Do Institutions Play a Role in Promoting Economic Growth? In Short, Yes.
Economists teach that institutions determine long-term economic growth—but are some institutions more crucial than others? The legendary Douglas North (1989) popularized the idea that the Glorious Revolution in England culminated in the imposition of institutional constraints on the monarchy. North argued that such an arrangement enabled growth by restricting the authority of political actors to extract resources.
Since the publication of North’s seminal text, many have applied his arguments to historical and contemporary growth. However, institutionalist explanations for economic growth are only partially accurate. To his credit, in later works, Douglas North updated his theory to account for the distinctions between open access orders in the political and economic spheres.
Nevertheless, current researchers give little credence to these subtleties. According to North and coauthors, open access orders entail the removal of privileges that make it easy for factions to accumulate power at the expense of citizens. It is indisputable that open access orders in the political realm allowing the unfettered dissemination of ideas are superior to autocratic systems—though we must appreciate that authoritarian regimes record growth when commerce is unobstructed.
A 2019 study published in the Dartmouth Law Journal opines that economic growth accelerated in authoritarian China because barriers to commerce were reduced. In concluding, the report enunciates a convincing case for the primacy of open access in the economic sphere in promoting growth:
The factors determining economic and human development are open access in the economic sphere and interconnected institutions in the areas of property right protection and contract enforcement, financial market, rule of law and the accumulation of human resources. The case of China shows again that the theory of North and his colleagues overemphasizes the role of open access to political organizations or competitive democracy in economic development.
For instance, despite restricting opposition, both Singapore and China have recorded stellar growth rates. Likewise, the case of India shows that open access to economic organizations are a better predictor of economic growth than open access to political organizations. Guanghua Yu in a fascinating paper contends that growth in India surged after it allowed open access to economic organizations:
Due to restrictions on open access to economic activities … India did not devote much effort or resources to building institutions related to the protection of property rights and contract enforcement, the financial market, rule of law, and education during the first 30 years after independence. In the 1980s, however, India started to liberalise the economy. The correlation between institution building in these areas and better economic and human development has been very clear since the beginning of 1990s…. India started to improve its economic and human development after 1990, when open access occurred both in the political sphere and in the economic sphere.
Open access in the political sphere also nurtures human capital formation by permitting economic freedom. Economic freedom presents opportunities for workers to garner resources and acquire higher levels of education, which equip them with the human capital to invent superior products that enrich the quality of life. Think about a hairdresser who is discouraged from pursuing her passion due to the costs imposed by occupational licensing regulations, whereas in the absence of these laws, she could have attained her goals and, in doing so, have recognized that she could deliver a more competitive product by upgrading her skills. Although some people could only be interested in exploiting the opportunities made available by economic freedom, human capital is still indirectly promoted because they will have the resources to educate their children.
Moreover, empirical research illustrates that economic freedom makes investments in human capital attractive, since people are able to keep a sizeable share of their earnings. On the other side of the spectrum, researchers Eva Medina-Moral and Vicente J. Montes-Gan in a 2018 article published in the Journal of Applied Economics posit that economic freedom is better at enabling growth than governance:
Particularly, the empirical analysis revealed that economic freedom was the most important to promoting development. Governance was also shown to be influential … however governance was not as significant as economic freedom…. There is no point trying to strengthen governance if a country does not have as a priority the openness of its economy to international markets and a strong commitment for the protection of the property rights.
Other than empirical weakness another problem is that institutionalist explanations lack cross-cultural comparisons. Contrary to notions of African despotism historians comment that several kingdoms in precolonial Africa were subject to checks and balances. The oba of Benin, for example, despite his clout was answerable to chiefs, who served as a counterpoint to his authority. But notwithstanding the semblance of a system of checks and balances in the economic sphere, the Benin monarchy was essentially a predatory actor—although it was never seen as such by the Binis of Benin, who saw the oba as the bedrock of peace and stability.
Yet the evidence gathered by historian Idahosa Osagie Ojo points to a different conclusion:
The Benin adage, “Oba yan oto ya se vbo ebo,” which is translated as ‘the Oba owns all the land up to those of the Europeans’ readily shows that the laws conferred ownership of land, anywhere it is located on the Oba in trust for the people and he alone can allocate it…. Since farming was the chief occupation of the Benin people and it required land, the Oba was highly patronised and the people, therefore had to make very large farms for the Oba annually. This contributed immensely to strengthening the economic power of the Oba and the state.
The Oba also monopolized trade:
By the law, the Oba held the monopoly of international trade. He chose certain councillors and merchants who also were allowed to come to the European traders at the port of Ughoton. Indeed, it was the special duty of chiefs … to supervise commerce and transact business on behalf of the Oba. By law, the common man could only take part in the trade, after the royal transaction was over and with the special permission of the Oba.
Evidently, establishing checks and balances to limit the authority of the oba in the political sphere was insufficient to induce economic growth when pursuing commerce without the oba’s permission was impossible. Neither did limitations of political power amount to much in the Oyo Empire. The ruler of Oyo, the alaafin, was even more constrained than the oba of Benin.
In Oyo, the council of chiefs known as the Oyo Mesi was so powerful that it could compel the alaafin to commit suicide. The colossal influence wielded by the Oyo Mesi made the monarchy a victim of stakeholder capture. Chiefs were granted so much power that they could cripple the institution of the monarchy and appropriate state revenue for themselves. E.C. Ejiogu recounts a troubling event in the 1700s, when the Oyo Mesi usurped monarchical authority:
Sometime towards the mid-1700s, a power situation developed in Old Oyo in which the Oyo Mesi invoked its constitutional authority to demand and obtain the deposition of successive Aláàfins. It got to the point in 1754 where the Basorun1
effectively seized state power. Thereafter, he rendered each Aláàfin that ascended the throne a puppet whom he placed on a daily token allowance. He replaced the ilari and ajele2 with his sons and relatives, and through them he appropriated state revenue from the vassalages and provinces.
The examples of Oyo and Benin demonstrate that creating open access in the political sphere without cultivating an open environment for commercial success fails to result in economic prosperity. Although in the present political climate democracy is revered, the evidence is clear: democracy without economic freedom stalls progress.