Governance Quality for Sustainable Growth: Evidence from Upper-Middle-Income Economies

Abstract

This study examines the governance–growth nexus in an unbalanced panel of 30 upper-middle-income countries (1996–2023, 750 observations). Addressing a gap in the literature that has often overlooked this income group, the paper employs both static panel models (Pooled OLS, Fixed Effects, Random Effects) and dynamic estimators (Difference and System GMM) to mitigate endogeneity and capture growth persistence. Static results indicate that government effectiveness, regulatory quality, and the rule of law are positively and significantly associated with per capita income (coefficients range from 0.16 to 0.50, significant at 1–5%). By contrast, control of corruption and voice and accountability remain insignificant, while political stability is significant only in pooled models. Dynamic GMM estimates confirm strong income persistence (lagged GDP ≈ 1.0, p<0.01) but governance indicators lose significance once endogeneity is addressed, implying that static correlations may partly reflect time-invariant, cross-country heterogeneity rather than short-run causal effects. Robustness checks (Hansen test non-rejection, AR(2) test no second-order autocorrelation) support the validity of the GMM specification, despite some Sargan test sensitivity. These results imply that while governance quality provides a critical institutional foundation for long-run development, its growth payoffs in upper-middle-income economies materialize gradually rather than immediately. As a policy recommendation, sustained governance reforms are essential for avoiding the middle-income trap, though policymakers should maintain realistic expectations about their long-run rather than immediate impact on economic growth.