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Men holding leaves pass through a bridge on the outskirt of Zaria in Nigeria's northern state of Kaduna November 15, 2016.REUTERS/Akintunde Akimleye - RTX2TV87

Domestic resource mobilization and external financing: When does governance matter?

Evidence from sub-Saharan Africa


This paper studies the relationship between two global priorities: financing for development and good governance. The Addis Ababa Action Agenda of the Third International Conference on Financing for Development identifies domestic revenue mobilization as central to achieving the Sustainable Development Goals (SDGs). The Action Agenda also recognizes the importance of international finance in the development process (United Nations, 2015). At the same time, the process leading to the SDGs has emphasized good governance as a development priority. One of the SDGs (Goal 16) is solely dedicated to the “[promotion] of peaceful and inclusive societies for sustainable development, [the provision] of access to justice for all and [building] effective, accountable and inclusive institutions at all levels.”

But does “good governance” really matter for mobilizing financing for development? And if so, do different financing sources respond equally to good governance? In particular, do domestic financing sources respond to good governance in the same way as external financing sources?

The literature has addressed the first question of whether governance matters for mobilizing financing flows. However, except for Faria and Mauro (2009) who focus on the external capital structure of countries, little is said about whether domestic financing sources, government revenues in particular, respond to governance in a different way than foreign financing sources. In this paper, we use the World Governance Indicators (WGI) to study how good governance relates to financing sources in sub-Saharan African countries. In particular, we focus on tax revenue on the one hand and on foreign direct investment (FDI) and official development assistance (ODA) on the other. We also take a look at remittances and illicit financial flows in spite of data limitations.

However, we find that while good governance matters for raising domestic revenues, its effect on external financing sources is mixed.

We conduct three separate tests. First, we use Spearman rank correlations to look at the relationship between WGIs and the different types of financing sources. Second, we run panel data regressions where we control for a number of indicators, such as GDP per capita and natural resource rents, which can have an effect on financial flows. Third, we conduct robustness tests using settler mortality as an instrument for governance. The three analyses all point to the same main finding: Good governance does indeed matter for financing development. However, we find that while good governance matters for raising domestic revenues, its effect on external financing sources is mixed. Good governance does not appear to matter much for FDI or is negatively associated with such flows to the region while ODA is positively associated with good governance.

Our results indicate that the bigger bang for improving governance is at home in the form of increased tax revenue (excluding resource rents). This is all the more important as domestic revenues are the largest sources of development finance. Although good governance does not help raise more resource rents, it has a positive effect on non-resource government revenues. Improving governance can support African countries’ efforts to diversify away from natural resources and increase government revenues coming from the non-resource sector.

Improving governance also appears to attract more ODA. In contrast, the inconclusive or negative response of FDI to good governance points to the importance of pursuing efforts on the global agenda that aim at increasing transparency in the natural resource sector (the most important destination of FDI in the region) and on emerging efforts to curb illicit financial flows. We also look at remittances to and illicit financial flows from the region and find that they are associated with governance indicators.

Throughout our analysis, corruption is the governance indicator that is consistently the most significant among the six indicators we consider. This result indicates that addressing corruption in the region could yield quick and important gains in terms of raising the much-needed financing for development.

The rest of the paper continues as follows. First, we use a simple correlation analysis to assess the relationship between good governance and different financing sources. Second, we review the existing literature and use panel data estimations to study this relationship. Finally, we conduct robustness tests before concluding with policy recommendations.

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