Lone Wolves, Sleeping Elephants or Predator Hawks? Institutional Shocks and Counterfactual Long-Run Development Paths

Abstract

This paper examines the importance of institutional shocks to long-run development. Our empirical method offers a clear empirical test to distinguish between three models of institutional shocks. We define gradual institutional change without a major shock, institutional change imposed by a major shock, and structural breakdowns. Drawing on several case studies from a sample of 56 countries for the period 1820-2015, we identify a series of institutional shocks and construct a synthetic counterfactual scenario of long-run development in response to a shock. Our evidence suggests that the long-run impact of institutional shocks on growth and development depends on the initial and pre-shock country-level characteristics. Gradual institutional changes help foster long-run development while changes imposed by a shock produce a large but temporary deviation from the long-run growth equilibrium. By contrast, institutional breakdowns produce a permanent change of long-run growth path, and depend on the nature of the shock.

Keywords: long-run growth, institutions, synthetics

JEL Classification: N10, O10, O43, O47, O57