Institutions and Development Emiko Nishii & Elisabeth Niendorf January 11th, 2010 University of Warsaw - MADE

Institutions and Development

Emiko Nishii & Elisabeth Niendorf

January 11th, 2010

University of Warsaw - MADE

January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE

Income differences across countries and institutional differences

Mind- mapping

Which characteristics of institutions would you consider favourable for growth?


Outline

1. What are institutions?

- economic and

- political institutions

2. How can institutional characteristics influence growth? How can we measure institutional quality?

3. What is the magnitude of the effects on growth?

4. Can we formulate policy implications then?

5. Future Research Objectives

6. Conclusions


1. What are institutions?

“Institutions are the rules of the game in a society or, more formally, are the human devised constraints that shape human interaction.” (Douglas North)

Economic institutions

Different groups and individuals benefit from different economic institutions! - social conflicting view

Political institutions

January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 5

Williamson’s perception of insitutions

LevelFrequency

(years) PurposeEmbeddedness:

informal insitutions, customs, tradition,

norms, religionL1 102 -103

Often noncalculative

spontaneous

Institutional environment

Formal rules of the game esp. property

(judiciary, bureaucracy)

L2 10-102

Get the insitutional environment right

1st order economizing

Governance:Play of the game – esp.

Contract (aligning governance structures

with transactions)

L3 1-10

Get the governance structure right

2nd order economizing

Resource allocation and employment

(prices & quantities; incentive alignment

L4 continuous

Get the marginal conditions right

3rd order economizing


2. How can institutions influence growth?

Market structure Laws Regulations matter in the background Policies

“Good institutions” Property rights and contract enforcement Effective constraints on power-holders Few rents to be captured by power-holders


2. How can we measure institutional quality?

We need: objective evaluations, comparable across countries over time.

- Institutions Index: Kaufmann et al. (2006)

1. Political rights, civil liberties2. Political stability and absence of violence3. Quality of public service4. Regulatroy Quality5. Rule of law6. Freedom of graft

- Quality of public institutions index: Knack & Kefer (1995)


2. How can we measure institutional quality?

Consensus in literature:

protection of property rights (North & Thomas (1973) and Rosenberg & Bridzell (1989),

control for corruption (Mydral 1968, DeSoto 1989), rule of law (Becker 1968, Becker & Stigler 1974), is of high importance for development.

Acemoglu & Verdier (1998) general equilibrium framework - socially optimal resource

allocation


3. What is the magnitude of the effects on growth?

Institutions Rule (Rodrik et al. 2002)

Main objectives:

How much of difference in income can be explained as a result of institutions? Are institutions more important than other variables?


Empirical Framework

OLS regression:

y= GDP per capita on a PPP basis for 1995

INT=Quality of Institutions (The survey of investor perceptions about protection of property rights and the strength of the rule of law)

INT=Integration (The ratio of trade to GDP)

GEO=Geography (A country’s distance from the equator)


Empirical Framework (Cont.)

Main problems:

Reverse causality

- INS and INT are both endogenous

Multicollinearity

- Interlinkages among the independent variables

Difficulty in identifying the independent contribution of these 3 variables to the cross-national variation in income levels



Source: Subramanian & Rodrik (2002)



Acemoglu, Johnson, and Robinson (AJR, 2001)

Use Settler Mortality (SM) as an instrument for INS.

=mortality rates of European settlers among 19th century

Frankel and Romer (FR, 1999) Use Constructed Trade Shares (CONST) as an instrument

for INT.

= trade/GDP shares constructed on the basis of a gravity equation for trade flows


Two-stage least squares:



*

*Extended AJR sample= sample of 80 countries *Larger sample= sample of 140 countries including countries which were not colonized

Source: Subramanian & Rodrik (2002)


Empirical Results


Empirical Results (Cont.)


Empirical Results (Cont.)


Robustness Check

1. Including regional dummies to drop certain influential observations which are arguably different from the rest of the countries

Main finding:

The coefficient of INS remains statistically significant, and increases in magnitude

These countries are not driving the results, thus the results are robust


Robustness Check (Cont.)

2. Use different instruments to measure for GEO to see if the results would be different

(e.g. access to the sea, number of frost days per month, mean temperature, etc.)

Main results:

- None of these GEO variables is statistically significant

- INT remains statistically insignificant

- INS remains statistically significant


Robustness Check (Cont.)

Frankel and Romer (1999)‘small countries tend to trade more’

3. Control for country size (area/population) to see the real effect of INT on income

Main results:- The size and significance of INS are unaffected- INT remains statistically insignificant


4. Can we formulate policy implications to reform institutions then?

Failure of Washington Consensus

How do formal rules function in practice?

Mukand & Rodrik (2002) assumptions: policies vary in 2 dimensions:

“appropriateness” and “transparency”


Mukand & Rodrik (2002)

Country 1: Leader, with z1 denoting the “unique state of the world” in which country 1 is located

Country 2: Follower, with z2 as its location

Policy aj affects national output: yi= -θ(aj-zi)² due its “specificity”

a1- Leader’s policy a2- Follower’s policy

Leader maximizes national income: y1= 0, because a1=z1.



Government’s utility function: v2= y2 –λ K,

where K is a private fixed cost.

Follower chooses to imitate as long as: v2(a1=a2)≥ v2(a2’=z2),

where a2´shows us that there is some uncertainty about the policy implementation a2´= z2+ η .


Source: Mukand & Rodrik (2002)




Source:





5. Future Research Institutions and Sustained Growth

Acceleration

Growth Acceleration

(Hausmann and Rodrik et. al 2005)

Main objective:

Identify the turning points in growth experience and ask what determines these transitions.

Uncover the effect of institutions on sustained growth acceleration.


Empirical Framework

Methodology

1. Identify the turning points in growth episodes

2. Observe what happened before the turning points



Criteria of growth episodes:

- an increase in per-capita growth of 2% points or more

- the increase in growth has to be sustained for at least 8 years

- the post-acceleration growth has to be at least 3.5% per year

- the post-acceleration output must exceed the preepisode peak level of income


Empirical Framework

Data: the Penn World Tables (PWT)

Sample: 110 countries, between 1957 and 1992



Did External shocks, Political changes, and Economic reform affect these growth acceleration?


Empirical Results Only 14.5% accelerations are associated with economic reform-

economics liberalization

Only 13.9% of political-regime changes are followed by growth acceleration

Growth accelerations are fairly frequent occurrence. However, most growth accelerations are not preceded or accompanied by changes in economic policies, institutional arrangements, and political circumstances.


6. Conclusions Empirical evidence: differences in institutions explain a significant part of

income variation across countries

One size does not fit all….. In order to implement effective institutions, a country must: - Identify the main constraints for economic growth - Derive policies that target these constraints

“Sound policies need to be embedded in solid institutions.” (Rodrik 2006)

Institutional change is a constant approach and has to adapt to a changing environment


Thank you for your attention!

Documents

Institutions and Development Emiko Nishii & Elisabeth Niendorf January 11th, 2010 University of Warsaw - MADE