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INSTITUTIONS, CAPITAL FORMATION AND ECONOMIC GROWTH:THEORY AND EVIDENCEErol Türker TÜMER[1]ABSTRACTThispaper examines the role of institutions in capital formation and economicgrowth by following a two-stage approach. In the first stage, the studydevelops a growth model that reveals how institutions affect capitalaccumulation and production when capital markets operate imperfectly due totransaction/information costs. Relying on the assumption that capital marketefficiency is primarily dependent on institutional quality, the model showsthat institutional structures have notable impacts on capital formation andeconomic performance.The results derived from this model indicatethat high-quality institutions that lower transaction costs and uncertainty inthe capital market will foster capital accumulation and output production inthe long run. Moreover, the model shows that the transitional period growthrate is a function of institutional quality, thus suggesting that institutionaldifferences not only matter for long-run development but also affect short-termeconomic performance and convergence dynamics. In the second stage, the study runsa series of regressions to test these implications empirically. The resultsfrom both cross-section and panel data models reveal that the data is compatiblewith the predictions of the theoretical model. As hypothesized, the evidenceshows that institutional quality is correlated positively with income levels,growth rates, and capital formation. More importantly, empirical results demonstratethat the effect of institutions on economic outcomes is sizeable and remainsvalid even after controlling for country-specific factors and the endogeneityproblem. In the light of these results, the study concludes that to prosper anddevelop, countries, especially those lagging in economic development, shouldprimarily focus on establishing an inclusive institutional framework thatsecures property rights, maintains the rule of law, and supports politicalfreedom.Keywords: Economic Growth, Institutions, Convergence,Economic DevelopmentJEL Codes: O41, O43, O47[1] Corresponding author: Department of Economics, Faculty of Business,Dokuz Eylül University, İzmir, e-mail:turker.tumer@deu.edu.tr/turkertumer@yahoo.com.tr |
