The Eэect of Inequality.

11

to the level of development a¤ects institutional variables. Based on many studies on resource curse, we also test whether after controlling for inequality and democracy, we still …nd an evidence on resource curse. To control for endogeneity biases because of the two-way relationship between institutions and economic development, we use the ArellanoBond (1991) 2-step GMM estimator, with a heteroskedastic-consistent error correction by Windmeijer (2005).

We …nd that among the four institutional variables that we use as the dependent variables namely government stability, investment pro…le, corruption, and bureaucratic quality, only government stability and investment pro…le depend on inequality, democracy, GDP per capita, and endowment. We argue that this is because corruption and bureaucratic quality may depend more on other factors excluded from the regression such as personal integrity. We …nd a strong evidence that GDP per capita has a positive e¤ect on government stability and investment pro…le. We also …nd that inequality has a negative e¤ect on investment pro…le, but a less negative e¤ect in a more democratic country. Our result also shows a strong evidence of a negative e¤ect of endowment on investment pro…le, suggesting the resource-curse phenomenon. The e¤ect of democracy on investment pro…le is ambiguous and insigni…cant on the rest of institutional variables. This is not surprising since there are many anomalies with respect to the impact of a more democratic political regime. In some countries, autocracy has been proven to be able to build a well-functioning market and support economic growths, including in Singapore and China.

All these results suggest that reinforcing factors behind the vicious cycles between low welfare and low institutional qualities are not so much corruption nor bad bureaucracy but lower investment pro…le and government instability. However, this is not to say that corruption and bureaucratic quality do not a¤ect economic performance. Hence, policy interventions on enhancing investment climate and ensuring political stability on the one hand, and increasing the level of development and reducing inequality on the other hand, are crucial in breaking the vicious cycle between low welfare and low institutional qualities.

We also …nd that lagged oneand two-periods institutional variables are signi…cant only for "structural" types of institutions, like investment pro…le and bureaucracy. These structural types of institutions are more persistent than corruption and government stability, which are prone to abrupt changes in a particular year.

There are rooms to try di¤erent regression speci…cations and models. Moreover, this model can be used to measure these e¤ects at the regional or local level.

Acknowledgements

Special thanks to the seminar participants at Monash University. This paper is based on a working paper started during a visiting fellowship with the Indonesia Project, ArndtCorden Division of Economics, Australian National University, in February 2011.

12

7. References

Acemoglu, D. (2008) "Growth and institutions," The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 03 November 2008 http://www.dictionaryofeconomics.com.

Acemoglu, D., Johnson, S., Robinson, J. (2002) "Reversal of fortune: geography and institutions in the making of the modern world income distribution," Quarterly Journal of Economics 117: 1231-94.

Acemoglu, D., Robinson, J. (2008) "Persistence of power, elites, and institution," American Economic Review 98(1):267-93.

Arellano, M., and Bond, S. (1991) "Some tests of speci…cation for panel data: Monte Carlo evidence and an application to employment equations," Review of Economic Studies 58: 277-297.

Arellano, M. and Bover, O. (1995) "Another look at the instrumental-variable estimation of error-components models," Journal of Econometrics, 68: 29-51.

Azis, I. and Wihardja, M. M. (2010) "Theory of endogenous institutions and evidence from an in-depth …eld study in Indonesia”Economics and Finance in Indonesia, 58(3).

Blundell, R., and S. Bond (1998), "Initial Conditions and Moment Restrictions in Dynamic Panel Data Models," Journal of Econometrics, Vol. 87, No. 1, pp. 115-143.

Busse and Groning (2011) "The Resource Curse Revisited: Governance and Natural Resources," Ruhr-University of Bochum and Hamburg Institute of International Economics, available at http://www.csae.ox.ac.uk/conferences/2011-EDiA/papers/399-Busse.pdf.

Della-Giusta, M. (2008) "A theory of trust based systems of intermediation," Cambridge Journal of Economics 32: 65-81.

Diamond, Larry. The Spirit of Democracy. The Struggle to Build Free Societies Throughout the World. Henry Hold and Company, LLC, New York, 2008.

Economic Review, Columns and Essays, RIETI (2009) Transparency of Government (Part 1) –Breakthrough for Reforming the Shape of Nation, accessed 2009 at

< http://www.rieti.go.jp/en/special/economics-review/013.html>.

Greif, A. (2006) Institutions and the Path to The Modern Economy, Cambridge University Press, N.Y.

Hirschman, A. (1970) Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States, Harvard University Press.

Ivanyna, M., and A. Shah (2010) "Citizen-Centric Governance Indicators: Measuring and Monitoring Governance by Listening to the People and not the Interest Groups," World Bank Policy Research Working Paper No.5181, The World Bank.

IMF (2005) "Indonesia, Selected Issues," IMF Country Report No.05/327, September 2005

Kau¤man, D., and A. Kraay. "Growth without governance," World Bank Policy Research Paper No.2928, 2002.

Keefer, P., Knack, S. (2000) "Polarization, politics, and property rights: Links between inequality and growth," Public Choice 111(1-2): 127-154.

King, D. Y. (2000) "Corruption in Indonesia: a curable cancer?" Journal of International A¤airs 53 (2): 603-624.

13

Leite, Carlos and Jens Weidmann (2002), "Does Mother Nature Corrupt? Natural Resources, Corruption, and Economic Growth," in George Abed and Sanjeev Gupta (eds.),

Governance, Corruption, and Economic Performance, Washington, DC:International Monetary Fund, pp. 159-196.

Myrdal, G. (1944) An American Dilemma. The Negro Problem and Modern Democracy, Harper &Brothers Publishers, N.Y., London.

North, D. (1990) Institutions, Institutional Change, and Economic Performance, Cambridge University Press, New York.

Ostrom, E. (1986) “An Agenda for the Study of Institutions,”Public Choice 48: 3-25, Martinus Nijho¤ Publishers, Dordrecht, Netherlands.

Plott, C.R. (1979) The application of laboratory experimental methods to public choice. In C.S. Russell (Ed.), Collective decisions making: Applications from Public Choice Theory, 137-160, Baltimore, Md.: Johns Hopkins University Press.

Savoia, A., Easaw, J., McKay, A. (2010) "Inequality, democracy, and institutions: A critical review of recent research," World Development 38(2):142-154.

Schotter, A. (1981) The Economic Theory of Social Institutions. Cambridge University Press, Cambridge, England.

Seda, F.S.S.E. (2001) "Petroleum Paradox: Natural Resources and Development in Indonesia, 1967-1997," Ph.D. Dissertation, University of Wisconsin-Madison, Madison, Wisconsin.

Serra, D. (2008) Combining top-down and bottom-up accountability: evidence from a bribery experiment, mimeo, Oxford University.

Von Luebke, C. (2009) "The political economy of local governance: …ndings from an Indonesian …eld study," Bulletin of Indonesian Economic Studies 45(2): 201-230.

Windmeijer, F. (2005) "A …nal sample correction for the variance of linear e¢ cient two-step GMM estimators," Journal of Econometrics 126: 25-51.

14

8. Appendix

Table 1

Summary Statistics.

(a) Total num b er of countries is 58

(b) Years 1998-2006

15

Table 2

Government Stability with Military in Politics.

(a)*** p=0.01, ** p=0.05, *p=0.1

(b)Time dummies and category dummies are included in all regressions

(c)Standard errors in brackets

16

Table 3

Government Stability with Ethnic Tension.

(b) Time dummies and category dummies are included in all regressions

(b) Time dummies and category dummies are included in all regressions

18

Table 5

Government Stability with Internal Con‡ict.

(b) Time dummies and category dummies are included in all regressions

19

Table 6

Government Stability with External Con‡ict.

(a)*** p=0.01, ** p=0.05, *p=0.1

(b)Time dummies and category dummies are included in all regressions

20

Table 7

Investment Provile with Military in Politicst.

(a)*** p=0.01, ** p=0.05, *p=0.1

(b)Time dummies and category dummies are included in all regressions