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Abstract:
Tunnelling is defined as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. We describe the various forms that tunnelling can take, and examine under what circumstances it is legal. We discuss two important legal principles -- the duty of care and the duty of loyalty -- which courts use to analyze cases involving tunnelling. Several important legal cases from France, Belgium, and Italy illustrate how and why the law accommodates tunnelling in civil law countries, and why certain kinds of tunnelling are less likely to pass legal scrutiny in common law countries.

Abstract:
Tunnelling is defined as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. We describe the various forms that tunnelling can take, and examine under what circumstances it is legal. We discuss two important legal principles -- the duty of care and the duty of loyalty -- which courts use to analyze cases involving tunnelling. Several important legal cases from France, Belgium, and Italy illustrate how and why the law accommodates tunnelling in civil law countries, and why certain kinds of tunnelling are less likely to pass legal scrutiny in common law countries.

Abstract:
Tunnelling is defined as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. We describe the various forms that tunnelling can take, and examine under what circumstances it is legal. We discuss two important legal principles - the duty of care and the duty of loyalty - which courts use to analyze cases involving tunnelling. Several important legal cases from France, Belgium, and Italy illustrate how and why the law accommodates tunnelling in civil law countries, and why certain kinds of tunnelling are less likely to pass legal scrutiny in common law countries.

Abstract:
The Coase theorem implies that, in a world of positive transaction costs, any of a number of strategies, including judicially enforced private contracts, judicially enforced laws, or even government regulation, may be the cheapest way to bring about efficient resource allocation. Unfortunately, some Coasians have ignored the possibility that the last of these strategies may sometimes be the best. This paper compares the regulation of financial markets in Poland and the Czech Republic in the 1990s, when the judicial systems remained underdeveloped in both countries. In Poland, strict enforcement of the securities law by an independent Securities and Exchange Commission was associated with rapid development of the stock market. In the Czech Republic, hands-off regulation was associated with a near collapse of the stock market. These episodes illustrate the centrality of law enforcement in making markets work, and the possible role of regulators in law enforcement.

Abstract:
The Coase theorem implies that, in a world of positive transaction costs, any of a number of strategies, including judicially enforced private contracts, judicially enforced laws, or even government regulation, may be the cheapest way to bring about efficient resource allocation. Unfortunately, some Coasians have ignored the possibility that the last of these strategies may sometimes be the best. This paper compares the regulation of financial markets in Poland and the Czech Republic in the 1990s, when the judicial systems remained underdeveloped in both countries. In Poland, strict enforcement of the securities law by an independent Securities and Exchange Commission was associated with rapid development of the stock market. In the Czech Republic, hands-off regulation was associated with a near collapse of the stock market. These episodes illustrate the centrality of law enforcement in making markets work, and the possible role of regulators in law enforcement.

Abstract:
Is investment constrained more by insecure property rights or by limited external finance; For five transition economies in Eastern Europe and the former Soviet Union we find that weak property rights limit the reinvestment of profits in startup manufacturing firms. Access to credit does not appear to explain differences in investment. At least in the early stages of post-communist reform, retained earnings appear to have been enough to finance the investments that managers wanted to make.

Abstract:
In this sample of 49 Latin American, OECD, and transition economies, it is the ineffective and discretionary administration of tax and regulatory regimes--not higher tax rates alone--as well as corruption, that increases the size of the unofficial economy. And countries with a larger unofficial economy tend to grow more slowly.

Johnson, Kaufmann, and Shleifer (1997) found that, in post-communist economies, the unofficial economy's share of GDP is determined by the extent of control rights held by bureaucrats and politicians.

Exploring in detail the role of taxation and bribery, and using data from an expanded data set of 49 Latin American, OECD, and transition economies, Johnson, Kaufmann, and Zoido-Lobaton find that the unofficial economy accounts for a larger share of GDP where there is great bureaucratic inefficiency and discretion, and where firms experience a greater tax and regulatory burden, as well as more bribery and corruption.

The unofficial economy is also much larger where there is less state revenue and where the rule of law is weak. They also find that countries with a larger unofficial economy tend to grow more slowly.

Thus, this framework suggests an additional channel whereby corruption and ineffective regulatory and tax administration can result in lower growth: the unofficial economy.

Wealthy OECD economies and some Eastern European economies find themselves in the "good equilibrium" of relatively low regulatory and tax burden (not necessarily low statutory tax rates), sizable revenue mobilization, good rule of law and control of corruption, and a small unofficial economy.

Several countries in Latin America and the former Soviet Union exhibit characteristics consistent with a "bad equilibrium": the discretionary application of heavy regulatory and tax burdens, the weak rule of law, heavy bribery, and an active unofficial economy.

In this large country sample (unlike in the earlier framework for transition economies only), the authors find that it is the ineffective and discretionary application of regulatory and tax regimes in many countries--not higher tax rates by itself--that increase the size of the unofficial economy.

The tax burden reported by firms appears to be more a function of regulatory and bureaucratic inefficiency and discretion rather than of tax rates alone.

This paper - a product of the Governance, Regulation, and Finance Group, World Bank Institute - is part of a larger effort in the institute to improve our understanding of institutional issues and their effects on development and of building a major new database on institutional indicators.

Abstract:
This article uses the different mortality rates of European colonialists to estimate the effect of institutions on economic performance. Europeans adopted very different colonization policies in different colonies. In places where mortality rates were high they did not settle, but set up extractive institutions that exist to the present day. By exploring the different mortality rates faced by soldiers, bishops and sailors in the colonies in the 17th, 18th and 19th Centuries, we were able to estimate the long-term effect of colonial institutions on per capita income.

European colonization, institutions, economic development, mortality rates, per capita income

Abstract:
We exploit differences in the mortality rates faced by European colonialists to estimate the effect of institutions on economic performance. Our argument is that Europeans adopted very different colonization policies in different colonies, with different associated institutions. The choice of colonization strategy was, at least in part, determined by whether Europeans could settle in the colony. In places where Europeans faced high mortality rates, they could not settle and they were more likely to set up worse (extractive) institutions. These early institutions persisted to the present. We document evidence supporting these hypotheses. Exploiting differences in mortality rates faced by soldiers, bishops and sailors in the colonies in the 17th, 18th, and 19th centuries as an instrument for current institutions, we estimate large effects of institutions on income per capita. Our estimates imply that differences in institutions explain approximately three-quarters of the income per capita differences across former colonies. Once we control for the effect of institutions, we find that countries in Africa or those closer to the equator do not have lower incomes.

Abstract:
We exploit differences in the mortality rates faced by European colonialists to estimate the effect of institutions on economic performance. Our argument is that Europeans adopted very different colonization policies in different colonies, with different associated institutions. The choice of colonization strategy was, at least in part, determined by whether Europeans could settle in the colony. In places where Europeans faced high mortality rates, they could not settle and they were more likely to set up worse (extractive) institutions. These early institutions persisted to the present. We document evidence supporting these hypotheses. Exploiting differences in mortality rates faced by soldiers, bishops and sailors in the colonies in the 17th, 18th and 19th centuries as an instrument for current institutions, we estimate large effects of institutions on income per capita. Our estimates imply that differences in institutions explain approximately three-quarters of the income per capita differences across former colonies. Once we control for the effect of institutions, we find that countries in Africa or those farther away from the equator do not have lower incomes.

Abstract:
Botswana has had the highest rate of per capita growth of any country in the world in the last 35 years. This occurred despite adverse initial conditions, including minimal investment during the colonial period and high inequality. Botswana achieved this rapid development by following orthodox economic policies. How Botswana sustained these policies is a puzzle because typically in Africa, 'good economics' has proved not to be politically feasible. In this Paper we suggest that good policies were chosen in Botswana because good institutions, which we refer to as institutions of private property, were in place. Why did institutions of private property arise in Botswana, but not other African nations? We conjecture that the following factors were important. First, Botswana possessed relatively inclusive pre-colonial institutions, placing constraints on political elites. Second, the effect of British colonialism on Botswana was minimal, and did not destroy these institutions. Third, following independence, maintaining and strengthening institutions of private property were in the economic interests of the elite. Fourth, Botswana is very rich in diamonds, which created enough rents that no group wanted to challenge the status quo at the expense of 'rocking the boat'. Finally, we emphasize that this situation was reinforced by a number of critical decisions made by the post-independence leaders, particularly Presidents Khama and Masire.

Development, institutions, Africa, political economy

Abstract:
Botswana has had the highest rate of per-capita growth of any country in the world in the last 35 years. This occurred despite adverse initial conditions, including minimal investment during the colonial period and high inequality. Botswana achieved this rapid development by following orthodox economic policies. How Botswana sustained these policies is a puzzle because typically in Africa, "good economics" has proved not to be politically feasible. In this paper we suggest that good policies were chosen in Botswana because good institutions, which we refer to as institutions of private property, were in place.

Why did institutions of private property arise in Botswana, but not other African nations? We conjecture that the following factors were important. First Botswana possessed relatively inclusive pre-colonial institutions, placing constraints on political elites. Second the effect of British colonialism on Botswana was minimal, and did not destroy these institutions. Third, following independence, maintaining and strengthening institutions of private property were in the economic interests of the elite. Fourth, Botswana is very rich in diamonds, which created enough rents that no groups wanted to challenge the status quo at the expenses of "rocking the boat." Finally we emphasize that this situation was reinforced by a number of critical decisions made by the post-independence leaders, particularly Presidents Khama, and Masire.

Growth, institutions, property rights, divergence, industrialization, urbanization, population.

Abstract:
This Paper documents that the rise of (Western) Europe between 1500 and 1850 is largely accounted for by the growth of European nations with access to the Atlantic, and especially by those nations that engaged in colonialism and long distance oceanic trade. Moreover, Atlantic ports grew much faster than other West European cities, including Mediterranean ports. Atlantic trade and colonialism affected Europe both directly and indirectly by inducing institutional changes. In particular, the growth of New World, African and Asian trade after 1500 strengthened new segments of the commercial bourgeoisie and enabled these groups to demand, obtain and sustain changes in institutions to protect their property rights. Furthermore, the most significant institutional changes, and consequently the most substantial economic gains, occurred in nations where existing institutions placed some checks on the monarchy and particularly limited its control of overseas trading activities, thus enabling new merchants in these countries to benefit from Atlantic trade. Therefore, the Rise of Europe was largely the result of capitalist development driven by the interaction of late medieval institutions and the economic opportunities offered by 'Atlantic trade.'

Capitalism, institutions, social conflict, economic growth, political economy, trade

Abstract:
This paper documents that the Rise of (Western) Europe between 1500 and 1850 is largely accounted for by the growth of European nations with access to the Atlantic, and especially by those nations that engaged in colonialism and long distance oceanic trade. Moreover, Atlantic ports grew much faster than other West European cities, including Mediterranean ports. Atlantic trade and colonialism affected Europe both directly, and indirectly by inducing institutional changes. In particular, the growth of New World, African, and Asian trade after 1500 strengthened new segments of the commercial bourgeoisie, and enabled these groups to demand, obtain, and sustain changes in institutions to protect their property rights. Furthermore, the most significant institutional changes and consequently the most substantial economic gains occurred in nations where existing institutions placed some checks on the monarchy and particularly limited its control of overseas trading activities, thus enabling new merchants in these countries to benefit from Atlantic trade. Therefore, the Rise of Europe was largely the result of capitalist development driven by the interaction of late medieval institutions and the economic opportunities offered by 'Atlantic trade.'

Abstract:
This paper documents that the Rise of (Western) Europe between 1500 and 1850 is largely accounted for by the growth of European nations with access to the Atlantic, and especially by those nations that engaged in colonialism and long distance oceanic trade. Moreover, Atlantic ports grew much faster than other West European cities, including Mediterranean ports.

Atlantic trade and colonialism affected Europe both directly, and indirectly by inducing institutional changes. In particular, the growth of New World, African, and Asian trade after 1500 strengthened new segments of the commercial bourgeoisie, and enabled these groups to demand, obtain, and sustain changes in institutions to protect their property rights.

Furthermore, the most significant institutional changes and consequently the most substantial economic gains occurred in nations where existing institutions placed some checks on the monarchy and particularly limited its control of overseas trading activities, thus enabling new merchants in these countries to benefit from Atlantic trade. Therefore, the Rise of Europe was largely the result of capitalist development driven by the interaction of late medieval institutions and the economic opportunities offered by "Atlantic trade."

Capitalism, Economic Growth, Institutions, Political Economy, Social Conflict, Trade

Abstract:
This paper evaluates the importance of "property rights institutions," which protect citizens against expropriation by the government and powerful elites, and "contracting institutions," which enable private contracts between citizens. We exploit exogenous variation in both types of institutions driven by colonial history and document strong first-stage relationships between property rights institutions and the determinants of European colonization strategy (settler mortality and population density before colonization) and between contracting institutions and the identity of the colonizing power. Using this instrumental variables approach, we find that property rights institutions have a first-order effect on long-run economic growth, investment, and financial development. Contracting institutions appear to matter only for the form of financial intermediation. A possible explanation for this pattern is that individuals often find ways of altering the terms of their formal and informal contracts to avoid the adverse effects of weak contracting institutions but find it harder to mitigate the risk of expropriation in this way.

Abstract:
This paper evaluates the importance of "property rights institutions," which protect citizens against expropriation by the government and powerful elites, and "contracting institutions," which enable private contracts between citizens. We exploit exogenous variation in both types of institutions driven by colonial history, and document strong first-stage relationships between property rights institutions and the determinants of European colonization strategy (settler mortality and population density before colonization), and between contracting institutions and the identity of the colonizing power. Using this instrumental variables approach, we find that property rights institutions have a first-order effect on long-run economic growth, investment, and financial development. Contracting institutions appear to matter only for the form of financial intermediation. A possible explanation for this pattern is that individuals often find ways of altering the terms of their formal and informal contracts to avoid the adverse effects of contracting institutions, but are unable to do so against the risk of expropriation.

Contracts, Economic Growth, Financial Development, Institutions, Law and Finance, Legal Formalism, Legal Origin, Political Economy, Politics, Property Rights

Abstract:
This paper evaluates the importance of 'property rights institutions', which protect citizens against expropriation by the government and powerful elites, and 'contracting institutions', which enable private contracts between citizens. We exploit exogenous variation in both types of institutions driven by colonial history, and document strong first-stage relationships between property rights institutions and the determinants of European colonization (settler mortality and population density before colonization), and between contracting institutions and the identity of the colonizing power. Using this instrumental variables strategy, we find that property rights institutions have a first-order effect on long-run economic growth, investment, and financial development. Contracting institutions appear to matter only for the form of financial intermediation. A possible interpretation for this pattern is that individuals often find ways of altering the terms of their formal and informal contracts to avoid the adverse effects of contracting institutions but are unable to do so against the risk of expropriation.

Abstract:
Across 69 countries, higher tax rates are associated with less unofficial activity as a percent of GDP but corruption is associated with more unofficial activity. Entrepreneurs go underground not to avoid official taxes but to reduce the burden of bureaucracy and corruption. Dodging the Grabbing Hand in this way reduces tax revenues as a percent of both official and total GDP. As a result, corrupt governments become small governments and only relatively uncorrupt governments can sustain high tax rates.

Abstract:
Across 69 countries, higher tax rates are associated with less unofficial activity as a percent of GDP but corruption is associated with more unofficial activity. Entrepreneurs go underground not to avoid official taxes but to reduce the burden of bureaucracy and corruption. Dodging the Grabbing Hand in this way reduces tax revenues as a percent of both official and total GDP. As a result, corrupt governments become small governments and only relatively uncorrupt governments can sustain high tax rates.

Abstract:
The initial impact of the Asian financial crisis in Malaysia reduced the expected value of government subsidies to politically favored firms. Of the estimated $60 billion loss in market value for politically connected firms from July 1997 to August 1998, roughly 9% can be attributed to the fall in the value of their connections. Firing the Deputy Prime Minister and imposing capital controls in September 1998 primarily benefited firms with strong ties to Prime Minister Mahathir. Of the estimated $5 billion gain in market value for Mahathir-connected firms during September 1998, approximately 32% was due to the increase in the value of their connections. The evidence suggests Malaysian capital controls provided a screen behind which favored firms could be supported.

Abstract:
A large fraction of business groups around the world are run by families. In this paper, we analyze how the structure of the families behind these business groups affects the groups' organization, governance and performance. To address this question, we constructed a unique data set of the family trees and the business groups they run for 70 of the largest business families in Thailand. We show that the group head and his brothers hold the majority of family positions within each group. However, we also find a positive relationship between family size and involvement of family members in the business group, especially when the ultimate control has passed from the founder to one of his descendants. Interestingly, groups that are run by larger families (more male siblings of the group head) tend to have lower performance. This negative performance effect coincides with a larger number of small firms in these group, more fragmented internal capital markets and possibly more tunneling along the pyramidal structure of the groups. These performance and within-group resource allocation effects are again especially pronounced in groups where the founder is no longer active and ultimate control has been passed to one of his descendant. One hypothesis that emerges from our analysis is that part of the decay of family-run groups over time may be due to in-fighting for group resources as control becomes more diluted among different family members.

Abstract:
Among countries colonized by European powers during the past 500 years those that were relatively rich in 1500 are now relatively poor. We document this reversal using data on urbanization patterns and population density, which, we argue, proxy for economic prosperity. This reversal is inconsistent with a view that links economic development to geographic factors. According to the geography view, societies that were relatively rich in 1500 should also be relatively rich today. In contrast, the reversal is consistent with the role of institutions in economic development. The expansion of European overseas empires starting in the 15th century led to a major change in the institutions of the societies they colonized. In fact, the European intervention appears to have created an "institutional reversal" among these societies, in the sense that Europeans were more likely to introduce institutions encouraging investment in regions that were previously poor. This institutional reversal accounts for the reversal in relative incomes. We provide further support for this view by documenting that the reversal in relative incomes took place during the 19th century, and resulted from societies with good institutions taking advantage of industrialization opportunities.

geography, institutions, property rights, divergence, industrialization, urbanization, population.

Abstract:
Among countries colonized by European powers during the past 500 years those that were relatively rich in 1500 are now relatively poor. We document this reversal using data on urbanization patterns and population density, which, we argue, proxy for economic prosperity. This reversal is inconsistent with a view that links economic development to geographic factors. According to the geography view, societies that were relatively rich in 1500 should also be relatively rich today. In contrast, the reversal is consistent with the role of institutions in economic development. The expansion of European overseas empires starting in the 15th century led to a major change in the institutions of the societies they colonized. In fact, the European intervention appears to have created an 'institutional reversal' among these societies, in the sense that Europeans were more likely to introduce institutions encouraging investment in regions that were previously poor. This institutional reversal accounts for the reversal in relative incomes. We provide further support for this view by documenting that the reversal in relative incomes took place during the 19th century, and resulted from societies with good institutions taking advantage of industrialization opportunities.

Abstract:
We revisit one of the central empirical findings of the political economy literature that higher income per capita causes democracy. Existing studies establish a strong cross-country correlation between income and democracy, but do not typically control for factors that simultaneously affect both variables. We show that controlling for such factors by including country fixed effects removes the statistical association between income per capita and various measures of democracy. We also present instrumental-variables estimates using two different strategies. These estimates also show no causal effect of income on democracy. Furthermore, we reconcile the positive cross-country correlation between income and democracy with the absence of a causal effect of income on democracy by showing that the long-run evolution of income and democracy is related to historical factors. Consistent with this, the positive correlation between income and democracy disappears, even without fixed effects, when we control for the historical determinants of economic and political development in a sample of former European colonies.

democracy, economic growth, institutions, political development

Abstract:
Which is the tighter constraint on private sector investment: weak property rights or limited access to external finance? From a survey of new firms in post-communist countries, we find that weak property rights discourage firms from reinvesting their profits, even when bank loans are available. Where property rights are relatively strong, firms reinvest their profits; where they are relatively weak, entrepreneurs do not want to invest from retained earnings.

Abstract:
Which is the tighter constraint on private sector investment: weak property rights or limited access to external finance? From a survey of new firms in post-communist countries, we find that weak property rights discourage firms from reinvesting their profits, even when bank loans are available. Where property rights are relatively strong, firms reinvest their profits; where they are relatively weak, entrepreneurs do not want to invest from retained earnings.

Abstract:
Post-communist countries offer new evidence on the relative importance of courts and relationships in enforcing contracts. Belief in the effectiveness of courts has a significant positive effect on the level of trust shown in new relationships between firms and their customers. Well-functioning courts also encourage entrepreneurs to try out new suppliers. Courts are particularly important when specific investments are needed for a relationship to develop. While relationships can sustain existing interactions, workable courts help new interactions to start and develop.

Abstract:
Post-communist countries offer new evidence on the relative importance of courts and relationships in enforcing contracts. Belief in the effectiveness of courts has a significant positive effect on the level of trust shown in new relationships between firms and their customers. Well-functioning courts also encourage entrepreneurs to try out new suppliers. Courts are particularly important when specific investments are needed for a relationship to develop. While relationships can sustain existing interactions, workable courts help new interactions to start and develop.

Abstract:
Post-communist countries offer new evidence on the relative importance of courts and relationships in enforcing contracts. Belief in the effectiveness of courts has a significant positive effect on the level of trust shown in new relationships between firms and their customers. Well-functioning courts also encourage entrepreneurs to try out new suppliers. Courts are particularly important when specific investments are needed for a relationship to develop. While relationships can sustain existing interactions, workable courts help new interactions to start and develop.

Abstract:
The conventional wisdom views high levels of education as a prerequisite for democracy. This paper shows that existing evidence for this view is based on cross-sectional correlations, which disappear once we look at within-country variation. In other words, there is no evidence that countries that increase their education are more likely to become democratic.

Abstract:
The conventional wisdom views high levels of education as a prerequisite for democracy. This paper shows that existing evidence for this view is based on cross-sectional correlations, which disappear once we look at within-country variation. In other words, there is no evidence that countries that increase their education are more likely to become democratic.

democracy, education, institutions, political development

Abstract:
The French Revolution of 1789 had a momentous impact on neighboring countries. The French Revolutionary armies during the 1790s and later under Napoleon invaded and controlled large parts of Europe. Together with invasion came various radical institutional changes. French invasion removed the legal and economic barriers that had protected the nobility, clergy, guilds, and urban oligarchies and established the principle of equality before the law. The evidence suggests that areas that were occupied by the French and that underwent radical institutional reform experienced more rapid urbanization and economic growth, especially after 1850. There is no evidence of a negative effect of French invasion. Our interpretation is that the Revolution destroyed (the institutional underpinnings of) the power of oligarchies and elites opposed to economic change; combined with the arrival of new economic and industrial opportunities in the second half of the 19th century, this helped pave the way for future economic growth. The evidence does not provide any support for several other views, most notably, that evolved institutions are inherently superior to those 'designed'; that institutions must be 'appropriate' and cannot be 'transplanted'; and that the civil code and other French institutions have adverse economic effects.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
The French Revolution of 1789 had a momentous impact on neighboring countries. The French Revolutionary armies during the 1790s and later under Napoleon invaded and controlled large parts of Europe. Together with invasion came various radical institutional changes. French invasion removed the legal and economic barriers that had protected the nobility, clergy, guilds, and urban oligarchies and established the principle of equality before the law. The evidence suggests that areas that were occupied by the French and that underwent radical institutional reform experienced more rapid urbanization and economic growth, especially after 1850. There is no evidence of a negative effect of French invasion. Our interpretation is that the Revolution destroyed (the institutional underpinnings of) the power of oligarchies and elites opposed to economic change; combined with the arrival of new economic and industrial opportunities in the second half of the 19th century, this helped pave the way for future economic growth. The evidence does not provide any support for several other views, most notably, that evolved institutions are inherently superior to those 'designed'; that institutions must be 'appropriate' and cannot be 'transplanted'; and that the civil code and other French institutions have adverse economic effects.

civil code, democracy, guilds, institutions, oligarchy, political economy

Abstract:
The French Revolution of 1789 had a momentous impact on neighboring countries. The French Revolutionary armies during the 1790s and later under Napoleon invaded and controlled large parts of Europe. Together with invasion came various radical institutional changes. French invasion removed the legal and economic barriers that had protected the nobility, clergy, guilds, and urban oligarchies and established the principle of equality before the law. The evidence suggests that areas that were occupied by the French and that underwent radical institutional reform experienced more rapid urbanization and economic growth, especially after 1850. There is no evidence of a negative effect of French invasion. Our interpretation is that the Revolution destroyed (the institutional underpinnings of) the power of oligarchies and elites opposed to economic change; combined with the arrival of new economic and industrial opportunities in the second half of the 19th century, this helped pave the way for future economic growth. The evidence does not provide any support for several other views, most notably, that evolved institutions are inherently superior to those 'designed'; that institutions must be 'appropriate' and cannot be 'transplanted'; and that the civil code and other French institutions have adverse economic effects.

institutions, civil code, guilds, democracy, oligarchy, political economy

Abstract:
This paper revisits and critically re-evaluates the widely-accepted modernization hypothesis which claims that per capita income causes the creation and the consolidation of democracy. We argue that existing studies find support for this hypothesis because they fail to control for the presence of omitted variables. There are many underlying historical factors that affect both the level of income per capita and the likelihood of democracy in a country, and failing to control for these factors may introduce a spurious relationship between income and democracy. We show that controlling for these historical factors by including fixed country effects removes the correlation between income and democracy, as well as the correlation between income and the likelihood of transitions to and from democratic regimes. We argue that this evidence is consistent with another well-established approach in political science, which emphasizes how events during critical historical junctures can lead to divergent political-economic development paths, some leading to prosperity and democracy, others to relative poverty and non-democracy. We present evidence in favor of this interpretation by documenting that the fixed effects we estimate in the post-war sample are strongly associated with historical variables that have previously been used to explain diverging development paths within the former colonial world.

democracy, economic growth, institutions, political development

Abstract:
This paper revisits and critically reevaluates the widely-accepted modernization hypothesis which claims that per capita income causes the creation and the consolidation of democracy. We argue that existing studies and support for this hypothesis because they fail to control for the presence of omitted variables. There are many underlying historical factors that affect both the level of income per capita and the likelihood of democracy in a country, and failing to control for these factors may introduce a spurious relationship between income and democracy. We show that controlling for these historical factors by including fixed country effects removes the correlation between income and democracy, as well as the correlation between income and the likelihood of transitions to and from democratic regimes. We argue that this evidence is consistent with another well-established approach in political science, which emphasizes how events during critical historical junctures can lead to divergent political-economic development paths, some leading to prosperity and democracy, others to relative poverty and non-democracy. We present evidence in favor of this interpretation by documenting that the fixed effects we estimate in the post-war sample are strongly associated with historical variables that have previously been used to explain diverging development paths within the former colonial world.

democracy, economic growth, institutions, political development

Abstract:
This paper revisits and critically reevaluates the widely-accepted modernization hypothesis which claims that per capita income causes the creation and the consolidation of democracy. We argue that existing studies find support for this hypothesis because they fail to control for the presence of omitted variables. There are many underlying historical factors that affect both the level of income per capita and the likelihood of democracy in a country, and failing to control for these factors may introduce a spurious relationship between income and democracy. We show that controlling for these historical factors by including fixed country effects removes the correlation between income and democracy, as well as the correlation between income and the likelihood of transitions to and from democratic regimes. We argue that this evidence is consistent with another well-established approach in political science, which emphasizes how events during critical historical junctures can lead to divergent political-economic development paths, some leading to prosperity and democracy, others to relative poverty and non-democracy. We present evidence in favor of this interpretation by documenting that the fixed effects we estimate in the post-war sample are strongly associated with historical variables that have previously been used to explain diverging development paths within the former colonial world.

Abstract:
Using a unique dataset of publicly placed corporate bonds in Korea, this paper assesses a bond market's ability to provide financing during a severe bank crisis. Evidence from Korea after the 1997-98 crisis confirms that bond markets can develop quickly in bank-dominated economies. However, access was feasible only for the largest firms and, as with bank loans before the crisis, bonds were not allocated well. Large firms with weaker pre-crisis corporate governance were no less likely to obtain bond financing, and default risk was not priced by investors. This evidence suggests that while bond markets can develop quickly in a crisis-hit, bank-dominated economy, they may fail to allocate resources well in the absence of reliable credit rating agencies and when 'too large to fail' beliefs persist among investors. In terms of access to capital during the crisis, the largest firms did best and the financial playing field tilted further in their direction.

Financial Development, Institutions, Economic Crisis

Abstract:
A dozen countries had weak institutions in 1960 and yet sustained high rates of growth subsequently. We use data on their characteristics early in the growth process to create benchmarks with which to evaluate potential constraints on sustained growth for sub-Saharan Africa. This analysis suggests that what are usually regarded as first-order problems - broad institutions, macroeconomic stability, trade openness, education, and inequality - may not now be binding constraints in Africa, although the extent of ill-health, internal conflict, and societal fractionalization do stand out as problems in contemporary Africa. A key question is to what extent Africa can rely on manufactured exports as a mode of escape from underdevelopment, a strategy successfully deployed by almost all the benchmark countries. The benchmarking comparison specifically raises two key concerns as far as a development strategy based on expanding exports of manufactures is concerned: micro-level institutions that affect the costs of exporting, and the level of the real exchange rate - especially the need to avoid overvaluation.

Economic growth, Africa, Trade liberalization, Imports, Exports

Abstract:
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.

Abstract:
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.

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Abstract:
Is investment constrained more by insecure property rights or by limited external finance? For five transition economies in Eastern Europe and the former Soviet Union we find that weak property rights limit the reinvestment of profits in startup manufacturing firms. Access to credit does not appear to explain differences in investment. At least in the early stages of post-communist reform, retained earnings appear to have been enough to finance the investments that managers wanted to make.

Abstract:
Johnson, Kaufmann, and Shleifer (1997) find that the share of the unofficial economy in GDP is determined by the extent of control rights held by politicians and bureaucrats in post-communist economies. Exploring in more detail the role of bribes and using a broader data set from the OECD, Latin America, and transition economies, we find that the unofficial economy accounts for a larger share of GDP when there is more corruption and when the rule of law is weaker. While these findings are consistent with the earlier results for transition economies, in the larger country sample we find it is not necessarily the case that more regulation or higher taxes directly increases the size of the unofficial economy. The problem appears to be not regulation or taxation per se, but whether the state administrative system can operate without corruption. A high level of regulatory discretion helps create the potential for corruption and drive firms into the unofficial economy.

Abstract:
The economies of Eastern Europe and the former Soviet Union (FSU) escaped communism with a heavy burden. Despite the collapse of central planning, these economies continued to suffer from heavy political control of economic activity, reflected in massive subsidization of state firms, heavy regulation of entry and operations of private firms, as well as punitive taxation by the government and - separately - by its agents (corruption). Such politicization of the economy had to be reduced significantly for small business formation and growth to begin. In recent years, some countries have succeeded in depoliticizing their economies much better than others. As this paper shows, these are the countries that also had the best growth records.

Abstract:
We revisit one of the central empirical findings of the political economy literature that higher income per capita causes democracy. Existing studies establish a strong cross-country correlation between income and democracy, but do not typically control for factors that simultaneously affect both variables. We show that controlling for such factors by including country fixed effects removes the statistical association between income per capita and various measures of democracy. We also present instrumental-variables estimates using two different strategies. These estimates also show no causal effect of income on democracy. Furthermore, we reconcile the positive cross-country correlation between income and democracy with the absence of a causal effect of income on democracy by showing that the long-run evolution of income and democracy is related to historical factors. Consistent with this, the positive correlation between income and democracy disappears, even without fixed effects, when we control for the historical determinants of economic and political development in a sample of former European colonies.

Democracy, economic growth, institutions, political development

Abstract:
We revisit one of the central empirical findings of the political economy literature that higher income per capita causes democracy. Existing studies establish a strong cross-country correlation between income and democracy, but do not typically control for factors that simultaneously affect both variables. We show that controlling for such factors by including country fixed effects removes the statistical association between income per capita and various measures of democracy. We also present instrumental-variables using two different strategies. These estimates also show no causal effect of income on democracy. Furthermore, we reconcile the positive cross-country correlation between income and democracy with the absence of a causal effect of income on democracy by showing that the long-run evolution of income and democracy is related to historical factors. Consistent with this, the positive correlation between income and democracy disappears, even without fixed effects, when we control for the historical determinants of economic and political development in a sample of former European colonies.

Abstract:
Countries that have pursued distortionary macroeconomic policies, including high inflation, large budget deficits and misaligned exchange rates, appear to have suffered more macroeconomic volatility and also grown more slowly during the postwar period. Does this reflect the causal effect of these macroeconomic policies on economic outcomes? One reason to suspect that the answer may be no is that countries pursuing poor macroeconomic policies also have weak 'institutions', including political institutions that do not constrain politicians and political elites, ineffective enforcement of property rights for investors, widespread corruption, and a high degree of political instability. This Paper documents that countries that inherited more 'extractive' institutions from their colonial past were more likely to experience high volatility and economic crises during the postwar period. More specifically, societies where European colonists faced high mortality rates more than 100 years ago are much more volatile and prone to crises. Based on our previous work, we interpret this relationship as due to the causal effect of institutions on economic outcomes: Europeans did not settle and were more likely to set up extractive institutions in areas where they faced high mortality. Once we control for the effect of institutions, macroeconomic policies appear to have only a minor impact on volatility and crises. This suggests that distortionary macroeconomic policies are more likely to be symptoms of underlying institutional problems rather than the main causes of economic volatility, and also that the effects of institutional differences on volatility do not appear to be primarily mediated by any of the standard macroeconomic variables. Instead, it appears that weak institutions cause volatility through a number of microeconomic, as well as macroeconomic, channels.

Exchange rates, crises, economic growth, economic instability, inflation, institutions, macroeconomic policies, volatility, the Washington consensus, government spending

Abstract:
Countries that have pursued distortionary macroeconomic policies, including high inflation, large budget deficits and misaligned exchange rates, appear to have suffered more macroeconomic volatility and also grown more slowly during the postwar period. Does this reflect the causal effect of these macroeconomic policies on economic outcomes? One reason to suspect that the answer may be no is that countries pursuing poor macroeconomic policies also have weak 'institutions', including political institutions that do not constrain politicians and political elites, ineffective enforcement of property rights for investors, widespread corruption, and a high degree of political instability. This paper documents that countries that inherited more likely to experience high volatility and economic crises during the postwar period. More specifically, societies where European colonists faced high mortality rates more than 100 years ago are much more volatile and prone to crises. Based on our previous work, we interpret this relationship as due to the causal effect of institutions on economic outcomes: Europeans did not settle and were more likely to set up extractive institutions in areas where they faced high mortality. Once we control for the effect of institutions, macroeconomic policies appear to have only a minor impact on volatility and crises. This suggests that distortionary macroeconomic policies are more likely to be symptoms of underlying institutional problems rather than the main causes of economic volatility, and also that the effects of institutional differences on volatility do not appear to be primarily mediated by any of the standard macroeconomic variables. Instead, it appears that weak institutions cause volatility through a number of microeconomic, as well as macroeconomic, channels.

Abstract:
In countries with weak legal systems, there is a great deal of tunnelling by the entrepreneurs who control publicly traded firms. However, under some conditions entrepreneurs prop up their firms, i.e., they use their private funds to benefit minority shareholders. We provide evidence and a model that explains propping. In particular, we suggest that issuing debt can credibly commit an entrepreneur to propping, even though creditors can never take possession of any underlying collateral. This helps to explain why emerging markets with weak institutions sometimes grow rapidly and why they are also subject to frequent economic and financial crises.

Abstract:
We study the determinants of vertical integration in a new dataset of over 750,000 firms from 93 countries. Existing evidence suggests the presence of large cross-country differences in the organization of firms, which may be related to differences in financial development, contracting costs or regulation. We find cross-country correlations between vertical integration on the one hand and financial development, contracting costs, and entry barriers on the other that are consistent with these "priors". Nevertheless, we also show that these correlations are almost entirely driven by industrial composition; countries with more limited financial development, higher contracting costs or greater entry barriers are concentrated in industries with a high propensity for vertical integration. Once we control for differences in industrial composition, none of these factors are correlated with average vertical integration. However, we also find a relatively robust differential effect of financial development across industries; countries with less-developed financial markets are significantly more integrated in industries that are more human capital or technology intensive.

Abstract:
Inter-household transfers in Russia, Ukraine, and Latvia to provide an important supplement to individual incomes. These transfers are as high as in many developing countries. Transfers are from richer to poorer, from older to younger, and to femaleheaded households. We find no evidence that Russia has lower transfers than Ukraine, which has had relatively little reform. The high level of inter-household transfers may help explain why there has been so little social protest in Russia despite the large fall in measured real wages.

Abstract:
Using a unique dataset of publicly placed corporate bonds in Korea, this paper assesses a bond market's ability to provide financing during a severe bank crisis. Evidence from Korea after the 1997-98 crisis confirms that bond markets can develop quickly in bank-dominated economies. However, access was feasible only for the largest firms and, as with bank loans before the crisis, bonds were not allocated well. Large firms with weaker pre-crisis corporate governance were no less likely to obtain bond financing, and default risk was not priced by investors. This evidence suggests that while bond markets can develop quickly in a crisis-hit, bank-dominated economy, they may fail to allocate resources well in the absence of reliable credit rating agencies and when 'too large to fail' beliefs persist among investors. In terms of access to capital during the crisis, the largest firms did best and the financial playing field tilted further in their direction.

Financial Development, Institutions, Political Economy, Economic Crisis

Abstract:
What is the effect of increasing life expectancy on economic growth? To answer this question, we exploit the international epidemiological transition, the wave of international health innovations and improvements that began in the 1940s. We obtain estimates of mortality by disease before the 1940s from the League of Nations and national public health sources. Using these data, we construct an instrument for changes in life expectancy, referred to as predicted mortality, which is based on the pre-intervention distribution of mortality from various diseases around the world and dates of global interventions. We document that predicted mortality has a large and robust effect on changes in life expectancy starting in 1940, but no effect on changes in life expectancy before the interventions. The instrumented changes in life expectancy have a large effect on population; a 1% increase in life expectancy leads to an increase in population of about 1.5%. Life expectancy has a much smaller effect on total GDP both initially and over a 40-year horizon, however. Consequently, there is no evidence that the large exogenous increase in life expectancy led to a significant increase in per capita economic growth. These results confirm that global efforts to combat poor health conditions in less developed countries can be highly effective, but also shed doubt on claims that unfavorable health conditions are the root cause of the poverty of some nations.

Abstract:
The initial impact of the Asian financial crisis in Malaysia reduced the expected value of government subsidies to politically favored firms. Of the estimated $60 billion loss in market value for politically connected firms from July 1997 to August 1998, roughly 9% can be attributed to the fall in the value of their connections. Firing the Deputy Prime Minister and imposing capital controls in September 1998 primarily benefited firms with strong ties to Prime Minister Mahathir. Of the estimated $5 billion gain in market value for Mahathir-connected firms during September 1998, approximately 32% was due to the increase in the value of their connections. The evidence suggests Malaysian capital controls provided a screen behind which favored firms could be supported.

Abstract:
The mix of formal and informal mechanisms for contract enforcement is examined using survey data from Russia, Ukraine, Romania, Poland, and Slovakia. Using the size of trade credit to quantify the success of contracting, we ask: Do the courts have a perceptible effect on contracting; When can a firm rely on its customer to repay trade credit voluntarily; Which is more effective, the courts or relational contracting; Do trade associations play a role in contract enforcement; Does relational contracting entail inefficiencies; Is the reliance on relation contracting merely a transitory phenomenon, reflecting the inadequacy of these countries; legal systems?

Abstract:
This paper sheds light on two problems in the Penn World Table (PWT) GDP estimates. First, we show that these estimates vary substantially across different versions of the PWT despite being derived from very similar underlying data and using almost identical methodologies; that this variability is systematic; and that it is intrinsic to the methodology deployed by the PWT to estimate growth rates. Moreover, this variability matters for the cross-country growth literature. While growth studies that use low frequency data remain robust to data revisions, studies that use annual data are less robust. Second, the PWT methodology leads to GDP estimates that are not valued at purchasing power parity (PPP) prices. This is surprising because the raison d'être of the PWT is to adjust national estimates of GDP by valuing output at common international (purchasing power parity [PPP]) prices so that the resulting PPP-adjusted estimates of GDP are comparable across countries. We propose an approach to address these two problems of variability and valuation.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
In this paper we revisit the central finding in Comparative politics that the greater the per-capita income of a country, the more likely it is to be democratic. We argue that the existing empirical literature fails to treat seriously the fact that income and democracy are jointly determined in a political-economic equilibrium. Based on our previous research we argue that whether or not a country is democratic and whether or not it is prosperous depends on its underlying institutions. We first show that once you control for country-specific variation in institutions using fixed effects income per-capita never plays a role in determining democracy. This finding is robust to different estimation techniques, covariates, and sample. We then try to directly control for institutions by using historical data from former European colonies. This restriction is motivated by the fact that we have exogenous sources of institutional variation for this sub-set of countries. We show that when we use these variables to control for the historical creation of institutions (age of country, population density in 1500, and a measure of institutions at the date of independence) they have statistically indistinguishable effects rom the results with fixed effect. The main conclusion is that we find no evidence that income causes democracy. Rather, different countries move onto different development paths as the results of critical junctures and historical circumstances (such as European colonialism). Different paths are supported by different sets of institutions and the nexus of institutions that promotes prosperity simultaneously tends to lead to democracy.

Abstract:
We use survey data to examine new firms in Poland, Slovakia, Romania, Russia and Ukraine. By measures of job growth, security of property, and market development, our countries fall into two groups: an advanced group including Poland, Romania and Slovakia, with Slovakia falling somewhat behind the other two; and a backward group of Russia and Ukraine. Macroeconomic stability is not sufficient for private-sector growth. A lack of bank finance does not seem to prevent private-sector growth. More inhibiting than inadequate finance are insecure property rights.

Abstract:
The "Asian Crisis" of 1997-98 affected all the "emerging markets" open to capital flows. Measures of corporate governance, particularly the effectiveness of protection for minority shareholders, explain the extent of exchange rate depreciation and stock market decline better than do standard macroeconomic measures. A possible explanation is that in countries with weak corporate governance, worse economic prospects result in more expropriation by managers and thus a larger fall in asset prices.

Corporate governance; Investor protection; Financial crisis

Abstract:
Our survey of private manufacturing firms finds the size of hidden 'unofficial' activity to be much larger in Russia and Ukraine than in Poland, Slovakia and Romania. A comparison of cross-country averages shows that managers in Russia and Ukraine face higher effective tax rates, worse bureaucratic corruption, greater incidence of mafia protection, and have less faith in the court system. Our firm-level regressions for the three Eastern European countries find that bureaucratic corruption is significantly associated with hiding output.

Corruption, taxation, legal system, unofficial economy

Abstract:
Our survey of private manufacturing firms finds the size of hidden "unofficial" activity to be much larger in Russia and Ukraine than in Poland, Slovakia and Romania. A comparison of cross-country averages shows that managers in Russia and Ukraine face higher effective tax rates, worse bureaucratic corruption, greater incidence of mafia protection, and have less faith in the court system. Our firm-level regressions for the three Eastern European countries find that bureaucratic corruption is significantly associated with hiding output.

Abstract:
The "Asian Crisis" of 1997-98 has affected almost all the "emerging markets" open to capital flows. Measures of corporate governance, particularly the effectiveness of protection for minority shareholders, explain the extent of stock market decline better than do standard macroeconomic measures. The explanation is that in countries with weak corporate governance, worse economic prospects result in more stealing by managers and thus a larger fall in asset prices.

Abstract:
We model policy reform as a way to affect the stochastic process of relative returns that firms face when switching from old to new activities. This stochastic process has an Ito process component that is noncontrollable and policy reforms result in jumps in relative returns that arrive according to a Poisson process. The intensity of policy reform depends on the arrival rate and magnitude of jumps. We use a single firm model to understand the reaction of the firm to such a stochastic process and the usual hysteresis results in switching between old and new activities. Aggregation to the level of all firms leads to an appropriate definition of the government payoff function, and we use this to obtain the optimal level of reform. The results are as follows: there exists and optimal level of radical reform that overcomes the hysteresis behavior of firms; if such a level is not desirable, then the intensity of policy reform is not an extreme point; and this gradual level of optimal reform is lower if uncertainty is higher.