Matthew Yglesias on the Bed-Wetters
links for 2007-09-29

Which Institutions Matter Most for Economic Growth?

Liam Brunt writes:

Which institutions matter for economic growth?: Historical evidence from a natural experiment in South Africa suggests that changing particular institutions is really only tinkering at the economic margins. Establishing clear property rights, by contrast, facilitates almost all economic interactions and unleashes the full potential of the economy....

When we talk about “institutions”,  we are referring to something much broader than simply the set of easily recognisable legal entities.... An institution is any generally accepted procedure that governs the process of interaction between members of a society. For example, waiting in line is a well-known institution for allocating goods that is particularly popular in England. Property rights.... Legal systems.... A challenge that we face in disentangling the economic impact of these and other institutions is that their occurrence tends to be very highly correlated....

[W]e need to find a country that has significantly changed its institutions... and we need to have sufficiently detailed data that we can reliably detect any performance changes.... South Africa... founded by the Dutch East India Company in 1656... seized by the British in 1795.... The Dutch system of property rights, law and administration were followed continuously until 1814... in 1814 [the British] undertook active steps to strengthen the colonial economy.... In 1827, the British imposed the English common law system over the former Dutch system.... In 1843, the British introduced a new Empire-wide policy that required public lands to be auctioned off in freehold to settlers....

There was a substantial step up in output after the British took over in 1795, despite the absence of any formal institutional changes.... But South African output was then static for the next 30 years, through two periods of important institutional reform: the government attempt at economic stimulation after 1814; and the transformation of the legal system from a civil to a common law régime in 1827. Only when private property rights in land became substantially more secure in 1843 do we see any significant improvement in the rate of output growth, at which point it suddenly quadruples. There is considerable evidence from agricultural surveys and census data that the increase in output was due largely to very substantial increases in fixed capital investment, particularly the creation of reservoirs and irrigation systems in areas that were naturally too arid for wheat production....

South African institutional development suggests that government efforts to stimulate growth by revising the institutional framework (such as labour laws and marketing regulations) are largely ineffective in the long run. Nor is it important whether legal disputes are resolved in the context of a civil or common law régime. By contrast, firmly establishing private property rights has very positive effects. This result is perhaps not surprising. Changing particular institutions is really only tinkering at the economic margins. But establishing clear property rights facilitates an almost infinite variety of economic interactions – most of them unforeseen and unforeseeable ex ante – that is limited only by the imagination of economic agents to dream up new types of contracts that permit them to more efficiently exploit the available resources. It is the firm establishment of private property rights that unleashes the full potential of the economy. Several developing economies – such as Vietnam and China – have recently been moving down this road and history suggests that the economic gains are likely to be large...

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