INSTITUTIONS AND ECONOMIC DEVELOPMENT: DISENTANGLING THE ROLE OF CONTRACTING AND PROPERTY RIGHTS INSTITUTIONS

Abstract

This paper aims at estimating the effect of different types of institutions on economic development. To tackle the endogeneity problem that is prevalent, an identification strategy exploiting the heteroskedasticity in the data is used. This also allows to analyze the reverse effect, running from economic development to institutions. In a sample of about 100 countries, an impact of property rights institutions but not contracting institutions on economic development is detected. Furthermore, the results suggest that a higher level of economic development improves contracting institutions, but not property rights institutions.Keywords: Economic Development, Institution, PropertyRightsJEL classification: O11, O43, P14, P16(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONA broad consensus prevails among economists that the institutional setting securing property rights is beneficial for economic development. The relative importance of different types of institutions has been studied recently by Acemoglu and Johnson (2005), suggesting that property rights institutions but not contracting institutions are pivotal for economic development. However, causality may run as well in the opposite direction, wherefore an appropriate identification method is needed.Due to the specific instrumental variables used, Acemoglu and Johnson (2005) have to restrict their sample to former colonies.1 Therefore, in order to increase the sample size, the effect of institutions on economic development is investigated by applying a novel identification strategy, the so-called identification through heteroskedasticity method (henceforth IH method) suggested by Rigobon (2003).2 The main objective of this paper is to contribute to the discussion about the relative importance of different types of institutions for economic development. However, as the IH method also allows to capture the reverse causality, the potential effect of economic development on different types of institutions can be analyzed as well.This paper contributes to a vast literature on the effect of institutions on economic development and growth. In their seminal work, North and Thomas (1973) expose how the development of efficient economic organization, that is the establishment of an institutional arrangement that secured property rights, was beneficial for the rise of Western Europe. North and Weingast (1989) point out how the institutional changes towards secure property rights and the elimination of confiscatory government in seventeenth-century England was favorable for economic development. According to North (1990), institutions are pivotal, as they determine under which constraints individuals organize themselves in their societies. Some institutional settings stimulate humans to save and to invest, to innovate, to learn or to educate, some do not (Acemoglu and Robinson, 2005). Developing a formal growth model, Tebaldi and Elmslie (2008) show how the quality of institutions, via their effect on technological innovation, affect the transitional and steady state growth rates of output. Hall and Jones (1999) analyze the effect of social infrastructure, that is institutions and government policies, on long-run economic performance. They conclude that differences in social infrastructure explain differences in the level of output per worker, due to the effect social infrastructure has on the rates of investment in physical and human capital and on the level of productivity. Acemoglu et al. (2001) and Acemoglu et al. (2002), exploiting differences in European mortality rates and population density in former colonies as instrumental variables, estimate large effects of institutions on economic performance. Other papers explaining differences in economic development with historic events are those by La Porta et al. (1997; 1998) and Engerman and Sokoloff (1997; 2002). Nunn (2009) provides an overview of this literature. Rodrik et al. …