Importance of an institutional framework in the growth of countries

Written by Johanna Contuliano.

Most of the countries in the world have an institutional framework to contain their internal
systems and regulations. But although many of them contain regulations, they are
insufficient to effectively manage the economic and social situations that have arisen in
recent times.

As we can see, for example with covid in 2020 where many countries have been an
economic recessions and have not being able to stablish the necessary policies to counteract
the situation, or another example, insufficient legislation to deal with climate change, the
investment in public infrastructure and other situations show how the lack of
institutionality affects the lives of people and how important it is for the growth of the
countries.

Governments affects the growth in many dimensions, like technological progress,

efficiency, factor accumulation.

Let us think for example in those countries whose authorities constantly intervene in
improving public infrastructure, materialize investment by managing a public spend well,
invest in scientific-technological research, and constantly adjust to social changes trough
new and better legislation and policies, this countries will tend to develop better well-being
for their inhabitants and will contribute to economic development more efficiently than
governments that do not carry out these interventions.

However, no matter how good some measures to improve long-run wellbeing may seem,
they could cause some problems for GDP and growth in the short term, let us think about a
very relevant situation for the world at this moment as the fight against climate change, for
example the creation of emission standards where in periods that pollution exceeds the
stablished limit, economic activities will be paralyzed to reduce emissions, or a more severe
measure where livestock or agriculture are considerably restricted or another example, the
possibility of distribution of income from rich to poor households. They will probably bring
market failures such as negative externalities, information asymmetries, coordination
failures, where “the remedy may be worse than the disease”.

So, where is the limit of government intervention?

The answer would be given on the separation of political powers, as indicated by

Montesquieu, with his theory of the social distribution of power, where the legislative,
executive, and judicial powers are differentiated. In this case, the judicial institution has a
preponderant role in economic growth, in the sense that a strong judiciary independent of
the other powers will allow better but not excessive control, in addition to balance between
economic growth where it does not affect other rights or guarantees. And how do we
achieve this balance? Setting a limit between the search for growth through predatory
practices or, contrary to good faith and, on the other hand, effectiveness in the rule’s
enforcement in a contractual matter.

In conclusion, these interventions reflect that an increase of the gross domestic product will
be good for the national welfare in the sense that they allow us to pay attention to what
aspects should the governments address to achieve better cohesion between development
and good faith in business.