Institutions and investment efficiency: An empirical investigation

Nội dung text: Institutions and investment efficiency: An empirical investigation

1. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 3 Institutions and Investment Efficiency: An Empirical Investigation By Nguyen Van Phuc1 I. Introduction quality. The BERI index includes contract New Institutional Economics has enforceability, nationalisation potential, revived the important role of institutions bureaucratic delays and infrastructure on economic growth. North (1990) was a quality. Knack and Keefer run a regression pioneering work. Institutions are defined for 97 countries in the period 1974-89. The as ‘the humanly devised constraints that explanatory variables include institutional structure human interaction. They are made quality (ICRG or BERI), initial per capita up of formal constraints (for example, rules, GDP, initial human capital, average annual laws, constitutions), informal constraints (for government consumption share/GDP, example, norms of behaviour, conventions, distortion index (absolute value of deviation self-imposed codes of conduct), and their of investment price level), the number of enforcement characteristics’ (North 1994, revolutions and coups per year and the p. 360). Formal institutions are constraints number of political assassinations per year sanctioned by state power if individuals per million population in the period 1974- violate them, while informal institutions 89. To avoid possible simultaneity between are self-imposing constraints. According to growth and institutional quality, the authors North, of primary importance to economic chose the initial value of the institutional performance is the economic institutions that indices rather than the average for the determine transaction costs and influence whole period. The earliest release of BERI the incentive structure in society such as the was 1974 and that of ICRG 1982. The scale structure of property rights and the presence for BERI was from 0 to 4 and for ICRG and perfection of markets. from 0 to 10 (the higher the better). The There are now various empirical findings indicated that the ICRG index was studies on the effect of institutions on positive and highly significant across the economic growth. Most studies used cross- specifications. The BERI index was positive country regressions to determine the effect and significant for most specifications. of institutional quality on economic growth. Mauro (1995) used a different dataset of Knack and Keefer (1995) was a pioneering institutions from Business International work. Four important institutional variables (later incorporated into the Economist were proposed by Knack and Keefer (1995): Intelligence Unit). His institutional variables protection of property rights, rule of law, included corruption and bureaucratic corruption and bureaucratic quality. Such efficiency (including corruption, efficiency data were compiled from International of the judiciary system, and bureaucratic Country Risk Guide (ICRG) data, published red tape). The data were collected for the by the U.S.-based Political Risk Services period 1980-83. The dependent variable Group, and from Business Environment Risk was average per capita GDP growth during Intelligence (BERI), based in Switzerland. 1960-85. The explanatory variables included The ICRG index includes protection of initial per capita income in 1960, population property rights (expropriation risk and growth, primary education in 1960, repudiation of contracts by government), government expenditure share, revolutions rule of law, corruption, and bureaucratic and coups, assassinations, political 1 Ho Chi Minh City Open University
2. 4 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 instability, two distortion indices (absolute individuals or groups in society. Without value of deviation of investment price level institutions, it is argued that no economic and its standard deviation), dummies for exchange or cooperation can take place. It regions, and Mauro’s corruption index or is because ‘one person cannot interact with bureaucratic efficiency index. The finding another without some shared understanding was that both low bureaucratic efficiency about how the other will respond and some and high corruption exerted strong and sanction if the other responds arbitrarily and negative effects on growth. Their effects contrary to agreement. Private individuals were statistically significant. Other and businesses can only buy, sell, employ significant studies include Sachs and Warner labour, invest and explore innovations if (1997a, 1997b), Barro (1998), Brunetti et they can have some confidence that their al. (1997), Kaufman et al. (1999b), Aron expectations will be met’ (Kasper and Streit (2000). Their findings in general indicate 1998, p. 2). Without institutions, human positive effects of institutional quality on action becomes very uncertain, and hence economic growth. the existence of widespread cheating, This paper is aimed to explore a shirking, opportunism, etc. Then the different but relevant relationship, i.e., costs and risks of economic exchange and the question is how institutions affect on cooperation are so high that they become efficiency of investment. The efficiency of difficult to achieve. Institutions reduce investment is defined as the incremental uncertainty, and hence the costs and risks capital-output ratio (ICOR). The ICOR of economic exchange and cooperation by measures the additional amount of capital making human action more predictable. required to produce an additional unit of North (1990, 1994) says that institutions output. The reciprocal of ICOR measures provide a structure to everyday life. As the productivity of additional capital (Gillis a result, the effectiveness of institutions et al. 1992). The efficiency of investment in facilitating economic exchange and is vital to growth because the level of cooperation plays a major role in explaining investment alone cannot fully explain economic performance across nations. growth performance across countries. It Moreover, formal and informal institutions is noteworthy that some countries can together define the incentive structure of achieve a fairly high investment rate, but societies and economies. The incentive only slow growth. For example, during the structure guides resource allocation, and period 1961-85, Argentina, Jamaica and hence the efficiency of an economy. Zambia achieved an investment/GDP rate Institutions as defined above are as high as that of Taiwan, Malaysia and indeed very broad, including a wide variety Thailand, but could only achieve a growth of factors ranging from formal institutions rate less than a third of the latter group. to informal institutions such as culture, The main hypothesis of this paper is that religion, ideology, etc. Therefore, until quality of institutions has positive effect on now there is no integrated variable that investment efficiency. can capture all dimensions of institutions, II. Literature Review which can be used for empirical cross- 2.1. Institutions country comparison. Knack and Keefer It has been argued that mainstream (1995) pioneered using four below economics often takes institutions for indicators to capture institutional quality granted. As we know, the basis of a modern for cross-country empirical comparison. market economy is the operation of economic exchange and cooperation among
3. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 5 Protection of property rights activities. When owners of assets cannot Among the institutions that are reap all the benefits from them, they are less the main bases for a market economy to motivated to invest and to exploit them in operate in general, and for entrepreneurs the most productive way. to function in particular, property rights Third, it is argued that in societies are considered one of the most important. where all individuals hold legally protected Indeed, North and Thomas (1973), North property rights to their own labour and human (1990) and Knack and Keefer (1995), just capital, with rights to contract relatively to name a few, have argued that private freely, people will be more motivated to property rights were a factor behind the work, to learn and to accumulate expertise rise of Western capitalism. Without secured and therefore innovation and economic private property rights, a society finds it productivity will be increased. difficult to develop. Fourth, the structure of property rights Property rights to an asset are defined has implications for resource allocation in the literature as the exclusive rights to because it stipulates the incentive structure control, use, benefit from, hire out or transfer of society. In a society where property rights that asset (Kasper and Streit 1998). The asset are unsecured, individuals and organisations can be tangible (physical) or intangible (such often restrict themselves to activities that as intellectual property). Private property are ‘secured’ by the state. Most talents and rights are those of individuals and private productive resources of society find their organisations. Property rights are stressed way to rent-seeking activities and other not merely from their stipulation in law but non-productive activities rather than to also from their actual implementation. productive activities. The establishment and security of Rule of law property rights are considered to have An issue which is recognised as some important implications for investment closely related to property rights is the efficiency and economic growth. rule of law. Knack and Keefer (1995, p. First, an economic exchange is in 225) define the rule of law as a variable fact the exchange of property rights. As a reflecting the degree to which the citizens result, without proper security of property of a country are willing to accept the rights fewer transactions would take place. established institutions to make and That would mean less specialisation, less implement laws and adjudicate disputes. division of labour, and less productivity Higher scores for this variable indicate growth. Rearranging resources (through sound political institutions, a strong court market transactions) to their most system, and provisions for an orderly productive uses cannot be possible if succession of power. Lower scores mean property rights are not clearly defined, a tradition of depending on physical force secured and transferable. Transaction costs or illegal means to settle claims and that would be high and complex transactions new leaders may be less likely to accept would be restricted. Moreover, when the obligations of the previous regime. By property rights are not properly secured, this definition, we see that the rule of law the owner of an asset has to spend more and security of property rights are closely resources to exclude others from using it. associated with each other. In a country Higher exclusion costs lower the value of where the rule of law is low, we expect the property (Kasper and Streit 1998). property rights to be less secured because Second, less security of property rights laws do not exist or are not properly results in less investment and less productive enforced, and there is a high risk of the
4. 6 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 government expropriating property or efficient. Officials may refuse to deal repudiating contracts. with those whom they do not have close Corruption and bureaucratic quality relationships with due to fear of exposure. The definition of corruption used by Corruption tends to worsen the the World Bank and many scholars is the allocation of talents in society by abuse of public office for private gains. encouraging rent-seeking rather than Public office can relate to public position entrepreneurship. Bardhan (1997) and or public resources. Corruption has the Elliott (1997) argue that there are a number following detrimental effects on investment of reasons to believe there is an increasing efficiency and economic growth. return to rent-seeking, for example an increase in rent-seeking lowers the cost of Corruption is a kind of arbitrary further rent-seeking. Talents in society are tax, thereby raising transaction costs and allocated with a bias towards rent-seeking uncertainty for business activities (Gray and Kaufmann 1998; Wei 1997). Wei rather than towards entrepreneurship and (1997, p.1) argues that ‘corruption, unlike other productive activities. tax, is not transparent, not pre-announced, Corruption also tends to slow down and carries a much poorer enforcement the process of technological transfer and of an agreement between a briber and a development through cumbersome, time- bribee. In other words, corruption embeds consuming permits, licenses, customs arbitrariness and creates uncertainty.’ procedures, etc. (Mauro 1995). Permits, licenses, red tape, delays all Corruption undermines rule of law increase transaction costs and uncertainty and property rights, thereby reducing for productive activities. incentives to invest and to carry out Corruption tends to reduce government productive activities (Gray and Kaufmann revenues (Elliott 1997, Gray and Kaufmann 1998, Mauro 1995, Tanzi 1998). For 1998) because tax evasion becomes example, entrepreneurs may fear that some widespread, but it tends to increase public of the future proceeds of their investments expenditure in order to create opportunities may be claimed by corrupt officials in a for corruption. This creates fiscal problems large number of ways, hence reducing (Tanzi 1998), reducing state investments investments. With corruption, laws are often in infrastructure which are important for poorly enforced and public officials can economic growth. Corruption also reduces arbitrarily impose additional ‘regulations’ the quality of government services, and of on entrepreneurial activities. infrastructure, education and health care, Corruption exacerbates the problem of etc. (Elliott 1997). inequality and poverty. This in turn retards Corruption leads to inefficient government legitimacy (Elliott 1997, Gray resource allocation (Bardhan 1997, Gray and Kaufmann 1998). As a result, this and Kaufmann 1998). In the public sector, may lead to political instability and more corruption may shift public investments disruption for government policies and the away from the most profitable projects process of economic growth. to less profitable projects with better Overall, corruption reduces opportunities for corruption (Shleifer and investment (Bardhan 1997, Gray and Vishny 1993). In the private sector, Elliott Kaufmann 1998, Mauro 1995, Shleifer and (1997) argues that corruption favours those Vishny 1993, Tanzi 1998), including foreign with close connections with public officials investment (Gray and Kaufmann 1998; over those who may be the most productively Wei 1998), and leads to more inefficiency
5. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 7 of investment because resources are of public services provided by corrupt misallocated. As a consequence, less governments. Therefore, in addition to economic growth is achieved. the variable of corruption, this variable It is worth noting a line of argument is necessary for cross-country study to that corruption may be a kind of ‘grease’ measure ‘the efficiency of the government.’ that lubricates the wheels of a rigid The relationship between the quality of administration, helping economic activities government services and economic growth rather than hampering them (see, for is expected to be positive. The higher the example, a survey of this line of argument quality of government services, the lower in Bardhan 1997, Kaufmann and Wei 1999, the transaction costs and the less uncertainty Mauro 1995, Shleifer and Vishny 1993, that entrepreneurs face. This should mean Tanzi 1998). However, Gray and Kaufmann higher economic growth. (1998) show evidence that this is not true. It 2.2. Investment Efficiency is often thought that bribery is paid in order The efficiency of investment is defined for businesses to have less bureaucracy to as the incremental capital-output ratio deal with and acquire more privileges for (ICOR). The ICOR measures the additional their operations. Evidence in the World amount of capital required to produce an Economic Forum’s Global Competitiveness additional unit of output. The reciprocal of Survey 1997 showed that ‘enterprises ICOR measures the productivity of additional reporting a greater incidence of bribery also capital (Gillis et al. 1992). With the above tend – even after taking firm and country definition, when we think about efficiency characteristics into account – to spend a of investment, we are not thinking only of greater share of management time with profits, but generally about the new output bureaucrats and public officials negotiating (value added) that investment generates. licenses, permits, signatures, and taxes. And If we can generate more output with less the evidence also suggests that the cost of investment or with the same investment rate, capital for firms tends to be higher where we can say that efficiency of investment is bribery is more prevalent.’ (p. 8). The same higher. In the end, what we are interested evidence was found in Kaufmann and Wei in is the relative economic performance of (1999). Moreover, corruption tends to create nations. If a nation can produce more output a vicious circle of corruption - increased than other countries with less investment or counter-productive regulations and control with the same investment rate, then efficiency - and further corruption. Tanzi (1998) argue of investment is higher there than in other that corruption may induce public officials to countries. This performance will show up in introduce more leg islation which creates a lower ICOR. Thus, our empirical analysis new obstacles and more opportunities for is aimed at explaining the differences in the them to engage in corrupt practices. Indeed, ICOR across countries. some regulations are intentionally created High capital accumulation is necessary to extract bribes (Tanzi 1998, p. 582). but not sufficient for growth. Efficiency Another indicator of good governance of capital accumulation is crucial. To be is the quality of services provided by efficient, the process of accumulation the government (bureaucratic quality). must be associated with intensive efforts Although the quality of public services to imitate, learn and innovate which link tends to be highly correlated with the level accumulation to effective assimilation. This of corruption, ‘clean’ governments may is because the essential feature of catching- not provide public services very efficiently, up in developing countries is mastering and there is a wide variation in the quality advanced technologies and practices
6. 8 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 from developed countries. This process to create legal and political institutions that requires physical investment that embodies reduce the intolerable risks and uncertainties technical progress and entrepreneurship that are associated with the introduction of that can assimilate advanced technologies, new innovation and technology. turning them into efficient and competitive In general, institutions affect investment products. In this sense, countries with the efficiency because they determine transaction same investment rate can produce quite costs, and the incentive structure provided different growth rates, depending on the by institutions strongly affects resource effectiveness of assimilation. allocation to productive or rent-seeking 2.3. Institutions on Investment activities. Institutions provide structure Efficiency for human interaction, without which It is obvious from the previous entrepreneurship through imitation, learning discussion that innovation, including and innovation cannot take place. imitative innovation, is key to investment North (1990) and Niehans (1998) efficiency. Institutions are a key determinant argued that, with transaction costs, both of innovation, and thus investment the volume of transactions and efficiency efficiency. Remarkable historical studies decline. With transaction costs, distance (North and Thomas 1973, Mokyr 1990, and complex transactions may not be Rosenberg and Birdzell 1986) showed possible because the costs and uncertainty an overwhelmingly important role for that accompany them may be prohibitively institutions in innovation. Historical high. In an economy with higher transaction evidence indicated that China could not costs, efficiency is relatively lower because turn its early advantage of technologies economic exchange is more limited, and into sustained economic growth because its there are fewer economies of scale and economic, social and political environment less specialisation. More resources and did not provide a favourable incentive effort are required to produce the same structure for innovators. North and Thomas amount of output. Rearranging resources (1973) argued that efficient economic (through market transactions) to their organisation was key to the growth and most productive uses cannot be possible rise of the West. It is efficient in the sense if property rights are not clearly defined, that the system of property rights and secured and transferable. In addition, institutional arrangements give individuals Kasper and Streit (1998) argued that when incentives to innovate and conversely property rights are not properly secured, inhibit rent-seeking activities that reduce the owner of an asset has to spend more individual incentives. Economic progress resources to exclude others from using it. was the outcome of raising the private rate Higher exclusion costs lower the value of of return on developing new techniques and the property. applying them to the production process. Corruption can generate significant Rosenberg (2003) maintains that the costs for private businesses. It is a kind principal role of institutions on economic of arbitrary tax and leads to inefficient growth is that they help reduce uncertainties investment (Bardhan 1997, Gray and associated with innovations. He argues Kaufmann 1998). In the public sector, that one of the most important features of corruption may shift public investments technological innovations is a high level of away from the highest profitable projects risks and uncertainty associated with the to lower profitable projects with better innovation process. Therefore, the success opportunities for corruption (Shleifer of economic development lies in the ability and Vishny 1993). In the private sector,
7. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 9 Elliott (1997) argues that corruption through the incentive structure that guides favours those with close connections with the allocation of talent. North (1990) public officials over those who may be argued that the kinds of knowledge, the most productively efficient. Officials skills and learning that individuals in may refuse to deal with those they do not society acquire depend on the structure have close relationships with because of payoffs embedded in the institutional of fear of exposure. Corruption tends to structure. A particular institutional slow down the process of technological structure is associated with a particular transfer by cumbersome, time-consuming incentive structure that may or may not permits, licenses, customs procedures, be favourable to entrepreneurship and etc. (Mauro 1995). efficiency. According to Baumol (1990, De Soto (1989, 2000) provided 1993), entrepreneurs have profit motives, convincing evidence of the costs of so they tend to invest their talent where they corruption on economic activities. In order can get the highest returns, irrespective to measure how costly it is to do business, of productive or rent-seeking activities. he and his research team opened a small As such, efficiency and growth would be garment workshop on the outskirts of Lima, reduced with an institutional structure Peru in 1983. Their goal was to create that favoured rent-seeking rather than a new and perfectly legal business. The entrepreneurship. ‘The allocation of team spent time filling in forms, standing entrepreneurship between productive in queues, taking bus trips to government and unproductive activities, though by agencies, etc. In the process of applying no means the only pertinent influence, for the project, ten bribes were asked, but can have a profound effect on the only two were paid. The entire process took innovativeness of the economy and the 289 days. The cost of legal registration degree of dissemination of its technological was $1,231 – thirty-one times the monthly discoveries.’ (Baumol 1993, p. 40). minimum wage. In another case study, it In summary, institutions may be vital took six years and eleven months, and 207 to the efficiency of investment. Innovation is bureaucratic steps in 52 government offices the social process by which a new technology, to obtain legal authorisation to build a house idea or practice is put into use and is sensitive on state-owned land. Opening a small store to various institutional factors. The principal legally meant complying with administrative role of institutions in economic growth is procedures with three different government to help reduce the uncertainties associated departments, taking 43 days and costing with innovations. Economic progress was $590 – 15 times the monthly minimum wage. the outcome of raising the private rate of The procedure to obtain recognition for a return on developing new techniques and minibus or a taxi route took about 26 months applying them to the production process. of rep tape. The lack or ineffectiveness of a Institutions provide a structure for human formal property system drives many assets interaction that helps reduce uncertainties and businesses related to them to operate and opportunistic behaviour, thus facilitating informally. However, the costs of operating impersonal exchange, specialisation and informally are also very high. De Soto the economies of scale. The quality of (2000) estimates that the cost of operating a institutions determines transaction costs. business informally in Peru includes paying The incentive structure provided by from 10 to 15 percent of its annual income institutions strongly affects the allocation in bribes and commissions to authorities. of resources to productive or rent-seeking Another important way in which activities. Corruption increases the costs of institutions contribute to efficiency is doing business and imposes efficiency loss.
8. 10 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 2.4. Empirical Model The effect of trade openness on Having identified the possible effects investment efficiency is less clear. On of institutions on investment efficiency, the one hand, traditional trade theories we now have to test them empirically. The emphasise gains when two countries trade specification for the investment efficiency with each other. The competition from function takes the form of a regression imports applies pressure on domestic firms equation as follows: to be efficient. On the other hand, ‘infant Y = a + a X + a X + + a X + ε industry’ argument argue that some initial 0 1 1 2 2 n n protection may be justified to get dynamic Where: gains. Initial protection is needed to support Y: Dependent variable infant domestic industries, giving them the X , ,X : Independent variables time and opportunity to learn, imitate and 1 n innovate so they can be internationally a , , a : coefficients 0 n competitive later on. ε: error term Financial development The dependent variable is ICOR, The availability of finance can be measuring investment efficiency. The important to the efficiency of investment independent variables include quality because lack of finance can prohibit good of institutions. Besides the variable of projects from being implemented. The role institutions, we also include control variables of financial development on the efficiency as follows: of investment has been emphasised from Export Growth and Trade Openness the viewpoint of its positive effects on the It is argued that export expansion has allocation of resources (Kitchen 1986; a considerable effect on efficiency. The Levine 1997). Another possible channel of resource allocation effect of export has influence is that the availability of credit been predicted by comparative advantage makes it easier for Schumpeter’s innovations trade theories. With the expansion of the to be readily carried out. According to export sector, there will be resource shifts Kitchen (1986) and Levine (1997), financial between the export and non-export sector. institutions are better at evaluating and These shifts take place in order to take the selecting entrepreneurs who are undertaking best advantages of export opportunities. investment projects than individual The efficiency of resource allocation is savers, thereby increasing the efficiency reinforced by the effects of competition of investment. Financial institutions are through international markets as argued also in a much stronger position to punish by Balassa (1989), Milner (1990) and bad borrowers than individual savers. Sundrum (1994). In addition, a developing Furthermore, by punishing managers who do country often needs large amounts of not perform well in the form of withdrawing foreign exchange to finance imports of loans, cutting future loans or liquidating technologies and inputs. Without sustained firms’ assets, financial institutions exert export growth, the country will lack more discipline on firms than individual sufficient foreign exchanges to finance lenders. Levine (1997) argued that, while these essential imports, which are critical savers generally do not like risk, high-return for the effective assimilation of advanced projects tend to be riskier than low-return foreign technologies, and will hence suffer projects. Thus, by pooling financial resources reduced efficiency. Export growth speeds and risks together, financial institutions up the process of technological assimilation induce a portfolio shift toward projects with and innovation. higher expected returns.
9. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 11 Public sector educated people may be highly risk-averse, There are two main variables to capture which will reduce their entrepreneurial the effect of the public sector on the efficiency spirit. Explaining where ‘all the education of investment: public investment and public has gone’ in many developing countries, consumption. However, the general effect of Pritchett (1999, p. 24) noted several reasons public investment on the ICOR is ambiguous. why education did not have a better effect On the one hand, it is argued that public on growth: i) years of education went into investment is often influenced by political poor quality schooling that created little interests rather than by entrepreneurship, or no educational capital; ii) the supply of thus increasing inefficiency. If the quality educational capital outstripped demand so of governance is low, public investment that education had nowhere to go and the tends to be associated with high corruption returns on schooling declined rapidly; and and thus, inefficiency of investment. On iii) that newly created educational capital the other hand, public investment tends went into piracy: privately remunerative, to be focused on infrastructure or public but socially unproductive activities. utilities that are very capital-intensive and Initial per capita income have long gestation periods, thus incurring The initial level of per capita income a higher ICOR. If we take the linkage of often appears on the explanatory list in public-private investment into account, we growth regressions implied by Neoclassical see that public investment in infrastructure growth theories of diminishing returns to and public goods is important to private capital. Thus, poor countries are supposed activities, reducing the costs of private to have lower ICORs. business and thus increasing efficiency. Good infrastructure appears to raise the return on III. Data and Estimation Results private economic activities. Barro (1998) 3.1. Data emphasised that large public consumption The sample used for regression consists may have a negative effect on efficiency of 43 developing countries with available and growth. His argument is that public data, averaged over the period 1970-2000. consumption is spent on nonproductive The dependent and explanatory variables of purposes that do not improve productivity. the regression equation are as follows: Human capital The dependent variable Education is considered the most ICOR (Incremental Capital-Output important element of human capital. ratio): calculated as the ratio of the average However, according to Nafziger (1990) investment rate divided by the average the relationship between education and GDP growth rate, measuring investment efficiency is not straightforward. On the one efficiency. The lower the ICOR, the higher hand, higher education may have positive the efficiency of investment. Average, 1970- effects on entrepreneurship. Higher- 2000. Source: Author’s calculations from educated people can be more innovative, find World Development Indicators (WDI), 2003 it easier to acquire new ideas and methods, published by the World Bank. may make sounder business decisions, etc. The independent variables On the other hand, Nafziger argues that the time and money spent on formal education Ln of Initial GDP per capita (1970, may reduce the time and resources for constant USD 1995), source: WDI 2003. entrepreneurial activities. Education also Average years of schooling of total may limit entrepreneurship by giving people population over 15 years old in 1970, other occupational choices. Also, higher- proxied for human capital. To avoid possible
10. 12 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 endogeneity between education and growth, 3.2. Estimation Results we used the initial value (1970) instead Table 1 reports the regression results. of the average value. Source: Barro-Lee The first regression (I) includes quality dataset 2000. of institutions, export growth, financial Export growth rate (%), average for development, public consumption, and the period 1970-2000. Source: calculated initial per capita income. In the second and from WDI 2003. In addition, we also test third regressions (II) & (III), we replace with Trade/GDP ratio (%) and the openness export growth by trade/GDP share and index (1965-90) constructed by Sachs and Sachs-Warner openness index, respectively. Warner. Trade/GDP ratio (%) is the average In the fourth regression (IV), the variable on for the period 1970-2000. Source: calculated education – initial years of schooling – is from WDI 2003. included. The results indicate that quality Public consumption: general of institutions and export growth have a government final consumption strong positive and significant effect on expenditure (formerly general government efficiency of investment (negative effect consumption), including all government on the ICOR) while initial per capita GDP current expenditures for purchases of goods and public consumption have a significant and services (including compensation negative effect on efficiency of investment. of employees). It also includes most Education, financial development, trade and expenditures on national defence and openness do not have a significant effect on security, but excludes government military efficiency of investment. expenditures that are part of government The effect of the quality of institutions capital formation. The variable is the general on investment efficiency is statistically government final consumption expenditure/ significant and positive as expected. The GDP ratio (%), averaged for the period 1970- magnitude of the effect seems substantial. 98. Source: calculated from WDI 2003. A one point increase in the index of quality Institutions (Institutional quality): of institutions is associated with a 1.0 to 1.8 Average for four indicators: protection of point decrease in the ICOR. For example, property rights (government repudiation of the difference of the index of institutional contracts, risk of expropriation), corruption, quality between Malaysia (7.5 points) and rule of law, bureaucratic quality. 1984 was Peru (3.3 points) is 4.2 points, which makes chosen as the earliest year. The higher the Peru’s ICOR higher by 4.2. to 7.6 points index, the better the quality of institutions compared with Malaysia. The ICOR of (scale from 0 to 10). The data are from the Malaysia is just 4.2 while that of Peru is International Country Risk Guide compiled 8.3, which implies that, in order to achieve by Knack and Keefer (1995). the same growth rate, the investment rate in Peru should be nearly twice higher than that in Malaysia. Table 1 Regression results – Dependent variable: ICOR (Developing countries, 1970-2000) Explanatory variable: (I) (II) (III) (IV) Constant -6.850 -10.108 -10.180 -5.637 (-1.35) (-1.97) (-1.98) (-1.38) Log of initial per capita GDP 2.111 2.188 2.164 1.468 (3.09) (2.91) (3.09) (2.12) M3/GDP ratio (Initial) -0.026 -0.017 -0.019 0.029 (-0.38) (-0.23) (-0.27) (0.89) Public consumption/GDP ratio 0.606 0.647 0.787 0.473 (2.06) (2.05) (2.79) (2.83)
11. Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 13 Export growth rate -0.422 -0.450 (-2.03) (-3.32) Trade/GDP ratio 0.027 (0.87) Sachs-Warner openness index 2.303 (1.05) Years of schooling (initial) 0.595 (1.51) Quality of institutions -1.240 -1.698 -1.810 -1.027 (-2.09) (-3.15) (-2.97) (-2.35) Number of observations 43 43 43 37 R2 0.5064 0.4730 0.4720 0.6247 Source: Author’s estimation. Notes: Heteroscedasticity may be existent in cross-country data, so the standard errors for the coefficients are based on White’s (1980) correction method. Numbers in parentheses are heteroscedastic- consistent t-statistics. ( ) means significant at 1% level, ( ) at 5% level, (*) at 10% level. We also tried the tests with inflation, public investment (as % of GDP) and public capital (as % of total public expenditure), terms of trade, and debt service ratio by adding them as explanatory variables in the above regressions, but they are statistically insignificant. Export growth also has a significant and effect on the efficiency of investment. This positive effect on efficiency of investment, result is unexpected given our emphasis on as expected. One percentage point increase the role of human capital. But the empirical in the rate of export growth is associated fact in many studies is that education is not with over a 0.4 point decrease in the ICOR. closely associated with growth performance. For example, the difference in export growth Cross-country growth empirical studies between South Korea (16%) and Algeria have not shown a strong and consistent (3%) decreases South Korea’s ICOR by over effect of education on growth. However, 5.0 points compared with Algeria. The ICOR it should be noted that the data of average of South Korea is 4.1 while that of Algeria is years of schooling cannot include training 8.4, which implies that, in order to achieve (i.e., out of formal school), learning-by- the same growth rate, the investment rate in doing and experience which the concept of Algeria should be more than twice as high human capital encompasses. It also ignores as that in South Korea. the quality dimensions of schooling, such Nevertheless, the trade/GDP share as input of teachers, substance of teaching, and openness index are not statistically etc. Due to these reasons, average years significant. This implies that the positive of schooling may be a poor indicator for effects of openness cannot outweigh its international comparison of human capital negative effects on efficiency. This is quite even though it is the best proxy available for possible, given the above argument about this purpose so far. the mixed effects of trade on efficiency of Initial financial development does not investment. have a significant effect on the efficiency Public consumption has a negative and of investment either. Initial per capita GDP significant effect on investment efficiency. shows a positive and significant relationship A ten percentage point rise in the public with the ICOR. This confirms the hypothesis consumption/GDP share tends to associate of diminishing returns to capital. with a 4.7 to 7.9 point increase in the ICOR. IV. Conclusions As such, if governments save and spend This paper reviews the relationship efficiently, ICOR improves, but if they do between institutions and investment not, ICOR worsens. efficiency. Theoretically, quality of Average years of schooling, used as institutions can have significant effects proxy for education, do not have a significant on investment efficiency, thus economic
12. 14 Ho Chi Minh City Open University Journal of science- No. 1(1) 2011 growth. There are many empirical studies Doing Business: Data Description on the relationship between institutions and Methodology of a Worldwide and economic growth, but it is hard to Private Sector Survey’, World Bank find a study on the relationship between Policy Research Working Paper, No. institutions and investment efficiency. This 1759, April. paper is an endeavour to fill in this gap. The Brunetti, A., Kisunko, G., and Weder, B. main conclusion from this study is that the (1998), ‘Credibility of Rules and quality of institutions has strong positive Economic Growth: Evidence from effect on investment efficiency. Statistically, a Worldwide Survey of the Private a one point increase in the index of quality Sector’, World Bank Economic Review, of institutions is associated with a 1.0 to 1.8 Vol. 12, No. 3: 353–84. point decrease in the ICOR. The implication De Soto, H. (1989), The Other Path: The is that developing countries must improve Invisible Revolution in the Third the quality of institutions to achieve better World, New York: Harper & Row, investment efficiency and higher economic Publishers. growth. The principal components of institutions which should be focused on De Soto, H. (2000), The Mystery of Capital: Why Capitalism Triumphs in the West include protection of property rights, rule and Fails Everywhere Else, New of law, to reduce corruption and to improve York: Basic Books. bureaucratic quality. Elliott, K. A. (1997), Corruption and V. References the Global Economy, Washington, Balassa, B. (1989), Comparative Advantage, DC: Institute for International Trade Policy and Economic Economics. Development, New York: Harvester Gillis, M., Perkins, D. H., Roemer, M. and Wheatsheaf. Snodgrass, D. (1992), Economics of Bardhan, P. (1997), ‘Corruption and Development, New York and London: Development: A Review of Issues’, W.W. Norton & Company. Journal of Economic Literature, Vol. Gray, C. W., Kaufmann, D. (1998), XXXV, September, pp. 1320-46. ‘Corruption and Development’, Barro, R. J. (1998), Determinants of Economic Finance & Development, March. Growth, Cambridge, Massachusetts Kasper, W. and Streit, M. E. (1998), and London: MIT Press. Institutional Economics: Social Order Baumol, W. J. (1968), ‘Entrepreneurship and Public Policy, Cheltenham, UK: in Economic Theory’, American Edward Elgar. Economic Review, Vol. 58, pp. 64-71. Kaufmann, D., Kraay, A., and Zoido- Baumol, W. J. (1990), ‘Entrepreneurship: Lobaton, P. (1999a). ‘Aggregating Productive, Unproductive, and Governance Indicators’. World Bank Destructive’, Journal of Political Policy Research Department Working Economy, Vol. 98, October, pp. 893-921. Paper No. 2195, Washington, D.C.: Baumol, W. J. (1993), Entrepreneurship, World Bank. Management, and the Structure of Kaufmann, D., Kraay, A., and Zoido- Payoffs, Cambridge, Massachusetts Lobaton, P. (1999b). ‘Governance and London: the MIT Press. Matters’. World Bank Policy Research Brunetti, A., Kisunko, G., and Weder, B. Department Working Paper No. 2196, (1997), ‘Institutional Obstacles for Washington, D.C.: World Bank.
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