Political Economy of Institutions: First Thoughts

The evidence presented in this chapter suggests that institutions are the most important fundamental cause of economic growth. We must therefore think about why institutions and policies differ across countries in order to understand why some countries are poor and some are rich.

However, an explanation of differences in income across countries and over time in terms of institutional differences is also incomplete. If, as this chapter has documented, some institutions are conducive to rapid economic growth and others to stagnation, why would any society collectively choose institutions that condemn them to stagnation? The answer to this question relates to the nature of collective choices in societies. Institutions and policies, like other collective choices, are not taken for the good of the society at large, but are a result of a political equilibrium. In order to understand such political equilibria, we need to understand the conflicting interests of different individuals and groups in societies, and how they will be mediated by different political institutions. Thus, a proper understanding of how institutions affect economic outcomes and why institutions differ across countries (and why they sometimes change and pave the way for growth miracles) requires models of political economy, which explicitly studies how the conflicting interests of different individuals are aggregated into collective choices. Models of political economy also specify why certain individuals and groups may be opposed to economic growth or prefer institutions that eschew growth opportunities.

The discussion in this chapter therefore justifies why a study of political economy has to be part of any investigation of economic growth. Much of the study of economic growth has to be about the structure of models, so that we understand the mechanics of economic growth and the proximate causes of income differences. But part of this broad study must also confront the fundamental causes of economic growth, which relate to policies, institutions and other factors that lead to different investment, accumulation and innovation decisions.

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