The Growth Effects of Institutional Instability

We study the effects of institutional instability on growth. Using principal components analysis, we construct measures of institutional quality and instability from the political risk index of the International Country Risk Guide. A panel-data analysis of 132 countries during 1984–2004 reveals that institutional quality, especially with regard to the legal system and the protection of property rights, is positively linked to growth. As for institutional instability, we find evidence of a positive relationship in rich countries but a negative link in poor countries, suggesting that instability may reduce problems of institutional sclerosis in the former and that instability primarily entails an increase in transactions costs and uncertainty in the latter.