This paper contributes to the governance literature by analyzing the specific mechanisms through which governance affects economic growth: The credit channel. Specifically, it investigates the growth impact of governance on industries with different levels of dependence on external finance. Better governance mitigates credit market imperfections by increasing transparency and accountability and reducing government-policy distortions, promoting productive investment and entrepreneurship development, with a disproportionate impact on sectors that depend on external finance. This paper indeed finds that countries with well-functioning governments are better at providing growth and investment environments for the expansion of industries that rely heavily on external finance and the formation of new establishments in these industries, when controlling for financial development. These results are robust to possible reverse causality, different specifications, subsamples and outliers.
