Handbook on Contemporary Austrian Economics

Economics as the study of coordination and exchange 23
portion of the Peruvian economy. He wanted to find out why Peru
remained poor despite the fact that there was clearly entrepreneurial
activity taking place. He concluded that the formal institutions clashed
with the underlying informal institutions leading to perverse outcomes.
Formal rules and regulations stifled productive entrepreneurship as entrepreneurs
were forced into the underground economy. While informal
institutions facilitated coordination and cooperation in the underground
economy, development was limited due to constraints created by formal
institutions.
There have been numerous quantitative studies exploring the role
of institutions on economic outcomes. These studies typically analyze
the connection between institutions (captured through some aggregate
measure of institutions or institutional quality) and various outcomes. The
seminal papers in this area are by Acemoglu et al. (2001; 2002) who consider
the role of institutions in economic performance. After controlling
for a variety of variables that could potentially explain development, the
authors find that private property institutions are the main determinant
for economic performance. Along similar lines, Rodrik et al. (2004) empirically
analyze the role of institutions, geography, and trade on income.
They find that institutions trump geography and trade in explaining
differences in income across countries.
Building on this earlier work, Acemoglu and Johnson (2005) "unbundle"
property institutions. They differentiate between "contracting institutions"
(e.g., courts) that enforce agreements between private citizens
and "property rights institutions" that protect citizens from government
expropriation. They find that property rights institutions are more important
than contracting institutions for economic performance. In other
words, state expropriation through property rights violations are more
harmful to economic performance than predation by private individuals
against other private individuals. One explanation for this is that individuals
can often avoid private predation through private mechanisms or by
avoiding interaction with certain people. In contrast, when government
engages in predation, it is difficult for citizens to avoid since the scope of
government is typically broader than that of private individuals.
Empirical studies typically rely on aggregate measures of institutions
or institutional quality. For example, the aforementioned studies by
Acemoglu et al. utilize survey indicators of institutional quality from the
International Country Risk Guide (lCRG), which provides a monthly
analysis of economic, political, and financial risks for numerous countries.
The ICRG places particular focus on the risk of expropriation of
property. The Rodrik et al. study relies on the "Governance Matters"
index, which attempts to measure the quality of public service provision,