Chapter 2: The Model and Empirics
This chapter discusses theoretical issues relevant to modeling institutional evolution and empirical issues regarding the estimation of the macroeconomic effects of institutions. In view of the institutional theories outlined previously, Chapter 2 first describes the dynamic aspects of institutional change in section 2.1 and then presents a formal model of institutional change in section 2.2. Next, section 2.3 lays out the measurement and estimation issues that are common to the empirical analyses involving institutional variables. 2.1 DYNAMICS OF INSTITUTIONAL CHANGE In light of the definitions of institutions and the underlying theories of institutional economics, it is clear that a formal model of institutional evolution must take into account the factors that affect the incentives for, facilitate the establishment of and explain the evolution or devolution of a particular type of institution; hence, the model should be dynamic. Subsections 2.1.1 and 2.1.2 review the sources of institutional change and the dynamics of different types of institutions, respectively. 2.1.1 Demand and Supply Sides of Institutional Change The literature suggests that the geography–religion–history trio is the deepest determinant of institutions (see, for example, Acemoglu et al., 2002; Easterly and Levine, 2003; Rodrik et al., 2002). Of these three factors, geography can be considered the deepest determinant since it determines 44 The model and empirics 45 the climate, natural resources and trading prospects of a country (see Sachs, 2003, for example). The trio also plays an important role in the formation of beliefs, informal norms and modes of conducting business, which can...
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