Structural policies and growth: Time series evidence from a natural experiment☆

a r t i c l e i n f o Documenting the long term impact of structural policies on economic performance has generated tremendous interest in the development literature. In contrast, contemporary effects of structural policies are difficult to establish. Structural policies seldom change sufficiently in the short run, and accepted instruments to control for endogeneity in cross sections are inappropriate for time series analysis. In this paper we utilize an eleven year panel of 26 transition countries to identify short term effects of structural policies that are large and significant. A ten percent change in the quality of structural policies (or the Rule of Law) towards OECD standards is shown to raise annual growth by about 2.5%. To control for endogeneity, we develop an instrument using the hierarchy of institutions hypothesis and find that it holds a robust explanatory power. We also document that early reformers reap the greatest benefits, but that it is never too late to begin structural policy reforms. A growing strand of the empirical growth literature focuses on the explanatory power of structural policies or institutions to account for differences in living standards across countries. 1 In general, structural policies evolve slowly, and empirical studies focus on their long term influences on income levels (e.g., Hall and Jones 1999; Acemoglu et al., 2001). 2 Instead of examining long term effects of structural policies that are captured in cross sections, we investigate their contemporary short term effects on economic growth in a panel of countries. Two issues have prevented researchers from identifying the growth effects of structural policies. A panel approach requires a sufficiently large variation not only in structural policies, but also in the relevant instruments that are necessary to control for endogeneity. Generally this variation does not exist in the data. We resolve both issues by utilizing the fall of the Iron Curtain as a natural experiment that allows us to examine how communist-to-capitalist system changes are associated with rapid changes in structural policies that catch up to OECD standards. The fall of the Iron Curtain provides a unique controlled, or natural, experiment in that the initial institutional change is clearly exogenous, which potentially mitigates the endogeneity bias. It also provides a unique opportunity to analyze the impact of subsequent structural policy changes on growth in a sizeable number of countries, with similar initial conditions, over the same period of time. The overriding …