Institutions, innovation and growth

Institutions, innovation and growth

London School of Economics

IRISStavanger, 5 May 2009

Andrés Rodríguez-Pose

Page 2Do institutions matter for regional development? Andrés Rodríguez-Pose

Introduction

Do institutions matter for innovation and growth? The link between institutions and growth has traditionally been overlooked Traditional approaches to spurring economic development were based on:

1. Greater investment in the stock of physical capital (neoclassical)2. Endogenising innovation, technology, and physical capital (endogenous growth)3. Agglomeration, externalities, and distance (new economic geography)

This system tended to work in the past1. National intervention in the postwar period had coincided with growth and a reduction in

disparities2. The first two approaches informed the European regional development effort during the

reform of the Structural Funds


Do traditional approaches still work?

These approaches, however, seem today less capable of explaining economic growth and development1. Regional convergence shifted to stability and divergence

- Cross-country convergence- Intranational stability or even strong divergence

2. Growth in the residual factor Institutions being rediscovered

1. Work by sociologists, geographers, and some economists since the mid-1980s2. Becoming mainstream in economics

- ‘Institutions matter’ (Hall and Jones, 1999; Rodrik et al, 2004)- Research now trying to understand which institutions matter - Some institutional arrangements are more appropriate than others, depending on the circumstances

(Aghion and Howitt, 2006)


Aim of the presentation

If1. We can explain less and less how economic development is being generated2. The role of institutions as a shaper of economic development is being regarded

as more prominent3. Economic development efforts have, by and large, overlooked local institutions

Ergo1. Institutions should become an essential element of development effort.

But, is that the case? If so, how can institutions be included in the local innovative and

development effort?


The role of institutions in growth

Across the world development strategies seem to be becoming less effective1. Neoclassical orthodoxies regarded as inadequate and perhaps providing imperfect

interpretations of regional development (Yeung, 2000) Growing attention has been paid to other factors and, especially

institutions Belief that different local institutional arrangements are key to our

understanding of development1. Emphasis on social capital (Putnam, 1993, 2000)2. On institutional thickness (Hudson, 1994; Amin and Thrift, 1995)3. Learning regions (Morgan, 1997)


But, what are institutions?

Concept of institutions is:1. Subjective2. Controversial3. Difficult to operationalise

Numerous nuances and distinctions in concepts1. Formal vs. informal institutions2. Informal institutions of community (norms, trust, face-to-face) vs. social

capital3. Institutions vs. organisations (rules vs. players) (North, 1990)


How do institutions promote development?

Markets as socially constructed (Bagnasco, 1988)1. This makes the role of institutions greater than simple regulators of economic

activity2. They determine the level of activity and its efficiency3. They facilitate knowledge and innovation transfer4. They shape incentives and disincentives

Different forms of institutions are in constant interaction1. The balance between formal and informal institutions (society and community)

‘Institutional thickness’ determines the development capacity of every territory


Society, community and development

Communities (Gemeinschaft or social capital) are complemented by Society

Communities refer to:1. features of group life (i.e.: informal rules and norms, tradition and

social expectations, contacts and connections, and relationships). Society refers to:

1. universal and transparent rules (i.e.: property rights, rule of law, promotion of individual choice, and factor mobility).


The economic impact of communities

The optimistic view: Communities are good for development1. Community improves:

- provision of public goods (Coleman, 1990; North, 1990) - market organisation (Granovetter, 1985)- promotes the embedding of firms in efficiency-enhancing networks of

relationships (Grabher, 1993)- generates institutions such as trust (Fukuyama, 1999; Putnam, 2000;

Bowles and Gintis, 2002)- reduces transaction costs (Storper, 1997)- reduces moral hazards and free-riding (Streeck, 1992)- mitigates information asymmetries (Granovetter, 1985; Wade, 1987)- matches individual and aggregate interests (Rodríguez-Pose, 1999)


The economic impact of communities (II)

The pessimistic view: Communities are bad for development1. Community leads to:

- pervasiveness of rent-seeking (Trigilia, 1992)- insider-outsider problems

2. unsatisfactory distributional effects- clientelism, and nepotistic practices (Trigilia, 1992)- it may be a second best solution in the absence of developed societal

institutions3. Communities may

- generate greater social polarization- hamper equal opportunity- exacerbate problems of imperfect competition, impacted information, and

principal-agent problems (Durlauf, 1999; Durlauf and Fafchamps, 2004).


The economic impact of society

The development of societal institutions is generally perceived as a positive sign

But, under certain circumstances it may be detrimental for development:1. In contexts dominated by weak group life, societal rules and laws

cannot always insure against opportunistic defection (Streeck, 1991) 2. Higher transactions costs and costly conflict resolution through

litigation, i.e. a confrontational society (Storper, 2004). 3. Inadequate production of public goods (education and training,

environmental management, or innovation)


Interaction between society and community

Society and community are thus generally viewed as mutually opposed

But they interact in all contexts Relations in any space take place in the form of:

1. ‘bonding’: within community relations2. ‘bridging’: across community relations (Putnam, 2000)

A system of checks and balances can be developed:1. Developed communities can offset the potentially negative effects of

society2. A developed society can offset the potentially negative effects of

community


Society and community interaction

Society Community Low High High Sub-optimal Optimal Low Worst case scenario Sub-optimal


Society and community (II)SOCIETY COMMUNITY LOW HIGH

HIGH Responsibility without autonomy: individual agency but insufficient voice

dominance of arms-length transactions; moral hazards contained when information

transparent only asymmetrical strength of individual agents; certain interests have no voice/no autonomy

(effort and reward markets are imperfect); costly conflict resolution and

confrontational society; insufficient public goods; tendency toward inequality;

Autonomy with responsibility: a good balance of voice and agency

costs for all kinds of transactions minimized; moral hazards contained for both transparent and

specific information; autonomy strong and participation high (strong

community reduces losses due to anonymity, fragmentation);

rent-seeking contained through competition, entry and exit (strong society modernizes communities);

LOW Neither autonomy nor responsibility: chaos and the law of the jungle (voice of the powerful, ubiquitous agency problems)

high costs for all types of transactions generalized instability: weak societal rules,

weak local bonding; high moral hazards, generalized

opportunism, low sanctions for defection and cheating;

public goods destroyed or stolen or appropriated;

Autonomy without responsibility: collective voice, but with agency problems

High transactions costs for arms-length transactions;

prevalence of primitive, non-modern communities;

rent-seeking widespread; individual voice subjugated to groups

(insufficient competition and mobility); insufficient generalized trust and confidence; skewed distribution of public goods


Integrating institutions in development

Developing and improving institutional capacity is therefore increasingly regarded as key for development

There is a need to integrate institutions in development strategies

But this is easier said than done Several factors limit the integration of institutions in

development strategies


Key problems

Measuring institutions is difficult and controversial1. Local institutional constructs tend to be intangible (Fine, 2000)2. Identical formal institutions may yield very different economic returns in different contexts

Efficient institutions are context- and geography-specific1. What is solid and efficient in one region may not be so in another2. There is a need to integrate institutions in development strategies

The effectiveness of institutions changes with time1. What are ‘good’ institutions in one period may no longer be appropriate in another (Storper,

2005)2. Institutions adapt (institutional migration)

Institutions are extremely resilient to change1. Persistence of family structures (Duranton et al., 2009)


Key problems (II)

Identifying the right mix of institutions is problematic1. More than the density of institutions…2. It is the quality of institutions

Endogeneity between institutions and development1. Direction of causality difficult to predict

Endogeneity between institutions and other constituents of growth1. Institutions may hide the effect of other factors and especially human

capital (Glaeser et al., 2004)


So, how to link institutions and innovation? With difficulty and not devoid of problems…


Approaches to the analysis of innovation

How can innovation and growth be generated? 3 traditional approaches:

1. The ‘linear model’ - Analysis of the link between R&D, patents and growth

- Fundamentally quantitative (econometric analysis)- Conducted mainly by ‘mainstream’ economists

2. The ‘systems of innovation’ approach- Analysis of the ‘territorially-embedded’ institutional networks that favour the generation of innovation- The capacity to set these networks depends in turn, on a series of social and structural conditions (‘the social

filter’) - Fundamentally qualitative- Conducted mainly by geographers, evolutionary economists, and some economic sociologists

3. Knowledge spillovers- Look at the diffusion and assimilation of innovation

- Quantitative and qualitative- Economists and geographers


Linking the approaches

Link betweeninvestment in R&D, patents,

and economic growth.(Fagerberg 1988, 1994 and 1997; Grossman and

Helpman 1991;Maurseth and Verspagen 1999)

Existence and efficiency of regional innovation systems.

(Camagni 1995, Becattini 1987, Morgan 1997 and 2004, Cooke et al. 1997, Iammarino 2005,

Rodriguez-Pose 1999)

Geographical diffusion of regional knowledge spillovers;

(Anselin et al. 1997, Adams and Jaffe 2002; Audretsch and Feldman 2003, Leamer and Storper 2001, Storper and

Venables 2004, Sonn and Storper 2005)


Linking the approaches (II)

Link betweeninvestment in R&D, patents,

and economic growth

Existence and efficiency of regional innovation systems

Geographical diffusion of regional knowledge spillovers


Innovative factors behind growthInvestment in R&D and patents, when other factors are controlled for, do not

lead to greater growthBut, social conditions

(fundamentally education)

matter

As do institutional conditions

(specialisation in clusters, focus and

diversification)

Lag 0 Constant 2.157*** 0.350 Log GDPpc 0.757*** 0.038 R&D Filter 0.009 0.008 Social Filter 0.049*** 0.005 Clusterisation Index 0.013** 0.005 R2 0.925 F 614.21 Number observations 1756


Innovative factors behind growth (II)But R&D and patents become significant

with time The social filter

(fundamentally education) remains the

most significant throughout

But institutions lose

significance in time

lag 1 lag 3 lag 6 Constant 1.956*** 1.683*** 1.392*** 0.314 0.243 0.248 Log GDPpc 0.785*** 0.853*** 0.899*** 0.034 0.028 0.028 R&D Filter 0.015** 0.017*** 0.015** 0.007 0.006 0.007 Social Filter 0.043*** 0.031*** 0.024*** 0.005 0.004 0.005 Clusterisation Index 0.011** 0.006 0.002 0.005 0.005 0.005 R2 0.932 0.947 0.968 F 582.94 705.77 1281.37 Number observations 1596 1276 796

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Institutions, innovation and growth