Do institutions matter for economic fluctuations? Weak property rights in a business cycle model for Mexico

In this paper we introduce weak property rights in the standard real business cycle (RBC) model in order to examine the role of institutions as a source of economic fluctuations in emerging markets. In particular, in Mexico, the movements in productivity in the data are associated with changes in institutions, so that we can explain productivity shocks to a large extent as shocks to the quality of institutions. We find that the model with shocks to the degree of protection of property rights can match the second moments in the data for Mexico very well. Moreover, the fit is better than that of the standard neoclassical model with full protection of property rights regarding the auto-correlations and cross-correlations in the data. Viewing productivity shocks as shocks to institutions is also consistent with the stylized fact of falling productivity and non-decreasing labor hours in Mexico over 1980–1994, which is a feature that the neoclassical model cannot match.