The link between institutional quality and economic growth: evidence from a panel of countries

[Truncated abstract] The links between the quality of a country’s institutions and its level of economic development is an important, and growing, area of research in economics. Broadly speaking, these institutions define the ‘rules of the game’, or the conditions under which firms and individuals operate within and between markets. The better the quality of these institutional arrangements, the more confidence market participants have to conduct transactions. Although the links between these institutions and economic growth have been empirically tested many times (and shown to be extremely important), several gaps still exist in our understanding of this relationship. Two of the more important issues are (i) what the causal relationship may be between institutions and economic growth, and (ii) what the (undoubtedly complex) transmission mechanisms may be between them . . . Using a variety of alternative variables and samples, the evidence presented here strongly suggests that institutional quality is a major causal determinant of investment and human capital (particularly higher levels of education), as well as having an additional (though weaker) causal effect on growth itself. There is also an indication that there is reverse causality running from economic growth back to institutions. The evidence of a causal relationship between institutional quality and trade remains somewhat mixed, however, there is a strong suggestion that the influence of trade on institutional quality depends heavily on what type of goods are being traded (specifically, primary commodities or manufactured goods).