Joanna Tyrowicz Institutions and growth Institutional Economics

2 We analysed empirical evidence so far institutions were important for capital accumulation… … but not for human capital (?) something was said about countries becoming „alike” or „different” What we do not know is why some countries are democratic, some not and some change? why some democratic countries do not grow and other nondemocratic grow quite well? is democracy the only thing that matters? What is the role of institutions exactly?

3 Questions Is there any way we can model use to describe these processes? Is there any way we can explain why some things change and some do not? Is there any empirical evidence to support it?

4 1.Markets require non-market institutions to work well 2.The institutional basis of market economies is not unique 3.Institutional diversity creates transaction costs and hampers full economic integration 4.Neither feasible nor desirable to eliminate these costs, cannot target total integration „Thin” versus „thick” models of globalization 5.Within the range of “thin” considerable choice of models. Each one of these privileges different groups…. Early conclusions

5 a. Markets are not self-creating i. Property rights ii. Contract enforcement b. Markets are not self-regulating i. Regulatory authorities ii. Correction of market and coordination failures c. Markets are not self-stabilizing i. Monetary, fiscal and currency arrangements d. Markets are not self-legitimating i. Political democracy ii. Social insurance iii. Redistribution Markets require non-market institutions to work well

6 a. Economic principles versus their institutional embodiment b. Institutional diversity grounded in: 1. Differences in social preferences (over equity versus opportunity, for example) 2. Hysteresis and path dependence due to institutional clusters and complementarities (US versus Japan versus various European models) 3. Context specificity of desirable institutional arrangements to promote economic development (China, India, Latin American examples) The institutional basis for market economies is not unique

7 a. Despite disappearance of border barriers, border effects remain strong 1. Missing trade 2. Small net capital flows b. Institutional diversity is an important source of market segmentation c. Trade: the role of regulatory & jurisdictional discontinuities, and problems of standards and contract enforcement. d. Capital flows: the problem of “sovereign” risk e. “Deep integration” agenda as a response - but is it wise? Institutional diversity as a source of transaction costs blocking deep integration

8 Things we should have a look at Religion (religiousness)? Cultural issues? Freedom? Anything else… But before I forget Few words about instruments and their quality (paper by Frank Kleibergen, Econometrica, 2002) Method: find instruments, run 2SLS, trust your results Problem: t-test and F-test may loose power under 2SLS In other words: estimators are fine, standard errors are fine, but the tests we use for them behave far from normal

9 Example of the power of tests

10 Example of the power of tests

11 So what about IV 1. Really hard to find instruments 2. Good instruments do not need a good theory 3. But to be good, correlation needs to be reliable 4. Once we find good instrument – run 2SLS 5. But remember that p-values may be out of the moon and there is little we can do to avoid this problem 6. If really want to work hard, use alternative tests (nobody puts them on statistical packages)

12 Religion and religiousness Religion and Economic Growth Across Countries (Barro & McLeary) Motivations of the study: previous studies neglect the influence of culture need for incorporation of social and political variables investigated the effects of church attendance and religious beliefs on economic growth Instrumental Variables the presence of state religion, regulation of the religion market, the composition of religious adherence, indicator of religious pluralism

13 Religion and religiousness (cont’d) Theoretical foundations Secularization hypothesis Market or supply side forces hypothesis greater state regulation of religion may decrease the efficiency of religion providers stimulates religious activities subsidy suppression (opposite!!) Data: World Value Survey, Gallup Millenium Survey, International Social Survey Programme Findings: For given religous belief, increases in church attendance tend to lower growth For given levels of church attendance, belief in hell, heaven, and an afterlife tend to boost growth

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15 Cultural issues The theory of human development: A cross-cultural analysis (C. Welzel, R. Inglehart, H-D. Klingemann) Foundations Socioeconomic development, emancipative value change and democratization Lack an integrated theory on social change Theoretical approach: The Means-Motives Linkage Self expression (freedom and choice) The Motives-Rules Linkage Effective freedom rights (stability of political regimes)

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17 Cultural issues (cont’d) Issues to incorporate into empirics: Emancipative values linked to people’s available resources Effective democracy linked to emancipative mass values Findings: linkage between individual resources, emancipative values and freedom rights is universal in its presence across nations, regions and cultural zones this human development syndrome is shaped by a causal effect of individual resources and emancipative values on freedom rights this effect operates through its impact on elite integrity, as the factor which makes freedom rights effective.

18 Freedom? Individuals have economic freedom when: property is protected no arrangements that restrain the realization of gains from economic activities Sources of data: Heritage Foundation/Wall street Journal (10 elements) Fraser Institute (17 elements) Issues to be addressed: Lack of sensitivity analysis Link between economic freedom and economic growth depends on the measure used No studies found that economic freedom does not influence growth

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21 Freedom (cont’d) On the relationship between economic freedom and economic growth (J. de Haan and J.-E. Sturm) The growth equation included : M: a vector of standard economic explanatory variables F: indicator of economic freedom Z: a vector of up to three possible additional economic explanatory variables Findings more economic freedom brings countries faster to steady state… … but level not affected by the level of economic freedom. => Lasting effect of institutional change?

22 Institutions vs. quality of institutions (1)  EFFICIENCY (no theory needed here!) (2)  CREATING VALUE (neoclassical vs. endogenous) PRIORITIES!!! (1) (2).

23 Research recipe (in historical order) 1. Take as many countries as you can 2. Find some measures of institutional development 3. Do a panel data regression but always controlling for opennes effects and geographical factors 4. Instrument for institutions (among others) and do 2SLS on these panels 5. Use GMM, SURE, treatment effect, etc.  Canada vs. Ghana?  Indices  Statistical significance vs. economic hypotheses  Implications?  Differences (!) in processes

24 Escaping econometrics Case study analyses take-off versus Augmented Washington Consensus  policies matter Growth accelerations (Rodrik et al., 2004) take turning points and see if policy change came before  policies do not matter that much Facilitating institutions vs. value creating institutions no measures for the latter...

25 Get some micro-theoretical insights… Model of democratisation: First stage: nondemocratic politics political power in the hands of an elite but „citizens” excluded from formal, de jure power still have a say in politics (de facto power to undertake collective action) Revolution changes distribution but at a loss of potential output Taxes as an instrument of redistribution (revolution may be prevented) Suppose you can change institutions for good Revolution arises because citizens have de facto power today, but fear having no power in future (this is why they take inefficient actions) De facto power is, by its nature, not always persistent, but de jure power, arising from formal institutions, more persistent

26 Some theoretical insights… Democratisation (more generally institutional change) as a commitment device The same model only: at beginning of each period „constitution” can change if not, revolution can be prevented at the expense of repression (decreasing potential output) Question: when will they use fiscal redistribution, when will they prefer repression and when will they go for democratization Findings: Democracy emerges as an equilibrium outcome only in societies with intermediate levels of inequality Too high inequality makes democracy too costly for the elite, too low inequality makes nondemocracy sufficiently attractive for the citizens, the revolution threat does not materialize What reality says? Most instances of democratization amidst conflict and threat of revolution (democratisation „partly taken” not „given”)

27 More theoretical insights… Often, electoral controls do not work so well (developing countries context) The model of lobbying (1980s already!) It is feasible to take over control in democratic system (elite persistence) Typical assumption: perfect correlation between economic and political institutions. In practice: political institutions change, while economic institutions persist (recall: fast moving and slow moving institutions)

28 Questions instead of conclusions How fast do we learn new design? What is the meaning of adaptation? Also negative adaptation! Each design degenerates. How to prevent “demoralisation”? How to monitor? How to implement changes? Suppose you only see positive changes? How long is it expected to last? What is the dynamic context? What is the internal and external pressure? What evidence do you have to „oppose” it? What costs do you expect the country to incure if you do not „oppose” the pressure?