Institutional infrastructure and economic performance: Levels versus catching up and frontier shifts

We analyze the relationship between institutional infrastructure (capturing political stability, quality of government and social infrastructure) and overall country productivity for a sample of 57 (OECD and non-OECD) countries. Specifically, we compare empirical results for alternative productivity measures: output per worker and total factor productivity (TFP); in addition, we consider both levels and changes, where we decompose TFP changes into efficiency changes and technical changes. This gives us insight into the different channels through which the institutional infrastructure impacts on overall productivity performance: the 'accumulation' of production factors versus the 'accommodation' of production factors, and the 'shifting' of the world productivity frontier versus the 'catching up' with this frontier. In line with the existing literature, our results suggest a substantial accumulation effect: good institutions enhance capital accumulation. In addition, we find significant evidence in favor of an accommodation effect (in terms of both levels and changes), which elicits institutional quality as a 'lubricant' of the economic system: good institutions facilitate complex transactions, specialization and flexibility while reducing transaction costs. Interestingly, we find that good institutions enhance technical change as well as efficiency change. Conveniently, the decomposition of TFP change also allows us to interpret the convergence issue, for which largely inconclusive evidence is obtained on the basis of a combined TFP measure. Our findings reveal that efficiency change is associated with convergence, i.e., countries with lower initial productivity realize higher productivity growth through catching up. By contrast, technical change corresponds to divergence, i.e., countries with higher initial productivity succeed in higher productivity growth through shifts of the technological frontier. One possible rationalization is that greater experience with technological innovation (i.e., a closer situation to the world technology frontier) benefits the implementation of new products and processes (i.e., the cost of additional innovations falls).status: publishe