Institutions and growth: A GMM/IV Panel VAR approach

- Institutions and growth have a bi-directional and dynamic relationship.
- I build a Panel SVAR which controls for country fixed-effects.
- A 1% shock in institutional quality leads to a peak 1.7% increase in GDP per capita.
- There are different dynamics for advanced economies and developing countries.

Both sides of the institutions and growth debate have resorted largely to microeconometric techniques in testing hypotheses. In this paper, I build a panel structural vector autoregression (SVAR) model for a short panel of 119 countries over 10 years and find support for the institutions hypothesis. Controlling for individual fixed effects, I find that exogenous shocks to a proxy for institutional quality have a positive and statistically significant effect on GDP per capita. On average, a 1% shock in institutional quality leads to a peak 1.7% increase in GDP per capita after six years. Results are robust to using a different proxy for institutional quality. There are different dynamics for advanced economies and developing countries. This suggests diminishing returns to institutional quality improvements.