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Institutions and economic development: How strong is the relation?

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  • Tiago V. de V. Cavalcanti
  • Álvaro A. Novo

Abstract

This paper investigates the relationship between institutions and economic development (output per worker). As in Hall and Jones (1999), we find that a 1% improvement in institutions (as we measure them) generates on average a 5% increase in output per worker. However, this relationship is not linear and the data have important heterogeneity. Countries with the same value of institutions have different levels of income per worker. We ask whether the "returns to institutions" are the same across countries conditional on the level of institutions. Using quantile regression methods, we show that for countries at the top of the conditional distribution of international incomes, the "returns to institutions" are lower (around 3.8%), than for countries at the bottom of this distribution (around 6.2%). We show that this result is robust for different model specifications and definitions of institutions. We also provide evidence that, conditional on the level of institutional development, the distribution of output per worker tends to become less disperse as countries improve their institutional framework. In other words, better institutions are fundamental to close the output per worker gap across countries. Finally, we provide the rationale behind the results through a modified version of a Neoclassical Growth Model with time varying wedges, representing policy distortions and institutions.
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Suggested Citation

  • Tiago V. de V. Cavalcanti & Álvaro A. Novo, 2005. "Institutions and economic development: How strong is the relation?," Empirical Economics, Springer, vol. 30(2), pages 263-276, September.
    • Handle: RePEc:spr:empeco:v:30:y:2005:i:2:p:263-276
    DOI: 10.1007/s00181-004-0217-5
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    Cited by:

    1. Dogaru Dorin-Madalin, 2015. "Public Policy, Quality Of Intitution And Economic Growth In Central And Eastern European Countries," Annals - Economy Series, Constantin Brancusi University, Faculty of Economics, vol. 2, pages 239-245, April.
    2. Cavalcanti, Tiago V. & Magalhães, André M. & Tavares, José A., 2008. "Institutions and economic development in Brazil," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(2), pages 412-432, May.
    3. Ann-Sofie Isaksson, 2011. "Social divisions and institutions: assessing institutional parameter variation," Public Choice, Springer, vol. 147(3), pages 331-357, June.
    4. Ghulam Mustafa & Muhammad Jamil, 2018. "Testing the Governance-Productivity Nexus for Emerging Asian Countries," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 23(1), pages 143-169, Jan-June.
    5. Camilleri, Silvio John & Falzon, Joseph, 2013. "The Challenges of Productivity Growth in the Small Island States of Europe: A Critical Look of Malta and Cyprus," MPRA Paper 62489, University Library of Munich, Germany.
    6. Koffi Délali Kpognon & Henri Atangana Ondoa & Mamadou Bah & Peter Asare-Nuamah, 2022. "Fostering Labour Productivity Growth for Productive and Decent Job Creation in Sub-Saharan African Countries: the Role of Institutional Quality," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 13(3), pages 1962-1992, September.
    7. Rodrigues Brás Gonçalo & Soukiazis Elias, 2019. "The Determinants of Entrepreneurship at the Country Level: A Panel Data Approach," Entrepreneurship Research Journal, De Gruyter, vol. 9(4), pages 1-17, October.
    8. Bournakis, Ioannis & Rizov, Marian & Christopoulos, Dimitris, 2021. "Revisiting the Economic Performance and Institutions Debate in SSA Countries: The Role of Legal Origins in the Context of Ethnic Heterogeneity," MPRA Paper 106557, University Library of Munich, Germany.
    9. KPOGNON, Koffi & BAH, Mamadou, 2019. "Does institutional quality contribute to increasing labour productivity in sub-Saharan Africa? An empirical analysis," MPRA Paper 98674, University Library of Munich, Germany.
    10. Bournakis, Ioannis & Rizov, Marian & Christopoulos, Dimitris, 2023. "Revisiting the effect of institutions on the economic performance of SSA countries: Do legal origins matter in the context of ethnic heterogeneity?," Economic Modelling, Elsevier, vol. 125(C).
    11. Luigi Aldieri & Cristian Barra & Nazzareno Ruggiero & Concetto Paolo Vinci, 2021. "Green Energies, Employment, and Institutional Quality: Some Evidence for the OECD," Sustainability, MDPI, vol. 13(6), pages 1-21, March.

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