Scandinavian Working Papers in Economics

Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

No 19/2014: How do Political and Economic Institutions Affect Each Other?

Elias Braunfels ()
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Elias Braunfels: Dept. of Economics, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Economics, Helleveien 30, N-5045 Bergen, Norway

Abstract: This paper provides evidence for the mutually reinforcing relation of political and economic institutions. To overcome problems of endogeneity I utilize lag instruments within a GMM framework for dynamic panel data. Employing recently developed tests, I show that limiting the number of lag instruments and collapsing the instrument matrix eliminates many and weak instrument biases. My major findings are that (i) improving economic institutions has a large positive effect on future political institutions, and (ii) political institutions have a positive but quantitatively smaller e ect on current economic institutions. In addition, (iii) political instability positively affects future political institutions. In line with predictions from the institutional literature, the timing of effects is such that political institutions depend on lags of explanatory variables, while economic institutions are contemporaneously determined. Moreover, results are driven by countries with initially low political institutions implying that in these countries, much is to be gained from institutional reform.

Keywords: Political Economy; Economic Institutions.

JEL-codes: O10; P16

45 pages, June 30, 2014

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