Most of the literature use cross-country data in their analysis. PU, however, points to the three limitations of doing so in the identification of channels through which institutions affect economic growth.
First, PU argues that the measurement used for institutional quality is “necessarily coarse”:
"The cross-country literature has largely relied on broad indices of institutional quality. The use of coarse institutional measures implies that cross-country regressions are typically unable to isolate the causal effect of any single institution."
PU also point to the possibility of generating omitted variable bias in the econometric methods used:
"[T]he inability to include the entire array of institutions which impinge on, say, growth as independent variables (often due to the small set of available instruments) raises the possibility of omitted variable bias. For example, some indices of institutions used in the cross-country literature are very strongly biased towards measuring the institutional environment facing urban and/or formal sector agents."
PU’s final concern deals with the nature of heterogeneity of institutions and of the actors being affected by such institutions, even within a given country. One of the many examples they gave is the fact that mechanisms of contract enforcement in the urban sectors may differ significantly to the mechanisms of contract enforcement in the rural sectors.
All in all, the authors conclude that:
"[T]he extraordinary diversity of institutional practices across and within countries places natural constraints on the usefulness of cross-country analyses for understanding the specific channels through which institutions affect economic outcomes, and how these institutions, in turn, respond to economic, demographic, political and social forces."
Given the limitations to current macro-centric efforts in the literature, PU suggest that future research in the relationship between institutions and growth is “best furthered by the analysis of much more micro-data than has typically been the norm in the literature.” Specifically, PU suggest two research programs that have significant potential:
- Using “policy-induced variation in specific institutions within a country to examine how specific institutions influence economic outcomes.”
- Exploiting the fact that “incentives provided by a given institutional context often vary with individuals’ economic and political status, and so close examinations can be done of the economic choices of individuals in a specific institutional context.” Identifying the specific channels on how institutions affect economic behavior and hence economic outcome can be achieved by analyzing how individuals’ respond to the same institution. Likewise, doing so would also help understand “how institutional change arises in response to changing economic and demographic pressures.”
Pande and Udry's paper goes into the heart of the new institutional economics (NIE) school. NIE has always been about institutions, and how institutions affect the behavior of agents in an economy. North (1991) states that “institutions provide the incentive structure of an economy; as that structure evolves, it shapes the direction of economic change towards growth, stagnation, or decline.”
This paper even presents another push to what I would consider an ongoing paradigm shift in how economists study the relationship between institutions and economic growth. The paradigm shift that I’m referring to is the current efforts in the literature of moving away from looking at the macroeconomic view of how institutions affect economic outcomes and into looking at the microeconomic view. PU may not have been pioneers in this research (for example, Gibson and Rozell, 2003, looked at how improved road access leads to lower poverty in Papua New Guinea), but where this paper is revolutionary is in laying down a firm conceptual framework in undertaking further research in analyzing the relationship at the micro level.
One of the strengths of the paper is the methodical way that PU presents their ideas. They start by doing a review of the rich “macro”-literature and proceeded to identifying the limitations of how the existing papers establish “a causal link between a cluster of ‘good’ institutions and more rapid long run growth.” They not only focused on some technical limitations, such as the problems of omitted variable bias when it comes to econometric specifications, but also on one obvious drawback—these studies never really specified the exact channels through which institutions do affect economic growth. They then proceeded to their main thesis which would solve the limitations—looking at the micro level in two different ways. The solutions they suggest also seemed practical, as they close their paper with an application of their suggested research framework to the land tenure system in Ghana.
PU’s suggestion of analyzing the relationship between institutions and economic growth at the micro level in two research perspectives is the biggest contribution of this paper in the literature. I mentioned earlier that this paper tries to suggest a solution to one obvious limitation in the current literature—that of the lack of specifying the exact channels through which institutions affect economic growth. Analyzing the exact channels has important implications in terms of policy. North (1993) points out that “successful development policy entails an understanding of the dynamics of economic change if the policies pursued are to have the desired consequences. And a dynamic model of economic change entails as an integral part of that model analysis of the polity since it is the polity that specifies and enforces the formal rules.” This paper provides two frameworks for researchers and policymakers on how to go about understanding the dynamics.
Even if the current empirical literature is strongly based on the theory that institutions affect growth through its effect on individual agents, it would still greatly advance the tenets of NIE if authors can provide empirical basis on what is happening down below—at the micro level. PU has definitely helped in that effort with this paper.
Referencs
Gibson, John and Scott Rozelle (2003), “Poverty and access to roads in Papua New Guinea”, Economic development and Cultural Change, 52(1):159-85.
North, Douglass C. (1991), “Institutions”, The Journal of Economic Perspectives, 5(1):97-112.
North, Douglass C. (1993), “The new institutional economics and development”, Working paper, Washington University in St. Louis.
Pande, Rohini and Christopher Udry (2006), “Institutions and Development: A View from Below” in Richard Blundell, Whitney Newey, and Torsten Persson, eds., Advances in Economics and Econometrics Theory and Applications (New York: Cambridge University Press) 981-1022.
Shirley, Mary M. (2005), “Institutions and Development”, in Claude Menard and Mary M. Shirley (eds.) Handbook of New Institutional Economics, Dordrech: Springer, 611-38.
Straub, Stephane (2008), “Infrastructure and growth in developing countries: Recent advances and research challenges”, World Bank Policy Research Working Paper 4460.