Lecture 2 (Optional) Institution building and grow

JEconGrowth(2006)11:157–186DOI10.1007/s10887-006-9000-0ORIGINALARTICLEInstitutionbuildingandgrowthintransitioneconomiesThorstenBeck·LucLaeven©SpringerScience+BusinessMedia,LLC2006AbstractDrawingontherecentliteratureoneconomicinstitutionsandtheoriginsofeconomicdevelopment,weofferapoliticaleconomyexplanationofwhyinstitutionbuildinghasvariedsomuchacrosstransitioneconomies.Weidentifydependenceonnaturalresourcesandthehistoricalexperienceofthesecountriesduringsocialismasmajordeterminantsofinstitutionbuildingduringtransition.Usingnaturalresourcerelianceandtheyearsundersocialismtoextracttheexogenouscomponentofinstitu-tionbuilding,wealsoshowtheimportanceofinstitutionsinexplainingthevariationineconomicdevelopmentandgrowthacrosstransitioneconomiesduringthefirstdecadeoftransition.KeywordsTransitioneconomies·Institutions·EconomicdevelopmentJELClassificationsO10·P201IntroductionThetransitionprocesshasopenedawidewedgeineconomicdevelopmentamongthetransitioneconomiesofCentralandEasternEuropeandCentralAsia.Whilein1992,GDPpercapitainconstant2000USdollarsvariedbetween300and7,000forthecountriesinthisregion,itvariedbetween200and11,000intheyear2004.T.Beck(B)TheWorldBank,1818HSt.,NW,Washington,DC20433,USAL.LaevenInternationalMonetaryFund,Washington,DC20431,USAL.LaevenCEPR,London,UK158JEconGrowth(2006)11:157–186Duringthesameperiod,GDPpercapitaincreasedby64%inPolandandshrankby26%inneighboringUkraine.Whilealltransitioneconomiesfacedthedifficulttaskofbuildingnewmarket-compatibleinstitutions,theprocessandsuccessofreformhasvariedgreatlyacrosscountries.Generally,theCentralandEasternEuropeancountriesprovedtobemoresuccessfulreformersandtodayscorebetterintermsofinstitutionalandeconomicdevelopmentthanthecountriesoftheformerSovietUnion,includingtheBalticStates.Whyhavesometransitioneconomiesfaredsomuchbetterthanothers?Whyhavesometransitioneconomiessucceededinbuildinganewinstitutionalframeworkafterthefallofsocialism,whileothershavenot?Thispaperproposesandtestsahypothesisbasedonpoliticaleconomyofwhyinstitutionbuildinghasvariedsomuchacrosscountriesinthispartoftheworldandshowstheimportanceofinstitutionbuildinginexplainingthevariationineconomicperformanceacrosstransitioneconomies.Theliteratureexaminingthegrowthexpe-rienceoftransitioneconomiesoverthelastdecadehasfocusedmostlyonreformstrategies—shockvs.gradualism—,macroeconomicpoliciesandinitialconditionstoexplainthedramaticvariationingrowthacrosstransitioneconomies(foranoverview,seeSvejnar,2002).However,asnotedbyCamposandCoricelli(2002)intheirreviewoftheliteratureongrowthintransitioneconomies,theroleofinstitutionshaslargelybeenneglectedinempiricalanalysisofeconomicgrowthintransitioneconomies.Thisisincontrasttoanextensivecross-countrygrowthliteraturethathasdiscussedtheimportanceofinstitutions.Theexperienceoftransitioneconomiesoffersauniquehistoricexperimentininstitutionbuilding.Thetransitionstartedwiththerapiddestructionoftheinstitu-tionssupportingsocialisminalltransitioneconomies.Thebuildingofnewinstitutionssupportingabroad-basedmarketeconomy,however,hasbeenmuchslowerandhasvariedsignificantlyacrosstransitioneconomies.1Thispaperoffersapoliticaleconomyexplanationofwhyinstitutionbuildinghasvariedsomuchacrosstransitioncountries,buildingonNorth’shypothesisthat“insti-tutionsarenotusuallycreatedtobesociallyefficient,[but]arecreatedtoservetheinterestsofthosewithbargainingpowertocreatenewrules”(North,1990,p.16).Thesocialisteliteremainedapowerfulpoliticalinterestgroupduringtheinitialphaseofthetransitionprocessinmosttransitioncountries,butitsauthorityvariedacrosscountriesdependingontheirentrenchmentinpower.Weconjecturethattheincum-bentsocialisteliteornomenclaturahadfewerincentivestocreateinstitutionsthatfosteredcompetition,asthiswouldreducetheireconomicpower.Further,economiesthatrelymoreonnaturalresourcesofferlargeropportunitiesfortheelitetoextractrents;theeliteshavethereforelessincentivetoestablishstrongpropertyrights.Polit-icalentrenchmentandrelianceonnaturalresourcescriticallydeterminedwhetherthebehavioroftherulingeliteandthusthetransitionprocesswas“catalytic”or“extractive.”Weusethenumberofyearsacountryhasbeensocialistasproxyfortheentrenchmentofthesocialisteliteandthustheirpowertoinfluencethetransi-tionprocess,andtheshareofnaturalresourceexportsinGDPatthebeginningofthetransitionprocessasanindicatorofthedominanceofnaturalresourcesinthe1Whilemosttransitioneconomiesinitiatedeconomicreformstoliberalizetheireconomies,onlyafewcountries,includingEstonia,HungaryandPoland,wereabletobuildinstitutionstoenforcetheprotectionofpropertyrightsandimplementanenablingbusinessenvironmenttoencourageinvest-ments(Berglof&Bolton,2002;WorldBank,2002).Ontheotherextreme,Tajikistanhasemergedasoneoftheleastreformed(WorldBank,2002)anditsGDPpercapitain2004waslowerthanatthestartofthetransitionperiod.JEconGrowth(2006)11:157–186159economyandasaproxyfortheelite’sopportunitiestoextractrents.Weshowthatcountriesthathadbeenlongerundersocialistgovernmentandrelymoreonnaturalresourcesexperiencedlessinstitutionbuildingoverthefirstdecadeoftransition.Thisfind