This Chapter will serve to review the theoretical and empirical literature on the impact of institutions on economic growth also in reviewing the empirical literature find the best methodology to employ to assess the impact of institutions on economic growth in Zimbabwe.Theoretical Review Balanced Growth Theories Big Push Theory Rosenstein Rodan introduced the Big Push Theory which pointed out that for countries to escape low equilibrium traps they would have to embark on mass industrialisation. He stated that poor countries require large amounts of investment to embark on the path of economic development. This then points to the need of capital injection into the economy for the industrialisation process to occur but Rodan emphasise there is need for a build-up of momentum before an economy can reach the take-off stage. Vicious Cycle of Poverty Theory Ragnar Nurske’s theory observed that poor countries are caught in interconnected vicious cycles of poverty from the demand side and supply side locking them in a low equilibrium trap. These where cyclic forces tending to keep a country in the state of poverty. On the supply side we have low income ,low savings ,low investment capital deficiency or low capital formation and low productivity whereas on the demand side we have low income ,low demand for goods ,limited home market and low investment According to Professor Nurske escaping the poverty cycle requires three conditions firstly the creation of strong incentives to invest along with increases in mobilisation of stable funds especially on the domestic front .
Secondly it requires a significant expansion of the lack of confidence in the market through simultaneous massive and balanced capital investments in a number of industrial sectors further re enforcing Rodans Big Push Theory .Thirdly he called for government involvement in order for the following to occur that is the planning of large scale investments projects like infrastructural projects and programmes and also to secure internal mobilisation of resources.Unbalanced growth Theories Harrod Domar Growth ModelIt shows the importance of saving and investment in a developing economy. The model states that the growth of an economy is positively related to its savings and negatively related to its capital output ratio. It suggests that there is no natural reason as to why an economy should have balanced growth. It also implies that a higher savings rate allows for more investment in physical capital. The investment then in turn can increase the production of goods and services within a country therefore increasing growth.
- Thesis Statement
- Structure and Outline
- Voice and Grammar
The capital output ratio shows how much the capital is needed to produce a single dollar’s worth of output. The model also reflects the efficiency of using machines to increase productivity and hence output. This then means that a lower capital –output ratio would lead to higher growth because the resources employed to generate higher output are lower owing to the use of machinery.Rodriks Key Institutions Rodrik (2000) gave five key types of market supporting institutions namely property rights, regulatory institutions, institutions for macroeconomic stabilization institutions for social insurance and institutions of conflict management.Property Rights North and Thomas (1973) and North and Weingast (1989) among others argued the establishment of secure and stable property rights have been key element in the rise of the West and the onset of modern economic growth. He emphasises sufficiently strong control of property rights to spur entrepreneurial activity giving precedence to the assertion that legislation is neither necessary nor sufficient for the provision secure control rights. Property rights are rarely absolute even when set in formal Law.
Societies decide as to the scope of allowable property rights and the acceptable restrictions on their enactment.Regulatory Institutions Failure of markets occurs when the participants engage in fraudulent or anti-competitive behaviour. When Transaction costs hinder the internalizing of technological and other non-pecuniary externalities. They also fail when there is a lack of information which results in moral hazard and adverse selection.
Economists as a result of the recognition of the failures have developed analytical tool to tackle them and possibly remedy the prevailing situation.Institutions for Social Insurance A modern market economy is one where change is constant and idiosyncratic that is individual specific, risk to incomes and employment is pervasive. Modern economic growth involves a transition from a static economy to a dynamic one where3tasks performed by workers evolve on a constant basis and the movement up and down the income scale is different. Traditional entanglements that is the kin group, the church and village hierarchy a dynamic market economy do not constrain individuals.
Social insurance legitimizes a market economy in that it renders it compatible with social stability and social cohesion.Institutions of conflict managementSocieties differ in terms of their makes up that is cleavages for instance some consist of an ethnically homogenous population marked by a relatively egalitarian distribution of resources for example Finland. whereas others are characterised by deep cleavages along ethnic and or income lines for instance Nigeria. The divisions present hamper social cooperation and prevent the undertaking of mutually beneficial projects. Social conflict destabilises economic performance due to the diversion of resources from economically productive activities an also the discouragement of such activities owing to the uncertainty generated as a result of the conflict. In Zimbabwe’s case the political ruckus in terms of the killings of people in rival factions hinders investment owing to the instability generated by such actions.Institutions for macroeconomic stabilizationFrom Keynes work we have come to a better understanding that capitalist economies are not self-stabilising. Most of the recent views of macroeconomic instability stress the volatile nature of financial markets and the transmission of that instability into the real economy.
Private investment success hinges on macroeconomic stabilization and thus it expected that monetary and fiscal institutions be set up so as to perform the stabilizing functions.Colonization and economic Growth Acemoglu et.al (2010) concluded that the colonisers institutions had no direct effect on economic performance but subsequently affected colonialists’ settlements patterns which lead to institutional development. Colonial history provides an explanation of the variation in institutions to the present day and thus economic performance. In conclusion it is shown in the case of China and India which were once colonies changed their economic path through reforms thus showing colonization alone cannot explain economic performance.
In addition, uncolonised countries are expected to be more prosperous but this does not hold in reality.Geography and Economic GrowthLocation and climate have pronounced effects on income levels and income growth through their effects on transport costs, disease burdens and agricultural productivity. The choice of economic policies to be undertaken seems to be related to geography. Many geographic regions not conducive to modern economic growth have high population density and are experiencing as population increase owing to lack of economic development. The areas most affected are those not in the vicinity of coastal areas which increases transport costs thus hinders growth due to higher price of resources such as intermediate goods import for use in businesses further inland good example being Zimbabwe.
Tropical regions also face the burden of disease.Other non-institutional determinants of economic growthTerms of trade Improvements in the terms of trade that is a higher growth rate of the ratio of export prices to import prices enhance economic growth. The positive effects on an improvement on the terms of trade on real GDP reflects increases in factor employments or productivity and would lead to economic growth improvements in that the countries trade balance would improve and hence the economy would improve. FDI and Capital Accumulation Foreign direct investment impact on economic growth can be positive or negative for instance as FDI flows into Zimbabwe it would bring in new technology which is paramount for growth but on the other hand it crowds out domestic investment. Openness to FDI and technology helped to increase productivity growth in the Sub Saharan Africa region.
Physical capital formation, vibrant export sector and human capital formation significantly contribute to growth while government expenditure, nominal discount rate and foreign aid significantly and negatively affect growth, Ndambiri et al (2012). Capital accumulation has a positive impact on growth which is consistent with the neoclassical theory, Holtz-Eakin (1993).Empirical and Qualitative Review Ha Joon Chang (2010) studies the links between institutions and economic development on a qualitative basis she explains that Global Standard Institutions which are institutions typically found in Anglo American countries are seen as the best institutions to spur economic growth these being institutions that maximise market freedom and protect private property rights most strongly with the pressure to adopt the GSI’s coming from various bilateral ,regional and multilateral trade and investment agreements which start to proliferate in the 1990’s For example the World Trade Organisation has forced developing countries to adopt American style intellectual property rights (TRIPS) agreement. The author also argues that the discourse neglects the causality running from development to institutions in that development increases the need for better institutions so not only the converse that institutions cause an increase in development.
Also a point raised is that there is a poor understanding as to how institutions themselves change with the usual emphasis being on scarce resources and opportunity costs , the issue of the costs of establishing and running the institutions is usually ignored in mainstream economics thus making proposals for institutional reforms seem more attractive than they actually are .In methodological terms there is a high optimism in the implementation of GSI’s as a result of simplistic views on what institutions are and how they change in response to the economic climate prevailing in a country and also the other factors affecting their implementation.Critique Though Ha Joon Chang’s analysis is broad and fairly extensive it fails to use an econometric model so as to give empirical relevance to theories put forward in the paper and thus should have employed the use of empirics to get a better understanding of the thought process put forward.Dani Rodrick et al in the paper Institutions Rule posit that institutions rank higher than geography and economic integration in terms of economic development. The methodology employed is a linear regression function with the use of OLS estimation but employing Acemoglu et al instrumental variable for institutions that being settler mortality to use 2SLS estimation to deal with the problems of omitted variable bias, causality, and measurement error. The other independent variables in the model are Integration and Geography where for integration there is use of The Frankel and Romer Instrumental variable that is constructed trade share which is the ratio of nominal trade to nominal GDP. Whereas Geography is proxied by the absolute latitude of a country. Critique The paper uses econometric modelling to explain the theory but it is limited as the institutions are proxied by one measure and of which though it has been used in other papers it is not the only measure of institutions with relevance and also integration and geography are not the only factors that affect economic growth hence it may not have enough explanatory power as shown by the moderate R squared values in the model ranging from 0.
Kilishi Institutions and economic performance in Sub-Saharan Africa the paper answers two questions do institutions really matter in Sub Saharan Africa and if they matter which of them matter the most. The results of the paper found that institutions really do matter for sub Saharan Africa’s economic performance and among which regulatory quality seemed to be the most important. The papers policy recommendation was therefore the region’s economic performance could be enhanced by improving regulatory quality. The methodology employed is that of the Arellano and Bond first difference and Blundell-Bond System Generalized Method of Moments(GMM) estimators to estimate the specified models. The model to which these methods are applied is the panel data specification of the augmented Solow growth model with a vector variable for institutions these being the World Bank Indicators for governance which are voice and accountability, regulatory quality, rule of law, political stability and absence of violence and control of corruption.
The other independent variables were investment, secondary school enrolment and investment as a share of GDP. With the dependent variable Gdp per capita.Critique The methodology employed is complex and opens up to the risk of erroneous calculation and thus though reliable a researcher not versed in the methodology employed will give misleading results. The advantage of using this methodology is that the GMM estimation removes corrects for endogeneity leading to the dependent variable not being related to the explanatory variables within a model. Hall and Jones (1999) hypothesis that differences in capital accumulation, productivity and therefore output per worker are fundamentally related to differences in social infrastructure across countries. By social infrastructure Hall and Jones refer to institutions and government policies that determine the economic environment in which individuals accumulate skills and firms accumulate capital and produce output.
To quantify the impact of institutions (as measured by an average of 5 indexes taken from the ICRG database, and by Sachs-Warner’s index of openness to trade), they accounted for feedback effects from output per worker to social infrastructure. The methodology employed to assess the relationship using the frame work of Mankiw, Romer and Weil (1992), Klenow and Rodriguez (1997) in writing the decomposition I terms of the capital –output ratio rather than the capital labour ratio. The model employedWhere S is the social infrastructure measured by openness and measures from Political Risk Services X is other variables instrumented by distance to the equator for Geography, extent to which primary European languages (English, French, German, Portuguese, and Spanish) are spoken, and the (log) predicted trade share of an economy.
Critique Though the model gives that many of the predictions of growth theory can be successfully considered in a cross-section context by examining the levels of income across countries. the use of instrumental variables to proxy the above equation brings to question as to the validity of the instruments and if there is sufficient literature so as to warrant the use of those specific instruments as proxies. Daron Acemoglu (2008) explains that differences in human capital, physical capital are only proximate causes of growth this lead to the question as to why some countries have less human capital, physical capital and technology and make worse use of their factors and opportunities. The Gap points to institutions backed by Luiz (2010) stating that the last decade had seen a growing acceptance of the fact that institutions are the ultimate driver of economic development proxied by economic growth.
Mauro (1995) studies corruption and impact on growth and finds that the negative association between corruption and investment as well as growth is significant statistically and in an economic sense he uses the subjective indices of bureaucratic honesty and efficiency to provide empirical evidence on the effect of corruption on economic growth. Thus this implies that If Zimbabwe were to improve the integrity and efficiency of its bureaucracy level its investment rate would rise and so would its yearly GDP growth rate. Rosenberg and Birdzell (1985) concluded in their paper that differences in governance and institutions are crucial for explaining innovation and even the industrial revolution and why modern economic growth emerged in the west rather than other parts of the world. in relation to Zimbabwe this would imply changing formal institutions namely government policies for example a better taxation system to stimulate foreign investment in the country. Stefan Voight (2007) in his paper how not to measure institutions argues that measures of institutions should be precise, objective and take inti account de jure and de facto elements.
His hypothesis is the factual enforcement of formal institutions is likely to be influenced by a number of informal institutions when estimating the economic impact of institutions, the aforementioned possibility should be reflected by incorporating a number of covariates proxying for these informal institutions. The relevance is that omitted variable bias would loom large if not taken into account. But the current data and modelling in the literature is insufficient to attest to this proposition thus it is a potential drawback in the literature of institutional impact on economic growth and thus worth mentioning in relation to the study topic.Conclusion Institutions have grown in importance in the past two decades in relation to growth theory as one of the important determinants of economics growth in that they better explain the variation in economic performance between nations, regions or continents. In the implementation of better formal institutions, the informal institutions such as traditions and culture need to be factored in so as to assess how to and which institutions to apply in different country cases as ones’ success is not directly transferrable.
In the literature inclusion if institutions in the economic growth model has the problem of endogeneity which can be resolved by the GMM method