An Analytical Perspective on the Role of Institutions in Economic Development

Abstract

Intrinsic differences in the development of different countries have remained to be a problem to the classical explanations of growth that have always been limited to capital accumulation, labor and technology alone. Institutions though becoming the major determinants of long run development, the processes through which they can determine the ultimate growth outcomes are not yet well understood. This research takes an analytical approach to investigate the nature of the impact of institutional quality on the economic development and through what channels. The research employs a balanced panel data that includes the countries belonging to various income groups and combines the aspects of governance indicators with the indices of investment, human capital, and the results of multidimensional development. The methodology of the analysis is made up of sequential panel regression-based mediation models and panel Structural Equation Modeling to break down the total institutional effect into a direct and indirect impact. The findings indicate that it has a great direct influence on development, and institutions also have an indirect effect via investment and human capital formation. The most influential transmission channel is human capital which is specifically important in the case of non-income development indicators. The results highlight the significance of supporting institutional changes with reforms in strengthening education and skill building with the aim of attaining inclusive and sustainable development.