1. Institutions and Development Emiko Nishii & Elisabeth Niendorf January 11th, 2010 University of Warsaw - MADE

2. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Income differences across countries and institutional differences Mind- mapping Which characteristics of institutions would you consider favourable for growth?

3. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Outline 1. What are institutions? - economic and - political institutions 2. How can institutional characteristics influence growth? How can we measure institutional quality? 3. What is the magnitude of the effects on growth? 4. Can we formulate policy implications then? 5. Future Research Objectives 6. Conclusions

4. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 1. What are institutions? “Institutions are the rules of the game in a society or, more formally, are the human devised constraints that shape human interaction.” (Douglas North) Economic institutions Different groups and individuals benefit from different economic institutions! - social conflicting view Political institutions

5. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 5 Williamson’s perception of insitutions Level Frequency (years) Purpose Embeddedness: informal insitutions, customs, tradition, norms, religion L1 10 2 -10 3 Often noncalculative spontaneous Institutional environment Formal rules of the game esp. property (judiciary, bureaucracy) L2 10-10 2 Get the insitutional environment right 1st order economizing Governance: Play of the game – esp. Contract (aligning governance structures with transactions) L3 1-10 Get the governance structure right 2nd order economizing Resource allocation and employment (prices & quantities; incentive alignment L4 continuous Get the marginal conditions right 3rd order economizing

6. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 2. How can institutions influence growth? Market structure Laws Regulations matter in the background Policies “Good institutions” Property rights and contract enforcement Effective constraints on power-holders Few rents to be captured by power-holders

7. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 2. How can we measure institutional quality? We need: objective evaluations, comparable across countries over time. - Institutions Index: Kaufmann et al. (2006) 1. Political rights, civil liberties 2. Political stability and absence of violence 3. Quality of public service 4. Regulatroy Quality 5. Rule of law 6. Freedom of graft - Quality of public institutions index : Knack & Kefer (1995)

8. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 2. How can we measure institutional quality? Consensus in literature: protection of property rights (North & Thomas (1973) and Rosenberg & Bridzell (1989), control for corruption (Mydral 1968, DeSoto 1989), rule of law (Becker 1968, Becker & Stigler 1974),  is of high importance for development. Acemoglu & Verdier (1998)  general equilibrium framework - socially optimal resource allocation

9. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 3. What is the magnitude of the effects on growth? Institutions Rule (Rodrik et al. 2002) Main objectives: How much of difference in income can be explained as a result of institutions? Are institutions more important than other variables?

10. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework OLS regression: y= GDP per capita on a PPP basis for 1995 INT=Quality of Institutions (The survey of investor perceptions about protection of property rights and the strength of the rule of law) INT=Integration (The ratio of trade to GDP) GEO=Geography (A country’s distance from the equator)

11. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework (Cont.) Main problems: Reverse causality - INS and INT are both endogenous Multicollinearity - Interlinkages among the independent variables Difficulty in identifying the independent contribution of these 3 variables to the cross-national variation in income levels

12. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework (Cont.) Source: Subramanian & Rodrik (2002)

13. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework (Cont.) Acemoglu, Johnson, and Robinson (AJR, 2001) Use Settler Mortality (SM) as an instrument for INS. =mortality rates of European settlers among 19 th century Frankel and Romer (FR, 1999) Use Constructed Trade Shares (CONST) as an instrument for INT. = trade/GDP shares constructed on the basis of a gravity equation for trade flows

14. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Two-stage least squares: Empirical Framework (Cont.)

15. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE * *Extended AJR sample= sample of 80 countries *Larger sample= sample of 140 countries including countries which were not colonized Source: Subramanian & Rodrik (2002)

16. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Results

17. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Results (Cont.)

18. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Results (Cont.)

19. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Robustness Check 1. Including regional dummies to drop certain influential observations which are arguably different from the rest of the countries Main finding: The coefficient of INS remains statistically significant, and increases in magnitude These countries are not driving the results, thus the results are robust

20. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Robustness Check (Cont.) 2. Use different instruments to measure for GEO to see if the results would be different (e.g. access to the sea, number of frost days per month, mean temperature, etc.) Main results: - None of these GEO variables is statistically significant - INT remains statistically insignificant - INS remains statistically significant

21. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Robustness Check (Cont.) Frankel and Romer (1999) ‘small countries tend to trade more’ 3. Control for country size (area/population) to see the real effect of INT on income Main results: - The size and significance of INS are unaffected - INT remains statistically insignificant

22. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 4. Can we formulate policy implications to reform institutions then? Failure of Washington Consensus How do formal rules function in practice? Mukand & Rodrik (2002) assumptions: policies vary in 2 dimensions: “appropriateness” and “transparency”

23. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Mukand & Rodrik (2002) Country 1: Leader, with z1 denoting the “unique state of the world” in which country 1 is located Country 2: Follower, with z2 as its location Policy aj affects national output: yi= -θ(aj-zi)² due its “specificity” a1- Leader’s policy a2- Follower’s policy Leader maximizes national income: y1= 0, because a1=z1.

24. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Mukand & Rodrik (2002) Government’s utility function: v2= y2 –λ K, where K is a private fixed cost. Follower chooses to imitate as long as: v2(a1=a2)≥ v2(a2’=z2), where a2´shows us that there is some uncertainty about the policy implementation a2´= z2+ η.

25. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Source: Mukand & Rodrik (2002)

26. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Source: Mukand & Rodrik (2002)

27. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Source: Mukand & Rodrik (2002)

28. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Source: Mukand & Rodrik (2002)

29. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 5. Future Research Institutions and Sustained Growth Acceleration Growth Acceleration (Hausmann and Rodrik et. al 2005) Main objective: Identify the turning points in growth experience and ask what determines these transitions. Uncover the effect of institutions on sustained growth acceleration.

30. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework Methodology 1. Identify the turning points in growth episodes 2. Observe what happened before the turning points

31. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework (Cont.) Criteria of growth episodes: - an increase in per-capita growth of 2% points or more - the increase in growth has to be sustained for at least 8 years - the post-acceleration growth has to be at least 3.5% per year - the post-acceleration output must exceed the preepisode peak level of income

32. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework Data: the Penn World Tables (PWT) Sample: 110 countries, between 1957 and 1992

33. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Framework (Cont.) Did External shocks, Political changes, and Economic reform affect these growth acceleration?

34. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Empirical Results Only 14.5% accelerations are associated with economic reform- economics liberalization Only 13.9% of political-regime changes are followed by growth acceleration Growth accelerations are fairly frequent occurrence. However, most growth accelerations are not preceded or accompanied by changes in economic policies, institutional arrangements, and political circumstances.

35. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE 6. Conclusions Empirical evidence: differences in institutions explain a significant part of income variation across countries One size does not fit all….. In order to implement effective institutions, a country must: - Identify the main constraints for economic growth - Derive policies that target these constraints “Sound policies need to be embedded in solid institutions.” (Rodrik 2006) Institutional change is a constant approach and has to adapt to a changing environment

36. January 11th, 2010 Emiko Nishi & Elisabeth Niendorf – University of Warsaw - MADE Thank you for your attention!