Institutions are not always so important (or easy to measure properly?)

Jinfeng Luo and Yi Wen from the St. Louis Fed have a new working paper (pdf), “Institutions Do Not Rule: Reassessing the Driving Forces of Economic Development”:

We use cross-country data and instrumental variables widely used in the literature to show that (i) institutions (such as property rights and the rule of law) do not explain industrialization and (ii) agrarian countries and industrial countries have entirely different determinants for income levels.

In particular, geography, rather than institutions, explains the income differences among agrarian countries, while institutions appear to matter only for income variations in industrial economies.  Moreover, we find it is the stage of economic development (or the absence/presence of industrialization) that explains a country’s quality of institutions rather than vice versa.

The finding that institutions do not explain industrialization but are instead explained by industrialization lends support to the well-received view among prominent economic historians — that institutional changes in 17th and 18th century England did not cause the Industrial Revolution.

I am reminded of a puzzle which I think was first posed by Jeff Sachs.  Go back to 1960 and choose any measure of institutional quality you want.  Then see how well it predicts cross-national growth since then.  And that is doing the exercise knowing how the answer comes out!


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