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.