27 January 2013

Acemoglu on unbundling the impact of specific institutions from the effect of broad economic systems

From "Constitutions, Politics, and Economics: A Review Essay on Persson and Tabellini's The Economic Effect of Constitutions":

"I now turn to a discussion of the problems involved in using these variables as instruments for specific institutions. This has become a common practice in the newly flourishing empirical political economy literature. … I will argue that there are serious problems in this procedure because of inherent complementarities between different types of institutions. … Here the distinction between a broad cluster of institutions and specific institutions is crucial. In AJR (2001), we defined a broad cluster of institutions as a combination of economic, political, social and legal institutions that are mutually reinforcing. …

As an example of the difficulty of this type of strategy to estimate the effect of specific institutions, consider the quasi-natural experiment due to international politics, the division of Korea into North and South. … Suppose now that we try to use this source of variation to understand the effect of some specific institutional feature, say financial development, on economic growth. It should be clear that this strategy will lead to a highly biased estimate. It is true that South Korea is financially more developed than North Korea. It is also true that the reason for this is the division in 1946 (had it not been for the division, the North and the South would probably have similar levels of financial development). But this does not make the division a good experiment to understand the effect of financial development, because this division also caused many other institutional changes. It is a good laboratory for the study of broad institutions, but not for a study of the specific institutions. …

the objective here is to estimate the effect of specific institutions. … Can we then use Z_i as an instrument for a specific institution, say S_1 ? The answer is no. If we were to do this, all of the S_k ’s would also load onto S_1. … we can get arbitrarily biased estimates of the effect of S_1 on the outcome of interest. This discussion also makes it clear that the problem of instrumenting for a specific institution, such as S_1, is in many ways similar to the omitted variable bias, since other specific institutions that make up the cluster of institutions, G, are omitted from the regression. Even if we include proxies for some of them, unless we can correctly estimate the causal effects of all of those, IV regressions will fail to estimate the causal effect of the specific institution of interest, S_1, consistently. …

a source of variation in the broad cluster of institutions is not sufficient to separately estimate the effects of specific institutional features. In other words, we can find clever instruments, from history, sometimes from geography, or international politics, that affect the whole social organization of a society, but this is only the first step. It does not enable us to conclude that one specific institution is more important than another.

However, what we want to know in practice is not only that “institutions” (defined as a broad cluster, and therefore almost necessarily as a black box) matter, but which specific dimensions of institutions matter for which outcomes. It is only the latter type of knowledge that will enable better theories of institutions to be developed and practical policy recommendations to emerge from this new area. Consequently, the issue of “unbundling institutions,” that is, understanding the role of specific components of the broad bundle, is of first order importance."

14 January 2013


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