| The main goal of this study is to examine the role of institutions in the economic performance of developing countries. Specifically, this study investigates the relationship between institutional quality and economic performance in two respects: first, the study explores the effect of poor institutional quality on returns to capital and growth; and second, the study investigates the impact of the interaction between poor institutional quality and increased openness to trade on growth. The primary hypotheses of the study are: poor institutional quality adversely effects both returns to capital and growth; and poor quality of institutions adversely affects growth through increased openness. The study uses the theoretical framework developed on the lines of Annett (2000) and Shleifer and Vishny (1993).; The empirical analysis utilizes cross-country data comprising of a sample of 42 developing countries observed over three periods: 1980--1985, 1985--1990, and 1990--1995. The equations are estimated using Generalized Least Square (GLS) method. The results are statistically significant and support the underlying hypotheses.; This study presents two important implications for developing countries. First, corruption biases bureaucrats toward present consumption instead of productive investments, which in turn negatively affects returns to capital and growth. Second, trade liberalization policies may not be effective in countries with poor institutional quality. Increased openness to trade could encourage corrupt bureaucrats to demand more rents from private agents, leading to a diversion of resources from productive sectors to unproductive areas. In this regard, poor institutional quality has a negative impact on growth through openness to trade. |
