The Impact of Institutions on Economic Growth: The Case of Transition Economies

By Redek, Tjasa; Susjan, Andrej | Journal of Economic Issues, December 2005 | Go to article overview

The Impact of Institutions on Economic Growth: The Case of Transition Economies


Redek, Tjasa, Susjan, Andrej, Journal of Economic Issues


Economic transition, a phenomenon that has marked the development of the bigger part of Europe in the past decade, is above all a problem of coordination. Economic transition is a process of institutional change, a process of building new institutions required by a capitalist economy. Transition brought about the overnight destruction of the socialist coordination mechanism, while the market coordination took time to be established and agents had to become cognizant of it.

The aim of this paper is to analyze the importance of institutional quality for economic performance in transition economies in the past decade. The structure of the paper is as follows. First, we present the results of analyses by other authors which deal with the importance of institutional quality for economic performance in general or for transition economies. Then, some institutional and economic characteristics of socialist economies are briefly presented, and these initial conditions are contrasted with the present situation to provide an illustration of how institutions might have contributed to transitional success or failure. This is followed by a more in-depth econometric analysis intended to isolate the influence of institutional quality on economic performance. Finally, the results are tested with a sensitivity analysis to confirm the importance of the speed and quality of institution building in the transition process.

Institutions and Economic Performance

Definition of Institutions

In recent years scholars and policy makers alike have paid increasing attention to the complex relationship between institutions and economic performance. There are numerous reasons why it is important to understand the role of institutions: economic stagnation in many developing countries; structural problems in the old industrial economies; the collapse of the economies in the former Soviet Union, Central Asia, and Eastern and Central Europe. Institutional analysis is of paramount importance for guiding the transition to markets in formerly centrally managed economies. Many scholars now recognize that mainstream economic analysis, neoclassical economics, is of little help in restructuring economies that lack secure markets; the same criticism holds for other disciplines in the social sciences (Alston et al. 1996, 1).

Institutional critiques of mainstream economics are not new. Todd Buchholz (1999, 176) very illustratively states that old institutionalists a century ago attacked the marginalists for assuming a smooth, gradual path to a point of equilibrium. Equilibria do not exist; the economy always changes: equilibrium is a daydream of economists who do not live in the real world. Today, new institutional economics is gaining a lot of interest. Malcolm Rutherford (1995, 443) has claimed that the central tenet of both old and new institutional economics is that institutions matter in shaping economic behavior and economic performance. But the two differ in their approach: the old institutional economics rejects the hypothesis of a rational economic player in favor of one that places economic behavior in its cultural context. (1) For new institutionalists mankind is still a rational chooser, but more focus is given to the role of institutions. The new institutional economics works with a set of more neoclassical scissors, which has been pointed out by William Dugger (1990). Regardless of the methodology used, what is important is that institutions are coming to the forefront of economic analysis. New or old, all institutionalists recognize what Thorstein Veblen (1898, 376) said: "Economics is a theory of a process, of an unfolding sequence." And institutions do shape this process. They impact the behavior of economic agents and thus affect economic performance. This can be seen, using the words of Paul Bush and Marc Tool (2003, 10), as the main "point of convergence" in the analytical interests of the original and the new institutional economics.

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The Impact of Institutions on Economic Growth: The Case of Transition Economies
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