Article Review

Informal institutions rule: institutional arrangements and economic performance

Author: Claudia R. Williamson (2008)

Here Williamson attempts to build on previous literature on institutional economics, looking

at various combinations of formal and informal constraints to find an institutional
arrangement that is optimal for economic development. In her article, Williamson suggests
that formal institutions must be implemented with careful attention to pre-existing informal
rules, or risk reduced economic progress.
This article expands on a framework by Boettke et al(1) built to understand how institutions
matter with regards to economic development. Williamson supplants this literature by
examining the economic effects of different institutional arrangements, which she defines as
the combination of formal constraints, informal rules, and their enforcement characteristics
Her analysis involves dividing countries into 4 quadrants based on different combinations of
institutional strength, then comparing the average GDP per capita for each quadrant.

The article uses benchmarks established by Glaeser et al (2004)(2) to quantify the strength of
formal institutions. Williamson eschews the broader, standard measures and instead focuses
on governance (pluralism, democracy and constitutional rigidity as indicators of formal
institutions). I argue that this scope is too narrow, and ignores other important institutions
such as property rights, which greatly impact economic development. Ignoring other
significant variables weakens the credibility of this analysis, and the justification given is
insufficient.
Williamson finds that there is no ideal combination of formal and informal that maximises
economic growth; they can act as substitutes or as complements, but she suggests the
successful formal institutions are always the ones that are created in accordance with
informal institutions. However, Williamson does not provide a suitable mechanism for why
exactly this might happen.
The results contribute to the claims that strong informal institutions (such as mutual trust and
obedience) are important in achieving economic growth. Countries in quadrants 1 and 2
tended to have higher GDP per capita on average.

To her credit, Williamson performs robustness checks to support these results. OLS
regression indicates the relationship between informal institutional strength and GDP per
capita is positive and highly significant. Further analysis finds that stronger formal institutions
can reduce GDP growth when informal institutions are not already established; the countries
in quadrant 4 were found to be the poorest on average. In short, the more formalized the
institutional arrangement, the weaker the economic performance.
In a wider context, Williamsons findings appear to support the development view(3), which is
that growth arises from governments unconstrained by formal rules, rather than the
institutional view that argues growth depends on formal institutions, which encourage capital
accumulation.
To conclude, the results show that institutional arrangements are complex, and that there is
no single arrangement that best promotes development. It also supports the claims of
informal institutions being beneficial to growth, which is shown to be highly significant in the
OLS analysis performed in the article. We also learn that unsuccessful formalisation can
weaken economic performance when not mapped properly to informal institutions. I agree
with the author in saying more research must be done with respect to different aspects of
formal and informal rule.

References

(1) Boettke, P., Coyne, C., & Leeson, P. (2008). Institutional stickiness and the new development
economics. American Journal of Economics and Sociology, 67(2), 331358.
(2) Edward L. Glaeser, Rafael La Porta, Florencio Lopez-De-Silanes and Andrei Shleifer (2004) Do
Institutions Cause Growth? Journal of Economic Growth, Vol. 9, No. 3 (Sep., 2004), pp. 271-
303
(3) Edward L. Glaeser, Rafael La Porta, Florencio Lopez-De-Silanes and Andrei Shleifer (2004) Do
Institutions Cause Growth? Journal of Economic Growth, Vol. 9, No. 3 (Sep., 2004), pp. 271-
303