Modeling institutional evolution

This paper proposes a formal framework to analyze the process of institutional evolution in relation with economic progress. Institutions have both formal (F) and informal (N) aspects that may exhibit varying processes of change. N is hypothesized to evolve with the level of capital stock, as in learning by doing, whereas F is chosen optimally by a government that maximizes output subject to social and political costs. F and N together define the production technology and affect the income level. Consistent with evidence, simulations of the model's solution reveal that optimum F exhibits a punctuated pattern.

► Formal (F) and informal (N) institutions evolve with economic development. ► The model's simulations show a punctuated pattern of F, as consistent with the evidence. ► Formal institutional change in LDCs is slower than in developed countries. ► Convergence can be achieved by institutional development.