The effects of institutions on economic performance have been widely debated in evolutionary economics. It basically seems that well-functioning economic and political institutions (laws and related monitoring, governance structures, democracy, economic policy, etc) underpin a free market economy and contribute to growth. Accordingly, institutions and their functioning are one of the key areas of research in transition economies, in which the institutions inherited from communist regimes have degenerated and become corrupt, no longer operating as hoped for. Even so, research findings concerning the effects of institutions on economic growth are contradictory precisely in respect of these countries, as the evidence for and against the proposition is more or less equal. On the other hand, it is difficult to reliably assess whether healthy institutions generate growth or whether growth helps develop institutions. The impact of human capital also occasionally mixes with the effects of institutions. Even the definition of an institution is not strictly delimited, and different types of institutions appear to have highly diverse effects on both development and growth.
In March 2009, the Bank of Finland Institute for Economies in Transition (BOFIT) hosted a seminar on the long-term growth potential of Russia and China. Institutions were naturally given a high priority in seminar presentations. Goel and Korhonen assessed economic growth in China and Russia in relation to the rest of the world and concluded that economic freedom strengthens growth. It might come as a surprise that corruption appears to boost growth, as bribery may add momentum to otherwise slow bureaucracy. Fang and Zhao dealt with the positive impact of western culture on Chinese economic growth. As mentioned above, it is difficult to ascertain the causes and effects between institutions and growth. To avoid this problem, Fang and Zhao observed past factors impacting China’s current regional institutions and used these observations to forecast regional differences in standards of living in 2003. Regions where western influence was strong at the beginning of the 20th century appear to have better institutions in place and are presently growing faster than other regions. Du, Lu and Ta, in turn, estimated the role of the Chinese government as a guardian of law and order and sought to determine the role that authorities should seek in market regulation. They showed that, as the central government has been slow in enacting and implementing laws, regional authorities have assumed a greater role in promoting business activity. So far, this model seems to operate well.
At the beginning of 2009, the BOFIT DP series published a study focusing on the effects of economic freedom on growth and particularly on the development of labour productivity in transition economies (BOFIT DP 1/2009). The study sought to avoid some shortcomings in previous research, by controlling for eg the impact of human capital and the dependence of growth on past trends. The nonlinearities of economic freedom were also taken into account, as well as the fact that a large proportion of output generated in these countries remains outside official statistics. After these adjustments, it was indicated that freer transition economies appear to grow faster. On the other hand, when account is taken of the combined effects of economic freedom, investment and the size of the public sector, the positive implications of freedom diminish. If, for example, both economic freedom and the public sector expand, their combined effect on growth may be detrimental. This finding could partly explain previous results according to which institutions had either a negative effect on growth or no effect at all.
Growth research and the assessment of the role of institutions will continue at BOFIT, where there are a number of related studies currently under way. Jenni Pääkkönen’s study, due for release shortly, compares growth in Chinese regions relative to production structures. The study shows that economic deregulation has particularly benefited industrialised regions, whose economic well-being is converging. Originally agricultural regions that have become industrialised during the process of transition also grow faster than others, gradually catching up on areas that industrialised earlier. If regional differences are excluded, non-industrialised areas lag behind industrialised ones. |