In Depth: Are institutions still important?
Strong institutions are a fundamental driver of both productivity and long-term growth. Their benefits extend well beyond economics, affecting people’s well-being on a daily basis. Adam Smith first highlighted this in 1776, and it has been established as empirically sound time and again ever since.12 Differences in institutional quality underlie many of the reasons for differences between countries in technology and physical and human capital, which can explain a large part of cross-country differences in income (see Figure 9).13 Further, ample empirical evidence has shown the ongoing importance of stable, effective institutions for economic productivity.14
It is because of the importance of these economic building blocks that the first of the GCI 4.0’s 12 pillars assesses the strength and quality of an economy’s institutions. By shaping the ways in which individuals organize themselves and their economic transactions, institutions form the backbone of economic activity and stable societies.
Weak institutions continue to hinder competitiveness, development and well-being in many countries. The Institutions pillar is the second-lowest scoring pillar of the 12 GCI pillars (after the Innovation capability pillar), with a median score of 53—just over halfway to the frontier. For 117 of the 140 economies studied, their Institutions pillar performance is a drag on their overall competitiveness score (Figure 10).
Among the six sub-pillars of the Institutions pillar, global performance is best on Security.15 Here, the median score is 72 and half of all countries score 75 or above, with Finland (97.5) coming closest to being free from terrorism and crime. With equal scores of 33.8, El Salvador and Venezuela are the worst performers, but crime and violence extract a huge economic and human toll across Latin America. The continent’s largest economies—Brazil (45.8), Mexico (46.0) and Colombia (43.5)—are less than halfway to the frontier. Nigeria, Yemen, South Africa, Pakistan and the Philippines are other countries with notable problems related to violence, crime or terrorism, and where the police are considered unreliable. Across all countries, the relationship between the prevalence of organized crime and the perceived reliability of the police is strikingly close.
Transparency is the weakest sub-pillar overall. Scores are assessed using Transparency International’s Corruption Perception Index (CPI), for which the World Economic Forum’s Executive Opinion Survey is a source (see Appendix B). On the CPI’s scale, ranging from 0 (“highly corrupt”) to 100 (“very clean”), two-thirds of the 140 GCI countries score lower than 50 and the median is just 43. When advanced economies are excluded, the median drops to 36. The worst-performing region is Eurasia but Latin America and the Caribbean is home to the world’s most corrupt country, Venezuela, which has a score of 18.
Public sector performance is the second weakest sub-pillar. Unnecessarily burdensome regulation creates delays, raises transaction costs, reduces accountability, and disproportionately penalizes smaller businesses and average citizens. It creates room for corruption and arbitrary decisions, which is reflected in the close association between the scores for this sub-pillar and those of the Transparency sub-pillar.
The overall level of ‘future preparedness’—which will become increasingly important in the 4IR—is very low. The Public sector performance sub-pillar is made up of indicators reflecting a government’s ability to prepare for the future, and covers policy stability, responsiveness to change, long-term vision and the adaptability of the legal framework to technological change. The median score is just 45, yet the most future-prepared governments are not necessarily those of the most competitive economies. Only three—Switzerland, the United States and Singapore—feature in the top 10 of both lists. The East Asia and the Pacific and Middle East and North Africa regions outperform Europe and North America, with Singapore (85.6) scoring highest followed by Luxembourg (79.0), the United States (78.3), and the United Arab Emirates (76.7). The relationship between future-preparedness and income level is positive but extremely loose, with Malaysia and Rwanda, for example, scoring significantly higher than Greece, Italy and Belgium. With a score of 8, Venezuela is by far the least future-prepared economy.
In summary, the results of the GCI are a reminder not to lose sight of the fundamental need for strong institutions, particularly as institutions have actually worsened in some economies over the past year. The fact that institutional strength as a driver of economic growth is a perennial yet fundamental correlation and not a new theory does not make it any less important.
Box 1: Defining ‘institutions’
Economic agents will not invest if they fear they will need to spend excessive amounts of time and money on protecting their property and monitoring the fulfilment of contractual obligations. Their expectations depend on the levels of trust in society; on whether public institutions are capable of ensuring a basic level of security and enforcing property rights, and are characterized by transparency, efficiency, and checks and balances; and on the strength of corporate governance standards and prevailing business ethics.
The GCI 4.0 therefore conceptualizes institutions broadly as including formal, legally binding constraints—rules, laws, constitutions and associated enforcement mechanisms—and informal constraints, such as norms of behavior, conventions and self-imposed codes of conduct.1-1 Pillar 1: Institutions comprises six sub-pillars and 20 indicators, as shown in Table 1.1.