive
significant impact on the Eastern African Economic performance at 10% and 1%
convection level. However, the larger significance level of Topen shows that trade
openness has negligible impact on the region economic performance. The positive
impact of lagged value of GDP per capita shows that the performance of the region
economies depends on its past performance.
Table 5.The effect of regulatory quality on economic performance
Dependent variable is GDP per capita
Variables C C&T C C&T
RQE 0.236*** 0.0599 0.236*** 0.0599 0.027
(0.0535) (0.0411) (0.0503) (0.0373) (0.037)
polity2 0.0215*** 0.00927* 0.0215*** 0.00927** -0.000
(0.00692) (0.00510) (0.00651) (0.00462) (0.002)
Topen 0.000067 -0.000449 0.000067 -0.000449 0.001*
(0.000844) (0.000660) (0.000795) (0.000598) (0.001)
Inv 0.00488*** 0.00303*** 0.00488*** 0.00303*** 0.001
(0.00128) (0.000929) (0.00120) (0.000842) (0.001)
Popg -0.156** -0.0419 -0.156** -0.0419 -0.039*
(0.0712) (0.0530) (0.0670) (0.0480) (0.018)
L.lnGDPpc 0.958***
(0.024)
Constant 7.198*** 6.619*** 7.198*** 6.619*** 0.354*
(0.230) (0.173) (0.217) (0.157) (0.188)
Observations 167 167 167 167 153
R-squared 0.980 0.991
Number of countries 14 14 14
Note: Standard errors in parentheses the Asterisk; *** p<0.01 means significant at 1%, ** p<0.05
means significant at 5%, * p<0.1 means significant at 10% level. Whereas, C indicate country fixed effect
and C & T indicate country & Time effect.
Table 6 shows the impact of rule of law (RLE) on economic performance of the
Eastern African. The robust FE estimation result shows that RLE has positive
significant impact on GDP per capita. This positive impact depends on the country and
time fixed effect. But, the SYS-GMM indicated that the impact of RLE on economic
performance of the region is negative at 1% convectional level. This finding contradicts
with what expected in this study, but in line with (Kaufman & kraay, 2002) which stated
that institutional development which depend on per capita income lead to a weak and
even negative economic performance.
On the other hand, table 6 shows that polity2 has only significant impact on GDP
per capita under the country fixed effect model, which is not consistent under the SYS-
GMM. This result indicates the deterioration of quality of political system in Eastern
Africa. In addition, Trade openness (Topen), which used control variable for RLE, has
no significant impact on economic performance under the fixed effect. But after
controlling for endogeneity, it turns out to be significant at 1% convection level. This
result implies that the impact of Topen depend well-functioning rule of law. Moreover,
Investment and annual population growth rate are the other variables that are used as
control variable. These two variables have significant impact on economic performance
at 1% and 10% convectional level under the fixed effect estimation. But, the result is
179
not consistent after dealing with the edongeneity problem. Finally, lagged value of GDP
per capital (l. lnGDPpc) has positive impact on economic performance at 1%
conventional level which implies that the performance of the region economies region
depend its past performance than institutional quality and other factors.
Table 6. Estimated impact of rule of law on economic performance
Variables C C &T C C &T
RLE 0.320*** 0.232*** 0.320*** 0.232*** -0.179***
(0.0631) (0.0440) (0.0594) (0.0399) (0.058)
polity2 0.0110 0.00283 0.0110* 0.00283 0.018
(0.00710) (0.00481) (0.00668) (0.00436) (0.010)
Topen 0.000217 -0.000112 0.000217 -0.000112 0.001***
(0.000831) (0.000605) (0.000782) (0.000548) (0.000)
Inv 0.00554*** 0.00307*** 0.00554*** 0.00307*** 0.000
(0.00123) (0.000844) (0.00116) (0.000765) (0.001)
Popg -0.167** -0.0782 -0.167** -0.0782* -0.016
(0.0700) (0.0491) (0.0659) (0.0444) (0.039)
L.lnGDPpc 0.948***
(0.058)
Constant 7.381*** 6.950*** 7.381*** 6.950*** 0.215
(0.237) (0.167) (0.223) (0.151) (0.479)
Observations 167 167 167 167 153
R-squared 0.981 0.992
Source: Own estimates using Stata 13
indicate country and Time effect.
CONCLUSION AND RECOMMENDATIONS

Conclusion
The finding of this study depict that institutional quality and economic institutions
in particular, has positive significant impact on economic performance of the region. To
understand which institutions has the most significant impact and which institutions has
lacking in the region, the effect of each individual institutional quality indicators were
estimated separately, along with the investment, population growth rate ,quality of
political institutions and trade openness. Accordingly, the result shows that quality of
economic institutions has significant impact on economic performance, among which
control of corruption and government effectives are the most important. The impact of
rule of law institution in Eastern Africa has negative significant effect, while regulatory
quality is lacking in the region. These impacts depend on individual and time fixed
effect, which implies that each country has its own specific fixed effect that shapes
economic institutions, which in turn affect economic performance by affecting
individual quality of economic institutions.
Recommendations
If we see from policy perspective, government policies should pay attention on
building strong institutions in terms of quality and quantity, since it is a key for further
economic growth. In the light of the limitation of this study, the following implication
180
will have proposed for future research; Even though this study has tried to control for
deep factors that shapes quality of institutions, such as trade openness and quality of
political institutions, still others factors such as income distribution, efficiency of tax
system and education are not considered due to lack of data availability. Thus, study
that interested to investigate the impact of institutional quality on the Eastern African
Economy should focus on these factors
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Jurnal Perspektif Pembiayaan dan Pembangunan Daerah Vol. 7 No.

2, September - October 2019 ISSN: 2338-4603 (print); 2355-8520 (online)

Impact of institutional quality on economic performance of

Fikadu Abera; Wondaferahu Mulugeta; Tesfaye Melaku*

Department of Economics, Jimma University, Ethiopia

*To whom correspondence should be addressed. Email: [email protected]

Today, Empirical literatures are exponentially increasing in searching for what

lnGDPcit = β0 + β1 lnGDPcit−1 + β2 I𝑖𝑡 + β3 polity2𝑖𝑡 + β4 popg 𝑖𝑡 + β5 topenit +

RESULTS AND DISCUSSION

Table 3. Estimated impact of Control of corruption on economic performance

Table 4. Estimated impact of government effectiveness on economic performance

CONCLUSION AND RECOMMENDATIONS

for Development Policy and Management (IDPM).

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