Panel data analysis of growth differences among countries in context of institutional economics

It has been accepted since Adam Smith that institutions, which arise as a consequence of individuals? interactions, affect the performance of the economy. Institutional perspective consists of both original and new institutional economics. Despite their differences, both schools of thought support the argument that institutions are important. However, due to problems related to quantifying institutional influence, the relationship between institutional structure and economic growth could only be analyzed empirically in the last quarter century. Generally, in these empirical analyses Solow model or other linear models had been preferred.Solow model and its derivatives do not incorporate institutional structure directly into the theoretical framework. Therefore Aghion-Howitt model, which addresses the institutions as a fundamental component of growth, is used in this study. The effect of institutions on growth differences among countries is analyzed using this model. In order to perform this analysis a panel data set which consists of 96 countries between 1970 and 2005 is used. Institutional structure is described by political and civil rights and economic freedom.According to findings of the analysis, differences in institutional structure count in explaining growth differences among countries. If the country is close to the technology frontier, an improvement in the indices, which describe the institutional structure, accelerates the growth rate of the economy. However, if a country is far from the technology frontier, an improvement in its institutional structure reduces the rate of growth. Consequently, countries distant from the technology frontier should primarily advance their technology level and thereafter should do reforms intended to enhance institutional structure.