How much attention should the analyst pay to economic institutions in studying economic development and growth? What is their policy relevance? This study from the Organisation for Economic Co-operation and Development (OECD) suggests that the economic and political institutions responsible for creating and enforcing them should be at the centre of any analysis.
The development strategies of the last fifty years have had a rather limited success. Neither capital transfers nor macroeconomic policies work by themselves. Giving people money alone, when they have no reason to use it productively, is not enough. Economic stabilisation is important but not sufficient to provide incentives for investment and trade. Rather, the key requirements are stable institutions, which safeguard property rights and impede both the misuse of power and irresponsible policy shifts.
New Institutional Economics (NIE), which focuses on areas ranging across property rights, transaction costs and asymmetric information, still lacks an integrated approach that analyses both the impact of institutions on economic development and the determinants that shape institutional quality. A properly integrated approach should:
- Distinguish between political institutions that govern the process from which formal rules and the legal system emerge, and economic ones, given that property and contract laws co-ordinate economic activity.
- Identify and measure the transaction costs resulting from the creation and enforcement of economic institutions, which are never perfect anywhere.
- Understand that poor economic institutions cause high transaction costs and crippling economic inefficiency.
- Understand that good economic institutions entail low transaction costs that spur economic activity and create a sturdy environment for capital accumulation and growth.
- Clearly define a serviceable notion of institutional efficiency since institutional quality becomes the key issue.
- Develop an empirically testable framework for analysing the determinants of institutional efficiency and measuring its impact on economic development.
Development policy needs to pay more attention to the institutional conditions for growth rather than to its pure mechanics. Good economic institutions need to be put in place and maintained.
- Secure property rights are a basic precondition for economic development. A limited state is not sufficient to protect property rights and to foster development.
- Democracy does not influence growth rates directly, but property rights are better protected in democratic states.
- Certain government activities are essential. The state must provide infrastructure, health care, education and so on. It must also protect property rights and political institutions against the demands of special interest groups.
- To these ends, it requires resources raised in the least distorted manner possible. It also needs an able civil service dedicated to the common good and not the pursuit of its own private ends.
- The reliance solely on policies for the quality of economic institutions can be misguided. While clearly they represent an important precondition for economic growth, they are not enough. The institutions themselves need protection by a strong and limited state.
- Therefore, the appropriate political institutions are vital to guard achievements on the economic side from misuse and mistakes by new or incumbent rulers.
