Expanded summary

The author wants to thank professor Iuri Ananiashvili for his helpful comments and suggestions. This work was supported by the Shota Rustaveli National Science Foundation (SRNSF) [grant number: PhD-F-17-137, Project Title: The Role of Institutions in Economic Growth and Development Models (Lessons from the Post-Soviet Union Countries)].

JEL codes: O43, P14, P20, P30

Keywords: Institutions, Economic Development, Post-Soviet Union Countries, Transition Economies

In the paper, based on the experience of the Post-Soviet Union countries, the author analyses the importance of institutions for economic development. In particular, the role of formal and informal institutions is assessed. To test the relationship, cross section as well as panel data regressions methods are deployed. In addition, to account for endogeneity in the regressions, instrumental variable approach is used. The main result is that informal institutions are more important in determining the level of economic development in our sample countries than formal institutions. Proposed explanation is that implemented reforms in formal institutions during the transition process were not consistent with informal institution, therefore reformers fails and were never adopter in practice.

When looking at post-Soviet Union countries one of the most vivid observation is that there is considerable difference in terms of economic development of these countries. On the on hand we see the countries, which have achieved the good level of development, on the other hand there are countries, which are still straggling to transform their economic and political system. The pattern is especially surprising if we will take into consideration that at the moment of the dissolution these countries were at the same level of development.  Therefore, the question which is arising naturally is that why some countries managed to achieve fast economic development over the last 25 years, while others failed to do so?

To answer the question, the author analyses the role of institutions in determination the level of economic development. Economics agree that institutions play an important role in determining the level of economic development. The main channel through which the institutions are able to do so is their ability to reduce transaction cost in an economy. However, disagreement exists about the type of institutions that matters the most. In this paper the role of formal and informal institutions is analyzed.

Under informal institutions culture, habits, world views of a society and taboos are meant. The main characteristics of these institutions is that they change slowly over time. Under formal institutions we mean constitutions, laws, legislation and other formal documents determining the roles and functions of different government entities and agencies. Unlike to informal institutions, it is relatively easy to make changes in formal institutions in relatively short period of time. As Hogson (2006) argues, in practice we often have a case when the implemented reform in formal institutions does not work. In the author’s view, the main reason is that formal institutions are not consistent with informal institutions. Therefore, in order to understand how institutional environment is formed in the country and how institutions contribute in the countries’ economic development it is important to analyze both group of institutions.

When talking about formal institutions, property rights and contract enforcement institutions are the most often discussed. As Acemoglu and Johnson (2005) argue, property right institutions are those regulating the relationship between government and private sector, since the main threat of violation of property rights come from the government. When it comes to contract enforcement institutions, they are institutions regulating relationship between two private parties and since they are not complete and completely enforceable there is the risk of opportunism from either side. Elimination of the risk requires strong institutional arraignment in the country.

After the dissolution of the Soviet Union, all former member countries were trying to transform their economic system from planned to market oriented. With the help of the international aid organizations and the governments of different countries the changes in formal institutions were more or less implemented successfully. However, in some countries newly imposed institutional changes were not consistent with existing informal institutions and the implemented reforms failed. In the second half of the countries, the institutional changes were consistent with informal institutions and therefore they managed to establish strong and growth supporting institutions right from the beginning.

In this paper, we empirically test the relationship between economic development and institutional quality based in the evidence from post-Soviet Union countries. First, we will use cross section data for the analyses. Next, to use all the information accumulated over the years main model will switch to panel regression. In the regression analyses, to address potential endogeneity and omitted variable problems we will use instrumental variable approach and additional control variables. To measure informal institutions, we will use index of rule of law from the World Bank World Governance Indicators. As an instrument for informal institutions we follow Beck and Laeven (2006) and use the years under socialism. The measure is the number of years the country was member of the Soviet Union and is meant to capture collectivism and individualism nature of a society. To measure formal institutions, we use constraints on executives from Polity IV project. As an instrument of the formal institutions we follow Eydam and Gabriadze (2018) and use the measure of institutional experience, the number of years during which the country was independent before joining the union. This measure is intended to capture the experience of self-administration and forming functional formal institutions, which could have been used as a benchmark during the transition period.

To measure the economic development of the country we use ppp adjuster GDP per capita for these countries. As an additional control different Geographic and economic measure are used in regression analysis, including absolute latitude, landlocked status, trade share in GDP and export of natural resources.

Regression analysis showed that informal institutions play more important role in determining the level of economic development in a set of post-Soviet Union countries. Therefore, if the countries want the implemented reforms in formal institutions to work in practice, they should take into consideration existing informal institutions. Also, it should be taken into account that these institutions constantly interact and their interaction determines the institutional arrangement of a country. However, one thing is to describe the existing situation and the other is to determine particular steps to change the situation and help least developed countries to achieve economic development. for this purpose, it is important to continue research to explain the causes of institutional development and change.