Document Library

Key Text Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development

Author: D Rodrik, A Subramanian and F Trebbi
Date: 2002
Size: 45 pages (531 KB)

Access full text: available online

Summary

Average income levels in the world’s richest and poorest nations differ by a factor of more than 100. What accounts for these differences, and what can we do to reduce them? This study by Harvard University looks at the effect of geography, integration and institutions on cross-national variations in income. It finds that the quality of institutions has by far the greatest influence but argues that this knowledge offers little guidance to policy-makers.

What determines the wealth of nations? It is hard to think of any question in economics that is of greater intellectual significance, or of greater relevance to the vast majority of the word’s population. First, there is a line of theorising that places geography at the center of the story. Geography is a key determinant of climate, endowment of natural resources, disease burden, transport costs, and diffusion of knowledge and technology from more advanced areas. It exerts therefore a strong influence on agricultural productivity and the quality of human resources. A second camp emphasises the role of international trade as a driver of productivity change. This is termed the integration view, as it gives market integration, and impediments thereof, a starring role in fostering economic convergence between rich and poor regions of the world. A third group centres on institutions and, in particular, the role of property rights and the rule of law. In this view, what matters are the rules of the game in a society and their conduciveness to desirable economic behaviour.

The quality of institutions is found to trump everything else. Once institutions are controlled for, integration has no direct effect on incomes, while geography has, at best, weak direct effects.

Trade often enters the income regression with the 'wrong' (i.e., negative) sign, as do many of the geographical indicators.
By contrast, the measure of property rights and the rule of law are always statistically significant.
Institutional quality has a positive and significant effect on integration.
Integration also has a positive impact on institutional quality, suggesting that trade can have an indirect effect on incomes by improving institutional quality.
Geography exerts a significant effect on the quality of institutions.
Trade and distance from the equator both exert a negative, but insignificant effect on incomes.

How much guidance do the results provide to policymakers who want to improve the performance of their economies? Not much at all.

It may be helpful to know that geography is not destiny, and that focusing on increasing the economy’s links with world markets is unlikely to yield convergence.
However, the operational guidance based on the central result, on the primacy of institutional quality, is extremely meagre.
The difficulty of extracting policy-relevant information from the findings is illustrated by the example of property rights.
The presence of clear property rights for investors is a key element in the institutional environment that shapes economic performance.
When investors believe their property rights are protected, the economy ends up richer. But nothing is implied about the actual form that property rights should take.

Access full text: available online

Source: Rodrik, D., Subramanian, A. and Trebbi, F., 2002, 'Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development', CID Working Paper No. 97, Center for International Development, Harvard University, Cambridge, MA.
Author: Arvind Subramanian , asubramanian@imf.org
John F. Kennedy School of Government, http://www.ksg.harvard.edu/