Institutions and Economic Performance: Endogeneity and Parameter Heterogeneity

Abstract

The hallmark of the recent development and growth literature is the quest to identify institutions that explain significant portions of the observed differences in living standards. There are two drawbacks to the prominent approaches that focus either on the global sample, or on developing nations. First, it is unclear whether the identified institutions also hold explanatory power in advanced countries. Second, it is unclear whether the identified institutions matter to the same degree across all countries, or whether perhaps an altogether different set of institutions matters in advanced countries. To address these issues, we examine parameter heterogeneity in prominent approaches to institutions and economic performance. We find that parameter heterogeneity is so strong that it requires a new set of instruments to control for endogeneity. At the same time, however, we confirm that a common set of economically important institutions does exist among advanced and developing nations. The impact of these institutions is shown to vary substantially across subsamples; they are about three times more important in developing countries than in OECD countries.