Measuring the Institutional Environment

23 March 2007 at 9:39 am 1 comment

| Peter Klein |

An central problem in empirical research on institutions is the difficulty of measuring key attributes of the institutional environment. Secure property rights, respect for the rule of law, transparency, free markets, norms of fairness and reciprocity, and similar characteristics are held to be critical for economic development. But how do you know them when you see them?

Most of the literature has used indicators derived from secondary data, such as the economic freedom measures produced by the Fraser Institute and Heritage Foundation, Witold Henisz’s polcon database, the World Bank’s database of political institutions, various indexes of shareholder and creditor rights compiled by the La Porta gang, and the like. These measures have much to recommend them, but may proxy only indirectly for the real institutional constraints of interest.

This paper by Jan Svejnar and Simon John Commander takes a different approach: it asks. The authors use primary data from the Business Environment and Enterprise Performance Survey (BEEPS), in which managers of several thousand firms in 26 transition countries are asked for their subjective perceptions about tax and regulatory policy, uncertainty about regulatory change, macroeconomic stability, the effectiveness of the judiciary, corruption, crime, infrastructure, and other institutional characteristics. (The authors conclude that most of the variation in firm performance is explained by time-invariant country fixed effects, and that individual institutional variables have little explanatory power, suggesting that existing studies using secondary measures of institutional characteristics may overstate their effects.)

Entry filed under: - Klein -, New Institutional Economics.

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1 Comment Add your own

  • 1. Bo  |  24 March 2007 at 9:14 pm

    This is a very interesting discussion. In a paper to appear later this year in JIM, we have used one of the aforementioned secondary sources (in this case the Kaufmann indices) to measure institutional risk – or macro governance as we call it – in a study of Danish firms IJV and FDI behavior. During this research it became clear that there is a significant difference between “perceived” insitutional risk and “country-level” risk. Unfortunately, our primary data could not adequately account for the perceived risk of the institutional investment climate, however, we did find some very interesting relationships to other perceptual measures, such as trust, cultural distance etc. in terms of Danish firm’s inclination to chose equity over non-equity types of investments. In fact, by splitting our sample into “high and low governance countries” based on the secondary insitutional values, we found some interesting differences pointing to the same sort of concluion as above – the potential for overstating the effects of secondary institutional variables.

    It should also be noted that most of these secondary insitutional variables are extremely highly correlated – in fact in our study we collapsed 6 measures into one – macro environmental governance – as using them independently did not make much sense…

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