Title: Institution and Growth: The East Asian Development

Authors: Mahyudin Ahmad
Institution: University of Leicester
Date: July 2009
Subject area(s): Development economics, institutional economics
Relevance to other area(s): Growth, GMM estimation technique, dynamic panel data
Project type: A chapter of PhD thesis

Summary

Photo by: Sinkdd, Creative Commons, Flickr
In this paper we investigate the East Asian growth experience in the past three decades from an institutional perspective and offer additional evidence that the institution is able to explain economic performance. The East Asian countries have seen a dramatic economic growth since early 1990s and the feat was once dubbed “the East Asian Miracle” by the World Bank.

Unique institutional settings in East Asian countries, such as a strong authoritarian government implementing interventionist policies is believed to have somehow contributed to this spectacular economic achievement. However, the unprecedented financial crisis in 1997/98 brought an abrupt end to the dream growth, and has resulted in severe recession for some of the previously high-performing countries in the region. Though not the main reason for the financial crisis, institutional weakness could somehow be attributed to having exacerbated the impact of the crisis. These episodes of high growth and financial crisis undoubtedly offer an interesting case study from the institutional perspective.

By employing dynamic panel data analysis, i.e. system Generalized Method of Moments (GMM) method and utilizing the latest institutional data, overall we find evidence that government stability, constraints on executive as well as institutionalised democracy matter significantly for growth in developing countries, whereas low investment risks and government stability show significant growth effects in the East Asian countries. The results also lend evidence to the positive effect of autocratic government towards economic growth particularly in the East Asian countries. During the period of high growth in the region throughout years 1984-1996, good investment policies emerge as the significant growth determinant while government stability has some influence on growth for the period post-Asian financial crisis 1997/98.

Datasets used

• World Bank (2009): World Development Indicators (Edition: April 2009). ESDS International, University of Manchester (Data on real GDP per capita and population growth)
• Investment share of real per capita GDP; obtained from Penn World Table 6.3 (2009)
• Institutional data from International Country Risk Guide (ICRG) provided by the PRS Group (2009) and Polity IV (Marshall and Jaggers, 2008)

Aims and objectives

To provide an empirical study that attempts to investigate the institutional quality linkage to growth and crisis in developing countries particularly East Asian countries.

To isolate a set of institutional indicators reflecting the security of property rights and political institutions which are perceived to be significant for developing economies as well as to the East Asian countries.

Methodology

We use the framework of textbook Solow model for growth estimation and augment the framework with institutional variables proxied by institutional data from ICRG and Polity IV for a sample of 68 developing countries for a period of 25 years beginning 1984 - 2008.

We employ dynamic panel data analysis i.e. system GMM method to identify the most important institutional quality to income growth. Our strategy is firstly to estimate general model consisting of all institutional variables, in addition to the casual growth determinants namely investment and population growth, followed by separate effect estimation where the institutional variables enter the model one at a time. The institutional variables that survive in both estimations will be considered as important growth determinants.

We also do robustness check for the results with the estimations in pooled OLS and fixed effect methods.

Results/Outcome

Table 1: System GMM regressions of institutional variables on growth for a sample of developing countries and Asian countries

Our results find evidence that Government Stability, Executive Constraints and Polity2 (Democracy/Autocracy) are the significant growth determinants in the developing countries under study, whereas in the Asian countries Investment Profile and Government Stability are the significant growth determinants. We also extend our analysis of Asian countries by looking at the institutional growth-effects for period before and after the Asian financial crisis. Investment Profile matters importantly for the Asian region for the period before crisis but Government Stability shows some influence to growth post-crisis (from estimation of significant regressors in Asian sample for whole years).

Overall, we are of the opinion that our analysis successfully achieves its objective to test the proposition that institutional quality is able to explain economic growth of developing countries particularly the Asian countries for the past 25 years. Though the test statistics of our analysis are somewhat imperfect with the possibility of serial correlation problem and weakened over identification test due to high number of instruments, we are of the opinion that it is acceptable at this stage since our focus is to identify the significant institutions growth-effects. Furthermore our effort is arguably the first to use dynamic panel data analysis to test for institutions-growth linkage for the period where significant growth achievement and severe financial crisis happened in the Asian region.

Additional information

Figure 1: Real GDP per capita growth in Asian countries vs. Institutional quality rating (ICRG)

Figure 2: Scatter plot of Real GDP per capita growth vs. Institutional quality rating (ICRG) – a pretty straightforward
positive relationship between both variables.

Figure 3: Scatter plot of Real GDP per capita growth vs. Institutional quality rating (Polity IV) –somehow relationship
between log GDP per capita growth to Polity IV index is not as straightforward positive as it is with the ICRG.

Selected references:

Acemoglu, D., Johnson, S. & Robinson, J. A., (2005). Institutions as a Fundamental Cause of Long-Run Growth, in: Philippe Aghion & Steven

Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 6, pages 385-472 Elsevier.

Arellano. M. & Bond, S.R. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. Review of Economics Studies 58 (2), pp.277-297.

Arellano, M. & Bover, O. (1995). Another Look at the Instrumental Variable Estimation of Error Component Models. Journal of Econometrics 68 (1), pp. 29-51.

Blundell, R. & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics 87 (1), pp. 115–143.

Heston, A., Summers, R. & Aten, B. (2009). Penn World Table Version 6.3, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, August 2009.

Mankiw, G. N., Romer, D. & Weil, D.N. (1992). A Contribution to the Empirics of Economic Growth. The Quarterly Journal of Economics, Vol. 107, No. 2. pp. 407-437.

Marshall G. M. & Jaggers, K. (2009). Polity IV Project, Center for Systemic Peace and Colorado State University
North, D. C. (1990) Institutions, Institutional change, and Economic Performance. New York: Cambridge University Press.

PRS Group, The. (2009). International Country Risk Guide dataset.

Roodman, D. (2009). How to do xtabond2: An introduction to difference and system GMM in Stata, The Stata Journal, 9 (1), pp. 86-136

Solow, R. M. (1956). A Contribution to Theory of Economics Growth, The Quarterly Journal of Economics, 70 (1), pp. 65-94.

World Bank (1993). The East Asian Miracle: Economic Growth and Public Policy. Oxford University Press: New York, NY.

World Bank (1998). East Asia: Road to Recovery. Washington D.C.: The World Bank.

World Bank (2009): World Development Indicators (Edition: April 2009). ESDS International, University of Manchester

**Comments and suggestions from Prof. Stephen G Hall and from all participants of the ESDS International Annual Conference 2010 on 29 November 2010 where this work was presented in a 'Meet the Researchers' poster presentation session were very helpful in finalising the analysis and text.