RESEARCH UNDERPINNING THE GRADE MODEL
A Model to Explain the Impact of Government Revenue on the Quality of Governance and the SDGs
Highlights
This paper empirically investigates the link between the level of government revenue per capita and six indicators of the quality of governance
It uses single-equation generalised method of moment (GMM) techniques and a vector autoregressive (VAR) and vector error correction model (VECM) approach to investigate this issue.
The results suggest a strong effect over time whereby an increase in government revenue leads to a steady improvement in governance.
Significance of the Study
These findings suggest an important virtuous circle between government revenue and governance. As a result, additional government revenue can significantly impact the Sustainable Development Goals more than our previous work has suggested.
Research Approach
We began by using a single equation equilibrium correction model (ECM) for each governance measure and government revenue, which had to allow for the endogeneity of government revenue; therefore, we used an estimation technique that can deal with this, namely, a panel instrumental generalised method of moments (one step GMM).
We then checked the robustness of these results by using a vector autoregressive (VAR) analysis, looking at the dynamic interactions between government revenue and each of the six dimensions of governance quality. This allows a complex and possibly slow interaction between the two to be explored. We then built a panel vector error correction model (VECM), which allowed us to model the dynamic adjustment towards the long-run equilibrium fully.
Study Results
We have employed two contrasting econometric methodologies to quantify the effects of an increase in the log of government revenue per capita on various indicators of governance quality (single equation GMM and a Vector Error Correction VECM model). Both models show significant effects of increasing government revenues on the governance indicators. The estimates of the long-run effects are of a similar order of magnitude, as is the speed of adjustment to this equilibrium. This yields a remarkably consistent picture over a ten-year horizon, as shown in the figure.
Findings
We have previously shown that the impact of government revenue and spending on progress towards the SDGs is non-linear (O’Hare and Hall 2022), with lower-income countries achieving higher benefits from marginal increases in government revenue compared to higher-income countries. This model shows that an increase in government revenue has a much more significant impact on progress towards the SDGs than our current model. Through its effects on improving the quality of governance over time, this is a slow effect that builds up significantly. Thus, identifying sources of lost revenues and inefficiencies could hold enormous potential for progress toward the SDGs.