South Asian Studies

A Research Journal of South Asian Studies

Vol. 30, No.2, July December 2015, pp. 381 - 403.

Institutional Quality and Economic Growth: Panel ARDL

Analysis for Selected Developing Economies of Asia

Nabila Asghar
University of the Punjab, Lahore, Pakistan.
Shazia Qureshi
University of the Punjab, Lahore, Pakistan.
Muhammad Nadeem
University of the Punjab, Lahore, Pakistan.

Abstract
The role of institutions in economic growth has received much attention of the researchers
and policy makers in the last two decades. The literature available on this issue is not clear.
The literature reveals that there is a growing dissatisfaction over the neo-classical and
endogenous growth models. In recent literature institutional economics has emerged for
determining the economic growth. In view of this fact, the present study is an attempt to
explain the impact of institutional quality on economic growth in developing economies of
Asia. The study uses panel data for the period 1990-2013 for 13 developing economies of
Asia. Institutional quality index has been constructed by using principal component
analysis. The results of Panel ARDL show that institutional quality has positive impact on
economic growth. The results of panel causality test show that causality runs from
institutional quality to economic growth. The study stresses that for increasing economic
growth there is a need to improve institutional quality in selected Asian developing
countries.
Keywords:
Institutional quality, Economic growth, Panel data

Introduction
The ongoing concern in the field of economics about the role of institutions may
be considered as part of current search for the factors influencing economic
growth. Up to large extent it can be viewed as increasing dissatisfaction that
started in late 1980s about the neoclassical growth model introduced by Solow
(1956) and Swan (1956). The standard neoclassical growth model considers
capital formation or investment as the major determinant of economic growth.
381

South Asian Studies 30 (2)

Several attempts have been made to test this model empirically but results
appeared to be inconclusive. These findings lead to move towards the
reconsideration about the determinants of economic growth and stress to include
human capital in the model (Becker, 1962). New growth models developed in late
1980s by Romer (1986), Lucas (1988) and in early 1990s by Romer (1990), Barro
and Lee (1994) reconnoiter the empirical relation between human capital and
economic progress. The introduction of the new growth models leads to consider
the technology and innovation an important factor of economic growth (Grossman
and Helpman, 1991). However, these models fail to explain truly the causative
questions. For example, keeping in view capital formation or technological
advancement as a major determinant of economic growth, the literature fails to
explain the difference in level of economic development among countries. North
and Thomas (1973) explain that the capital accumulation and innovation are not
determinants of growth in fact they are growth themselves. In this way the existing
growth models have clarified only the channels of growth and not the determinants
of growth. In the light of this background, a new branch of economic literature
known as institutional economics, has emerged which tries to extend the
neoclassical growth models by including institutional rule in determining the long
run economic growth. There are some studies that have highlighted the role of
institutions1 for economic growth (see for example, Acemoglu et al., 2000; 2002;
2003; 2005; Easterly and Levine, 2000; Dollar and Kraay, 2003; Hall and Jones,
1999; Rodrik et al., 2004; Rodrik et al., 2002; Rodrick, 1999; Knack and Keefer,
1995; Mauro, 1995).
Rodrik et al. (2002) stress the role of institutions in determining the economic
growth as compared to other factors. The literature reveals that institutions play an

1Institutions

refer to formal rules (constitutions, laws and regulations, political systems, etc.) and
informal rules (value systems, beliefs, social norms, etc.) that humans use when interacting
within a wide variety of repetitive and structured situations at multiple levels of analysis.

382

Salma Khatoon & Asma Khatoon

Dislocation of South

important role in reducing uncertainty and helps in mitigating economic volatility

(for details, see North, 1990; Klomp and Haan, 2009; Aceomglu et al., 2003;
Rodrik, 1999; Mobarak, 2005; Quinn and Wooley, 1996, 2001; Economides and
Egger, 2009). Brousseau and Glachant (2008), Kirman (2007) and Furubotn and
Richter (2005) explain that the literature of institutions has been becoming richer
in economic growth over time.
There are three kinds of institutions, i.e. Economic, Political and legal
institutions. Political institutions are responsible for making laws, rules and
regulations for: protection of life, respect, property and enforcement of contracts.
Economic institutions are important because they play their role in determining the
investment decisions in human capital, physical capital, production process and
technology. They are also helpful in the efficient allocation of resources. Legal
institutions are responsible for the enforcement of laws, rules and regulations set
by political institutions for the protection of life, respect, property and enforcement
of contracts. These institutions ensure life security, safety of property rights,
execution of contracts, accountability and transparency, checks and balances, rule
of law, political stability, rheostat of corruption and provides the business friendly
environment. If the institutions are weak, they may lead to poor policy making,
inefficient allocation and poor law enforcement that may in turn retard the process
of economic growth. Keeping in view the importance and role of institutions in
economic growth, there is a need to conduct more research in this area. This helps
us to provide business environment conducive to economic growth through the
proper allocation of existing resources. This study is unique in this way that it
analyzes the impact of quality of all these institutions, i.e. quality of economic,
political and legal institutions. Furthermore, it uses quality of overall 2 institutions;
on economic growth of developing economies of Asia. For this purpose,

2Index

generated from quality of economic, political and legal institutions with the help of
Principal Component Analysis.

383

South Asian Studies 30 (2)

institutional quality index constructed through the principal component method
has been used in the econometric analysis.
Remaining study is systematized as: section II reviews the relevant existing
literature. Section III sheds light on theoretical framework, Section IV discusses
the research methodology, data, sample, and results, and, finally, section V
concludes the study.

II. Literature Review

Knack and Keefer (1995) examine the association between institutions and
economic progress. They use different proxies for institutions and find that
political rights and civil liberties are not sufficient for measuring institutions; they
used property rights as well. They find that property rights are significant
determinant of economic growth. Their results show conditional convergence by
controlling institutions. Grogen and Moers (2001) conclude that institutions are the
major determinant of FDI and economic progress of 25 countries for the period
1990 to 1998.
Ali and Crain (2002) explain the interconnections among economic freedom,
institutional distortion and economic growth. Using a sample of 119 countries for
the period from 1975 to 1998, they conclude that civil liberties and political
administration have no significant impact on economic growth, however,
economic freedom plays significant role in enhancing economic growth.
Vijayaraghavan and Ward (2001) test the empirical relation between institutions
and economic growth for the period 1975 to 1990 for 43 countries. For analysis
purpose, they use different proxies of institutional quality like property rights,
structure of governance, size of the government and the political freedom. The
results show that well defined property right and the size of the government are
significant determinants of institutional quality which enhance economic
performance. Adkins et al. (2002) investigate the determinants of inefficiency

384

Salma Khatoon & Asma Khatoon

Dislocation of South

employing stochastic frontier analysis by using two samples one having seventy
three and second having seventy six countries. They find that institutions are
helpful in enhancing economic freedom and efficiency which in turn increases
economic growth. Ulubasoglu and Doucouliagos (2004) explore the relation
between institutions and economic performance for the period 1990 to 1999.
Using a sample of 119 countries, they use simultaneous model for econometric
analysis using two proxies for institutional quality, one for political freedom and
second for economic freedom. They find that political freedom has positive impact
on human capital and total factor productivity (TFP) and physical capital. Le
(2008) investigates the relationship among institutions, remittances, trade and
economic growth for the period 1970 to 2005 for 67 developing economies. Using
different estimation techniques, the study finds that better quality of institutions
leads to higher economic growth in the long run as well as in the short run.
However, remittances show negative impact on economic growth. Acemoglue and
Robinson (2006) explore the significance of institutions in economic progress.
They explain that main differences in economic performance among countries are
due to differences in the quality of economic institutions. The study suggests that
it is necessary to build high quality economic institutions although it is very
difficult to do this as it requires strong political power. Klomp and Haan (2009)
explore the relation between institutions and volatility of economic growth for 116
countries for the period 1960 to 2005 using different indicators for political
administration like political stability, regime types and uncertainty of policy. They
study employs specific to general approach and finds that uncertainty and
instability, democratic regime and economic growth volatility are negatively
related to each other. Hasan et al. (2009) find the relation among development of
quality of institutions, deepening of finance and growth in china from 1986 to
2002. They apply OLS and GMM for analysis. They find that main institutional
developments for a developing country are legalization and development of
385

South Asian Studies 30 (2)

market economy, safe guarding the property rights, expansion of financial system
and the liberalization. The results show that development of quality of institutions,
deepening of finance and legal environment have positive impact on economic
growth. Lee and Kim (2009) explain that institutions and economic growth are
positively related but it works through different channels in different conditions.
Using data for the period 1965 to 2002 and different estimation techniques, the
study finds that education, technology and institutions are main determinants of
long run growth. The study points out that secondary education is helpful for
growth in low income countries and higher education and better technology are
appropriate for growth in middle and higher income countries. The results of
causality indicate that bidirectional causality exist between institutions and
growth. Zhuang et al. (2010) highlight the role of institutions and governance in
enhancing economic progress. The study emphasizes the measurement of
institutional quality and its impact on economic performance. The results of the
study indicate two way long run relation between institutional quality and
economic performance. Khan and Khawaja (2011) explore the relation among
predation, quality of institutions and economic growth by using game theory
model. They find that predation is significant hurdle in the way of economic
progress as it reduces per capita consumption, enhances inequality and reduces
overall output. Predators have comparative advantage in predation and high
quality institutions eliminate this comparative advantage and enhance economic
growth. Gwartney et al. (2004) explore the fact that differences in institutional
quality are the major reason for differences in growth rates among countries. The
study suggests that increase in economic freedom index is a long run phenomena.
Islam (2012) investigates the relationship between compensation to civil servants
and economic growth. Using threshold regression methodology, this study finds
that growth is having vicious and virtuous circles with multiple equilibria. The

386

Salma Khatoon & Asma Khatoon

Dislocation of South

findings of the paper suggest that salary reduction of civil servants as part of
budget balancing austerity measures may result in lower economic performance.

III. Theoretical Framework

In order to observe the influence of institutional quality on economic growth, the
study uses neoclassical production function which has its origin in the work of
Ramsey (1928). The neoclassical model was popularized by Solow (1956). This
model assumes technological change as exogenous and returns to scale are
considered to be constant. The model postulates that capital and labor can be
substituted and their marginal products are assumed to be diminishing. The basic
neoclassical production function can be written as:
Y = f (K, L) (a)
Here, Y denotes the level of output, K is capital formation and L is the labor
force.
Human capital is also considered to be the major determinant of economic
growth in endogenous growth theories advanced by Romer (1986, 1990) and
Lucas (1988) and it is the key extension of neoclassical model. Incorporating the
Human capital (H) in the basic neoclassical production function:
Y = f (K, L, H)

(b)

Standard aggregate production can be modified as suggested by Feder (1983),

Grossman (1988) and Ram (1996). Introducing the institutional quality and trade
openness as independent inputs in the standard aggregate production function, (b)
can be specified as:
Y = f (K, L, H, INSQ, TO)

(c)

To obtain the marginal effects of capital, labor, human capital, institutional

quality and trade openness, we take the total derivatives and normalize them using
the gross domestic product (Y) as follows:

387

South Asian Studies 30 (2)

dY Y dK Y dL Y dH Y dINSQ Y TO

Y K Y L Y H Y INSQ Y
TO Y

(d)

Y
b1
K

Y
b2
L
Y
b3
H

dK
K
Y

dL
L
Y

dH
H
Y

Y
b4
INSQ

Y
b5
TO

dINSQ
INSQ
Y
dTO
TO
Y

As per equation (d), it is expected that we may have positive signs of the
partial derivatives of labor, human capital and physical capital with respect to
output as literature shows that educated labor force plays a vital role for enhancing
economic growth (Barro, 1991; Mankiw et al., 1992; Barro and Sala-i-Marin,
1995; Brunetti et al., 1998; Hanushek and Kimko, 2000). Knowledge is the
significant source of growth (Romer, 1990; Grossman and Helpman, 1991) and
investment is also major determinant of economic progress (see for example,
Kormendi and Meguire, 1985; DeLong and Summers, 1992; Levine and Renelt,
1992; Mankiw, 1992; Auerbach et al., 1994; Barro and Sala-i-Martin, 1995; Salai-Martin, 1997; Easterly, 1997; Bond et al., 2001; Podrecca and Carmeci, 2001).

IV. Model Specification and Results

In recent literature, panel data analysis involves models having large time spans
(T) for analysis purpose due to readily availability of data. The asymptotics of
large number of cross sections (N) and large time periods (T) dynamic panels are

388

Salma Khatoon & Asma Khatoon

Dislocation of South

diverse from the asymptotic of the usual large number of cross sections (N) and
small time periods (T) dynamic panels. Small time periods (T) panel estimation
involves fixed and random effect estimators or Generalized Method of Moments
(GMM) presented by Arellano and Bond (1991). These estimators involve pooling
individual cross sections and allowing the constant term only to vary across cross
sections. The main conclusions drawn from the large N, large T, reveal that the
supposition of homogeneousness of slope coefficients is frequently unsuitable (for
details see Pesaran and Smith, 1995; Pesaran, Shin, and Smith, 1997, 1999;
Phillips and Moon, 2000; Im, Pesaran and Shin, 2003). The latest work on
dynamic heterogeneous panel valuation with large N and T, proposes various
methods for estimation. In fixed effect estimation method, time series data for
each cross section are pooled, intercept terms are permitted to vary across cross
sections. If slope coefficients are not alike then fixed effect may provide deceptive
upshots. On the other hand, model may be built individually for each cross section
and arithmetic mean of coefficients is obtained. This procedure is known as Mean
Group (MG) estimator presented by Pesaran and Smith (1995). In MG technique
the intercepts, slope coefficients, and error variances are all allowed to differ
across cross sections.
Pesaran et al. (1997, 1999) popularize novel technique known as Pooled Mean
Group (PMG) to estimate nonstationary dynamic panels as with an increase in
time period of analysis, dynamic panels; nonstationarity is very important issue.
PMG estimator is based on a blend of amalgamating and averaging of coefficients
(Pesaran et al., 1997, 1999). This estimator permits short run parameters,
intercepts terms and error variance to vary across groups (as in MG estimator).
However, it restrains the long run coefficients to be equivalent. Starting from
primary guesstimate of long run coefficient

the short run coefficients and

swiftness of correction term can be found. These estimates are in turn, used to
estimate , the process is iterated until convergence is achieved.
389

South Asian Studies 30 (2)

The general form of the empirical specification of the PMG model can be
written as below.
p

j 1

j 0

Yit ij yi ,t j ij X i ,t j t it
Where no of cross sections i = 1, 2, . N and time t = 1, 2, 3 . T.
vector of K 1 regressors,

ij

X it

is a

is a scalar, i is a group specific effect. If the

variables are I(1) and co-integrated then the disturbance term is an I(0) process. A
major characteristic of co-integrated variables is their rejoinder to any deviance
from long run equilibrium. This characteristic infers error correction dynamics of
the variables in the system are swayed by the deviance from equilibrium. So it is
common to re-parameterize above equation into the error correction equation as
p 1

q 1

j 1

j 0

Yit i yi ,t j i X i ,t j ij yi ,t j ij X i ,t j t it
The error correction parameter

i indicates the speed of adjustment. If i =

0, then there is no evidence that variables have long run association. It is expected
that

is negative and statistically significant under the prior supposition that

variables indicate a convergence to long run equilibrium in case of any

disturbance.
With increase in time period of analysis, dynamic panels; nonstationarity is
very important issue and in present study this issue has been taken into
consideration by applying Levin, Lin and Chu (LLC) and Im, Pesaran and Shin
(IPS) unit root tests.

LLC Unit Root Test

Levin, Lin and Chu (2002) introduced different panel unit root tests having
different specifications dependent upon the assumption about entity specific
intercepts terms and time trends. LLC test inflicts homogeneousness on the
autoregressive coefficient (intercept and trend may vary across individual series)
390

Salma Khatoon & Asma Khatoon

Dislocation of South

which shows the presence or nonexistence of unit root. This test is based on ADF
regression for examining unit root problem. The common form of LLC test with
intercept term only may be written as
pi

yi ,t 0i pyit 1 1i yi ,t j i ,t
i 0

In the overhead equation

0 i is the constant term which is supposed to differ

across cross sectional entities while p is the identical autoregressive coefficient,

i denotes the lag order, i,t is the disturbance term supposed to be sovereign

across panel entities and follows ARMA stationary process for every cross section.

i ,t 1i yi ,t j i ,t
j 0

The null and alternative hypotheses of this are as

H0: i = = 0
HA: i = < 0 for all i
LLC model is based on t-statistics, where is supposed to stay fix across
entities under null and alternative hypothesis.

tp

p
SE( p )

Under the assumption of independently and normally distributed error term and
cross sectional independence, panel regression test statistics tp converges to
and

standard normal distribution when N and T

N
T

0. However if

cross sectional units are dependent, error term is serially correlated and time trend
is present then test statistics does not converge to 0, under such circumstances
LLC suggested modified version of test statistics as

tp

m*

and

m*

~
t p NT S N 02 ( p ) m*

m*

are modified mean and standard deviation, values of these are

generated from monte carlo simulation by LLC (1993).

IPS Unit Root Test
391

South Asian Studies 30 (2)

Im, Pesaran and Shin (IPS), (2003) developed a test to check unit root in
heterogeneous panel. This test is based on ADF test to individual series, however
overall test statistics is based on the arithmetic mean of individual series, a series
may be denoted by ADF as.
pi

yi ,t wi pyit 1 pi , j yi ,t j i ,t
j 1

IPS test allows for heterogeneity in

i value, the IPS unit root test equation

may be written as

tT

1 N
ti,t ( pi )
N i 1

Where ti,t is the ADF test statistics, pi is the lag order. In ADF test statistics is
calculated as:

At

N (T )[tT E (tT )]
Var(tT )

The data for present study has been collected from 1990 to 2013 for thirteen
developing economies of Asia.3 Various measures of institutional quality are
available like pioneer effort to catch institutional environment by the Global
Competitiveness Report of the World Economic Forum (Sala i Martin et al.,
2011), Quality of Government project, compiled by the Quality of Government,
Institute at the University of Gothenburg (Teorell et al., 2011). The CESifo Group
in Germany has constructed an Institutional climate index (Eicher and Rohn,
2007). With the objective of using a most appropriate measure we used Kuncic
(2013) data base which is based on specific institutional classification system as
legal, political and economic institutions which is a more comprehensive measure.
Rest of the data has been collected from World Banks data base of world
development indicators (WDI 2015).
3Bangladesh,

China, Cyprus, India, Indonesia, Iran, South Korea, Malaysia, Pakistan, Philippines,
Sri Lanka, Thailand and Turkey.

392

Salma Khatoon & Asma Khatoon

Dislocation of South

Table 1
Summary Statistic of Variables

Variables

Mean

Min

Max

Std.
Dev

Quality of Legal Institutions

0.504

0.222

0.888

0.1438

Quality of Political Institutions

0.490

0.186

0.799

0.1415
3

Quality of Economic Institutions

0.475

0.150

0.851

0.1231

Overall Institutional Quality Index

0.533

0.029

1.398

0.1949

GDP Growth Rate

5.237

13.126

14.240

3.655

Gross Fixed Capital Formation

Growth Rate

6.368

44.323

46.367

10.240

Log of Labor Force

17.270

12.673

20.491

1.764

Trade Openness

71.137

15.239

220.40
7

43.952

Table 1 shows the summary statistics of the variables used in the study. There is
significant variations in minimum and maximum values of different measures of
institutional quality as in case of legal institutional quality minimum value is 0.22
while maximum value is 0.88, minimum value of political institutional quality is
0.18 and maximum value is 0.79, minimum value of institutional quality of
economic institutions is 0.15 while maximum value is 0.85. There is significant
variation in GDP growth rate ranges from 13.12 to 14.24. Similarly growth rate
of capital formation has lot of variations ranging from -44.32 to 46.36. The
variable which shows the maximum variation is trade openness which has lowest
value 15.23 and highest value 220.40.
The results of panel unit root tests are presented in Table 2. The results
indicate that the trade openness and Labor Force are non-stationary at level,
however they are stationary at first difference, so both variables have order of
integration I(1), while remaining variables are integration of order I(0). In panel
ARDL approach, unit root test is applied to exclude the possibility of I (2)
variables (Pesaran et al., 2001). None of the variable is of order I (2). So Panel
393

South Asian Studies 30 (2)

ARDL appears to be more suitable technique for estimation in present
circumstances. Long run results are presented in Table 3.
Table 2
Panel Unit Root Tests
Level
With Intercept
Variables

With Trend & Intercept

Statistic

P-Values

Statistic

P-Values

LLC

0.583

0.279

1.98

0.238

IPS

1.129

0.870

0.358

0.639

LLC

5.17

0.000***

4.37

0.000***

IPS

5.12

0.000***

4.39

0.001***

LLC

9.00

0.000***

7.55

0.000***

Trade openness

GDP Growth

Capital Growth
IPS

8.38

0.000***

5.95

0.000***

LLC

2.65

0.003***

0.275

0.39

IPS

1.44

0.926

1.737

0.95

LLC

2.82

0.002***

2.686

0.003***

IPS

1.365

0.086

3.34

0.000***

LLC

4.310

0.000***

2.86

0.000***

IPS

4.90

0.000***

4.56

0.000***

Political Institutional
quality

LLC

2.13

0.016**

2.88

0.000***

IPS

3.01

0.001***

3.62

0.000***

Economic Institutional
quality

LLC

2.83

0.002***

4.14

0.000***

IPS

1.82

0.034**

3.86

0.000***

Log of Labor

Institutional quality index

Legal Institutional quality

394

Salma Khatoon & Asma Khatoon

Dislocation of South
First Difference
With Intercept

Variables

With Trend & Intercept

Statistic

P-Values

Statistic

P-Values

LLC

9.79

0.000***

9.210

0.000***

IPS

8.85

0.000***

7.707

0.000***

LLC

3.39

0.000***

2.863

0.000***

IPS

3.77

0.000***

2.868

0.000***

Trade openness

Log of Labor
Note:

Levin, Lin & Chun (LLC) assumes common unit root process; Im, Pesaran and Shin (IPS) assume individual unit root
process. ***, ** represent 1 and 5 percent level of significance respectively.

Table 3
Panel ARDL (1, 2, 2, 2, 2) Long Run Results (Dependent variable GDP growth)
1

Labor

1.7545** (0.0770)

1.1094 (0.3274)

4.354***
(0.0000)

1.326 (0.193)

2.8981***
(0.0030)

2.349*** (0.0132)

3.582*** (0.0005)

Capital

0.3261*** (0.000)

0.3234***
(0.0000)

0.2981***
(0.0000)

0.318***
(0.0000)

0.3103***
(0.0000)

0.3313*** (0.0000)

0.3345***
(0.0000)

Trade openness

0.0406*** (0.000)

0.0358***
(0.0000)

0.0080
(0.460)

0.029***
(0.0001)

0.0370***
(0.0000)

0.0345*** (0.0000)

0.048***
(0.0000)

Institutional Quality
Index

1.3716*** (0.0098)

Political Institutional
Quality

Economic
Institutional Quality
Legal Institutional
Quality
Legal*Economic

Legal*Political
Economic*Political

0.8098 (0.712)

1.952 (0.280)

3.123**
(0.078)
2.2923
(0.2972)
3.157 (0.1202)
1.982 (0.467)

***, ** represent 5 and 10 percent level of significance respectively. In parenthesis ( ) are probabilities.

The results reveal that the index of overall institutional quality (generated
from legal, political and economic institutional quality) has positive sign and it is
statistically significant. It implies that higher level of institutional quality is
associated with higher level of economic growth. Institutions provide incentives
and penalties, which in turn play important role as catalyst and pave the way for
rapid economic growth. Institutional quality may influence the economic growth
of the country through the proper allocation of resources which is related in
supplying public goods and services. Better resource allocation decisions may
increase the functioning of the market. If allocation of resources is efficient, it will
enhance economic growth. Better institutional quality increases economic
performance by reducing the level of corruption and improving the check and
395

South Asian Studies 30 (2)

balance. Better quality of institutions is supposed to be well equipped with updated
information relating to current market situations which can enhance investment
level and higher investment enhances economic growth. High quality of
institutions also creates an environment which is business friendly and very
conducive to foreign investment. As a result higher inflows of foreign direct
investment lead to an increase in economic growth. Similar conclusions were
drawn by Acemoglu et al. (2001, 2002, 2004), Keefer and Knack (1997), Rodrik et
al. (2004), Easterly and Levine (2003), and Bardhan (2005). When subcomponents
of institutional quality (legal, political and economic institutional quality) are used
separately they give quite different results. Only legal institutional quality has
been found to be associated with higher economic growth which means that legal
institutions are more important. Both political institutional quality and economic
institutional quality are not found significant in determining economic growth. The
results become quite interesting when legal institutional quality has been
interacted with political and economic institutional quality, the effect is
insignificant which means that the significant effect of legal institutional quality
has been vanished by insignificant effect of political and economic institutional
quality. The interaction of political and economic institutional quality is also
insignificant. Neither of interaction of the two is significant. This means that
institutional quality of all institutions is required to be enhanced to foster
economic growth.
Labor force carries positive sign and statistically significant coefficient in all
specifications which means that an increase in labor force contributes significantly
in economic growth. The study finds similar results for gross fixed capital
formation. An increase in gross fixed capital formation leads to an increase in
gross domestic product; so, both of these variables have expected signs consistent
to growth theory. The results of this study are in line with the results of previous
studies (for example, Kormendi and Meguire, 1985; DeLong and Summers, 1992;
396

Salma Khatoon & Asma Khatoon

Dislocation of South

Levine and Renelt, 1992; Mankiw, 1992; Auerbach et al., 1994; Barro and Sala-iMartin, 1995; Sala-i-Martin, 1997; Easterly, 1997; Bond et al., 2001; Podrecca and
Carmeci, 2001).
Table 4
Panel ARDL (1, 2, 2, 2, 2) Short Run Results; Dependent variable d(GDP growth)
ECT(1)

D(Institutional Quality
Index)

0.780***
(0.0000)

0.719***
(0.0000)

0.775***
(0.0000)

0.741***
(0.0000)

0.751***
(0.0000)

0.741***
(0.0000)

0.733***
(0.0000)

10.190 (0.6407)

15.797
(0.371)

15.29 (0.433)

8.6931
(0.662)

1.1851 (0.953)

0.0138 (0.680)

0.0327
(0.388)

0.021 (0.586)

0.0144 (0.537)

0.029
(0.537)

0.0078 (0.911)

2.321 (0.679)

d(Labor)

16.346
(0.427)

4.388
(0.84)

D(Capital)

0.0258
(0.439)

0.0262
(0.443)

0.0124 (0.808)

0.0198
(0.492)

0.025 (0.600)

0.0142
(0.771)

0.0243 (0.695)

0.0380
(0.413)

D(Trade openness)
D(Legal Institutional
Quality)

7.3516
(0.102)
2.1058
(0.787)

D(Political Institutional
Quality)
D(Economic
Institutional Quality)

3.173 (0.541)

D(Legal*Economic)

4.8173 (0.359)
5.908
(0.314)

D(Legal*Political)
D(Economic* Political)

4.558 (0.625)
18.99***
(0.000)

cons

9.537***
(0.000)

55.29*** (0.000)

13.61***
(0.000)

33.40***
(0.000)

26.19***
(0.000)

40.82***
(0.000)

*** represent 5 percent level of significance. In parenthesis ( ) are probabilities.

Trade openness has negative impact on economic growth which means that an
increase in trade openness leads to reduction in economic growth which may be
due to the fact that developing economies are unable to reap the benefits of
international trade. These countries face difficulties in competing the developed
countries in international markets.
Table 4 shows the results of short run analysis. The results reveal that the
coefficient of error correction term is negative and is statistically significant as
well in all specifications. This is an indication that model converges towards
equilibrium. The speed of adjustment is more than seventy percent in each
specification.
Table 5 presents the results of Panel Homogeneous Causality Test which
reveals that there is uni-directional causality between overall institutional quality
397

South Asian Studies 30 (2)

and Economic growth. The causality runs from institutional quality to economic
growth which means that high quality of institutions leads to higher economic
growth but higher economic growth in turn does not lead to higher quality of
institutions. This is against the notion that there seems to be two way relationships
between institutions and economic growth. Better institutions lead to higher
economic growth and resultantly higher economic growth requires better quality
institutions.
There is uni-directional causality between capital and GDP growth, running
from GDP growth to capital. There is bi-directional causality between Labor and
GDP growth which means that increase in labor force leads to increase in
economic growth and economic growth in turn also leads to higher labor force
which may be due to the reason that with higher levels of income people can
afford to have more children which will increase labor force. There is unidirectional causality between trade openness and GDP growth, running from GDP
growth to Trade openness.
Table 5
Panel Homogeneous Causality Test
Dependent
Variable

GDP
Prob.

LABOR
Decision

CAPITAL

INSQ Index

Trade Openness

Prob.

Decision

Prob.

Decision

Prob.

Decision

Prob.

Decision

0.41

No
Causality

0.052

Causality
exist*

0.41

No
Causality

0.001

Causality
exist***

LABOR

0.052

Causality
exist*

0.005

Causality
exist***

0.941

No
Causality

0.046

Causality
exist**

CAPITAL

0.007

Causality
exist***

0.105

Causality
exist*

0.036

Causality
exist**

0.65

No
Causality

INSQ
Index

0.91

No
Causality

0.000

Causality
exist***

0.003

Causality
exist***

0.001

Causality
exist***

Trade
Openness

0.048

Causality
exist**

0.000

Causality
exist***

0.60

No
Causality

0.60

No
Causality

GDP

***, **, * represent 1, 5 and 10 percent level of significance respectively.

V. Conclusion
This study is an attempt to explore the impact of institutional quality on economic
growth of 13 developing economies of Asia. An index of institutional quality has

398

Salma Khatoon & Asma Khatoon

Dislocation of South

been constructed from quality of legal, economic and political institutions using
principal component method. Panel ARDL and Panel causality have been used for
econometric analysis. Various specifications of the model have been used for
different types of indicators of institutional quality, and overall institutional quality
index generated with the help of principal component method. The results of Panel
ARDL show that overall institutional quality index exerts positive impact on
economic growth. The results of panel causality show that causality runs from
institutional quality to economic growth. Quality of legal institutions also has
positive impact on economic growth but economic and political institutional
quality are unable to foster economic growth. Neither of the interaction of
institutional quality indicators is significant. This study concludes that economic
growth can be increased through enhancing the institutional quality of all
institutions or at least quality of legal institutions. For achieving this objective,
there is a need to take certain effective steps for improving the institutional
quality. This requires for integrated efforts and introduction of radical changes in
the political, social and institutional set up of the country.
References
Acemoglu, D. and Johnson, S. (2005). Unbundling institutions. Journal of Political
Economy, 113 (5), 949-995.
Acemoglu, D., Johnson, S., & Robinson, J. A. (2000). The colonial origins of comparative
development: An empirical investigation (No. w7771). National bureau of economic
research.
Acemoglu, D., Johnson, S., & Robinson, J. A. (2012). The colonial origins of comparative
development: An empirical investigation: Reply. The American Economic Review,
3077-3110.
Acemoglu, D., & Johnson, S. Robinson; James A.(2002): Reversal of Fortune: Geography
and Institutions in the Making of the Modern World Income Distribution. The
Quarterly Journal of Economics, 117, 4.
Acemoglu, D., & Robinson, J. A. (2006). Persistence of power, elites and institutions (No.
w12108). National Bureau of Economic Research.
Acemoglu, D., Johnson, S., & Robinson, J. A. (2005). Institutions as a fundamental cause of
long-run growth. Handbook of economic growth, 1, 385-472.
Acemoglu, D., Johnson, S., Robinson, J., & Thaicharoen, Y. (2003). Institutional causes,
macroeconomic symptoms: volatility, crises and growth.Journal of monetary
economics, 50(1), 49-123.
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo
evidence and an application to employment equations. The review of economic
studies, 58(2), 277-297.

399

South Asian Studies 30 (2)

Adkins, L. C., Moomaw, R. L., & Savvides, A. (2002). Institutions, freedom, and technical
efficiency. Southern Economic Journal, 92-108.
Ali, A., & Crain, W. M. (2001). Institutional Distortions, Economics Freedom, and
Growth. Cato J., 21, 415.
Auerbach, A. J., Hassett, K. A., & Oliner, S. D. (1993). Reassessing the social returns to
equipment investment (No. w4405). National Bureau of Economic Research.
Barro, R. J. (1991). Economic growth in a cross section of countries (No. w3120). National
Bureau of Economic Research.
Barro, R. J., & Lee, J. W. (1994, June). Sources of economic growth. InCarnegie-Rochester
conference series on public policy (Vol. 40, pp. 1-46). North-Holland.
Barro, R. J., & Sala-i-Martin, X. (1995). Economic growth, 1995. McGraw0Hill, New York.
Becker, G. S. (1962). Investment in human capital: A theoretical analysis. The Journal of
Political Economy, 9-49.
Blackburne, E. F., & Frank, M. W. (2007). Estimation of nonstationary heterogeneous
panels. Stata Journal, 7(2), 197.
Brunetti, A., Kisunko, G., & Weder, B. (1998). Credibility of rules and economic growth:
Evidence from a worldwide survey of the private sector. The World Bank Economic
Review, 12(3), 353-384.
Brousseau, E., & Glachant, J. M. (2008). New institutional economics: a guidebook (No.
123456789/12319). Paris Dauphine University.
De Long, J. B., Summers, L. H., & Abel, A. B. (1992). Equipment investment and
economic growth: how strong is the nexus?. Brookings Papers on Economic Activity,
157-211.
Dollar, D., & Kraay, A. (2003). Institutions, trade, and growth. Journal of Monetary
Economics, 50(1), 133-162.
Economides, G., & Egger, P. H. (2009). The role of institutions in economic outcomes:
editorial introduction. European Journal of Political Economy, 25(3), 277-279.
Eicher, T., & Rhn, O. (2007). Institutional determinants of economic performance in oecd
countriesan institutions climate index. CESifo DICE Report, 5(1), 38-49.
Feder, G. (1983). On exports and economic growth. Journal of Development
Economics, 12(1), 59-73.
Furubotn, E. G., & Richter, R. (2005). Institutions and economic theory: The contribution
of the new institutional economics. University of Michigan Press.
Grossman, G. M., & Helpman, E. (1993).91 Innovation and growth in the global economy.
MIT press.
Grogan, L., & Moers, L. (2001). Growth empirics with institutional measures for transition
countries. Economic Systems, 25(4), 323-344.
Gwartney, J., Lawson, R., & Hall, J. (2012). 2012 Economic Freedom Dataset, published in
Economic Freedom of the World: 2012 Annual Report.
Gwartney, J. D., Holcombe, R. G., & Lawson, R. A. (2004). Economic freedom,
institutional quality, and cross-country differences in income and growth. Cato J., 24,
205.
Hasan, I., Wachtel, P., & Zhou, M. (2009). Institutional development, financial deepening
and economic growth: Evidence from China. Journal of Banking & Finance, 33(1),
157-170.
Hanushek, E. A., & Kimko, D. D. (2000). Schooling, labor-force quality, and the growth of
nations. American economic review, 1184-1208.
Hall, R. E., & Jones, C. I. (1999). Why do some countries produce so much more output per
worker than others? (No. w6564). National bureau of economic research.
Im, K. S., Pesaran, M. H., & Shin, Y. (2003). Testing for unit roots in heterogeneous
panels. Journal of econometrics, 115(1), 53-74.
Islam, N. (2012). Quality of Civil Administration and Economic Growth: A Threshold
Analysis. The Journal of Developing Areas, 46(2), 315-350.

400

Salma Khatoon & Asma Khatoon

Dislocation of South

Kirman, A. P., (2007). Individual and aggregate behaviour: of ants and men. In: Hodgson,
G.M. (Ed.), The Evolution of Economic Institutions-A Critical Reader. Edward Elgar
Publishing
Ltd., Cheltenham, Northampton, pp. 3452.
Khan, S., & Khawaja, I. (2011). Predation, institutional quality and economic growth. The
Pakistan Development Review, 809-820.
Klomp, J., & de Haan, J. (2009). Political institutions and economic volatility. European
Journal of Political Economy, 25(3), 311-326.
Knack, S., & Keefer, P. (1995). Institutions and economic performance: Cross-country tests
using alternative institutional indicators.
Kormendi, R. C., & Meguire, P. G. (1985). Macroeconomic determinants of growth: crosscountry evidence. Journal of Monetary Economics, 16(2), 141-163.
Kuncic, A. (2014). Institutional Quality Dataset, Journal of Institutional Economics,
forthcoming.
Levin, A., Lin, C. F., & Chu, C. S. J. (2002). Unit root tests in panel data: asymptotic and
finite-sample properties. Journal of Econometrics, 108(1), 1-24.
Levine, R., & Renelt, D. (1992). A sensitivity analysis of cross-country growth
regressions. The American Economic Review, 942-963.
Le, T. (2009). Trade, remittances, institutions, and economic growth. International
Economic Journal, 23(3), 391-408.
Lee, K., & Kim, B. Y. (2009). Both institutions and policies matter but differently for
different income groups of countries: Determinants of long-run economic growth
revisited. World Development, 37(3), 533-549.
Levine, R., & Easterly, W. (2000). It's Not Factor Accumulation: Stylized Facts and Growth
Models.. In International Monetary Fund Seminar Series (No. 2000-12, pp. 1-52).
Lucas, R. E. (1988). On the mechanics of economic development. Journal of Monetary
Economics, 22(1), 3-42.
Mankiw, N. G., Romer, D., & Weil, D. N. (1992). A contribution to the empirics of
economic growth (No. w3541). National Bureau of Economic Research.
Mauro, P. (1995). Corruption and growth. The Quarterly Journal of Economics, 681-712.
Mobarak, A. M. (2005). Democracy, volatility, and economic development. Review of
Economics and Statistics, 87(2), 348-361.
North, D. C. (1981). Structure and change in economic history. Norton.
North, D. C. (1990). Institutions, institutional change and economic performance.
Cambridge university press.
North, D. C. (2006).2005 Understanding the process of economic change. Academic
Foundation.
North, D. C., & Thomas, R. P. (1973). The rise of the western world: A new economic
history. Cambridge University Press.
North, D. C., Wallis, J. J., & Weingast, B. R. (2006). A conceptual framework for
interpreting recorded human history (No. w12795). National Bureau of Economic
Research.
Pelikan, P. (2003). Bringing institutions into evolutionary economics: another view with
links to changes in physical and social technologies. Journal of Evolutionary
Economics, 13(3), 237-258.
Pesaran, M. H., & Smith, R. (1995). Estimating long-run relationships from dynamic
heterogeneous panels. Journal of Econometrics, 68(1), 79-113.
Pesaran, M. H., Y. Shin, and R. P. Smith. 1997. Estimating long-run relationships in
dynamic heterogeneous panels. DAE Working Papers Amalgamated Series 9721.
Pesaran, M. H., Shin, Y., & Smith, R. P. (1999). Pooled mean group estimation of dynamic
heterogeneous panels. Journal of the American Statistical Association, 94(446), 621634.
Podrecca, E., & Carmeci, G. (2001). Fixed investment and economic growth: new results
on causality. Applied Economics, 33(2), 177-182.
Quinn, D. P., & Woolley, J. T. (1996). Economic growth, equity, and democracy. In Annual
Meeting of the American Political Science Association, San Francisco.

401

South Asian Studies 30 (2)

Quinn, D. P., & Woolley, J. T. (2001). Democracy and national economic performance: the
preference for stability. American Journal of Political Science, 634-657.
Ram, R. (1996). Productivity of public and private investment in developing countries: A
broad international perspective. World Development, 24(8), 1373-1378.
Ramsey, F. P. (1928). A mathematical theory of saving. The Economic Journal, 543-559
Rodrik, D. (1999). Where did all the growth go? External shocks, social conflict, and
growth collapses. Journal of Economic Growth, 4(4), 385-412.
Rodrik, D. (2004). Getting institutions right. CESifo DICE Report, 2(2004), 2-4.
Rodrik, D., Subramanian, A., & Trebbi, F. (2002). Institutions rule: the primacy of
institutions over integration and geography in economic development.
Rodrik, D., Subramanian, A., & Trebbi, F. (2004). Institutions rule: the primacy of
institutions over geography and integration in economic development. Journal of
economic growth, 9(2), 131-165.
Romer, P. M. (1986). Increasing returns and long-run growth. The Journal of Political
Economy, 1002-1037.
Romer, P. M. (1990, May). Human capital and growth: theory and evidence. InCarnegieRochester Conference Series on Public Policy (Vol. 32, pp. 251-286). North-Holland.
Sala i Martin, X., R. Greenhill, and World Economic Forum (2011). The global
competitiveness report 2011-2012. Geneva: World Economic Forum. Available online.
Solow, R. M. (1956). A contribution to the theory of economic growth. The Quarterly
Journal of Economics, 65-94.
Swan, T. 1956. Economic Growth and Capital Accumulation. Economic Record 32(63):
33461.
Teorell, J., N. Charron, M. Samanni, S. Holmberg, and B. Rothstein (2011). The quality of
government dataset.
Ulubasoglu, M. A., & Doucouliagos, C. (2004, February). Institutions and Economic
Growth: A Systems Approach. In Econometric Society 2004, Australasian Meetings
Paper No (Vol. 63).
Vijayaraghavan, M., & Ward, W. A. (2001). Institutions and economic growth: empirical
evidence from a cross-national analysis. Clemson University.
Zhuang, J., De Dios, E., & Martin, A. L. (2010). Governance and institutional quality and
the links with economic growth and income inequality: With special reference to
Developing Asia. Asian Development Bank Economics Working Paper Series, (193).

Appendix
Legal institutions quality index is constructed from different aspects of
institutional quality like it uses index of economic freedom, Press freedom, civil
liberties, judicial independence, impartial courts, protection of property rights, law
and order, religion in politics, rule of law etc.
Political institutions quality index is generated from checks and balances,
democratic accountability, control of corruption, bureaucratic quality, military in
politics, political terror scale, political rights etc.
Economic institutions quality: This is computed from different measures like
index of economic freedom, regulatory quality, Credit market regulations,

402

Salma Khatoon & Asma Khatoon

Dislocation of South

Economic Environment, Labor market regulations, Business Regulations, Capital

controls, Investment profile etc.
Null Hypothesis:

W-Stat.

Zbar-Stat.

Prob.

Labor does not homogeneously cause GDP

4.62512

3.28064

0.0010***

GDP does not homogeneously cause Labor

3.65897

1.93672

0.0528**

Capital does not homogeneously cause GDP

1.68261

0.81903

0.4128

GDP does not homogeneously cause Capital

4.23026

2.67181

0.0075***

Institutional Quality does not homogeneously cause GDP

3.65987

1.93796

0.0526**

GDP does not homogeneously cause Institutional Quality

2.34527

0.10933

0.9129

Trade Openness does not homogeneously cause GDP

2.88133

0.81239

0.4166

GDP does not homogeneously cause Trade Openness

3.73187

1.97201

0.0486***

Capital does not homogeneously cause Labor

4.33001

2.80850

0.0050***

Labor does not homogeneously cause Capital

3.46021

1.61667

0.1059

Institutional Quality does not homogeneously cause Labor

2.31629

0.06903

0.9450

Labor does not homogeneously cause Institutional Quality

11.8499

13.3304

0.0000***

Trade Openness does not homogeneously cause Labor

3.74875

1.99503

0.0460***

Labor does not homogeneously cause Trade Openness

4.93781

3.61618

0.0003***

Institutional Quality does not homogeneously cause Capital

3.80673

2.09149

0.0365***

Capital does not homogeneously cause Institutional Quality

4.44980

2.97263

0.0030***

Trade Openness does not homogeneously cause Capital

1.95586

0.44939

0.6531

Capital does not homogeneously cause Trade Openness

2.66439

0.51662

0.6054

4.59877

3.15393

0.0016***

1.94871

0.45914

0.6461

Trade Openness does not homogeneously cause Institutional

Quality
Institutional Quality does not homogeneously cause Trade
Openness

Biographical Note
Nabila Asghar is Assistant Professor of Economic, Department of Economics,
University of the Punjab, Lahore, Pakistan.
Dr. Shazia Qureshi is Associate Professor / Principal, University Law College,
University of the Punjab, Lahore, Pakistan.
Muhammad Nadeem is Research Scholar, Department of Economics at the
University of the Punjab, Lahore, Pakistan.
________________________

403