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Rodrik (2000) examined the functioning of economic and political institutions in aligning the incentives of economic actors. He developed a taxonomy of institutions that identified four key functions of institutions within the economy; i) market-
creating; ii) market-regulating; iii) market-stabilising; and iv) market-legitimising. Rodrik’s taxonomy specifies a useful structure for examining the different
mechanisms through which different categories of political and economic institutions can affect long-run economic performance. Rodrik (2000) envisaged that both political and economic institutions that perform these key functions within the economy protect against market coordination failure.
Each of these categories of institutions is related to a need within the
market. For example, any type of market exchange will presuppose the existence of property rights and some form of contract enforcement. Using Rodrik’s taxonomy, political and economic institutions can be more specifically categorised in terms of their function as either creating or deepening the market. Market-creating and market-legitimising institutions refer to those political and economic institutions that are instrumental for economic exchange, regulating interaction, transactions and exchanges amongst economic actors and the state (Rodrik, 2005). While market- regulating and market-stabilising political and economic institutions contribute to the deepening of markets (Ugur, 2010).
Though not strictly market creating, market-legitimising institutions support the creation of markets through regulating social conflict and creating a level playing field within the economy. Market-legitimising institutions reduce potential market coordination failure by redistributing and managing social conflict, providing social protection and insurance in the event of shock (Rodrik, 2005). Conflicts increase the risk and costs of transactions and diverts resources from accumulation,
diminishing productivity. Institutions that regulate conflict management can mitigate against opportunistic behaviour aimed at amassing a disproportionate share of resources (Siddiqui & Ahmed, 2013). Institutions that provide social insurance and social protection, like unemployment benefits, government pensions, public health care, reduce social divisions and distributional gaps that arise along lines of wealth, ethnic identity and geography within the market.
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Market-regulating institutions mitigate against fraudulent and anti-
competitive behaviour by economic actors. Market-regulating political and economic institutions are those rules and norms that are enforced in response to situations of market failure and are aimed at sustaining economic growth over the long-run (Rodrik, 2005). Regulatory institutions coordinate conduct in goods, services, labour, asset and financial markets. For example, employment regulations regarding working hours and hiring and firing practices regulate the labour markets, increasing the efficiency of the labour markets, deepening their operation and mitigating
against market failure and agency problems. Market-regulating institutions
contribute to providing economic actors with incentives to investment and increase the volume of contracting and reduce the incidence of externalities and market failures. These institutions reduce the cost of enforcing market-creating institutions and increase the benefits to be derived from market-creating institutions by ensuring that they are more evenly distributed within the economy (Siddiqui & Ahmed, 2013).
Economies are not self-stabilising (Rodrik, 2000). Market-stabilising institutions are those institutions that enable markets to develop resilience against shocks, reduce inflationary pressure, minimise macroeconomic volatility and avert financial crisis (Rodrik, 2005). Market-stabilising political and economic institutions stabilise the functions of the market, they include monetary policies designed to regulate the size and extent of growth of the money supply, which affects the stability of interest rates. Market-stabilising institutions reduce uncertainty and encourage investment and long-run productivity by protecting the market against external shocks (Bhattacharyya, 2009). This category of political and economic institutions provides a system within the market that enables investors to divest themselves of risks.
3.6
Summary
The way institutions are categorised is important for interpreting their effects.
Categorisations as ‘good’ or ‘weak’, ‘extractive’ or ‘inclusive’, ‘efficient’ or ‘inefficient’ may be artificial and axiomatic, providing no real indication of the quality of
institutions, but providing a description of the effect of their outcomes. These axiomatic and parsimonious categorisations of institutions have resulted in the call for the use of much more robust techniques for identifying and quantifying
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institutions in the investigation of the role of institutions on economic performance. The only distinction that has withstood empirical and theoretical scrutiny is between political and economic institutions. The categorisation of institutions as either political or economic has provided the most useful unit of analysis to explain the relationship amongst informal norms and formal rules, accumulation of capital and labour, productivity and economic growth.
While some studies categorise institutions based on their outcome or effect of institutions, others categorise institutions by the function they perform within the economy. This latter approach, provides a more straightforward framework within which to examine the influence of institutions within the economy, which prioritises function over effect. The functional categorisation of institutions as either political or economic acknowledges the complexity of the role of institutions as either creating or deepening the resource and produce markets. Yet the simplistic categorisation of institutions as merely political and economic has proven insufficient to elucidate the relationship between institutions and the economic system. This has led to the further functional categorisation of political or economic institutions as either market- creating or market-deepening. This functional categorisation has been taken a step further by Rodrik (2000) who developed a taxonomy of institutions based on four key functions; market-creating, market-regulating, market-stabilising and market- legitimising. While this taxonomy provides a useful method with which to examine the different mechanisms through which different categories of political and
economic institutions can affect long-run economic growth, there has been no consensus on the relationship between these categories of institutions and the proximate determinants or productivity.
Market-regulating and market-stabilising institutions reduce uncertainty in the market and encourage sustainable economic growth, thereby having a market- deepening effect in the economic system. Markets that are more efficient reduce the impact of externalities and market failures and reduce macroeconomic unpredicabiilty. Market-deepening institutions support the function of market-
creating and market-legitimising institutions, such as, supporting the enforcement of property rights.
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Market-creating and market-legitimising institutions not only create the markets within the economic system, but also provide social insurance and support systems for risk sharing. By legitimising the market, they ensure social cohesion and stability, reducing social conflict that can potentially divert resources from productive activities. These institutions could contribute to the reduction of transaction costs, security of private property and enforcement of bureaucratic procedures that increase market participation and investment in factor
accumulation, skills, knowledge and R&D.
The combined effect of market-creating and market-deepening institutions is to encourage and support economic actors and economic decision-making to engage in mutually beneficial activities through interaction and conclusion of
contracts. They enable economic actors to achieve higher overall returns on a given capacity of contracting by decreasing transaction costs. The combined effect of these institutions underpins the incentive for investing in factor accumulation and productivity.
The theoretical case for the significance of institutions for economic growth, is that they matter as determinants of the costs and benefits of undertaking growth- enhancing activities, such as the accumulating physical and human capital or participating in international trade. If that is indeed the case, then these factors should be only intermediary channels through which institutions are associated with economic growth and they should not be controlled for in estimations aimed at examining the overall effect of institutions on economic growth. In other words, physical and human capital and trade openness are the outcomes of the institutional infrastructure and their inclusion would include some of the growth effects that should ultimately be ascribed to institutions.
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CHAPTER 4 COMPARATIVE STUDIES OF THE
RELATIONSHIP BETWEEN ECONOMIC
GROWTH, PRODUCTIVITY AND INSTITUTIONS
4.1
Introduction
The conceptual framework for this thesis is based upon the relationship amongst the proximate determinants, productivity and institutions as fundamental
determinants of economic growth. The theory surveyed in Chapter 2 has highlighted the origins of endogenous and exogenous economic growth theoretical perspectives of the role of the proximate determinants of economic growth. Both theories suggest that economic growth is driven in part by the impact of technological advancements on the efficient allocation and use of the factors of production. They both agree that skills, knowledge and R&D contribute to the relative efficiency and productivity of labour and capital. This functional relationship occurs within the resource markets. The exogenous neoclassicism theory further posits that investment in capital in the resource market contributes to the relative productivity of labour. One of the
constituent assumptions of the neoclassical economic growth theory, propounded by Solow (1994) is that economies that use similar technology, should have converging rates of productivity. This assumption is predicated on the further assumption that knowledge and technology are independent of capital and labour and are non-rival goods that are free for use by all businesses within an economy.
Chapter 2 has highlighted that there is a lack of consensus on how to quantify productivity. While the endogenous growth theories endogenise
productivity, measured as the level of technological progress, exogenous growth theorists consider that productivity occurs outside the economic system and can be quantified by 𝑇𝑇𝑇𝑇𝑇𝑇 measured as anything that contributes to economic performance that is not otherwise accounted for as capital or labour. It is within the context of this lack of consensus that the extant literature has failed to provide a consistent
measure of productivity. This lack of consensus and consistency on the
quantification of productivity has led to different assumptions on the corresponding importance of productivity for economic growth of economies with different levels of national income.
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Section 4.2 surveys the extant empirical literature that adopts an exogenous approach to decomposing economic growth. For sustained long-run economic growth, there must be a measure of productivity that supports the efficient allocation and deployment of the proximate determinants of economic growth within the resource and product markets. This survey will explore the continued empirical disagreement on how productivity should be measured and disagreement on the relative importance of accumulation of capital and labour versus productivity.
This research will suggest that the neoclassical model of economic growth provides a consistent theoretical grounding for the focus on the proximate
determinants of economic growth. Solow’s inclusion of the residual 𝑇𝑇𝑇𝑇𝑇𝑇 in the simple Cobb-Douglas production function, expands the basic neoclassical model of economic growth to take account of those deeper determinants that can influence the productivity of capital and labour. This has given rise to burgeoning literature that has attempted to quantify those deeper determinants of the productivity of capital and labour.
The theory explored in Chapter 3 tend to agree that there may be an
association between political and economic institutions and economic growth. More recent literature suggests that institutions win out as a more fundamental deep determinant of economic growth. The extant literature has identified that institutions can override the impact of geography, luck or culture and trade openness. In fact, some of the empirical literature would suggest that geography and trade openness have a relation to levels of economic growth, in the presence of appropriate
institutional infrastructure (Easterly & Levine, 2001; Lauridsen, 2012). This
suggestion puts the focus on the critical role that institutions can play in influencing decisions within the resource market and resultant levels of productivity. As resource markets develop, either spontaneously or are deliberately constructed, they require institutional frameworks that protect against the diversion of free trade of goods and services within the resource market, by either predation, high costs of exchange or information asymmetries.
Chapter 3 examined some of the issues in the theoretical definition of institutions. Chapter 3 highlighted that the underlying assumption is that institutions are those endogenous building blocks of social and political exchange within the economy. Institutions as either formal rules or informal norms provide the set of
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rules that constrain, prescribe or sanction trade within the resource and product market. In this context, institutions provide the basis for the efficiency of economic relationships such as contracts, employment relationships, supply of goods or services or the provision of credit. Yet with the consensus on the role of institutions within the economy, there remains a lack of agreement on how they should be categorised.
The remainder of this Chapter 4 is presented as follows. Section 4.2 considers the extant literature that have examined productivity, accumulation of capital and labour as proximate determinants of economic growth. Section 4.3 presents a survey of the empirical literature that explores the association amongst institutions, productivity, accumulation of capital and labour. Section 4.4
summarises the literature surveyed in this Chapter and establishes the conceptual framework within which the empirical work of this study will be conducted.