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Institutions and Economic Development: How Strong is the Relation?


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


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.

Suggested Citation

  • Tiago V. de V. Cavalcanti & Álvaro A. Novo, 2002. "Institutions and Economic Development: How Strong is the Relation?," Working Papers w200213, Banco de Portugal, Economics and Research Department.
  • Handle: RePEc:ptu:wpaper:w200213

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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Ann-Sofie Isaksson, 2011. "Social divisions and institutions: assessing institutional parameter variation," Public Choice, Springer, vol. 147(3), pages 331-357, June.
    3. 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.
    4. 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.

    More about this item

    JEL classification:

    • B40 - Schools of Economic Thought and Methodology - - Economic Methodology - - - General
    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development


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