Abstract

After it has been hypothesized and empirically validated that institutional quality (InQ) is an essential ingredient for development, examining whether InQ impacts living standards (LStds) is a worthwhile exercise. Using data from 2000 to 2019 on 20 SSA countries, this study modelled the impact of InQ on LStds in a VAR framework, upon satisfactory data suitability tests. The impulse response functions and forecast error variance decomposition estimates provide evidence that InQ does not directly impact LStds but does so through its effects on financial development (FDI). As the forecast horizon moves from 1 to 5 forecast periods, InQ accounts for about 7.13% of FDI shocks, while FDI explains about 0.55% of LStd, and LStds account for about 1.13% of FDI shocks. Ultimately, InQ impacts LStds through FDI. This paper concludes that FDI optimizes inflation and improves LStds, while inflation retards FDI in the short-run. The autocorrelation LM and Eigen value tests confirmed the robustness of the results. Government in SSA should implement laws and policies that will strengthen institutions to improve the LStds of their people.

Key words: Institutional quality, living standards, stochastic trend, impulse response functions (IRFs), forecast error variance decompositions (FEVD).