The impact of institutions on economic growth: Evidence for advanced economies and Latin America and the Caribbean using a panel VAR approach

Abstract

This study aims to empirically investigate the impact of institutions on economic growth in advanced economies and in Latin America and the Caribbean. We use a Panel Vector Autoregressive Model (PVAR) for 42 countries from 1970 to 2019 and estimate orthogonalized impulse-response functions to assess the impact of political and economic institutions on the growth rate of gross domestic product per capita. We also control for gross capital formation and trade openness. Our results indicate that the average growth rate responds positively to exogenous shocks in institutional performance, and the response to shocks in political institutions is higher in Latin America and the Caribbean than in advanced economies. Also, in Latin America and the Caribbean, shocks to economic growth can reduce the quality of political institutions, signaling a vicious circle of institutions. Furthermore, we find evidence of unidirectional Granger causality running from economic growth to political institutions in Latin America and the Caribbean and bidirectional Granger causality from economic institutions to the growth rate in both groups. Therefore, improvements in the institutional environment provide better economic performance, and these effects change according to the income level of economies. Thus, policymakers who aim to stimulate economic growth, especially in emerging economies, must improve the main components that determine the institutional environment and strengthen democratic foundations, such as political and property rights, regulatory systems, and commercial and financial openness, among others.