Scandinavian Working Papers in Economics

Ratio Working Papers,
The Ratio Institute

No 135: The Growth Effects of Institutional Instability

Niclas Berggren (), Andreas Bergh () and Christian Bjørnskov ()
Additional contact information
Niclas Berggren: The Ratio Institute, Postal: The Ratio Institute, P.O. Box 3203 , SE-103 64 Stockholm , Sweden
Andreas Bergh: The Ratio Institute, Postal: The Ratio Institute, P.O. Box 3203 , SE-103 64 Stockholm , Sweden
Christian Bjørnskov: Aarhus University, Department of Economics, Postal: Department of Economics , Frichshuset , Hermodsvej 22 , DK-8230 Åbyhøj , Denmark, phone: +

Abstract: Both institutional quality and institutional stability have been argued to stimulate economic growth. But to improve institutional quality, a country must endure a period of institutional change, which implies at least a little and possibly a lot of institutional instability. We investigate the growth effects of institutional quality and instability, using the political risk index from the ICRG in a cross-country study of 132 countries, measuring instability as the coefficient of variation. Using the aggregate index, we find evidence that institutional quality is positively linked to growth. While institutional instability is negatively related to growth in the baseline case, there are indications that the effect can be positive in rich countries, suggesting that institutional reform is not necessarily costly even during a transition period. Sensitivity analysis, e.g., decomposing the political risk index by using both its constituting components and the results of a principal components analysis, using other measures of institutional quality and excluding outliers, confirm the general results, with qualifications.

Keywords: Institutions; Instability; Growth; Transaction costs; Uncertainty

JEL-codes: B52; D80; O11; O17; O43

36 pages, June 2, 2009

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