How do institutions promote development?

Institutions, innovation and growth

Andrés Rodríguez-Pose

London School of Economics

IRIS

Stavanger, 5 May 2009

Introduction



Do institutions matter for innovation and growth?



The link between institutions and growth has traditionally been overlooked



Traditional approaches to spurring economic development were based on:

1.

Greater investment in the stock of physical capital (neoclassical)

2.

Endogenising innovation, technology, and physical capital (endogenous growth)

3.

Agglomeration, externalities, and distance (new economic geography)



This system tended to work in the past

1.

National intervention in the postwar period had coincided with growth and a reduction in disparities

2.

The first two approaches informed the European regional development effort during the reform of the Structural Funds

Do institutions matter for regional development? Andrés Rodríguez-Pose

Page 1

Do traditional approaches still work?



These approaches, however, seem today less capable of explaining economic growth and development

1.

Regional convergence shifted to stability and divergence

Cross-country convergence

Intranational stability or even strong divergence

2.

Growth in the residual factor



Institutions being rediscovered

1.

Work by sociologists, geographers, and some economists since the mid-

1980s

2.

Becoming mainstream in economics

‘Institutions matter’ (Hall and Jones, 1999; Rodrik et al, 2004)

Research now trying to understand which institutions matter

Some institutional arrangements are more appropriate than others, depending on the circumstances (Aghion and Howitt, 2006)


Page 2

Aim of the presentation



If

1.

We can explain less and less how economic development is being generated

2.

The role of institutions as a shaper of economic development is being regarded as more prominent

3.

Economic development efforts have, by and large, overlooked local institutions



Ergo

1.

Institutions should become an essential element of development effort.



But, is that the case?



If so, how can institutions be included in the local innovative and development effort?


Page 3

The role of institutions in growth



Across the world development strategies seem to be becoming less effective

1.

Neoclassical orthodoxies regarded as inadequate and perhaps providing imperfect interpretations of regional development (Yeung, 2000)



Growing attention has been paid to other factors and, especially institutions



Belief that different local institutional arrangements are key to our understanding of development

1.

Emphasis on social capital (Putnam, 1993, 2000)

2.

On institutional thickness (Hudson, 1994; Amin and Thrift, 1995)

3.

Learning regions (Morgan, 1997)


Page 4

But, what are institutions?



Concept of institutions is:

1.

Subjective

2.

Controversial

3.

Difficult to operationalise



Numerous nuances and distinctions in concepts

1.

Formal vs. informal institutions

2.

Informal institutions of community (norms, trust, face-to-face) vs. social capital

3.

Institutions vs. organisations (rules vs. players) (North, 1990)


Page 5

How do institutions promote development?



Markets as socially constructed (Bagnasco, 1988)

1.

This makes the role of institutions greater than simple regulators of economic activity

2.

They determine the level of activity and its efficiency

3.

They facilitate knowledge and innovation transfer

4.

They shape incentives and disincentives



Different forms of institutions are in constant interaction

1.

The balance between formal and informal institutions (society and community)

 ‘Institutional thickness’ determines the development capacity of every territory


Page 6

Society, community and development



Communities (Gemeinschaft or social capital) are complemented by Society



Communities refer to:

1.

features of group life (i.e.: informal rules and norms, tradition and social expectations, contacts and connections, and relationships).



Society refers to:

1.

universal and transparent rules (i.e.: property rights, rule of law, promotion of individual choice, and factor mobility).


Page 7

The economic impact of communities



The optimistic view: Communities are good for development

1.

Community improves:

provision of public goods (Coleman, 1990; North, 1990)

market organisation (Granovetter, 1985)

promotes the embedding of firms in efficiency-enhancing networks of relationships (Grabher, 1993)

generates institutions such as trust (Fukuyama, 1999; Putnam, 2000;

Bowles and Gintis, 2002)

reduces transaction costs (Storper, 1997)

reduces moral hazards and free-riding (Streeck, 1992)

mitigates information asymmetries (Granovetter, 1985; Wade, 1987)

matches individual and aggregate interests (Rodríguez-Pose, 1999)


Page 8

The economic impact of communities (II)



The pessimistic view: Communities are bad for development

1.

Community leads to:

pervasiveness of rent-seeking (Trigilia, 1992)

insider-outsider problems

2.

unsatisfactory distributional effects

clientelism, and nepotistic practices (Trigilia, 1992)

it may be a second best solution in the absence of developed societal institutions

3.

Communities may

generate greater social polarization

hamper equal opportunity

exacerbate problems of imperfect competition, impacted information, and principal-agent problems (Durlauf, 1999; Durlauf and Fafchamps,

2004).


Page 9

The economic impact of society



The development of societal institutions is generally perceived as a positive sign



But, under certain circumstances it may be detrimental for development:

1.

In contexts dominated by weak group life, societal rules and laws cannot always insure against opportunistic defection (Streeck, 1991)

2.

Higher transactions costs and costly conflict resolution through litigation, i.e. a confrontational society (Storper, 2004).

3.

Inadequate production of public goods (education and training, environmental management, or innovation)


Page 10

Interaction between society and community



Society and community are thus generally viewed as mutually opposed



But they interact in all contexts



Relations in any space take place in the form of:

1.

‘bonding’: within community relations

2.

‘bridging’: across community relations (Putnam, 2000)



A system of checks and balances can be developed:

1.

Developed communities can offset the potentially negative effects of society

2.

A developed society can offset the potentially negative effects of community


Page 11

Society and community interaction

Society Community

High

Low

Sub-optimal

High

Optimal

Low Worst case scenario Sub-optimal


Page 12

Society and community (II)

SOCIETY

LOW

COMMUNITY

HIGH

HIGH Responsibility without autonomy: individual agency but insufficient voice

 dominance of arms-length transactions;

 moral hazards contained when information transparent only

 asymmetrical strength of individual agents;

 certain interests have no voice/no autonomy

(effort and reward markets are imperfect);

 costly conflict resolution and confrontational society;

 insufficient public goods;

 tendency toward inequality;

Autonomy with responsibility: a good balance of voice and agency

 costs for all kinds of transactions minimized;

 moral hazards contained for both transparent and specific information;

 autonomy strong and participation high (strong community reduces losses due to anonymity, fragmentation);

 rent-seeking contained through competition, entry and exit (strong society modernizes communities);

LOW Neither autonomy nor responsibility: chaos and the law of the jungle (voice of the powerful, ubiquitous agency problems)

 high costs for all types of transactions

 generalized instability: weak societal rules, weak local bonding;

 high moral hazards, generalized opportunism, low sanctions for defection and cheating;

 public goods destroyed or stolen or appropriated;

Autonomy without responsibility: collective voice, but with agency problems



High transactions costs for arms-length transactions;

 prevalence of primitive, non-modern communities;

 rent-seeking widespread;

 individual voice subjugated to groups

(insufficient competition and mobility);

 insufficient generalized trust and confidence;

 skewed distribution of public goods


Page 13

Integrating institutions in development



Developing and improving institutional capacity is therefore increasingly regarded as key for development



There is a need to integrate institutions in development strategies



But this is easier said than done



Several factors limit the integration of institutions in development strategies


Page 14

Key problems



Measuring institutions is difficult and controversial

1.

Local institutional constructs tend to be intangible (Fine, 2000)

2.

Identical formal institutions may yield very different economic returns in different contexts



Efficient institutions are context- and geography-specific

1.

What is solid and efficient in one region may not be so in another

2.

There is a need to integrate institutions in development strategies



The effectiveness of institutions changes with time

1.

What are ‘good’ institutions in one period may no longer be appropriate in another (Storper, 2005)

2.

Institutions adapt (institutional migration)



Institutions are extremely resilient to change

1.

Persistence of family structures (Duranton et al., 2009)


Page 15

Key problems (II)



Identifying the right mix of institutions is problematic

1.

More than the density of institutions…

2.

It is the quality of institutions



Endogeneity between institutions and development

1.

Direction of causality difficult to predict



Endogeneity between institutions and other constituents of growth

1.

Institutions may hide the effect of other factors and especially human capital (Glaeser et al., 2004)


Page 16

So, how to link institutions and innovation?



With difficulty and not devoid of problems…


Page 17

Approaches to the analysis of innovation



How can innovation and growth be generated?



3 traditional approaches:

1.

The ‘linear model’

Analysis of the link between R&D, patents and growth

Fundamentally quantitative (econometric analysis)

Conducted mainly by ‘mainstream’ economists

2.

The ‘systems of innovation’ approach

Analysis of the ‘territorially-embedded’ institutional networks that favour the generation of innovation

-

The capacity to set these networks depends in turn, on a series of social and structural conditions (‘the social filter’)

Fundamentally qualitative

Conducted mainly by geographers, evolutionary economists, and some economic sociologists

3.

Knowledge spillovers

Look at the diffusion and assimilation of innovation

Quantitative and qualitative

Economists and geographers


Page 18

Linking the approaches

Link between investment in R&D, patents, and economic growth.

(Fagerberg 1988, 1994 and 1997; Grossman and

Helpman 1991;Maurseth and Verspagen 1999)

Geographical diffusion of regional knowledge spillovers;

(Anselin et al. 1997, Adams and Jaffe 2002; Audretsch and

Feldman 2003, Leamer and Storper 2001, Storper and

Venables 2004, Sonn and Storper 2005)

Existence and efficiency of regional innovation systems.

(Camagni 1995, Becattini 1987, Morgan 1997 and

2004, Cooke et al. 1997, Iammarino 2005,

Rodriguez-Pose 1999)


Page 19

Linking the approaches (II)

Link between investment in R&D, patents, and economic growth

Geographical diffusion of regional knowledge spillovers

Existence and efficiency of regional innovation systems


Page 20

Innovative factors behind growth

Investment in R&D and patents, when other factors are controlled for, do not lead to greater growth

Lag 0

Constant

Log GDPpc

R&D Filter

Social Filter

Clusterisation Index

R

2

F

2.157***

0.350

0.757***

0.038

0.009

0.008

0.049***

0.005

0.013**

0.005

0.925

614.21

Number observations 1756


But, social conditions

(fundamentally education) matter

As do institutional conditions

(specialisation in clusters, focus and diversification)

Page 21

Innovative factors behind growth (II)

But R&D and patents become significant with time

Constant

Log GDPpc

R&D Filter

Social Filter

Clusterisation Index

R

2

F

Number observations lag 1

1.956***

0.314

0.785***

0.034

0.015**

0.007

0.043***

0.005

0.011**

0.005

0.932

582.94

1596 lag 3

1.683***

0.243

0.853***

0.028

0.017***

0.006

0.031***

0.004

0.006

0.005

0.947

705.77

1276

Do institutions matter for regional development? Andrés Rodríguez-Pose lag 6

1.392***

0.248

0.899***

0.028

0.015**

0.007

0.024***

0.005

0.002

0.005

0.968

1281.37

796

The social filter

(fundamentally education) remains the most significant throughout

But institutions lose significance in time

Page 22

How do institutions promote development?

Institutions, innovation and growth

Introduction

Do traditional approaches still work?

Aim of the presentation

The role of institutions in growth

But, what are institutions?