August 30, 2010

Investing in Institutions

  • Ryan A. Compton

    Visiting Assistant Professor of Economics, University of Western Ontario
  • Noel D. Johnson

    Senior Research Fellow
  • Daniel C. Giedeman

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Robust institutional change is difficult to achieve.  However, the growth paths of some countries are more likely to be affected by contemporaneous political turmoil than others.  This paper supports this claim using data on GDP growth during periods of extreme political turmoil for 69 countries between 1870 and 2000.  The authors argue that the robustness of a country's growth path to political uncertainty depends on the degree to which individuals are invested in its current institutions.  A simple model is developed to illustrate the factors which govern an agent's decision of how much to invest in a country's institutions governing property rights and impersonal exchange.  The model predicts a nonlinear relationship between investment in institutions and the effect of political uncertainty on the stability of growth.  Empirical tests in which Contract Intensive Money is used to proxy for the amount of investment in the contract intensive sector in a cross-sectional and panel framework between 1960 and 2000 support the predictions of the model.  Results are also robust to controlling for the endogeneity of political change and economic growth using instrumental variables approaches.

This article is available in its entirety at the Wiley Online Library.