Institutions and Economic Development

A Critical Discussion of the Institution-Centred Orthodoxy in Development Economics

Term Paper, 2008

14 Pages



1. Introduction

2. The Institutional Turn
2.1. Different approaches of explaining growth through institutions
2.1.1. Colonial Heritage
2.1.2. Colonial Heritage Plus
2.1.3. Political Conflict
2.1.4. Beliefs and Norms
2.1.5. International Trade

3. Discussion of the institution centred orthodoxy in development economics
3.1. What is a ‚good property rights system‘?
3.2. How persistent are institutions really?
3.3. Is institutional imitation the road to success?

4. Conclusion


1. Introduction

The main goal of Development Economics is to find the reasons for the rather big differences in levels of income throughout the world. Why, for instance, did European nations after the eighteenth century develop faster than Asian, African or Latin American nations and what can be done to reduce the so caused differences in income and growth?[1] In recent years, many economists used institutions to explain why structural adjustment programs in poor countries have failed so far. Not the programs itself, so the tenor, but the lack of “good institutions” has been blamed for the failure of many developing countries to catch up. In this paper, the current institution centered orthodoxy in development economics will be discussed from a critical point of view. In the first part, different strands of development theory will be reviewed. Secondly, the reasons for the prominence of New Institutional Economics will be analyzed. Finally, it will be discussed, if the institutional approach is holding its promises and if it is useful to focus on the institutional variable to explain economical development.

2. The Institutional Turn

From the mid 1990s on, strong institutions[2] have been viewed as the main building blocks of efficient economies by many scholars. Ha Joon-Chang argues that the focus on institutions in the orthodox literature can be viewed “as an attempt to cope with the continued failures of orthodox policies of market liberalization in the real world.”[3] Underdevelopment of particular countries has been explained by a lack of strong institutions ever since, because institutions play several important roles in the economy.[4] They affect the ideas and actions of groups and individuals and consequently shape preferences that are expressed through public and private decision making processes.[5] “Good Institutions” further promote exchange by lessening transaction costs and strengthening trust on the one hand and exerting pressure on the state to protect property rights and persons on the other hand. If the state is either too weak or too strong, the property and the independence of private actors are threatened. If, for example, contracts cannot be enforced and order cannot be established within a state, the likelihood that investments yield returns would be low. As a consequence, specialization and exchange would be low as well.[6]

“Countries with better ‘institutions’, more secure property rights, and less distortionary policies will invest more in physical and human capital, and will use these factors more efficiently to achieve a greater level of income.”[7]

2.1. Different approaches of explaining growth through institutions

The school which examines the relationship between institutions and growth is referred to as New Institutional Economics. Shirley divides the literature on New Institutional Economics into four categories: Colonial Heritage, Colonial Heritage Plus, Political Conflicts and Norms and Beliefs. Shirley`s categorization is extended here by one more category, which is International Trade. Please note that the categories cannot be viewed as entirely separate from each other, instead they overlap and are intertwined with each other.

2.1.1. Colonial Heritage

Theories in this category are used to demonstrate that institutions that were passed on by certain colonial powers are inefficient. According to Douglass North, colonial powers created exact copies of their own institutions in their colonies. Spanish institutions were blamed for being unsuccessful, because industrialization in Latin America was much slower, state power stronger and markets far less competitive than in the United States and Canada which inherited institutions from England. Yet, the fact that many African, South Asian and Caribbean countries inherited English institutions as well, but did not develop at a fast pace, proves that this theoretical approach is only valid for a limited amount of cases and cannot be applied universally.[8]

2.1.2. Colonial Heritage Plus

Other authors consider additional factors when explaining problems of colonial heritage. Acemoglu et al. for instance argue that the conditions that were found in the colonies had a profound influence on the types of institutions that the European settlers created there. According to their theory, good institutions developed mainly in safe places that were relatively thinly populated and where the land was not very fertile. Where labor was scarce, elites created institutions that guaranteed wider participation in politics and in the economy as well as private property rights. Countries with abundant labor, on the contrary, either developed or adjusted repressive production methods. Political power was concentrated “in the hands of a few who used their power to extract resources from the rest of the population.”[9] With the onset of the industrialization, institutions in previously rich colonies did not possess secure property rights preventing innovation in technological and entrepreneurial areas.[10]

Engermann and Sokoloff also emphasize the role of factor endowments in shaping institutions. In their opinion, institutions arise from the conditions that were present when the colonists arrived.[11] Institutions that ensured elite power and consequently led to an uneven distribution of wealth could be created where conditions, such as soil, climate and population size were favorable for plantation agriculture with slaves.


[1] (Engermann et al., 2005)

[2] Institutions are understood as constraints that are imposed by humans (Author).

[3] (Chang, 2006 p. 1)

[4] ( […] economic history is overwhelmingly a story of economies that failed to produce a set of economic rules of the game (with enforcement) that induce sustained economic growth (North 1991, p. 2).

[5] (Engermann, et al., 2005, p. 644)

[6] (Shirley, 2005, p. 611)

[7] (Acemoglu, et al., 2001, p. 1)

[8] Arguments that legal origins (Frensh civil law vs. English common law) have a direct effect on growth could not be confirmed empirically either.

[9] (Shirley, 2005, p. 619) see also (Sokoloff et al. 2003)

[10] (Shirley, 2005, p. 619)

[11] (Engermann, et al., 2005)

Excerpt out of 14 pages


Institutions and Economic Development
A Critical Discussion of the Institution-Centred Orthodoxy in Development Economics
University of Flensburg  (European Studies)
Seminar: "World Economic Policy"
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ISBN (eBook)
ISBN (Book)
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Institutions, Economic, Development, Critical, Discussion, Institution-Centred, Orthodoxy, Development, Economics
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Marlene Langholz (Author), 2008, Institutions and Economic Development, Munich, GRIN Verlag,


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