Further Unbundling Institutions.

Abstract

This paper analyzes the effects of institutions on economic development, and focuses on separating political institutions from contracting and economic institutions. For a sample of former European colonies, I find that differences in income levels are strongly affected by political institutions, which regulate political accountability and constrain political elites. There is some evidence for a positive effect of economic institutions, which protect property rights, but no evidence for positive effects of contracting institutions, which facilitate contracting among individuals. A decomposition of GDP reveals that political institutions work through the channel of physical and human capital accumulation. Economic institutions have a positive impact on total factor productivity. To identify and unbundle effects, I exploit exogenous variation in each of the three institutions using instrumental variables based on colonial history and geographic endowments. The application of a recently developed test for weak instruments in the multiple endogenous variables setting shows that the effects of institutions can be separated. The paper adds to the literature by identifying the fundamental importance of political institutions for economic development, and provides an inside into the channels through which specific institutions affect income levels.