Question

(150 words-300)

What is the link between institution and development? Explain practical evidences (considering any case studies you are familiar) that show the direct link between these two?

Answer 1

This talk is about the framework for understanding the role of institutions in economic development. The issue of institutional development has recently come to prominence. In the 1980s, the World Bank and International Monetary Fund (IMF) were criticized for ignoring the economic roles of institutions, politics, and history; all of which were deemed by both organizations to be minor details. Times have changed though, and today even the World Bank and the IMF put great emphasis on institutional reform, to the extent that some people now worry that these organizations are interfering in areas where they do not have a political mandate.

Recently, a substantial amount of literature has been developed on the relationship between institutions and economic development, including relatively abstract theoretical work, historical studies of particular institutions, and econometric studies that attempt to measure the correlation between institutional quality and economic growth rates.

One fundamental difficulty involved in the study of relationships between institutions and economic development is that, after years of debate, there remains no widely accepted definition of "institution."Thus, when the term is used its limitations must be kept in mind. This can make dialogue more difficult because people often mean different things when they use the term "institution."

At a very general level, we may say that there are certain functions that institutions have to serve if they are to promote economic development, and that there are certain forms of institutions that are best designed to carry out these functions. Most institutions, however, serve more than one function, and many institutions have functions that overlap with those of other institutions. What's more, the same function can be served by different institutions in different societies. This means that there is no straightforward way to map institutional functions with institutional forms.

Sometimes institutional forms and functions are confused, as when "governance" indexes mix up variables that capture the differences between the forms of institutions (e.g., the absence of state ownership) and their functions (e.g., respect for private property). As the principal interest in these institutions centers around what they do rather than in their particular forms, especially given the large number and diversity of institutional forms in existence, the correct basic approach is to prefer the function variables over the form variables. Still, the forms cannot be ignored and real life cases need to be examined very closely to identify the various kinds of different combinations that would otherwise never have been imagined.

In the long run, cultures and institutions are not immutable, largely because cultural/institutional changes and economic developments influence one another. Mainstream theories hold that individuals are born with a predetermined preference, so causality always runs from culture and institutions to economic development. This view is too simplistic. Taking a broader view of institutions, they can be seen influencing individuals; so causality does run both ways. Economic development changes people: the Germans and the Japanese, for example, were not always the hardworking, efficient, cooperative and well-organized peoples that they are thought to be today. That a given nation holds to certain values does not mean that the people refuse to, or cannot develop economically. In short, attitudes change when there are changes in material conditions.

Institutional imitation is rarely sufficient, as every country needs to adapt imported institutions and ideally, in the long run, add their own institutional innovations. There is no better example of this process than Japan in the Meiji era (1868-1912): when importing institutions from Europe, the authorities took a pick-and-mix approach based on what model they thought would be best for Japan (e.g., the Japanese modeled their navy on the British one, and their army on the Prussian one). Each of the selected models in this patchwork was adapted; for example, the Japanese initially implemented the American education system, but when it became clear that it was not working as well as had been hoped for, a shift was made to a hybrid of the French and German systems. Modifications such as these were made by the Japanese, who then added their own innovations, like lifetime employment and subcontracting networks