What are the key forces that drive changes in institutions, the rules governing social and economic exchange? New research on the transition from central planning to the market economy in Eastern Europe and the former Soviet Union shows that the process of institutional change can be influenced by policy choices but that historical legacies also play an important role. In a study published in the April 2007 Economic Journal, Dr Melvyn Weeks and his colleagues show that:
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The extent of economic liberalisation and privatisation undertaken by governments during the 15 years of economic transition ‘explains’ 38% of the variation in institutions across 26 transition economies.
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But countries cannot escape their history completely. Almost 30% of the variation in institutions is accounted for by historical legacies, such as the length of time that central planning was imposed on a country (70 years in the former Soviet Union against 40 years in Eastern Europe and the Baltic states) and the country’s dominant religion (Western Christian versus Muslim).
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The process of accession to the European Union (EU) has been an important anchor for institution building, explaining 19% of the variation in outcomes.
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The remainder (15% of the total variation in outcomes) is explained by the degree of political liberalisation – democracies seem to build better institutions than non-democracies.
Because institutions are recognised as one of the fundamental determinants of economic prosperity, it is of great interest to researchers and development policy-makers alike to understand how institutions change. This study analyses the process of institutional change using measures of institutions developed by the European Bank of Reconstruction and Development (EBRD).
The results also inform the theoretical debate about how institutions change. Economists often attribute the biggest role to economic factors such as changes in technology and resulting changes in relative prices, which render existing rules inefficient and thus act as catalysts of change.
Political scientists instead stress the role of relations of power in determining the extent to which the demand coming from economic actors is translated into changes in institutions. And cultural theories attribute an important role to the norms and values that have developed in a particular society, since these influence the acceptance and hence the efficiency of new rules.
It seems that in the context of transition, all three channels were at work. Lack of cultural affinity with Western Europe, authoritarian politics and the absence of an EU anchor have presented formidable but not insurmountable handicaps for institutional change in the countries of Central Asia and the Caucasus. Given the handicaps, however, it is perhaps salutary how much change has already taken place.
Methodologically, the research breaks new ground in applying the MIMIC (Multiple Indicators, Multiple Causes) model to the analysis of institutional change. The MIMIC model allows the authors to derive a single measure of institutional change from four different components, letting the weights for the aggregation be determined as an outcome of estimating the structural model.
It turns out that among the four EBRD measures of institutional change – enterprise restructuring, competition policy, banking reform and reform of non-bank financial institutions – banking reform and enterprise restructuring have the largest weights, while competition policy has the smallest.
As more and more time series of measures of institutional quality become available, the method used by the authors may lead to a more comprehensive understanding of the institutions that matter most for institutional performance.
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Notes for editors: ‘Home Grown or Imported? Initial Conditions, External Anchors and the Determinants of Institutional Reform in the Transition Economies’ by Maria Di Tommaso, Martin Raiser and Melvyn Weeks is published in the April 2007 issue of the Economic Journal.
Maria Di Tommaso is at the University of Torino. Martin Raiser is at the World Bank. Melvyn Weeks is at the University of Cambridge.
For further information: contact Romesh Vaitilingam on 07768-661095 (email: romesh@compuserve.com); or Melvyn Weeks via email: Melvyn.Weeks@econ.cam.ac.uk