Istituzioni e Crescita
Among the various factors influencing economic growth the role institutions in this regard has attracted a lot of attention from economists. It is without any doubt that institutions have a huge impact on the growth process of a country. The aim of this article is to highlight and explain the channels through which institutions affect the economic expansion of a country. Furthermore, the idea is to show some potential problem arising when analyzing the impact of institutions.
However, the most straightforward task is to provide a description or definition of the term “Institutions”. In fact, there exists a large variety of definitions in the literature, from which the definition of Douglass North is the most widely accepted. He defines Institutions as “humanly devised constraints that structure political, economic and social interaction consisting of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights).“[1] In the context here formal rules are more important (although informal constraints are not to be neglected as formal rules have to be in line with them). Well functioning institutions imply that individual behavior is effectively constrained. When putting it into the context of two countries, say Zimbabwe and Sweden, it becomes obvious that in a country like Zimbabwe, where President Mugabe repeatedly ignores election outcome individuals are poorly constrained. The fact that a similar behavior in Sweden is unthinkable makes clear that institutions function well there. It is also straightforward that Sweden is by far economically more successful than Zimbabwe. In fact, when looking at global income disparities, it is straightforward that the rich countries have a well functioning rule of law and effective governments. Poor countries in the south are often characterized by corruption, bad governance and an elite which unscrupulously enriches itself at the expense of the vast majority of the population. So how do institutional quality and economic performance relate to each other? Or is it just by chance that well-functioning institutions coincide with economic success?
Think of a country with bad institutions. Bad institutions, i.e. poorly constrained individuals imply that corruption is widespread, courts depend upon political power or the elite and property rights are not respected. Any economic activity is severely limited in such a context. In order to become economically active individuals want to be secure that agreements are kept. But in an environment where an investor can not be sure that the merchandise he paid really is delivered prefers not to buy. Economically speaking, individuals face high transaction costs which means that economic agents do not realize exchange they would have done otherwise. But a good which is not bought will not be produced in the future. Therefore, bad institutions discourage investment and productive activities which harms economic growth. This idea gets dates back to the grandfather of Economics, Adam Smith, who as early as in the second half of the 18th century stated that for an economy to be prosperous, clear rules of the game not only have to be established but also have to be respected.
This implies that there is a clear correlation between the quality of institutions and economic success. But is this relationship causal as well? Is it true that well-shaped institutions cause economic prosperity or might it rather be that economic success creates good institutions? Despite the above reasoning which suggests that institutions are a prerequisite for growth, the answer of this question is not as straightforward as it seems. It is well-known that well functioning institutions require a lot of bureaucracy, administration and properly functioning laws which costs a lot of money. On the other hand, there are historical examples where dictators – which imply bad institutions as they face hardly any restrictions – provided a well-functioning rule of law which in turn created economic prosperity. For example, Pinochet who ruled Chile with an iron fist imposed the rule of law. In fact, this is a hotly debated issue in the economic literature as it is almost impossible to isolate the effect of institutions on growth. Economists call this phenomenon of mutually influencing factors an endogeneity problem.
This is precisely the reason for why it is almost impossible to draw policy implications. It seems straightforward to claim that the only thing poor countries with bad institutions need are simply good institutions. However, this is almost impossible to implement from outside. There are initiatives from the EU aimed at improving control mechanism and good governance. Unfortunately, these efforts have not carried a high yield. Firstly, the existing elite is reluctant to pass on their privileges (see Mugabe in Zimbabwe or the Junta in Burma) and on the other hand there is a wide range of well-intended projects designed in the northern hemisphere but just did not function because they were not properly adapted to what North called informal constraints. It is evident that institutions have to be changed from within. The example of the Junta in Burma makes clear that this is a highly complicated task.
[1] North, D.: Institutions, Institutional Change and Economic Performance. Cambridge
University Press. 1990
