Institutions and Economic Development: New Measurements and Evidence

Abstract

We propose a new set of indices to capture the multidimensionality of a country's institutional quality. Our indices are obtained by employing a dimension reduction approach on the institutional variables provided by the Frazer Institute (2018). We estimate the impact that our measures of institutional quality have on the level and the growth rate of per capita GDP, using a large sample of countries over the period 1980-2015. To identify the causal effect of our measures of institutional quality on a country's GDP dynamics we employ the Generalized Propensity Score method. Institutions matter especially in low and middle-income countries, and not all institutions are alike for economic development. For this group of countries, we find: i) a positive correlation between our main institutional index and the GDP growth and ii) that improvement in the reliability and fairness of the legal system leads to a higher long-run per capita GDP level. We also document non-linearities in the causal effects that different institutions have on growth, and the presence of threshold effects.

Keywords: Economic Development, Institutions, Threshold Effects, Mixture Model, High- income countries, Low- and middle-income countries.

JEL Classification: O43, O47