Formal Institutions and Development in Low-Income Countries: Positive and Normative Theory

This paper reviews and discusses the literature on formal institutions and development. We first discuss the mapping from institutions to economic development, with the main emphasis on the effect on economic growth. We thereafter discuss two main literatures on endogenous institutions. First, the positive literature focusing on how factor endowments, history, and political power interact, and influence, the evolution of institutions. Second, the normative theory of how institutions should be designed, taking into account both how this depends on initial institutions (which we term context dependent institutional design), and how institutional reform that is socially desirable, but meet political resistance from those with current political power, can be designed. A main shortcoming with the current literature, and at the same time the possibly most pressing policy question, regards the last point: how does one undertake institutional reform when those with current power see such reforms as against their own interests?

Author: Ragnar Torvik