Importance of institutions in long term growth

But the accumulation of physical and human capital are not sufficient conditions for productivity growth in developing economies. There are many economies that have emphasized the accumulation of these inputs but have not achieved successful development. Neither old growth theory nor new growth theory provides a good explanation of why some developing countries have achieved rapid growth and others have not. The old growth theory is broadly consistent with the data, but the tendency towards convergence predicted by that theory is very weak in practice. The new growth theory predicts that the fastest growing countries will be the highest income countries and this is inconsistent with observation. It is difficult to use either theory to describe developing country growth when there are often zero or negative rates of total factor productivity growth. Versions of new and old growth theory that suggest a very large role for education in development appear to be strongly inconsistent with observation. The rate of accumulation of human capital is negatively correlated with productivity growth. A number of countries that have emphasized human capital accumulation have large negative total factor productivity residuals. This paper suggests that economic institutions play an important role in explaining why some economies have grown successfully and others have not. Evidence from recent studies of productivity in developed economies and in Latin America supports this view. For example, the reason that capital accumulation does not guarantee economic growth is illustrated by Latin American countries where large investments in steel-making facilities have resulted in plants that have never been made operational. Further investment in human capital accumulation in Latin America may be of limited value given that the existing skills of the workforce are not being utilized effectively because of inefficient state-owned or regulated companies. The geographic pattern of economic development is indicative of the importance of institutions. Economic development spread from Britain to North America and Australia, aided by common language and institutions. It spread more slowly to adjacent continental European countries. (Author abstract)