Institutions and
Development
Emiko Nishii & Elisabeth Niendorf
January 11th, 2010
University of Warsaw - MADE
Income differences across countries and
institutional differences
Mind- mapping
Which characteristics of institutions would you consider
favourable for growth?
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Outline
1.
2.
3.
4.
5.
6.
What are institutions?
- economic and
- political institutions
How can institutional characteristics influence growth?
How can we measure institutional quality?
What is the magnitude of the effects on growth?
Can we formulate policy implications then?
Future Research Objectives
Conclusions
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
Williamson’s perception of insitutions
Level
Frequency
(years)
Embeddedness:
L1
informal insitutions,
customs, tradition,
norms, religion
Institutional
environment
L2
Formal rules of the game
esp. property (judiciary,
bureaucracy)
Often noncalculative
102 -103
L4
Play of the game – esp.
Contract (aligning governance
structures with transactions)
Resource allocation and
employment
January (prices
11th, 2010&
quantities;
incentive alignment
spontaneous
Get the insitutional
environment right
10-102
1st order economizing
Get the governance
structure right
Governance:
L3
Purpose
1-10
2nd order economizing
Get the marginal
conditions right
continuous
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
3rd order economizing
5
2. How can institutions influence
growth?




Market structure
Laws
Regulations
Policies
matter in the background
“Good institutions”
 Property rights and contract enforcement
 Effective constraints on power-holders
 Few rents to be captured by power-holders
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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 liberties
Political stability and absence of violence
Quality of public service
Regulatroy Quality
Rule of law
Freedom of graft
2.
3.
4.
5.
6.
-
Quality of public institutions index: Knack & Kefer (1995)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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?
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework (Cont.)
Source: Subramanian & Rodrik (2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework (Cont.)
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework (Cont.)
Two-stage least squares:
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
*
*Extended AJR sample= sample of 80 countries
*Larger sample= sample of 140 countries including countries which were not colonized
Source: Subramanian & Rodrik (2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Results
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Results (Cont.)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Results (Cont.)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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”
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Mukand & Rodrik (2002)
denoting the “unique state of the world” in
which country 1 is located
Country 1: Leader, with z1
Country 2: Follower, with
Policy
aj
z2
as its location
affects national output:
yi= -θ(aj-zi)²
due its “specificity”
a1- Leader’s policy
a2- Follower’s policy
Leader maximizes national income:
January 11th, 2010
y1= 0, because a1=z1.
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Mukand & Rodrik (2002)
Government’s utility function:
where K is a private fixed cost.
v2= y2 –λ K,
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 .
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Source: Mukand & Rodrik (2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Source: Mukand & Rodrik (2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Source: Mukand & Rodrik
(2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Source: Mukand & Rodrik (2002)
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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.
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework
Methodology
1. Identify the turning points in growth episodes
2. Observe what happened before the turning points
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework (Cont.)
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework
Data: the Penn World Tables (PWT)
Sample: 110 countries, between 1957 and 1992
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Framework (Cont.)
Did External shocks, Political changes, and Economic
reform affect these growth acceleration?
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Empirical Results

Only 14.5% accelerations are associated with economic reformeconomics 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.
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
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
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE
Thank you for your attention!
January 11th, 2010
Emiko Nishi & Elisabeth Niendorf – University of
Warsaw - MADE