Revisiting the institutions–growth nexus in developing countries: The new evidence

Abstract

In this paper we revisit the institutions–growth nexus in developing countries including the East Asian region. The region has in the past three decades not only achieved spectacular economic growth, but also experienced one of the worst financial crises, i.e. Asian financial crisis (AFC) in 1997–1998. Utilising the neoclassical growth framework augmented with institutional controls and latest estimation technique in panel data analysis, this study finds evidence of positive institutions effect on growth. Nonetheless, the evidence is limited to security of property rights only with no similar evidence on efficient bureaucracy and strong government. This study also uncovers the channel of the institutional effects on economic growth, i.e. via total factors productivity. This study adds to the literature of East Asian growth, which hitherto, to the best of our knowledge, has seen only two studies, namely Rodrik (1997) ‘TFPG controversies, institutions, and economic performance in East Asia’ and Campos and Nugent (1999) ‘Development performance and the institutions of governance: Evidence from East Asia and Latin America’ that document the evidence of institutional importance on economic growth, and these studies are however for the period before the AFC.

Keywords:

• institutions
• economic growth
• dynamic panel data analysis
• generalised methods of moments

Acknowledgements

Stephen Hall acknowledges the support of ESRC-DFID Growth Programme (Award number RS10G0066).

Mahyudin Ahmad is grateful to his PhD advisor, Professor Stephen G. Hall for his continued support in publishing this paper. He kindly thanks the participants at the USM-AUT International Conference 2012 for their supportive remarks. His gratitude extends to Dr Saten Kumar, guest editor of this special issue, Professor Mark J. Holmes, editor-in-chief, New Zealand Economic Papers, and Julia Powys, production editor, and the referees involved in this paper. All remaining errors are his.

Notes

1. The phenomenal economic performance during the period of 1960s to 1990s was once dubbed as ‘the East Asian Miracle’ by the World Bank (1993). There are studies that documented the underlying factors behind the economic achievement by the region such as Krugman (1994), Collins and Bosworth (1996), Sarel (1997), Senhadji (2000), Nelson and Pack (1999), Easterly and Levine (2002) and Iwata, Khan, and Murao (2002).

2. Influential studies such as Hall and Jones (1999), Acemoglu, Johnson, and Robinson (2001, 2005) and Rodrik, Subramaniam, and Trebbi (2004) have found evidence of institutions’ positive effects on economic growth.

3. If institutions primarily affect investment and therefore indirectly affect growth (via the investment channel), the Solow framework could therefore be extended to include institutions via s_it as a function of institutions, i.e. and . However, the implication of this specification is that, if it is proven the institutions affect growth via the investment channel only, it will be redundant to include both investment and institutions as regressors in a growth model. Investment (as a proximate growth determinant) should therefore be omitted. On the other hand, if institutions affect growth only partially via the investment channel, omitting investment would not be appropriate as important information would be lost (see Dawson, 1998) for more discussion on the possible channels of institutional effects on growth and the ensuing assumptions that need to be made).

4. The estimation using pooled OLS and fixed effect methods will allow an appropriate comparison to the results of previous institutional studies, such as Rodrik et al. (2004) and Glaeser, La Porta, Lopez-de-Silanes, and Shleifer (2004), which rely on similar methods.

5. These sets of lags are chosen after a series of estimations involving multiple combinations of lags were run using the system GMM regression. The decision to use these sets of lags is because they yield the best results as far as the significance of the steady state determinants and institutional variables as well as the strength of diagnostic tests of the regressions are concerned.

6. We follow Bond et al. (2001) and employ one-step GMM estimators since efficiency gains from two-step GMM estimators is shown by Bond et al. to be small, and two-step estimators normally converge to its asymptotic distribution relatively slowly, and in a finite sample its asymptotic standard errors can be seriously biased downwards, and thus making it unreliable. Despite Windmeijer's (2005) correction to this problem of achieving robust standard errors in two-step GMM estimation, we have already enforced heteroskedastic and autocorrelation robust standard error in the one-step GMM estimation, therefore, one-step GMM estimation is preferred.

7. By construction, the differenced error term is probably serially correlated at the first order even if the original error is not. While most studies that employ GMM dynamic estimation report the test for first order serial correlation, some do not.

8. Recall that the Solow growth framework shows that savings and population growth are the two key drivers of economic growth. Mankiw et al. (1992), despite basing their study on the Solow growth framework, however use the investment share of real GDP per capita to proxy for savings.

9. See footnote 7.