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Научни трудове на Съюза на учените в България-Пловдив. Серия В. Техника и технологии, естествен ии хуманитарни науки, том XVI., Съюз на учените сесия "Международна конференция на младите учени" 13-15 юни 2013. Scientific research of the Union of Scientists in Bulgaria-Plovdiv, series C. Natural Sciences and Humanities, Vol. XVI, ISSN 1311-9192, Union of Scientists, International Conference of Young Scientists, 13 - 15 June 2013, Plovdiv.
INSTITUTIONS AND ECONOMIC GROwTH
Elizabeta Tosheva№ and Elena Tilovska -Kechegil
University St. Clement Ohridski «Faculty of law, Rudnicka bb. 6250 Kichevo,
Republic of Macedonia;
№ elizabeta.tosheva@uklo.edu.mk I elena_tilovska_kechegi@hotmail.com
Abstract
The purpose of this paper is to provide an analytical review of the recent literature on the relationships between institutions and economic growth. Institutions including both formal rules and the nature of interactions of economic, political and social spheres are crucial for understanding economic incentives and long-run economic growth. An emerging literature provides new empirical evidence for more precisely pinpoint how institutions operate and affect economic performances, as well as the conceptual framework for modeling their impact and dynamics.
We limited the scope of this review to recent and macro-oriented studies of institutions and growth. In short, we can interpret the rediscovery of institutions and to a lesser extent the renewed interest, as a product of two trends. The first trend consists of an autonomous rediscovery of the importance of institutions in the economics that resulted in new theories of how institutions doing a significant and sizable effect on growth. The second trend is a renewed focus of international organizations, policy makers and development researchers on the role of the institutions and governance aimed at understanding and overcoming the heterogeneous outcomes of previous market-oriented reforms.
In addition to the primary influences of the capital accumulation and skills embodied in the human capital, the results confirm the importance for growth of research and development activity, the macroeconomic environment, trade openness and well developed financial markets. Together with the policies and culture, institutions provide the incentives that guide the behavior of economic actors.
Keywords: economic growth, institutions, laws, regulation, institutional framework
Introduction
Institutions are defined as the humanly devised constraints that structure human interaction, and provide the rules of the game. To an important extent, institutions determine the scope and degrees of freedom for policymaking. While neoclassical growth theory has proved a powerful
device for understanding the proximate sources of growth, empirical investigations have shown that much of growth remains unexplained by factor accumulation.1 In different ways, these literatures gave rise to a search for 'ultimate sources' of growth that can explain the causes of factor accumulation, technical change and thus opened the door to institutional analysis. There is now a growing consensus that institutions matter for growth, but disagreement about how exactly, the extent to which this is the case, and which institutional arrangements affect growth more than others. Over time, early institutionalism (e.g. Veblen, 1899; Commons, 1936; Mitchell, 1910) and post-WWII institutionalism (e.g. Gruchy, 1947, 1978; Kapp, 1950; Hirschman, 1958; Myrdal, 1968) have offered varying approaches to the study of institutions. New Institutional Economics with its transaction cost approach integrated institutions with neoclassical analysis (e.g. North and Thomas, 1973; North, 1990; Williamson, 1985). Building on this neo-institutional literature, recent theories and econometric studies suggest varying causal mechanisms of how institutions developed and determine long-run growth.
Sources of the growth framework
When we talk about "institutions", we are referring to something much broader than simply the set of easily recognizable legal entities, such as parliaments or central banks or unions (although these are all particular examples of institutions). An institution is any generally accepted procedure that governs the process of interaction between members of a society. Institutions determine the incentives of and constrains of an economic actors and shape economic outcomes. Legal systems are another fundamental institution and here much attention has focused on the distinction between civil law and common law systems - the former being based on a set of statutes handed down by a supreme authority, the latter being based on a corpus of case law formulated by judges. A second characteristic of legal systems that has attracted attention is the degree of independence of the judiciary from the legislative authorities. An important social and economic institution that is distinct from the legal system, yet closely related to it, is that of corruption; corruption provides an important and accepted framework for economic transactions in many countries, although is virtually absent from some others.
Figure 1 that follows, illustrates our conceptualization of ultimate, proximate and intermediate causes of growth including socio-economic outcomes. This framework is useful for several reasons. First, it allows us to highlight the different levels of growth analysis. Second, using the framework we can visualize the concept of endogeneity, which is mostly a function of time and interdependencies with other variables. Third, it helps to clarify that development is a nonlinear process, subject to simultaneity and circular causation at almost every level, as is evident from the many feedback relationships in Figure 1. This is closely related to the problem of endogene-ity. Fourth, it allows us to distinguish between two important aspects of development: growth of productive capacity (GDP, GDP per capita) and socio-economic outcomes. In the following, we briefly review the components of this framework.2
The proximate sources of growth are directly measurable sources of output growth, or, in other words, the inputs into the production function (for both classical and endogenous growth theory). We understand the equation in Figure 1 as the result of decisions of a variety of heterogeneous economic actors responding to constraints and incentives provided by policies and the institutional framework.
In Figure 1, Y refers to output, K, L and R refer to the primary factors of production capital, labor and natural resources, and the exponent e refers to the efficiency with which the primary
1 There is plenty of historical evidence in favor of this assertion (for example, Solow, 1956, 1957; Denison, 1967; Abramovitz, 1989; Solow, 1991; Easterly and Levme, 2001; Hoff and Stiglitz, 2001)
2 See Szirmai (2008), and Second edition of "The dynamics of socio-economic development" by Szirmai (2012) for a much more detailed discussion of the framework.
factors are used to turn intermediate inputs into final goods and services.3 Once we have quantified the proximate sources of growth, we can subsequently explore their links with the wider economic and social sources of growth and development. Intermediate sources of growth refer to two types of factors: first, trends in domestic and international demand and, second, economic, social and technology policies. Policies include a wide range of interventions such as trade policy, macroeco-nomic policy, industrial policy or subsidies to stimulate innovation and industry. They also include all kinds of social policies in the area of social protection/insurance, education and welfare, which affect the distribution of the fruits of growth. Including demand as an intermediate factor in this framework shifts the emphasis away from conceiving of growth in the medium run and short run as only supply-side driven.
Figure 1: Sources of the growth framework
Ultimate sources of growth
- Institutions (political & economic)
- Geographic conditions
- Demographic characteristics
- Class and power-relationships
- Historical shocks
- Culture and attitudes
- Long-run science & technology cycles
- Distance to technological frontier
Intermediate sources of growth
- Economic, technology & social policy
- Demand trends (economic cycles)
Proximate sources of growth
economic actors
Y=tf(KLR) I+A++P
Socio-economic outcomes
- Standards of living and consumption
- Poverty and inequality
- Health and education
- Environmental sustainabillity
-_
Source: Adapted from Szirmai (2008)
Underlying both the proximate and intermediate sources, there are even 'deeper' factors that affects that we call the ultimate sources of growth. These include economic, political and social institutions, institutional change, historical shocks, geographic conditions, long-run trends in scientific and technological knowledge, demographic conditions and trends, culture, basic social attitudes and capabilities, changes in class structures and relationships between social groups, and long-run developments in the international economic and political order.
Socio-economic outcomes are what ultimately matter in development. However, we argue that the most fundamental engine of development, especially in historical perspective, is sustained increases in productive capacity and output growth over long stretches of time. The degree to
3 The concept of efficiency as used here refers to everything that increases output per unit of primary input. It includes econo-
mies of scale, efficient allocation of the factors of production within sectors (appropriate choice of technology), efficient allocation between less productive and more productive economic sectors (structural change), reallocation of resources towards more dynamic sectors (structural change), efficient allocation between countries (specialization and comparative advantage), utilization of capacity and, last but not least, disembodied technological change. Disembodied technological change refers to changes in the state of our knowledge that cannot be measured through changes in the quality of capital and labor.
which productive capacity is transformed into social outcomes depends on the nature of social and economic policy (intermediate causality), institutions, and initial levels of social inequality (ultimate causality).
In addition to the primary influences of capital accumulation and skills and experience embodied in the human capital, we would like to point out the importance for growth of research & development activity, the macroeconomic environment and trade openness and well developed financial markets. In addition, the empirical evidence lends some support to the notion that the overall involvement of government in the economy may reach levels that impede growth. Although expenditure on health, education and research clearly sustains living standards in the long term, and social transfers help to meet social goals, all have to be financed. It should be stressed, however, that as in the case of education, the reverse causality argument can be raised for the "size" of government, to the extent that certain government services have an income-elastic demand. Bearing this caveat in mind, the results suggest that for a given level of taxation, higher direct taxes lead to lower output per capita, while on the expenditure side transfers as opposed to government consumption, and especially as opposed to government investment, could lead to lower output per capita. Government investment does not seem to influence the rate of private accumulation of capital significantly but it may affect growth by improving the framework conditions (e.g. better infrastructure) in which private agents operate.
Concluding remarks
Assessing the role of the institutions for economic growth is not an easy task. Long-standing, deep-rooted political and social challenges have shaped each national institution and economy today. Similar political institutions, set in two different countries, can affect their respective economy in different ways. Moreover, at the same time, institutions that differ politically, set in two different countries, can lead their countries to similar economic performance.
It has been already demonstrated that economic institutions (such as property rights, regulatory institutions, institutions for macroeconomic stabilization, institutions for social insurance, institutions for conflict management, etc.) are the major source of economic growth across countries (Rodrik, 2007). Among other things, economic institutions have decisive influence on investments in physical and human capital, technology, and industrial production. It is also well understood that in addition to having a critical role in economic growth, economic institutions are also important for resource distribution.
It is obvious that a country's political, legal, economic and social institutions will affect its rate of economic growth. However, it is much more difficult to identify exactly which institutions matter and exactly how they matter. This is an issue of some practical importance. Countries are free to redesign their institutions in order to improve their economic performance. However, unless they can pinpoint the beneficial aspects of particular institutions, the only option is to import wholesale the institutional structures of another, more economically successful country.
References:
1. Acemoglu, D. (2009) "Introduction to Modern Economic Growth", Princeton: Princeton University Press
2. Acemoglu, D. and Robinson, J. (2006) "Overview" in Weingast, Barry R. and Wittman, D. (Ed.)" The Oxford Handbook of Political Economy, Oxford: Oxford University Press
3. Pereira, C. &Teles, V. (2010) "Political Institutions and Substitute for Democracy: A Political Economy Analysis of Economic Growth' Manuscript presented at the Annual Conference of the European Economic Association
4. Przeworski, A.; Alvarez, M.; Cheibub, J. A.; & Limongi, F. (2000)," Democracy and Development: Political Institutions and Well-Being in the World, 1950-1990", New York: Cambridge University Press
5. Rodrik, D. (2007), "One Economics Many Recipes: Globalization, Institutions, and Economic Growth", Princeton: Princeton University Press
6. Szirmai, A. (2008) "Explaining success and failure in development' UNU-MERIT Working Paper, 2008-013
7. Szirmai, A. & Bluhm, R. (2012),"Institutions and long-run growth performance: An analytic literature review of the institutional determinants of economic growth', UNU- MERIT Working Paper Series, 2012-033
