Economía / Investigaciones y publicaciones / CEDE / Publicaciones / Documentos CEDE / 2004 / Institutions as the Fundamental Cause of Long-Run Growth

This paper develops the empirical and theoretical case that differences in economic
institutions are the fundamental cause of differences in economic development. We
first document the empirical importance of institutions by focusing on two "quasi-natural
experiments" in history, the division of Korea into two parts with very different economic
institutions and the colonization of much of the world by European powers starting in
the fifteenth century. We then develop the basic outline of a framework for thinking
about why economic institutions differ across countries. Economic institutions
determine the incentives of and the constraints on economic actors, and shape
economic outcomes. As such, they are social decisions, chosen for their
consequences. Because different groups and individuals typically benefit from different
economic institutions, there is generally a conflict over these social choices, ultimately
resolved in favor of groups with greater political power. The distribution of political
power in society is in turn determined by political institutions and the distribution of
resources. Political institutions allocate de jure political power, while groups with
greater economic might typically possess greater de facto political power. We therefore
view the appropriate theoretical framework as a dynamic one with political institutions
and the distribution of resources as the state variables. These variables themselves
change over time because prevailing economic institutions affect the distribution of
resources, and because groups with de facto political power today strive to change
political institutions in order to increase their de jure political power in the future.
Economic institutions encouraging economic growth emerge when political institutions
allocate power to groups with interests in broad-based property rights enforcement,
when they create effective constraints on power-holders, and when there are relatively
few rents to be captured by power holders. We illustrate the assumptions, the workings
and the implications of this framework using a number of historical examples.