This paper develops the empirical and theoretical case that differences in economic institutions are the fundamental cause of differences in economic development. We first document the empirical importance of institutions by focusing on two “quasi-natural experiments” in history, the division of Korea into two parts with very different economic institutions and the colonization of much of the world by European powers starting in the fifteenth century. We then develop the basic outline of a framework for thinking about why economic institutions differ across countries. Economic institutions determine the incentives of and the constraints on economic actors, and shape economic outcomes. As such, they are social decisions, chosen for their consequences. Because different groups and individuals typically benefit from different economic institutions, there is generally aconflict over these social choices, ultimately resolved in favor of groups with greater political power. The distribution of political power in society is in turn determined by political institutions and the distribution of resources. Political institutions allocate de

This article reviews the evidence on the importance of finance for economic well-being. It pro-vides data on the use of basic financial services by households and firms across a sample of countries, assesses the desirability of universal access, and provides an overview of the macro-economic, legal, and regulatory obstacles to access. Despite the benefits of finance, the data show that use of financial services is far from universal in many countries, especially develop-ing countries. Universal access to financial services has not been a public policy objective in most countries and would likely be difficult to achieve. Countries can, however, facilitate access to financial services by strengthening institutional infrastructure, liberalizing markets and facilitating greater competition, and encouraging innovative use of know-how and tech-nology. Government interventions to directly broaden access to finance, however, are costly and fraught with risks, among others the risk of missing the targeted groups. The article con-cludes with recommendations for global actions aimed at improving data on access and use and suggestions on areas of further analysis to identify constraints to broadening access. Finance matters for economic development. There is considerable evidence today for a strong causal relationship between the depth of the financial system (as measured,

Credit market imperfections provide the key to understanding many important issues in business cycles, growth and development, and international economics. Recent progress in these areas, however, has left in its wake a bewildering array of individual models with seemingly conflicting results. This paper offers a road map. Using the same single model of credit market imperfections throughout, it brings together a diverse set of results within a unified framework. In so doing, it aims to draw a coherent picture so that one is able to see some close connections between these results, thereby showing how a wide range of aggregate phenomena may be attributed to the common cause. They include, among other things, endogenous investment-specific technical changes, development traps, leapfrogging, persistent recessions, recurring boom-and-bust cycles, reverse international capital flows, the rise and fall of inequality across nations, and the patterns of international trade. The framework is also used to investigate some equilibrium and distributional impacts of improving the efficiency of credit markets. One recurring finding is that the properties of equilibrium often respond non-monotonically to parameter changes, which suggests some cautions for studying aggregate implications of credit market imperfections within a narrow class or a particular family of models.

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We present an OLG model in which life expectancy and environmental quality dynamics are jointly determined. Agents may invest in environmental quality, depending on how much they expect to live. In turn, environmental conditions affects life expectancy. The model pro-duces multiple steady-states (development regimes) and initial conditions do matter. In par-ticular, some countries may be trapped in a low life expectancy / low environmental quality trap. This outcome is consistent with stylized facts relating life expectancy and environmental performance measures. Possible strategies to escape from this kind of trap are also discussed. Finally, we show that our results are robust to the introduction of human capital dynamics, driven by parentally funded education.

We develop a model for markets for catastrophic risk. The model explains why insurance providers may choose not to offer insurance for catastrophic risks and not to participate in reinsurance markets, even though there is a large enough market capacity to reach full risk sharing through diversification in a reinsurance market. This is a “nondiversification trap. ” We show that nondiversification traps may arise when risk distributions have heavy left tails and insurance providers have limited liability. When they are present, there may be a coordination role for a centralized agency to ensure that risk sharing takes place. In a calibration we estimate the value of avoiding a trap in residential California earthquake insurance to be up to USD 3.0 Billion per year.

We estimate finite-mixture models in which countries are sorted into groups based on the similarity of the conditional distributions of their growth rates. We strongly reject the hypothesis that all countries follow a common growth process in favor of a model in which there are two classes of countries, each with its own distinct growth regime. Group membership does not conform to the usual categories used to control for parameter heterogeneity such as region or income. We find strong evidence that the quality of institutions and specifically, the degree of law and order, helps to sort countries into different regimes. Once we control for institutional features of the economy, we find no evidence that geographic features such as latitude and being landlocked play a role in determining the country groupings.

This paper proposes and implements a method to predict the evolution of the crosscountry income distribution using a stochastic parameterization of the Azariadis– Drazen (1990) nonconvex growth model. We estimate the dynamic structure of that model from data in the Penn World Tables, and define inductively all future distributions as a norm-convergent sequence in the function space L1. Elements of the sequence are calculated using Monte Carlo simulation. Our results suggest that nonlinearities in the growth process are responsible for the emerging bimodality in the distribution of income, but that bimodality will eventually peak and then decline. In the long run we predict convergence. 1 1

Abstract: We analyze public investment in social infrastructure using a two-period model in which a government must intermediate all infrastructure investment. Voters choose a government from two alternative types, high quality and low quality. A high quality government obtains higher returns on infrastructure but also demands a bigger consumption payoff for intermediating investment, implying higher taxes for the voting public. We find that these intermediation costs cause threshold effects in the electoral process-- closed economies above a critical level of first period income elect high quality governments while economies below that level elect low quality ones. Thresholds vanish when voters can borrow abroad; capital mobility reduces the current consumption cost of infrastructure investment and favors better quality governments. We then study the choice of government when government actions are observable with “noise”. Small amounts of noise have no effect on the choice of government type or on infrastructure provision. However, once the level of noise becomes large, the agency problem raises the cost of intermediation, reduces infrastructure provision, and biases elections toward low quality governments. Finally, we test the model with cross-country data and find preliminary empirical support for the principal results.

We are not seeing faster progress against poverty amongst the poorest developing countries. Yet this is implied by widely accepted “stylized facts ” about the development process. The paper tries to explain what is missing from those stylized facts. Consistently with models of economic growth incorporating borrowing constraints, the analysis of a new data set for 100 developing countries reveals an adverse effect on consumption growth of high initial poverty incidence at a given initial mean. A high incidence of poverty also entails a lower subsequent rate of progress against poverty at any given growth rate (and poor countries tend to experience less steep increases in poverty during recessions). Thus, for many poor countries, the growth advantage of starting out with a low mean (“conditional convergence”) is lost due to their high poverty rates. The size of the middle class—measured by developing-country, not Western, standards—appears to be an important channel linking current poverty to subsequent growth and poverty reduction. However, high current inequality is only a handicap if it entails a high incidence of poverty relative to mean consumption. This paper—a product of the Director's Office, Development Research Group—is part of a larger effort in the department to understand why some countries are more successful in the fight against poverty than others. Policy Research Working Papers are also posted on the Web at