Does Public Financial Management Quality Improve Governance? Evidence from PEFA Assessments

This paper investigates the specific institutional mechanisms within Public Financial Management (PFM) that drive improvements in governance outcomes, a critical determinant of long-run economic development. Leveraging a comprehensive dataset of 185 national PEFA assessments across 103 countries, we demonstrate that governance enhancements are most robustly associated with the integrity of the execution-stage control-audit chain within PFM systems. Specifically, our disaggregated analysis reveals that internal expenditure controls (PI-20), internal audit (PI-21), and external audit with legislative follow-up (PI-26) operate as an integrated accountability mechanism, significantly influencing Control of Corruption, Government Effectiveness, and Rule of Law across all six Worldwide Governance Indicators. Furthermore, we uncover significant regional heterogeneity, with the PFM-governance association being substantially larger and more statistically significant in Sub-Saharan Africa and Latin America and the Caribbean, suggesting that this execution-stage accountability acts as a binding constraint in weaker institutional environments. Our work extends the empirical understanding of the PFM-governance nexus by identifying precise institutional practices and proposing the control-audit chain as a core theoretical mechanism, offering crucial policy implications for targeted PFM reforms in developing economies. These findings, robust to both panel fixed-effects and cross-sectional specifications, underscore the critical role of monitoring and enforcement in policing principal-agent relationships within the public sector.