PhD Dissertation: “Essays on Institutions and Institutional Change”

My PhD dissertation focussed on the evolutionary nature of institutions. It explored how changes in the economic environment affect institutions and whether these changes, in turn, have any effect on the economic environment. Below is the introduction of my PhD dissertation and an overview of the rest of the chapters.


Introduction

The New Institutional Economics (NIE) perspective highlights the importance of institutions in shaping economic outcomes. The basic premise of NIE is that economic outcomes realized by a society are also a function of the institutions put in place, which create incentives and impose constraints that in turn motivate agent’s behavior. Numerous empirical studies have established that institutions are critical for economic development (e.g., see Acemoglu, Johnson, & Robinson, 2001; Easterly & Levine, 2003; Hall & Jones, 1999; Knack & Keefer, 1995; Mauro, 1995; Rodrik, Subramanian, & Trebbi, 2004). A large body of literature has explored the relevance of institutions in determining international trade, foreign direct investments, financial development, and efficiency (Adkins, Moomaw, & Savvides, 2002; Busse & Hefeker, 2007; Levchenko, 2007; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998). Still further, institutions have been identified as substantive predictors of macroeconomic stability, and entrepreneurship (Acemoglu, Johnson, Robinson, & Thaicharoen, 2003; Aidis, Estrin, & Mickiewicz, 2010; Simón-Moya,
Revuelto-Taboada, & Guerrero, 2014; Stephen, Urbano, & van Hemmen, 2005).

The quality of these institutions varies significantly across countries. Shirley (2005) highlights four explanations for these differences. The first is a legacy of poor institutions inherited from colonizers (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1999; North, 1990). The second explanation refers to differences in initial resource endowments that led to the development of distinct institutional development pathways (Acemoglu & Johnson, 2002; Acemoglu, Johnson, & Robinson, 2005b; Acemoglu & Robinson, 2012). The third is that a lack of political competition may have encouraged leaders to build institutions to serve their own interests rather than the interests of the people (Nugent & Robinson, 2010). The final explanation is that distinct cultural and ideological beliefs and norms may have discouraged the development of anonymous markets and market-supporting institutions such as property rights, contract laws and investor protection (Knack & Keefer, 1997; North, 1994, 2006). Although these theoretical explanations help explain the deeper causes of institutional differences, they offer limited guidance to improve local institutions in the short and medium terms.

Another strand in the literature interprets institutional quality as a by-product of economic development and shifting policy demands (Chang, 2011). The modernization hypothesis assumes that the relative benefits of institutions increase with the level of economic development (e.g., see Acemoglu, Johnson, Robinson, & Yared, 2009; Chang, 2011; Lipset, 1959). Along this reasoning, the causal chain predicts that accelerating economic development and increased wealth create corresponding demands for high-quality institutions (e.g., demands for political institutions with greater transparency and accountability), nurture agents who introduce change dynamics, and finally provide resources to introduce and maintain institutional change (Chang, 2011). Similarly, the grand transition perspective interprets “development” as a process of steady economic growth leading to broad institutional transitions (Paldam & Gundlach, 2008). Naturally, other economic factors, such as economic openness and human capital, also contribute and shape these complex processes of institutional change (Al-Marhubi, 2005; Alonso & Garcimartín, 2013; Bergh, Mirkina, & Nilsson, 2014; Bhattacharyya, 2012; Islam & Montenegro, 2002; Nicolini & Paccagnini, 2011).

Most empirical studies aiming to document institutional change do not distinguish between different types of institutions. Rather, they treat different institutions as alternative proxies for overall institutional quality (Acemoglu & Johnson, 2005). However, North’s (1990) definition of institutions as “rules of the game” that “structure incentives in human exchange, whether political, social, or economic” distinguishes between different types of institutions that are unlikely to be equally open to change. Economic and social institutions determine the incentives and constraints of economic and social actors, and political institutions determine the incentives and constraints of key actors in the political sphere. In non-democratic systems, these key actors often have ultimate control over the distribution of political rights (Acemoglu, Johnson, & Robinson, 2005a).

This taxonomy provides a useful approach to study the complex dynamics and contingencies of institutional change. For instance, how do modifications of one distinct institution affect other institutions? Does spillover have positive effects or counterbalancing tendencies? Which institutions deserve priority? Finally, how can contingency effects be exploited to advance institutional change? Inspired by these open questions, this thesis distinguishes between political and economic institutions as two types of institutions that likely differ in their malleability and are also likely to mutually affect related change-dynamics. Political institutions form the basis of economic institutions (Acemoglu et al., 2005a; Acemoglu & Robinson, 2012; North, 1990, 1991, 1994). Thus, Acemoglu et al. (2005a) argue that political institutions define the constraints limiting the use of political power, and they condition the distribution of resources (and rents) within the economy, thereby determining which group holds the de jure political and economic power in a given society. Political institutions play a crucial part in the institutional system. Any change in political institutions can modify the distribution of economic resources and the structure of economic institutions (Acemoglu et al., 2005a). Various historical illustrations demonstrate how the unequal distribution of de facto economic power combined with extractive de jure political institutions can lead to the persistence of socially inefficient economic institutions over time (Acemoglu & Robinson, 2012).

The theoretical and conceptual framework underscores the importance of distinguishing between several types of institutions and the interactions among them. Relying on North’s (1990) broader definition of institutions as “rules of the game” provides little insight on the process of institutional change. This basic definition helps identify the importance of institutions in the economic system, but it requires further development to understand their specific functions in relation to different parts of an economy. In particular, institutions should be delineated in terms of their specific effects on economic outcomes to establish how individual institutions (or institutional groupings) cause (either directly or indirectly) or hinder growth. Rodrik (2000, p. 2) summarizes the question as follows: “Which institutions matter and how does one acquire them?” This question highlights the need for broader empirical efforts that consider interactions among different types of institutions. Any discourse on institutions and institutional change should also consider the mutually reinforcing and dynamic relations of well measured, distinct political and economic institutions. As Acemoglu and Johnson (2005) state, it is necessary to “unbundle” institutions to explain how and why they develop.


Overview of the Chapters


Chapter 2: Trade, Political Institutions and Economic Institutions

This chapter contributes to the growing literature on identifying the determinants of economic institutions. Recent empirical studies confirm a positive relation between international trade and the quality of domestic economic institutions (Bergh et al., 2014; Bhattacharyya, 2012; Nicolini & Paccagnini, 2011). However, the effect of trade on economic institutions is likely to vary with different political regimes. From a short-term perspective, trade regimes and domestic rules of international trade participation reflect the priorities of the ruling class and, in this sense, they are political constructs. In an authoritarian regime, the political elite can effectively restrict broader participation of the public in trade and can use regulations, quotas, and licenses to manipulate the market structure and impede market access (Aidt & Gassebner, 2010). Increased trade is therefore not necessarily associated with better economic institutions. I argue that institutional effects stemming from international trade are unlikely to be independent of the prevailing political regime. Centralized power in the hands of a small group of political elites is likely to have moderating effects on the assumed link between trade and economic institutional quality. Thus, the effect of international trade on economic institutions will be attenuated in countries with more extractive political institutions compared to countries with democratic institutions.

Using panel data from 138 countries from the year 1984 to 2010, this chapter reports a positive link between the level of international trade and the quality of economic institutions. However, in the presence of extractive political institutions, the effect of trade on economic institutions decreases significantly and even becomes negative. The results are in line with the theoretical predictions and reinforce the conditional relationship between trade and economic institutions. These results appear to confirm that authoritarian regimes effectively restrict broader participation of the public in trade and may also resort to use of regulations, quotas, and licenses to manipulate the market structure and impede market access, reducing the effect of trade openness on economic institutions. The findings underscore the role played by political institutions in determining economic institutions and calls for the inclusion of political institutions in the analysis of economic institutions.

Note: Full version of this chapter can be accessed from here.


Chapter 3: Catch-up in Institutional Quality: An Empirical Assessment

This chapter contributes to the literature studying the dynamics of institutional change and the differences in change patterns among political and economic institutions. This chapter deviates from examining the determinants of institutions and instead focuses on institutional change. The central question is whether there is a process of catch-up in institutional quality across countries and whether there are any differences in how economic and political institutions change. To answer this question, this chapter investigates the evolution of these institutions over time. A key objective of reforms aimed at promoting economic growth in developing countries has been to improve institutional quality, as dysfunctional and ineffective institutions and weak governance “is increasingly seen to be at the heart of the economic development challenge” and “building effective and accountable institutions is arguably the core challenge for sustainable poverty reduction” (World Bank, 2000, p. 1). However, institutional development is a challenging endeavor, as new institutions must comply with the existing social norms and face opposition from elites (Acemoglu et al., 2005a; Evans, 2004). Moreover, economic institutions are more likely to change, compared to political institutions, as the interests of elites align with changing economic institutions vis-à-vis political institutions (Nye, 2011; Olson, 1993). Therefore, it is fitting to ask whether a catch-up in institutional quality has occurred and whether the catch-up process differs between economic and political institutions.

The chapter uses a novel testing method to test for catch-up in institutional quality across countries. The study uses data on 81 countries from 1985 to 2010 and three different measures of institutional quality that capture both political and economic dimensions of institutions. The results suggest that economic institutions in most countries tend to change in similar directions. Moreover, evidence supports a catch-up in institutional quality, as most countries with weak institutions have a higher rate of change than that in countries with strong institutions. In contrast, for political institutions, the catch-up process was short-lived, lasting only a few years. The results indicate that the pattern of change for economic and political institutions is different and underscores the need to incorporate the differentiation between economic and political institutions in future studies.

Note: A working paper version of this chapter can be found here.


Chapter 4: Firm Ownership and Provincial CO2 emissions in China (Co-authored with Fredrik N. G. Andersson and Sonja Opper)

Chapter 4 contributes to the literature on the effects of public and private ownership of firms on environmental quality by studying the effects of regional differences in ownership structure on overall provincial carbon dioxide (CO2) emissions in China. Since the 1980s, China has emerged as one of the world’s largest economies and the main emitter of CO2. Many contend that China’s leadership has prioritized economic growth over environmental concerns throughout most of its reform, causing severe air, water, and land pollution (He, Lu, Mol, & Beckers, 2012). However, China has also experienced a gradual capitalist transformation from a fully state-owned economy to a hybrid economy largely relying on private production and mixed ownership forms (Nee & Opper, 2012). The question remains whether and to what extent the country’s openness to capitalist forms of production has reinforced or possibly mitigated accumulating environmental costs.

To model the effect of this capitalist transformation on environmental quality, the chapter uses Chinese provincial data from 1992 to 2012. The approach followed here is to decompose the short-run and long-run cause of emissions into scale, energy, and carbon intensity components. The results show that capital growth is the main driver of emissions growth and that private-firm capital is more energy efficient than capital employed in non-private firms. This translates into emission growth between 3 and 4 percent per year in the longterm, had private firms been as inefficient as non-private firms. This result emphasizes that market-oriented reforms and general firm efficiency can decrease future CO2 emission growth. The competitive pressure on private firms, as compared to non-private firms, is likely to be the main driver of the negative long-run correlation between private enterprises and emissions. The results also show that continued structural changes from an agricultural economy to a modern industrialized economy, coupled with an active environmental policy (i.e. regulation of carbon price) may reduce overall emissions growth close to zero, despite economic growth in excess of 5 percent per year. These insights offer valuable lessons for many developing countries, which continue to rely on large state-owned sectors. Economic development and environmental concerns can be coupled into a win-win situation through reforms that directly enhance productivity and competition and indirectly decrease environmental degradation.


References
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Acemoglu, D., Johnson, S., & Robinson, J. (2005a). Institutions as a Fundamental Cause of Long-Run Growth. In A. Philippe & N. D. Steven (Eds.), Handbook of economic growth (Vol. Volume 1, Part A, pp. 385-472): Elsevier.
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Please cite the dissertation as follows: Khalid, U. (2016). Essays on Institutions and Institutional Change, (diss.), Lund Economic Studies, No. 191.

 

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