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Rodrik D., Subramanian A., Trebbi F. (2002) Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development, NBER Working Paper 9305

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Why are there huge differences in average incomes between the world’s richest and poorest countries?

In this paper the authors test three alternative explanations for varying development performance between countries using regression analysis:

  • Geography (i.e. climate, natural resource endowments, disease burden, transport costs, and extent of diffusion of technology from more advanced areas)
  • International trade (integration into the global economy)
  • Institutions (in particular the role of property rights and the rule of law)

The analysis uses instrumental variable techniques to distinguish the effects of two-way causality and interactions between variables in order which effects are exogenous. The quality of institutions appears to override all else as the determining factor.

The authors stress that while economic analysis can help by identifying the incentive effects of different institutional set-ups, public deliberation and collective choice within societies should be at the core of making institutional choices.

They stress that their findings should raise serious questions about IMF and World Bank conditionality. As institutional change is slow, the time horizons for structural adjustment programs cannot be 3-5 years. Also, the focus in conditionality on getting policies right needs to be rethought, because policy changes are driven by institutional processes.