DO DEMOCRACY AND INSTITUTIONAL QUALITY DRIVE GROWTH? EVIDENCE FROM SOUTH ASIA

Abstract

Conducting a 2026 evidence review of the relationship between corruption, public debt, democracy and economic growth, the study re-visits this relationship in a more rigorous framework in six countries from South Asia Association for Regional Cooperation (SAARC): Bangladesh, Bhutan, India, Nepal, Pakistan and Sri Lanka, and builds on a modified and expanded 1996-2020 macro panel data (150 country year observations) also updated and expanded. This study re-examines the relationship between corruption, public debt, democracy and economic growth in six South Asian Association for Regional Cooperation (SAARC) economies (Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka) on a macro panel level, with a methodological upgrade, and with new evidence review included till 2026, after the previous update in 1996-2020 was expanded and upgraded. The model is designed by adopting a modified Solow growth model and includes a regression of real per-capita GDP growth against the democracy index (political rights/civil liberties), the level of external debt (relative to GNI), and control-of-corruption, while holding foreign direct investment, total investment, population growth, and trade openness constant. In addition to the couple of widely used estimators available in SAARC studies (Pool OLS, Fixed Effects and Random Effects), this new study includes the Driscoll-Kraay standard errors because of the identification of material cross sectional dependence (average pair wise residual correlation of 0.295) which was not available in the past researchers' papers about this region. The results indicate that overall, public debt has a statistically significant negative impact on the overall growth in all specifications tested, and that democracy and corruption are statistically insignificant in the pooled and random-effects specifications (although the latter becomes significant in the within/fixed-effects specification), while investment and trade openness are significant positive determinants of growth. A parallel comparison of evidence from the 2021-2025 shows the debt-growth relationship being reflected in two extreme and specific ways or cases, namely, Sri Lanka's sovereign default in 2022 and Pakistan's balance-of-payments crisis in 2022-23, the former in favor of growth and the latter against it; the debt-growth relationship is then verified as being loosely and non-contemporaneously reflected in two other transitions, the transition towards democracy in Bangladesh in 2024 and “Free” status in Bhutan in 2024. The paper uniquely recognizes and overcomes a key missing link: no previous study simultaneously estimates the influences of corruption, debt and democracy in SAARC considering panel estimators that can account for CD, nor systematically brings the evidence together that was collected before the COVID era and that will be useful in the era after. Policy implications focus on the debt sustainability management framework as the main tool in the governments of the SAARC that can be leveraged, while governance and democratic institution reform can be considered complementary measures that run on a longer time horizon.