The Impact of Institutional Quality on Economic Performance: An Empirical Study of Turkey and 28 Countries in the European Union

Using a panel set of 28 European Union member states and prospective members to the bloc over a period of 1996-2014, this paper examines to what extent institutional quality (governance index) and its sub-indicators (control over corruption, government effectiveness, political stability, regulatory quality, rule of law and voice and accountability) can influence overall economic performance measured by gross value added per capita. The paper expands on existing literature by disaggregating the growth impactof institutions for all countries in the sample, developed and less developing countries. The independent variables included in the model are gross fixed capital formation as a percentage of GDP, net barter terms of trade, government size (expenditure), quality of institution and inflation while gross value added per capita is the dependent variable. Because of the weakness of the fixed effects model, system GMM is used to estimate the coefficients. Generally, the results show a positive and significant relationship between economic performance and the quality of institution. Precisely, a 10 units improvement in the quality of overall institution is predicted to have an effect of increasing gross value added per capita by 1.72 indices holding other things constant. Also, the impact of institutional improvements on economic performance in developed countries is higher than in less developing. As for the decomposed institutions it is evident that control over corruption, regulatory quality and voice and accountability have a positive and significant impact on economic performance of the 36 countries in the sample. Shockingly, rule of law is negative. However, there is no evidence of influence of government effectiveness and political stability and absence of violence on economic growth.