Yuri Pleskachev on the pitfalls of interpreting the impact of institutions on economic growth

Yuri Pleskachev said that the impact of institutions on economic growth is recognized as one of the leading topics in economic science, but research findings are often ambiguous, and interpreting the results requires accuracy and consideration of many factors.

He noted that economic institutions create incentives for investment in physical and human capital and contribute to the organization and development of production, which underlies the differences in long-term economic growth between countries. Indicators of institutional quality also include political, economic, and social components (legal system and property rights, bureaucracy, corruption, etc.). Their comprehensive measurement is difficult due to differences in methodologies and scales.

The expert analyzed in detail the main pitfalls in interpreting the impact of institutions on economic growth:

1. Error in cause and effect (endogeneity). Economic growth can have a positive impact on institutions, and not just institutions on growth. To combat endogeneity, researchers have used various instrumental variables. But the instruments themselves have often been criticized. Therefore, it cannot be unconditionally asserted that the influence of “institutions → growth” is unidirectional.
2. Measurement errors. Most empirical studies use aggregate indices (WGI, Polity, etc.). These indices combine expert assessments, surveys, and indirect indicators—each component has its own measurement error and conceptual heterogeneity.
3. Ignoring contextual specifics. The impact of institutional quality on economic growth varies depending on a country's income level, political system, distribution of power, and cultural characteristics. Universal indices and indicators do not reflect these nuances, which reduces the validity of large cross-country comparisons and recommendations based on them.
4. Missing variables. Geographic factors, endemic diseases, natural resources, and historical characteristics can simultaneously influence both institutions and economic growth. Some studies have shown that these variables have a significant impact on growth only through the channel of institutions, but it is important to note that this may be true for specific samples and historical periods, and that the correct control variables must be used. Otherwise, the effect of institutions may be overestimated or, conversely, underestimated and hidden.
5. Simplification of models and ignoring complex interactions between institutions. Models often consider the impact of a single institution in isolation, without taking into account that the institutional environment is a system of interdependent elements (property rights, the judicial system, corruption, the regulatory environment) whose interactions can significantly alter the impact on economic growth. Institutions change over time, and their impact on the economy evolves, but most studies use static models of analysis, which limit our understanding of the mechanisms and pathways of institutional development. The literature also tends to oversimplify institutions by dividing them into “good” and “bad,” which ignores the complexity and interdependence of social and economic processes and reduces the ability to understand and analyze institutional dynamics, including transitional stages of development.
6. A one-sided view of institutional effectiveness—overestimating formal costs and underestimating hidden or “service” benefits. Reforms and empirical measurements often focus too much on reducing costs and procedures (e.g., business registration), ignoring the role of institutions as providers of important services that reduce future transaction costs. This leads to the erroneous conclusion that reducing procedures is always positive, when in fact reducing procedures can worsen the quality of services and increase hidden costs for businesses and the state. The pursuit of quick results in the form of simplifying procedures (as exemplified by Doing Business) often leads to superficial policy recommendations without a deep understanding of local institutional conditions and possible side effects. It is also important to emphasize the importance of informal norms, social ties, and trust, which can play a decisive role in economic interaction and growth, especially in the context of weak formal institutions.

Yuri Pleskachev noted the need for a comprehensive approach. To adequately understand the impact of institutions on growth, it is important to use panel data, methods to combat endogeneity, take into account institutional and cultural hierarchies, and conduct cross-country comparative analysis that takes into account differences in development, avoiding oversimplification and methodological errors.