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Critique of the "Institutions Cause Economic Development" View

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What explains the economic prosperity of nations? This seemingly simple question has been asked since ancient times. Rulers in the major capitals across the ancient world sought the advices of sages on ways to strengthen their power and legitimacy through actions that would bring prosperity to their lands. At the core of many of the advices rendered were rules relating to how societies should be ordered

These may be loosely translated to mean “institutions”.

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Of primary importance to economic outcomes are the economic institutions in soci-ety such as the structure of property rights and the presence and perfection of markets.Economic institutions are important because they influence the structure of economicincentives in society. Without property rights, individuals will not have the incentive toinvest in physical or human capital or adopt more efficient technologies

Economic insti-tutions are also important because they help to allocate resources to their most efficientuses, they determine who gets profits, revenues and residual rights of control. Whenmarkets are missing or ignored (as they were in the Soviet Union, for example), gainsfrom trade go unexploited and resources are misallocated. Societies with economic in-stitutions that facilitate and encourage factor accumulation, innovation and the efficientallocation of resources will prosper.

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These form prosperous social relationships, which are conducive to greater economic interaction by increasing levels of trust and wider availability of information (Putnam, 1993). They allow greater sharing of resources through democratic institutions and the use of the state to reduce the risk attached to economic activity (Bardhan, 2006, p.5). The welfare state is an example of an institution which pools resources to limit the negative effects of business cycles on incomes and unemployment

Institutions conducive to development pool resources to provide the investments in education, health and infrastructure which lie at the basis of economic interaction and are necessary and complementary to private investment. Informal institutions lie at the basis of an economy. They include public agencies, trade unions, community structures and professional associations. They make up the fabric which determines the response to laws and government decisions. Most often they shape these outcomes themselves.

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To summarize, the State is also often considered as the centre of corruption and the major risk of private property expropriation. However there is no market without a State to create and organize it, with the help of legal and working rules. Moreover, the historical perspective shows that the construction of the modern Western States was a precondition for the modernisation of the economy and of the emergence of market mechanisms. Today, experience shows that poorer countries are also those that have the weakest States

Conversely the most dynamic emerging countries are precisely those with have the most structured States.

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Putnam, R., 1993. Making Democracy Work : Civic Traditions in Modern Italy, Princeton : Princeton University Press.

Rodrik, D., 2000. “Institutions for High-Quality Growth: What they are and how to acquire them”. Working Paper 7540, February.

Rodrik, D., Subramanian, A., and Trebbi, F., 2004, “Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development”, Journal of Economic Growth, 9(2), p.131-165.

Savoia, A., Easaw, J., McKay, A., 2010. “Inequality, Democracy, and Institutions: A Critical Review of Recent Research”, World Development, Vol. 38, No. 2, pp. 142–154.

Shirley, M. M., 2005. “Institutions and Development”. In Claude Ménard and Mary M. Shirley, eds., Handbook of New Institutional Economics. New York: Springer.

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