Sebastian Petric








Jan 2019 - Sept 2020

By Sebastian Petric

Institutions and Vulnerability to Crises

After the first week of the Executive MBA at the University of Oxford, I would like to briefly summarise my impressions and write a short note on a subject we touched upon in our course work: “Institutions”. Classes ranged from statistics to Global Rules of the Game by Prof. Akshay Mangla. In particular, the latter class resonated with me as I am an emerging market investor and strategist in my professional life and the institutional quality of countries is one of the factors that actually makes a difference.

Many financial market observers speak of a weak institutional set-up without knowing the core. ‘Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction’ (North 1990: 3). Indeed, output volatility and economic performance are inevitably linked to the quality of an institutional set-up. This is one reason why many fail to predict crises. It is a misguided belief in financial and economic drivers as the sole explanatory factors of outcomes.

Foremost, the weakness of institutions in developing countries make them particularly vulnerable to crises and thus, the institutional dimension is one key determinant. In contrast to structural variables, which refer to the abilities of a country, institutional determinants constrain nations in their actions. Given historical examples, the latter is a crucial factor in analysing crises. Institutional strengths and weaknesses make a difference in the long-run trajectory of a country as these variables set the guidelines for the growth trajectory of a nation through both the effective accumulation of productive factors and through the prevention of diversion and predatory rent-seeking. Thus, institutions form the backbone of sustainable growth (Ngai 2015).

Indeed, according to Olson (1996: 20), poor institutions is the single most important factor holding back developing countries from catching-up with the developed world. Consequently, it is vital for a society to discourage predatory behaviour and foster an environment of inclusive growth by establishing effective institutions. The question that emerges is why does the growth trajectory of many countries significantly diverge. Part of the puzzle is related to institutions. For instance, Weil (2008: 193) attributes the Asian growth miracle primarily to factor accumulation, namely high investment rates directed by a strong state-sector as well as decent population growth. However, factor accumulation by itself does not lead to a sustainable growth path due to diminishing marginal returns.

Therefore, the build-up of inclusive institutions is key for this region, as well as fostering innovation and entrepreneurship (Ngai 2015). Indeed, the institutional system of a country can determine whether the nation ends up in poverty or prosperity or suffers from political turmoil. Empirical research links the quality of institutions to the income of a country and the effects are non-negligible. The quality of institutions in developing countries is particularly poor and thus the gap between advanced economies and the latter with respect to the quality of institutions is often termed ‘The Great Divergence’ (Kaufmann et al. 2006). However, it takes a relatively long period of time to build an inclusive institutional system and governments play a crucial role in this respect. Therefore, I am looking forward to our trip to India, where we will further explore this topic!

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