Why can institutional development be an important cause of economic growth, and what role does geography play in this process?

When looking at the impact of institutional development on economic growth, geographic conditions also play an important role. Institutions promote social stability and innovation, and geographic conditions can have an indirect or direct impact on economic performance.

 

Many economists have considered the development of institutions to be an important cause of economic growth. This has been an important argument because institutions provide the legal and political framework of a society, ensuring predictability and stability of economic activity. For example, a well-developed property rights system helps to reward investment and innovation, which in turn helps economic growth. In particular, in societies with more stable institutions, companies can devote more resources to developing new technologies or engaging in productivity-enhancing activities, and such innovation is an important factor in fostering economic growth.
However, this is not easy to prove. Even if there is a correlation between the level of institutional development and income levels, it is difficult to determine causality because institutions can affect economic growth, but they can also be affected by economic growth. For example, it is possible that as a country becomes economically wealthier, it can afford to build better institutions, which in turn leads to better economic performance, creating a virtuous cycle. The relationship between institutions and economic growth is complex and multifaceted, with no single cause and effect.
Understanding the relationship between institutions and economic growth is further complicated by the fact that the development of institutions can vary depending on a country’s historical context, cultural characteristics, political stability, etc. For example, countries that experienced colonization may have a profound impact on their current institutional landscape, which may shape a different trajectory for economic growth. In this context, it is important to look at institutions not as a single variable, but as a product of historical processes. However, recent statistical evidence has shown that countries’ income levels are strongly correlated with geographic conditions such as latitude and climate. Unlike institutions, geographic conditions are not affected by income levels. This has led to a persuasive interpretation that geography affects economic growth through direct channels, such as people’s health and productivity. In particular, unfavorable geographic conditions, such as high rates of disease and inhospitable soils in tropical regions, are often cited as major factors inhibiting economic development.
Institutional economists have noted that if geography is a direct cause, then countries with more favorable geographic conditions for economic growth should have higher income levels, but in many cases they do not. To explain both the “correlation between geographic conditions and income levels” and this “reversal in income levels,” they argue that institutions are the direct cause of economic growth and that geographic conditions are related to economic growth through an indirect pathway that influences the direction of institutional development. In other words, geographic conditions are not the direct cause of current economic growth. Rather, geographic conditions have influenced a historical process called “institutional inversion,” whereby institutions have developed in ways that are unfavorable to economic growth in better-off regions and favorable in poorer regions.
Even scholars who emphasize the direct impact of geography now recognize the existence of indirect pathways. However, the position remains unchanged that the direct route is the more important and lasting influence on economic growth. The argument is compelling because past and present examples show that geography plays an important role in shaping the economic structure of societies as a whole. Moreover, an integrated view that institutions and geography can interact and contribute to economic growth in complex ways is becoming increasingly important. These complex relationships require more sophisticated analysis to understand the path of economic growth in a given country or region. Rather than understanding the determinants of economic growth as a single factor, a multifaceted study of how institutional and geographic factors influence and interact with each other is needed.