Institutional Quality, Public Debt and Economic Growth in Ghana: Evidence from FMOLS and DOLS Estimations

For decades, economists have watched a familiar pattern unfold in developing nations: governments borrow money to build roads, schools, and hospitals, hoping to spark a boom in the economy. The logic is straightforward. When a country spends borrowed funds on productive projects, it creates jobs, increases demand, and lifts living standards. However, there is a persistent worry that borrowing too much can backfire. If the debt becomes too heavy, investors may fear that the government will raise taxes or print money to pay it back, causing them to pull their money out and stalling growth. This tension between the promise of borrowed capital and the risk of crushing debt loads has long been a central question in development economics.

In recent years, a new layer has been added to this debate. Researchers now suspect that the size of the debt is not the only thing that matters; the quality of the government managing that debt is equally critical. Imagine a country with a massive pile of cash but a chaotic system for deciding where to spend it. In such a place, money might vanish into corruption, wasted projects, or inefficient spending, leaving the economy no better off than before. Conversely, a country with strong rules, transparent accounting, and effective leaders might use even a modest amount of borrowed money to generate significant growth. This idea—that the "rules of the game" determine whether debt helps or hurts—has become a crucial lens for understanding why some nations thrive while others struggle, even when they face similar financial pressures.

A recent study focused on Ghana, a nation in West Africa that has navigated a complex path of economic reform and rising debt over the last three decades, offers a fresh look at this dynamic. The researchers, Thomas Osei Bonsu Dankwah and Selva Kumar D., set out to understand how public debt and the quality of institutions work together to shape the country's economic growth. They gathered annual data spanning from 1990 to 2024, a period that saw Ghana transition from heavy debt relief to new borrowing cycles, and even weather global shocks like the pandemic. Their goal was to move beyond simple questions of "how much debt is too much" and instead ask how the strength of a country's governance changes the outcome of borrowing.

To do this, the team looked at several moving parts of the Ghanaian economy. They tracked the country's real economic output, the total amount of public debt relative to the size of the economy, and a composite score representing the quality of institutions. This score measured things like how effective the government was, how well laws were enforced, how much corruption was controlled, and how stable the political environment remained. They also kept an eye on other factors that influence growth, such as inflation, how open the country was to international trade, and the flow of foreign investment. Using advanced statistical methods designed to handle long-term trends in data, they tested whether these variables moved together in a stable relationship over time.

The analysis confirmed that a stable, long-term connection exists between these factors in Ghana. When the researchers looked at the numbers, they found that public debt, on its own, has a positive effect on economic growth. This suggests that, historically, the money Ghana borrowed has been used in ways that have helped expand the economy, supporting the idea that borrowing for development can work. However, the story becomes more nuanced when the quality of institutions is brought into the picture. The study found that better governance does more than just help the economy grow on its own; it actively changes how well borrowed money works.

The most significant finding was that strong institutions act as a force multiplier for public debt. When the quality of governance is high, the positive impact of borrowing on economic growth becomes even stronger. In practical terms, this means that borrowed funds are more likely to be turned into productive investments when there are robust systems in place to manage them. Strong institutions help ensure that money goes to the right projects, that corruption is kept in check, and that the benefits of spending are actually realized. The data showed that without this institutional strength, the potential benefits of borrowing might not be fully captured, or the debt could become a burden rather than a tool for progress.

The study also shed light on other economic forces at play. High inflation was found to drag down economic growth, confirming that price instability makes it harder for businesses and the government to plan for the future. Similarly, while trade openness is often seen as a path to prosperity, the data suggested that in Ghana's specific context, it has not yet translated into sustained growth, possibly due to reliance on imports or vulnerability to global shocks. On a positive note, foreign direct investment—money coming from abroad to build businesses—was shown to support long-term economic performance, but only when the broader environment of governance and debt management was sound.

The researchers were careful to note that their work identifies a strong association between these factors over the long run, rather than proving a direct cause-and-effect in every single year. The data covers a specific period in Ghana's history, and the findings reflect the unique mix of policies and challenges the country faced between 1990 and 2024. Nevertheless, the consistency of the results across different statistical tests gives the findings weight. The evidence points clearly to a conclusion that challenges the idea that debt is simply good or bad. Instead, the effectiveness of public borrowing depends fundamentally on the quality of the institutions that manage it.

For policymakers in Ghana and other nations facing similar choices, the message is clear. Simply borrowing money is not enough to guarantee economic success. The study suggests that the path to sustainable growth requires a dual approach: prudent borrowing strategies must be paired with continuous efforts to strengthen governance. This means improving how public funds are managed, ensuring transparency in how projects are selected, and building systems that hold leaders accountable. When these institutional foundations are strong, borrowed resources are far more likely to be transformed into the kind of productive investments that lift living standards and secure a stable economic future. The research underscores that the rules of the game are just as important as the money being played with.