There is no exact definition of institutions; however a commonly used one is North’s (1990), defining them as “institutions are the rules of the game, whilst organisations are the players. The players can consist of groups that are bound by a common interest, be it economic, social political, or educational. The evolving roles of the players are influenced by the rules that govern the game. But they, in turn, affect the evolution of the rules.”
Institutions can come in many different forms, from political institutions to social norms and traditions to property rights or rules of law. These institutions will have two main influences on an economy: economic growth and income distribution. This is because they determine investment and productivity, which in turn determines the wealth of a nation. Two examples of countries that have experienced large change in institutions that have led to growth miracles or disasters are Japan and Argentina. Until World War 2 Japans’ income remained at 25% of that of the US, today, Japans’ income is roughly 2/3 of that of the US; this means that in the past 70 years Japan has been growing a lot more rapidly than the US. Argentina is the opposite example, in the nineteenth century it was as rich as most western European countries where as today this is far from being the case. This is due to disastrous policy reforms such as those of Juan Peron.
If we analyse the world as a whole, we can simply count the number of growth disasters and growth miracles over the past 40 years. If we compare this to the long run average we can see that the in the past 40 years the frequency of growth miracles has been higher than the long run average and that the frequency of growth disasters has been lower. A possible explanation for this is that economies are slowly discovering what types of institutions favour economic growth. Perhaps it is the increase in the wealth promoting institutions and social infrastructures that have led to the continuous increase in income distribution. There is no reason to think that institutions have reached their limit, they are likely to keep on evolving and improving to amiliorate income distribution even further. “Institutions themselves are simply ideas, and it is very likely that better ideas are out there waiting to be found” (Introduction to economic growth, Charles I. Jones and Dietrich Vollrath, p177).
We can see that there are many different factors that will determine if institutions in an economy will be successful, one of these is the geography of a country. A countries’ population density in 1500 hand an effect on whether they were colonised or not. As Acemoglu, Johnson and Robinson (2002) suggested, countries with a high population density encouraged colonisation. People wanted to extract resources from them. In these countries the institutions that were formed were extractive, in favour of the land owners (the rich). This has increased the De facto political power, increasing inequalities. Countries that had low population in 1500 made them attractive to European settlers. Once they settled in a region in large numbers they had incentives to establish institutions that provided a broad protection for themselves of property rights and broadly distributed political power, thus, decreasing inequalities. When the industrial revolution came along the extractive economies deterred whereas the later prospered. The results of colonisation on institutions are still visible today as some favour economic growth and some do not.
The type of political power will have a large effect on institutions. Przeworski and colleagues believe that democracies grow at greater rates than autocracies. However the Modernisation theory argues that