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Long-term effects of institutional instability

Abstract

We examine the contribution of de jure and de facto institutional instability to long-run growth and development for a large panel of countries in the period 1820–2016. To this end, we extract the latent components of de jure and de facto instability of political institutions from several existing datasets. We distinguish between two types of instability where the positive type is associated with adaptive efficiency, while the negative type promulgates insecurity of property rights and institutional weakening. The evidence suggests that greater de jure and de facto institutional instability has a strong negative impact on income and growth, where de facto instability appears to be relatively more important than de jure instability. The negative effects of institutional instability operate independently of the positive effects of institutional quality, which implies that even second-best institutions are able to sustain a high-level growth path and economic development if they manage to maintain a minimum level of stability. The negative effects of greater institutional instability are robust across a variety of specification checks, and do not seem to be driven by sample selection bias. Instrumental variable estimates provide results with strong identification properties and suggest that the effect of institutional instability on long-run growth and development appears to be causal. Our instrumental variable estimates show that a modest increase in de facto instability is associated with 26 percent lower per capita income in the long run.

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Notes

  1. 1.

    North (2005) defines adaptive efficiency as the ability of societies “…to flexibly adjust in the face of shocks and evolve institutions that effectively deal with altered reality.”

  2. 2.

    An alternative we could construct CVs on the original polity indicators and use PCA analysis on them. As this sequence appears to be logic when constructing latent indices of institutional instability, it is by default quantitatively unchanged with our approach because calculating them from over Polity components would have a very similar inter-component variation, which would be reflected in the resulting synthetic instability indices. We tried this approach without finding any changes to our results.

  3. 3.

    The importance of taking care of institutional quality in testing the relationship between political instability and investment has been shown, for example, by Svensson (1998).

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Hartmann, S., Spruk, R. Long-term effects of institutional instability. Empir Econ 61, 2073–2112 (2021). https://doi.org/10.1007/s00181-020-01934-z

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Keywords

  • Institutional instability
  • Long-run development
  • Panel data