Institutions and Economic

Growth
 What are institutions?
• Institutions are the rules of the game in a society or,
more formally, are the humanly devised constraints that
shape human interaction
– formal rules that include laws and contracts
– informal means such as social norms and conventions that
evolve over time
• Institutions are defined as helping form stable
expectations in exchange
• Institutions created or evolved in response to
uncertainty, risk and information cost associated with
living and transacting in an imperfect world
– Exp. Sharecropping
• Which objects (?) are institutions?
– Money ?
– RBI ?
– IRMA?
– Sea level?
– Marriage?
– Market?
– Government?
– Social club?
– Gravitation?
– Photosynthesis?
– Painting?
– International Boundary?
– Football Game?
– Language?
 The Logical Structure of Institutional facts

Collective intentionality Assignment of function

Intentionality: Feature of Impose functions on objects where
Mind the object does not have function

Collective assignment of function

Collective Assignment of Status

The object or person performs its function only in virtue
of collective acceptance by the community that the
object or person has the requisite status
 Economic Institutions
Function Examples Typical formal Informal
Regulating Agency Regulating Agency

Property rights Land rights Land registries Oral history, chiefs

Inheritance law and local political
Intellectual property authorities,
right; patents; copyright Customs
Patent Offices

Reciprocity: Weights, measures Standards bureau Elders, religious

facilitating courts
transaction Contract laws, dispute Civil court,
arbitration arbitration councils

Auditing and accounting Professional

conventions associations

Cooperation Regulations on Ministry Social norms of co-

cooperatives; operation
Cooperative Societies
Act
How do Institutions Affect Economic Growth and Poverty
reduction

• Investment – property rights

– Easy to trade
– Obtain credit
– Retain resonable share of profits
– Insure against risks
– Investment is encouraged
• Technical Innovation –intellectual property
rights
 Economic Organization and
Institution
• Economic Organisation
– Facilitate transaction and co-operation between
individuals
– reinforce interaction between factors
– Allow those without immediate access to factors
of production to obtain credit, rent land, trade and
to form small companies or cooperatives
• Economic Institution much broader and
deeper concept
• Both reduce transaction cost
 Drivers of Economic Growth
• Factor Accumulation
• Technological progress
• Institutions structure incentives in human
exchange, whether political, social, or
economic
• Develop good Economic Institutions
– Easy ?????
 de facto
political power Distribution of
Market resource
Polson
• External shock
• Movement led by de facto
political power
Tribhubandas Patel
C
M ollec
ov tiv
em e
en
t
Milk from Bombay Milk Scheme
uncertainties Bombay
Khira COOPERATIVE
1945 Milk Market
District

• Sustainable Business de jure political

• Increase business power
• Three tier structure
Government
Role of Manager
Economic Institutions and Growth
• Economic institutions shape the
– Incentives
• Influence investments in physical and human capital and
technology and organisation of production

– Distribution of resource
• Wealth, physical capital, human capital

• Different EI different distribution

– conflicts
• Conflict of interest
– Which group’s power would prevail?
• Political power

May not be maximum growth promoting

 Why groups with conflicting interests do not agree on
economic institutions that maximise growth?

• Commitment problem
– Individuals who have political power cannot
commit not to use it in their best interest
– Credible compensatory transfers and side-
payments cannot be made
Efficiency

Political Economic
Political
power Institution Institution
Distribution
Why not political institutions resolve commitment problem?

Distribution of political power is endogenous

 de jure political power
• power that originates from political
institutions (determine constraints and
incentives in political sphere)
• determines constrains on and incentives of
key actors
 de facto political power

• Even if political power not allocated by political

institutions but still possessed
• Depends on
– ability of the group to solve collective action
problem;
– Economic resource which determine ability to use
existing political institutions and also hire and use
force against different groups
• Those who hold political power influence
evolution of political institutions
– de jure
– de facto occasionally creates changes in political
institutions
state variable
Institutional change

• Economic institutions are determined by political

institutions and distribution of resource
• Endogenous institutions
– Political institutions and distribution of resource stable
– Reproduce initial relative wealth disparity in future
– Framework also emphasises potential for change
 People and Political Institutions
• Political institutions place all political power in the
hands of single individual or group of individuals
• Without checks of political power, political holders
are more likely to opt for a set of economic
institutions that are beneficial for themselves and
detrimental for the rest of the society

Solution
• Distribute power amongst many How to
• Distribute income among many distribute?
 Role of “shocks”

• Modify balance of (de facto) political power

– Changes in technology
– International/External environment
• Governance structure
• Major change in political institutions and
therefore economic institutions and economic
growth
Manorial System
 Mercantilism
16th to 18th Century

Rise of de facto political power of

gentry and merchants

Change in de jure political power

Towards capitalism (mid 18th Century) and

Democracy
Why Good Economic Institutions Do not Evolve
• Political institutions place checks
• Likely to arise when political power is in the
hands of a relatively broad group
– Commitment problem tackled
• Likely to arise and persist when only limited
rents that power holders can extract from rest
of the society
– Rents encourage to opt for a set of economic
institutions that make expropriation of others
possible
• Would Collective Action be helpful in
Developing Good Economic Institutions?