Better Governance, More Equitable Growth

An example of an MCC Scorecard from FY2024.

Are well-governed countries better at addressing the needs of poor people? According to a new paper from the Millennium Challenge Corporation (MCC), the answer is yes, and even small improvements in governance are associated with large reductions in poverty. This analysis concludes two important findings:

1. Economic growth is more effective at reducing poverty in well-governed countries, and
2. Good governance as measured by the MCC Scorecard has a relationship with poverty reduction independent of economic growth.

If you look at two countries with the same GDP and population, on average, the country that passes more indicators on the MCC scorecard has over 386,000 fewer people living in extreme poverty for \*every additional indicator\* passed. Going from failing the MCC Scorecard overall to passing it has an even bigger impact. Without any change in GDP or population, newly passing the scorecard is associated with moving 1.9 million people out of extreme poverty. Passing the scorecard has the same impact on extreme poverty as increasing GDP by $1.2 trillion. Good governance can be challenging to achieve, but, as this analysis shows, the impacts can be transformational.

MCC's Unique Country Selection Model

MCC's Board of Directors selects countries as eligible for MCC assistance using MCC's Country Scorecards, which assess countries on 20 policy indicators that measure good governance. MCC uses indicators that are public, independent, and that help MCC determine whether country governments have demonstrated a commitment to ruling justly, economic freedom, and investing in their people. To pass most indicators, a country must perform better than the majority of countries in its income pool (i.e. above the median, or 50th percentile). To pass the scorecard overall, a country must pass at least 10 of the 20 indicators, including passing the Control of Corruption indicator and either the Political Rights indicator or the Civil Liberties indicator. To be considered for MCC's compact program, a country must pass the scorecard.

MCC works in countries with relatively strong policy environments due to the notion, at MCC's founding in 2004, that economic growth translates more effectively into poverty reduction in relatively well-governed countries. The MCC model is also supported by evidence that good governance has benefits for a country independent of its impact on economic growth, including by having a separate impact on reducing extreme poverty. MCC's recent paper finds evidence that supports this claim that good governance reduces poverty.

Economic Growth Is More Effective at Reducing Poverty in Well-Governed Countries

MCC's mission is to reduce poverty through economic growth. Given limited resources to achieve this mission, MCC's founders sought to prioritize two key avenues for maximizing impact: the way MCC provides grant assistance, and by prioritizing those countries dedicated to the strong policy environments most conducive to inclusive economic growth. MCC must understand the conditions that will most effectively translate economic growth into poverty reduction. In other words, where should MCC invest its scarce grant resources to ensure that the economic growth that is generated will be inclusive of the poorest in a society? MCC's founding statute is clear that the agency should focus on countries that demonstrate a commitment to ruling justly, economic freedom, and investing in their people. Is this focus backed up by the literature?

In the paper we conduct a literature review and find that yes, there is a justification for focusing on the best governed countries to reduce poverty. In corrupt countries, the benefits of economic growth are likely to be siphoned off by powerful corrupt actors before they filter down to the poorest in a society. In autocracies, leaders need to be more responsive to the elite in society than the general population or the poorest, as they do not face electoral consequences. Governments that do not have strong protections for civil liberties are less likely to invest in policies that benefit marginalized groups that disproportionately make up the extreme poor in many countries.

Good Governance Reduces Poverty

In the paper we conduct an analysis of the empirical relationship between growth, poverty, and governance, looking specifically at the differences in the number of poor people in better and worse governed countries holding GDP and overall population equal. We find that good governance is associated with reductions in extreme poverty, regardless of whether it leads to increases in economic growth. Many authors and development practitioners argue that good governance leads to poverty reduction by increasing growth. While there are linkages between governance and growth, and between growth and poverty reduction, this paper shows that governance has another relationship with poverty reduction independent of its relationship with GDP. Specifically, improving governance can bring people out of poverty even when the overall size of the economy remains the same.

Even small improvements can have outsize impacts. Improving only a single point on MCC's Civil Liberties Indicator (scores range from 0 to 60) is related to lifting over 55,000 people out of poverty, controlling for GDP and population. Improving 0.1 on MCC's Control of Corruption indicator (scores range from around -2.5 to 2.5) is associated with bringing over 173,000 people out of extreme poverty with no change in GDP or population.

While the exact size of these improvements varies by the measure of governance used, on average, for each new indicator passed on the MCC scorecard, we expect that over 385,000 people would be brought out of extreme poverty, holding GDP and population constant. However, improvements on specific indicators have an even greater effect. Going from failing to passing the Civil Liberties indicator is associated with bringing 1.9 million people out of extreme poverty, even if there is no change to GDP or population. Newly passing the Control of Corruption indicator is associated with bringing 3.7 million people out of extreme poverty.

Another way to put these numbers into context is to see the increase in GDP that would be required to reduce poverty by these levels. An increase in GDP of $617,000 is associated with bringing 1 person out of extreme poverty, holding population constant. This means that it would take an increase in GDP of nearly $34 billion to have the same impact on extreme poverty as improving a single point on the Civil Liberties indicator. Moving from failing the MCC scorecard to passing the MCC scorecard is associated with the same amount of poverty reduction as an increase in GDP of $1.2 trillion.

What This Means for MCC's Model

When MCC was founded, the creators argued that sound policies were as important to a country's development as the grant assistance MCC was providing, if not more important. After 20 years of MCC supporting comparatively well-governed developing countries, this research validates that claim. Countries often undertake governance reform efforts with the goal of passing the MCC Scorecard before MCC provides any assistance, a phenomenon called the MCC Effect. While many countries enact reforms to receive MCC's grant assistance, based on this research, the reforms in themselves confer a separate and substantial benefit to the poorest people in these countries before MCC spends a single program dollar, as improvements in governance bring millions of people out of extreme poverty.

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