Why institutions matter for economic growth

If you want to predict the prosperity of a country, just look at its institutions. Together, the legal and administrative organizations that underpin every society form what we economists call an “enabling environment” for the creation of wealth. When they fail, trust is eroded and economies can become damaged, as Ricardo Hausmann recently suggested. Collaboration between public and private sectors is particularly important when it comes to boosting productivity. But in the absence of strong institutions the alliance can become dysfunctional, with both sectors colluding in the pursuit of profit at the expense of the consumer.

Hausmann is right to argue that a healthy relationship between business and government should be a priority for an economy at any stage of its development. Here, institutions are key in establishing such a long-term agenda, allowing for public-private collaboration in the public interest, free from the vagaries of the legislative cycle. However, Hausmann is not correct to assert that insufficient recognition is awarded to institutions on which such a successful symbiotic relationship depends, including in the World Economic Forum’s Global Competitiveness Report, our annual assessment of the economic health of more than 140 economies. The fact is, national institutional frameworks have had a pivotal influence since we began measuring competitiveness in 1979.

How do we measure the importance of a country’s enabling environment for long-term economic health? The answer is through a blend of quantitative data, taken from leading agencies such as the United Nations, World Bank or OECD, as well as subjective responses from more than 15,000 top executives around the world, who respond every year to our proprietary Executive Opinion Survey. This approach allows us to measure the relative strengths and weaknesses of economies across a total of 112 separate indicators.

Most of these 112 indicators are influenced by public and private institutions – some directly, others less so. The first and most basic pillar (there are 12 in total) on which we assess an economy is dedicated to institutions, providing 16 different measurements, including observance of ethics, levels of corruption, and government efficiency and accountability.

Without strong institutions, progress in the other 11 pillars would not be easy either: the quality of electricity provision in the Infrastructure pillar, for example, or the local availability of specialized research and training in the Higher Education and Training pillar.

For those countries at the upper end of the development spectrum, institutions play an important role in maintaining economic health and keeping public-private collaboration on track, whether it is through the encouragement of industry clusters (pillar 12, Business Sophistication) or better collaboration between universities and businesses (pillar 12, Innovation).

We do this not so much out of intellectual curiosity, but to create a practical guide that will help countries make informed decisions about how to improve their economic performance. In the almost 35 years that the Forum has been measuring competitiveness, we have found, unsurprisingly, a marked correlation between those countries that have strong institutions and those that regularly appear towards the top of the Global Competitiveness Index. Out of the Nordic economies, for example, where standards of corporate ethical behaviour are generally higher, we see Finland, Denmark and Norway in the top 10 of the related indicator of the index. Nordic countries also fare well in terms of trust and the integrity of politicians – another condition for effective public-private collaboration.

Raising awareness of the importance of public-private partnerships has led to the creation of a number of National Competitiveness Councils and enabled the Forum to work with countries in every region of the world, putting in place the long-term determinants for productivity and prosperity. One such collaboration, our Competitiveness Lab in Latin America, will present key recommendations this month at our Annual Meeting in Davos.

However, indexes only work for as long as they are relevant, which is why the Global Competitiveness Report 2015-2016 will feature a revised methodology, sensitive to the world’s evolving economy and the changing nature of innovation. Public and private institutions will continue to play a central role in our assessment, as without them long-term economic growth remains out of reach.

Author: Margareta Drzeniek is Director and Lead Economist, Global Competitiveness and Benchmarking Network, World Economic Forum.

Image: A man looks at the Pudong financial district of Shanghai November 20, 2013. REUTERS/Carlos Barria