Investing in Institutions

Investing in Institutions - ECONOMICS & POLITICS Volume 22...

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INVESTING IN INSTITUTIONS RYAN A. COMPTON, DANIEL C. GIEDEMAN, AND NOEL D. JOHNSON à Robust institutional change is difficult to achieve. However, it is more difficult for some countries than others. We use data on 69 countries between 1870 and 2000 to show that political instability does not always aFect growth outcomes. We then develop a simple model to explain this fact in which the likelihood that ‘‘good’’ institutions are abandoned during periods of political uncertainty depends on the opportunity cost of doing so. We operationalize our model by using contract intensive money as a proxy for this initial investment in growth-enhancing in- stitutions. Cross-sectional and panel growth regressions support the model’s predictions. 1. INTRODUCTION THERE IS signi±cant support in the economic history and growth literatures for the idea that ‘‘good’’ institutions lead to higher growth. Unfortunately for policy-makers, ‘‘good’’ is often associated with deeply determined fac- tors, such as ethnic fractionalization (Easterly and Levine, 1997), colonial history (Acemoglu et al., 2001), or initial resource endowment (SokoloF and Engerman, 2000). It is perhaps unsurprising then, that the instruments of development appear much less eFective than the instruments of the authors cited above. Countries that have adopted political and economic reforms, like those associated with the Washington Consensus, have experienced disappointing economic outcomes. 1 The case that good policy is not suffi- cient for good growth has been made repeatedly in the cross-country growth literature (e.g. Easterly and Levine, 2003, or Rodrik et al., 2004). This raises the question of whether reforms fail to take hold because a country lacks some necessary ‘‘deep’’ factor, or if there is a simpler explanation. We argue that failures of reform often have less to do with whether or not speci±c institutional changes are ‘‘correct’’ than with whether or not in- dividuals have had the time to accept them as the norm. There are many à Corresponding author: Noel D. Johnson, Department of Economics, George Mason Uni- versity and Mercatus Center, 3301 North ²arifax Dr., Suite 450, Arlington, VA 22201, USA. E-mail: [email protected] 1 The original Washington Consensus as detailed by Williamson (1990) laid out policies to be encouraged by international aid organizations including ±scal discipline, tax reform, trade liberalization, privatization, and the establishment of secure property rights. ²or a critique of the Consensus, see Rodrik (2007) or World Bank (2005). ²or the argument that good policies are actually more important for growth than good institutions, see Glaeser et al. (2004). r 2010 Blackwell Publishing Ltd 419 ECONOMICS & POLITICS DOI: 10.1111/j.1468-0343.2010.00370.x Volume 22 November 2010 No. 3
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ways for a country to escape poverty (Rodrik, 2007), but for any serious institutional change to actually bind on behavior, individuals must accept it as legitimate. North (1990, 1994) points out that formal rules alone do not shape economic performance. It is also necessary that informal norms adjust so that formal rules are internalized as behavior (North, 1990, p. 366).
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This note was uploaded on 04/05/2011 for the course ECO 365 taught by Professor Giederman during the Winter '11 term at Grand Valley State University.

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Investing in Institutions - ECONOMICS & POLITICS Volume 22...

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