Institution Building and Growth in Transition Economies

1
Institution Building and Growth in Transition
Economies

• Thorsten Beck
• Luc Laeven

2
Large and widening disparity in GDP per capita
over the first decade of transition
3
Large variation in institution building across
transition economies
4
Motivation

• Large and widening disparity in economic and
  institutional development over the first decade
  of transition
• Explanations of growth performance in transition
  economies have focused on macroeconomic policies
  and initial conditions
• Large cross-country literature on impact of
  institutions on growth
• Experience of transition economies offers a
  unique historic experiment in institution
  building (similar to colonization in Acemoglu et
  al. (2001, 2002)

5
Our explanation

• Political economy theory of institution building
• institutions are not usually created to be
  socially efficient, but are created to serve
  the interests of those with bargaining power to
  create new rules (North)
• Socialist entrenchment
• Incumbent socialist elite had fewer incentives to
  create institutions that fostered competition, as
  this would reduce their economic power
• Reliance on natural resource
• Economies that rely more on natural resources
  offer larger opportunities for the elite to
  extract rents
• Countries that spent longer time under socialism
  and are more reliant on natural resources had
  less open political system at start of transition
  and a larger presence of former communist in
  parliament after first election, with negative
  repercussions for subsequent institution building
  and economic growth

6
Overview

• Motivation
• Institution Building in Transition Economies
• Conceptual Framework
• Data and Results
• Institutions and Growth in Transition Economies

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What are institutions?

• Underlying rules that govern transactions between
  agents in an economy, both transactions between
  private parties, as well as between private
  parties and the government
• Property right protection gives incentives for
  investment in tangible and intangible assets and
  risk-taking
• Contract enforcement encourages market-based
  commercial and financial transaction
• Socialist institutions did not allow for
  effective private property and for market-based
  exchange
• Transition economies had to build new
  market-compatible institutions

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Framework of Institution Building Natural
resource curse

• Reliance on natural resources
• Easier to realize short-term gains from natural
  resources than manufacturing
• Elites were most interested in securing property
  rights over natural resources rather than
  building up market-compatible institutions
• Hypothesis Countries with higher natural
  resource reliance had less open political systems
  at start of transition and slower institution
  building
• Examples
• Armenia vs. Azerbaijan
• Albania
• Measures Initial Raw Exports/GDP, Gas
  reserves/population

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Framework of Institution BuildingSocialist
entrenchment

• Socialist entrenchment
• Absence of civil society institutions, more
  centralization, thus more entrenched elites
• Outside opportunities for bureaucrats lower
• Hypothesis Countries longer under socialism had
  less open political systems at start of
  transition and larger role for former communists,
  with negative repercussions for institution
  building
• Examples Belarus and Ukraine
• Measure Years under Socialism

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Time under socialism
Initial Raw exports/GDP
Communist Entrenchment
Natural Resource Endowment
Initial Political Structure
1. Communist share 2. Executive constraints
Institutional Development
(?) KKM
1. Per capita GDP growth 2. Household consumption
3. Electricity consumption
Economic Growth
Macroeconomic Policies and Reforms
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Sample
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Determinants of Initial Political Structure - OLS
regressions
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Time under socialism
Initial raw exports/GDP
Communist Entrenchment
Natural Resource Endowment
Initial Political Structure
1. Communist share 2. Executive constraints
Institutional Development
(?) KKM
1. Per capita GDP growth 2. Household consumption
3. Electricity consumption
Economic Growth
Macroeconomic Policies and Reforms
14
Determinants of Institutional Development - IV
regressions
1st stage Political Structure aZ bX e
2nd stage Institutions gPolitical Structure
dX e Z Initial raw exports/GDP, Years under
Socialism
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Determinants of Institutional Development -
Robustness Tests

• Relationship between initial political structure
  and institution building robust to controlling
  for
• Other country characteristics Ethnic
  fractionalization, landlocked
• Other transition characteristics EU Accession,
  civil war
• Initial conditions FSU, CMEA Trade share,
  repressed inflation
• Education tertiary enrolment rate
• Policies Initial liberalization and speed of
  liberalization, Voucher privatization

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Overview

• Motivation
• Institution Building in Transition Economies
• Conceptual Framework
• Data and Results
• Institutions and Growth in Transition Economies

17
Time under socialism
Initial raw exports/GDP
Communist Entrenchment
Natural Resource Endowment
Initial Political Structure
1. Communist share 2. Executive constraints
Institutional Development
(?) KKM
1. Per capita GDP growth 2. Household consumption
3. Electricity consumption
Economic Growth
Macroeconomic Policies and Reforms
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Indicators of economic development

• Average annual GDP per capita growth, 1992 2002
• Robustness checks
• Average annual GDP per capita growth, T-2002
• T start of transition
• Annual growth in electricity consumption per
  capita, 1992 2002
• Annual growth in real household consumption, 1992
  2002
• Two-Stage Least Square
• 1st stage Institutions aZ bX e
• 2nd stage Growth gInstitutions dX e
• Z Initial raw exports/GDP, Years under
  Socialism
• X Initial dependent variable, other controls

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Institution building and economic development
IV regressions
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Institution building and economic development -
Robustness Tests

• Relationship between institution building and GDP
  per capita growth is robust to controlling for
• Other country characteristics Ethnic
  fractionalization, landlocked
• Other transition characteristics EU Accession,
  civil war
• Initial conditions FSU, CMEA Trade share,
  repressed inflation
• Education tertiary enrolment rate
• Policies Initial liberalization and speed of
  liberalization, voucher privatization,
  government consumption, monetary growth

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Conclusions

• Institutions are more important than policies in
  explaining growth variation across countries
• Easterly and Levine (2003), Rodrik et al. (2004)
• Institutional development has to be interpreted
  in the context of political economy