What Types of Institutions?

As already noted above the notion of institutions used in this chapter and in much of the literature is rather broad. It encompasses different types of social arrangements, laws, regulations, enforcement of property rights and so on.

causes, but can provide us a better sense of what types of models to develop in order to link fundamental causes to growth mechanics and to ultimate economic outcomes.

There is relatively little work on “unbundling” the broad cluster of institutions in or­der to understand what specific types of institutions might be more important for economic outcomes. Much of this type of work remains to be done in the future. Here it is useful to briefly mention some recent existing work attempting to distinguish the impact of “contract­ing institutions” from the influence of “property rights institutions”. One of the important roles of institutions is to facilitate contracting between lenders and borrowers or between different firms, to facilitate the functioning of markets and the allocation of resources. Such contracting is only possible if laws, courts and regulations uphold contracts in the appropriate way. Let us refer to institutional arrangements of this sort that support private contracts as contracting institutions. The other cluster of institutions emphasized above relates to those constraining government and elite expropriation. Let us refer to these as property rights institutions. Although in many situations contracting institutions and property right institu­tions will be intimately linked, they are nonetheless conceptually different.

Acemoglu and Johnson (2005) investigate the relative roles of these two sets of institu­tions. Their strategy is again to make use of the natural experiment of colonial history. What helps this particular unbundling exercise is that in the sample of former European colonies, the legal system imposed by colonial powers appears to have a strong effect on contracting institutions, but little impact on the available measures of property rights institutions. At the same time, both mortality rates for potential European settlers and population density in 1500 have a large effect on current property rights institutions, and no impact on contract­ing institutions. Using these different sources of variation in the sample of former European colonies, it is possible to estimate the separate effects of contracting institutions and property rights institutions.

The empirical evidence estimating the different sources of variation in colonial history finds that property rights institutions are much more important for current economic out­comes than contracting institutions. Countries with greater constraints on politicians and elites and more protection against expropriation by these powerful groups appear to have substantially higher long-run growth rates and higher levels of current income. They also have significantly greater investment levels and generate more credit for the private sector. In contrast, the role of contracting institutions is more limited. Once the effects of prop­erty rights institutions are controlled for, contracting institutions seem to have no impact on income per capita, the investment to GDP ratio, and the private credit to GDP ratio.

These results suggest that contracting institutions affect the form of financial interme­diation, but have less impact on economic growth and investment. It seems that economies can function in the face of weak contracting institutions without disastrous consequences, but not in the presence of a significant risk of expropriation from the government or other powerful groups. A possible interpretation is that private contracts or other reputation-based mechanisms can, at least in part, alleviate the problems originating from weak contracting institutions. For example, when it is more difficult for lenders to collect on their loans, interest rates increase, banks that can monitor effectively play a more important role, or reputation-based credit relationships may emerge. In contrast, property rights institutions relate to the relationship between the state and citizens. When there are no checks on the state, on politicians, and on elites, private citizens do not have the security of property rights necessary for investment.

Nevertheless, in interpreting the evidence in Acemoglu and Johnson (2005), one should also bear in mind that the sources of variation in income per capita and investment rates identifying the different effects of contracting and property rights institutions relate to very large differences discussed in Chapter 1. It is possible that contracting institutions have relatively small affects, so that they are hard to detect when we look at countries with thirty-fold differences in income per capita. Therefore, this evidence should be interpreted as suggesting that contracting institutions are less important in generating the very large differences in economic development than the property rights institutions, not necessarily as suggesting that contracting institutions do not matter for economic outcomes.

4.6.