Working Paper: CEPR ID: DP6735
Authors: Patrick Francois
Abstract: This paper analyzes the dynamic interaction between norms - internalized restraints on opportunistic behaviour - and institutions - restraints on such behaviour deriving from external enforcement. When individuals following a norm suffer pecuniary losses to doing so, the norm is eroded. Institutions, on the other hand, are strengthened when institution designers are rewarded for improving them. The dynamic interaction between these two factors leads to both good steady states with functioning institutions, widespread norm compliance, and trade, and bad steady states where trade breaks down, institutions are dysfunctional and beneficial norms are violated. The model here shows the situations that lead economies to converge on good steady states rather than bad ones; why countries with a history of institutional success are more likely to be successful in future, why countries with a history of failure will require better institutions to achieve even the same level of compliance, and why functional institutions may not be readily transplated from successful to unsuccessful countries.
Keywords: economic development; institutional change; social norms
JEL Codes: O17; O43; Z10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| adherence to norms (F55) | formation of functioning institutions (D02) |
| formation of functioning institutions (D02) | trust (G21) |
| trust (G21) | trade (F19) |
| high initial levels of trust (Z13) | increased trade (F19) |
| increased trade (F19) | exposure of institutional shortcomings (I24) |
| exposure of institutional shortcomings (I24) | demand for improvements (R22) |
| lack of trade (F19) | no political or economic demand for institutional development (O17) |
| mistrust (D83) | lack of trade (F19) |
| lack of trade (F19) | stagnation (D50) |
| history of institutional success (B15) | maintenance of success (L21) |
| history of failure (N80) | barriers to developing effective institutions (O17) |
| functioning institutions and norm compliance (F55) | good steady states (C62) |
| dysfunctional institutions and norm violations (P37) | bad steady states (C62) |