In the late 1980s economics and political science started to explore the influence of institutions, giving rise to ‘new institutionalism’ (e.g. North, 1990; March & Olsen, 1989; Fritz & Rocha Menocal, 2007, p. 50). This mainstream development discourse posits a link between the right type of institutions and poverty reduction. The widely-accepted theory is that institutional change supports poverty reduction by improving the quality and accessibility of basic services, expanding income-earning opportunities, and increasing citizen participation (World Bank, 2000, p. 2).
International actors and research emphasise the importance of inclusive and equitable institutions (DFID, 2011b; see also Inclusive Institutions Topic Guide). Inequitable institutions result in high income inequality; this is understood as explaining much of the disparity in countries’ ability to transform growth into poverty reduction (OECD, 2011). Acemoglu and Robinson (2012) posit that economic and political institutions need to be inclusive to achieve sustainable growth. North et al. (2009) describe the key characteristics of ‘open-access societies’ in which political, economic and social organisation, by being open, enables societies to achieve positive developmental outcomes.
Empirical econometric studies on the relationship between types of institutions and development outcomes, typically growth, have been influential (World Bank, 2000). Statistical analyses have sought to find a correlational, even causal, relationship between governance and development (Grindle, 2007, p. 558). The IMF’s 2003 review of growth and institutions concludes that there is a strong link between income per capita and institutional quality, regardless of the measure of institutional quality used (International Monetary Fund, 2003). Issues identified with this body of evidence include:
- Establishing causality (governance causes growth and development outcomes) is controversial and ruling out reverse causality (growth and development cause governance) is difficult.
- ‘Institutions’ and ‘governance’ are often used inconsistently to refer to concepts (state capacity, rule of law, democracy) that affect growth in different ways (Fukuyama in North et al., 2008, p. 27).
- The impact of institutions on poverty reduction, health, education or broader measures of development such as sustainability has been under-researched (Casson et al., 2010, p. 138; Earle & Scott, 2010, p. 10).
- Econometric studies focus on the impact of institutions on growth, normally defined as GDP per capita (Fukuyama in North et al., 2008, p. 27). However, research has neglected the type or quality of growth and gender dimensions of developmental outcomes.
- There is a lack of systematic empirical evidence linking institutions involved in managing public sector financial and human resources to impacts on growth and poverty (World Bank, 2012, p. 4; Welham et al., 2013). The Dabla-Norris et al. study (2010) (see below) starts to fill this gap.
Poverty reduction and other development outcomes
- Chong and Calderon (2000) find significant links between the quality of institutions and reduction in poverty incidence: ‘the degree, severity, and incidence of poverty appears to be robustly and negatively linked with the development of better institutions’ (p. 133).
- Using six aggregate governance indicators, Kaufmann et al. (1999) find that an increase in governance indicators of one standard deviation causes a 2.5 to 4-fold increase in per capita incomes, a 2.5 to 4-fold decrease in infant mortality and a 15-25% increase in literacy (p. 3). However, others have pointed out that an inherent reverse causality and endogeneity problem is still an issue (Goldsmith, 2007, cited in Rothstein, 2011).
- Channa and Faguet note that ‘the empirical evidence of decentralisation’s effects on service delivery is weak, incomplete, and often contradictory’ (2012, p. 1). However, their analysis focusing on empirical quality and credibility finds that ‘higher quality evidence indicates that decentralisation increases technical efficiency across a variety of public services, from student test scores to infant mortality rates’ (p. 1).
Growth, income and related indicators
- Using the same six governance indicators mentioned above, Kaufmann (2003) finds that effects of governance on income are very large: a 400% improvement in per capita income is associated with an improvement in governance of one standard deviation (p. 14). He finds ‘an absence of (or even possibly negative) feedback from per capita income to governance’ (p. 12).
- Knack and Keefer (1995), with attempts to control for reverse causality, find that growth and investment are increased in the presence of institutions to protect property rights.
- Chong and Calderon (2000) find evidence of causation in both directions: growth increases the values of institutional indicators, but higher institutional values increase the growth rate.
- Woller and Phillips (1998) fail to find a strong systematic positive relationship between fiscal decentralisation and growth in less developed countries, but Huther and Shah (1998) do find that fiscal decentralisation is positively correlated with good governance.
- Using data from 29 developing and middle-income countries, Evans and Rauch (1999) identify a strong positive relationship between bureaucratic quality of public institutions and economic growth.
- Drabek and Payne (2001) find that low levels of transparency have a significant negative impact on foreign direct investment (cited in Parry, 2007).
- From a low-income and middle-income composite index of the quality of budget institutions, Dabla-Norris et al. (2010) find that sound budget institutions promote fiscal discipline and are relevant for shaping less procyclical responses to the fiscal cycle in low-income countries.
- Acemoglu, D. & Robinson, J. (2012). Why nations fail: The origins of power, prosperity, and poverty. New York: Crown Publishers. See document online
- Casson, M., Della Giusta, M., & Kambhampti, U. (2010). Formal and informal institutions and development. World Development, 38(2), 137-141. See document online
- Channa, A., & Faguet, J.P. (2012). Decentralisation of health and education in developing countries: A quality-adjusted review of the empirical literature (EOPP discussion paper no. 38). See document online
- Chong, A. & Calderon, C. (2000). Institutional quality and poverty measures in a cross-section of countries. Economics of Governance, 1(2), 123–135. See document online
- Dabla-Norris, E., Allen, R., Zanna, L.F., Prakash, T., Kvintradze, E., Lledo, V., Yackovlev, I., & Gollwitzer, S. (2010). Budget institutions and fiscal performance in low-income countries. Washington D. C.: International Monetary Fund. See document online
- DFID. (2011b). The politics of poverty: Elites, citizens and states. Findings from ten years of DFID-funded research on governance and fragile states 2001-2010 (A Synthesis Paper). London: Department for International Development. See document online
- Drabek, Z., & Payne, W. (2001). The Impact of transparency on foreign direct investment (Staff Working Paper). World Trade Organisation. See document online
- Earle, L. & Scott, Z. (2010). Assessing the evidence of the impact of governance on development outcomes and poverty reduction (Issues Paper). Birmingham: Governance and Social Development Resource Centre. See document online
- Evans, P., & Rauch, J. (1999). Bureaucracy and growth: a cross-national analysis of the effects of ‘Weberian’ state structures on economic growth. American Sociological Review, 64(5), 748-65. See document online
- Fritz, V., & Rocha Menocal, A. (2007). Understanding state-building from a political economy perspective: an analytical and conceptual paper on processes, embedded tensions and lessons for international engagement (Report for DFID’s Effective and Fragile States Team). London: Overseas Development Institute. See document online
- Grindle, M. S. (2007). Good enough governance revisited. Development Policy Review, 25(5), 533-74. See document online
- Huther, J., & Shah, A. (1998). Applying a simple measure of good governance to the debate on fiscal decentralization (Policy Research Working Paper No. 1894). Washington, DC: World Bank. See document online
- International Monetary Fund. (2003). World economic outlook: Growth and institutions. Washington, DC: International Monetary Fund. See document online
- Kaufmann, D. (2003). Governance redux: The empirical challenge. World Bank Institute. See document online
- Kaufmann, D., Kraay, A., & Zoido-Lobaton, P. (1999). Governance matters (Policy Research Working Paper 2196). World Bank Institute. See document online
- Knack, S., & Keefer, P. (1995). Institutions and economic performance: Cross-country tests using alternative institutional indicators. World Bank. See document online
- March, J. G., & Olsen, J. P. (1989). Rediscovering institutions: The organizational basis of politics. The Free Press. See document online
- OECD. (2011). Supporting state-building in situations of conflict and fragility: Policy guidance (DAC Guidelines and Reference Series). Paris: Organisation for Economic Co-operation and Development. See document online
- North, D. (1990). Institutions, institutional change, and economic performance. New York: Cambridge University Press. See document online
- North, D., Acemoglu, D., Fukuyama, F., & Rodrik, D. (2008). Governance, growth, and development decision-making. Washington D.C.: World Bank. See document online
- North, D.C., Wallis, J. J., & Weingast, B.R. (2009). Violence and the rise of open-access orders. Journal of Democracy, 20(1), 55-68. See document online
- Parry, T. (2007). The role of fiscal transparency in sustaining growth and stability in Latin America. IMF. See document online
- Rothstein, B. (2011). The quality of government. Chicago: University of Chicago Press. More information
- Welham, B., Krause, P., & Hedger, E. (2013). Linking PFM dimensions to development priorities. London: Overseas Development Institute. See document online
- Woller, G., & Phillips, K. (1998). Fiscal decentralisation and LDC economic growth. An empirical investigation. The Journal of Development Studies, 34(4), 139-148. See document online
- World Bank. (2000). Reforming public institutions and strengthening governance. A World Bank strategy. Washington, DC: World Bank. See document online
- World Bank. (2012). The World Bank’s approach to public sector management 2011-2020: ‘Better results from public sector institutions’. Public Sector & Governance Board, Poverty Reduction and Economic Management. See document online