In order to understand some of the social, economic and political problems of our society, it is essential to know what institutions are and what their purpose is. Historically, institutions have been conceived by human beings to sustain order and reduce uncertainty (North, 1991). Lin and Nugent (1995) define institutions as a set of rules of behavior created by human beings, which guide social interactions. On the other hand, North (1990) emphasizes that institutions structure incentives in human exchanges, whether political, social, or economic.
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Institutions can be distinguished between formal and informal. Formal institutions refer to the political, economic, and legal rules that condition the behavior of individuals and facilitate exchanges, while informal institutions are the beliefs, values, and behaviors of a society (North, 1990). Examples of institutions are systems of property rights; regulatory apparatuses that discourage the worst forms of fraud, anti-competitive behavior, and immoral acts; and a rule of law that promotes good governance (Rodrik, 2000).
Economic institutions, such as property rights, are especially important because they influence the structure of economic incentives in society. Acemoglu et al. (2005) argue that without property rights individuals will not have the incentives to invest in human or physical capital or adopt more efficient technologies. It is important to foster a high-quality business environment that promotes activities that lead to greater economic growth (Acs, 2006).
In turn, political institutions, similar to economic institutions, determine the constraints on the incentives of the main actors, but in the political environment. Political institutions refer to the forms of government (democracy, dictatorship, etc.) and the limits of power imposed on politicians and political elites. Political institutions will determine economic institutions and their performance directly and indirectly (Acemoglu et al., 2005); for this reason, it is essential that political institutions function as a system of checks and balances between political power holders and society; otherwise, power holders could hijack economic institutions for personal gain (Rodrik, 2000).
When political and economic institutions fail, government failures and market failures can occur. These failures can manifest themselves in different ways, for example: the omission of reliable information for consumers, misguided government regulations to favor political interests, corrupt judicial systems, and the lack of intermediary institutions to facilitate economic transactions and audit committees (Khanna & Palepu, 2005). In addition, the failure of government institutions can also affect "the performance of business activity and the variance around expected revenue streams" (Lecuna & Chávez, 2018, p. 30-31). In turn, market failures limit development by causing low appropriability, which in turn creates low returns to economic activity resulting in low levels of investment and entrepreneurship (Hausmann et al., 2005).
The above issues are characteristic of extractive institutions. These institutions are designed by governments to extract wealth from a sector of society and use it for personal benefit or for the benefit of their privileged elites (Acemoglu & Robinson, 2012). Colón (2019) demonstrates that this is the case of Puerto Rico and how the difficulties the country is going through are the product of a legacy of extractive government institutions, which have influenced the socioeconomic deterioration that continues to advance. Colón adds that it is enough to look at the economic evolution, the demographic decline and the performance of the country's main institutions in managing the circumstances, to be able to appreciate the economic and social destruction of Puerto Rico. In that sense, for a nation to be prosperous it must have reliable institutions (Cogan & Warsh, 2022).
References
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., & Robinson, J. A. (2012). Why nations fail: The origins of power, prosperity, and poverty. Finance and Development, 49(1), 53.
Acs, Z. (2006). How is entrepreneurship good for economic growth. Innovations, 1(1), 97‒107.
Cogan, J. F., & Warsh, K. (2022). Reinvigorating economic governance: Advancing a new framework for American prosperity. Hoover Institution.
Colón, D. (2019). Instituciones extractivas e improductivas: el caFrodrso de Puerto Rico.F
Hausmann, R., Rodrik, D. & Velasco, A. (2005). Growth Diagnostics. Growth Lab, Harvard University.
North, D. C. (1991). Institutions. Journal of Economic Perspectives, 5(1), 97‒112.
North, D. C. (1990). Institutions, institutional change and economic performance. Cambridge University Press.
Khanna, T., & Palepu, K. (2005, August). Spotting institutional voids in emerging markets. Harvard Business School Background Note, pp. 1‒11.
Lecuna, A. & Chávez, R (2018). Entrepreneurship and Weak Institutions in Latin America, Journal of Private Enterprise, The Association of Private Enterprise Education, vol. 33(Fall 2018), pages 25-47.
Lin, J. & Nugent, J. (1995). Institutions and economic development, Chapter 38 Handbook of Development Economics, 1995, vol. 3, Part 1, pp 2301-2370.
Rodrik, D. (2000). Institutions for high-quality growth: What they are and how to acquire them. Studies in comparative international development, 35(3), 3‒31.
