Chapter 8: Which Institutions Matter Most for Economic Growth?
8.1 UNBUNDLING INSTITUTIONS Institutions are often defined as a collection of many attributes. The most commonly used measure of institutions in the institutions and development literature is the rule of law. The implicit assumption made in these studies is that better implementation of the rule of law is an indication of the overall quality of institutions. However, from the point of view of policy, it remains crucial to find out which type of institutions are important for growth and development. In this section, I make an attempt to unbundle institutions and estimate their impact on growth. I adopt Rodrik’s (2005) four-way classification (market creating, market regulating, market stabilizing and market legitimizing) of institutions and include them as explanatory variables of growth in my model. This is in contrast to other studies in the contemporary literature that focus on the importance of property rights and contracts in creating the right incentive structure for investment and entrepreneurship. But long-run economic growth requires more than just a boost in investment or entrepreneurship. To sustain growth momentum requires institutions that can facilitate exchange in a world of imperfect information, handle random shocks to the economy and facilitate socially acceptable burden sharing in the event of a shock. The four-way classification attempts to cover all aspects of institutions and also distinguish them on the basis of their functions. Market-creating institutions are those that protect property rights and ensure contract enforcement. They are called market creating since, in their absence, either the markets do not exist...
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