Imperative of Institutions for Effective Relationship Between Economic Performance and Ethnic Diversity

The impact of ethnic diversity on economic performance is a divisive topic in literature that needs to be explored further. There are two opposing views about the relationship between economic performance and ethnic fractionalization; it is perceived that highly segregated communities have social conflicts and tensions which affect economic activities in a negative way. On the other hand, ethnically diverse communities are assumed to have more capacity for problems-solving because people have a variety of diverse thinking approaches. The role of institutional quality is hardly discussed in earlier studies while exploring the relation between diversity and economic performance. It is argued in this study that the relation between economic performance and diversity is determined by prevailing quality of institutions in a country. The instrumental variable threshold regression approach is used for an unbalanced panel data of 89 economies covering the time period of 1990–2020 to investigate the relation among economic performance, ethnic diversity, and institutional quality. The empirical outcomes of the paper highlight that the presence of institutional quality up to a certain threshold level is mandatory to increase economic performance through ethnic diversity, while ethnic diversity deteriorates the economic performance, if the quality of institutions is below the threshold level in an economy. The policy makers of ethnically fractionalized societies should focus to improve the quality of institutions for better economic performance.