Elsevier

Economic Modelling

Volume 25, Issue 1, January 2008, Pages 161-169
Economic Modelling

The quality of institutions: A genetic programming approach

https://doi.org/10.1016/j.econmod.2007.05.001Get rights and content

Abstract

The new institutional economics has studied the determinants of the quality of institutions. Traditionally, the majority of the empirical literature has adopted a parametric and linear approach. These forms impose ad hoc functional structures, sometimes introducing relationships between variables that are forced and misleading. This paper analyses the determinants of the quality of institutions using a non-parametric and non-linear approach. Specifically, we employ a Genetic Program (GP) to study the functional relation between the quality of institutions and a set of historical, economical, geographical, religious and social variables. Besides this, we compare the obtained results with those employing a parametric perspective (Ordinary Least Square Regression). Following the empirical results of our application, we can conclude that the parametric perspective adopted in previous papers about institutional quality could be accurate.

Introduction

In recent decades, the new institutional economics (NIE) has constituted a program of research that has propelled the return of institutions into the agenda of mainstream economics. The coasean notion of transaction costs (Coase, 1937, Coase, 1960) and the northian notion of institutions (North, 1990) established the foundations for the theoretical framework of the NIE. Political rules, informal norms and enforcement mechanisms constitute the “rules of the game” of a society and these rules establish an incentives structure that affects the level of transaction costs and the efficiency in the economy.

The NIE is a young program that is in a stage of development and it includes some academic debates and controversies, but has already allowed significant advances in different areas such as economic history, economics of organization, law and economics, policy analysis and development economics (Willliamson, 2000, Ménard and Shirley, 2005). The progress of the NIE is generated via a “guerrilla action” (Coase, 1999) that stems from several social sciences, and that was propelled by the award of the Nobel Prize to Ronald Coase in 1991 and to Douglass North in 1993. Since then, the NIE has experienced a growing process in which its analytical abilities have been recognized (Caballero, 2001, Caballero, 2002). Nevertheless, although North (2005) already proposed an extension of the NIE, this program continues requiring efforts in the theoretical and applied work. In fact, debates on definition (for example, the notion of institutions as an equilibrium (Greif, 2006) versus the view of institutions as rules (North, 1990)), methodology and measurement are present, and we need small pieces of work that expand the stock of knowledge on institutions and economy. In this sense, empirical work is the best way to improve this knowledge.

The contribution of institutions in determining income levels around the world has been one of the main programs of empirical research that has been developed since the last decade (Knack and Keefer, 1995, Knack and Keefer, 1997, Mauro, 1995, Hall and Jones, 1999, Rodrik, 1999, Acemoglu et al., 2001, Rodrik et al., 2004). There is now widespread agreement among economists studying economic growth that institutional quality holds the key to prevailing patterns of prosperity around the world (Rodrik, 2004). In this way, economics understands the relevance of analysing the quality of institutions and its determinants.

The study of the quality of institutions includes papers such as La Porta et al. (1999) or Islam and Montenegro (2002). Traditionally, this program of research, which analyzes the effect of a set of variables on the quality of institutions, has adopted a parametric perspective; therefore a specific functional form (usually linear) is assumed and the unknown parameters are later estimated using some optimization procedure as ordinary least square (OLS). The theoretical validity of the model is easily analysed considering the signs of the coefficients, the statistical significance of the parameters estimated and some fit criterion such as the Adjusted R-Square. However, assuming a parametric point of view might cause misspecification problems and, in consequence, originate a bias in the results, a loss of predictive ability and an absence of generalization of the model in the face of new observations.

Nowadays, the great advances done in the field of Computer Science allow us to develop, improve and apply powerful and sophisticated techniques for the estimation and prediction of different phenomena. One of these techniques, called Genetic Programming (GP), is inspired by Genetics and by the Darwinian theories of natural selection and survival (Holland, 1975, Koza, 1992, Mitchell, 2001). The method has already been used satisfactorily in different scientific areas, including economics (Koza, 1995, Beenstock and Szpiro, 2002), finance (Álvarez-Diaz and Álvarez, 2003, Álvarez-Diaz and Álvarez, 2005) and environmental economics (Álvarez-Diaz and Domínguez-Torreiro, 2006). This increasing and intense spread of GP is mainly due to its advantages. Firstly, they do not have any initial restriction on the functional form underlying in the data. Moreover, unlike other methods based on Computer Science, the GP also offers explicitly a mathematical equation which allows a simple ad hoc interpretation of the results. However, as opposed to these advantages, these techniques usually have the difficulty of being computationally intensive and the construction of confidence intervals and hypothesis contrasts is not trivial.

This paper studies the relationship between the quality of institutions and a set of historical, economical, geographical, religious and social variables via a genetic programming application. In this sense, we intend to verify the existence of a bias motivated by employing a parametric perspective; therefore, we try to detect possible misspecifications problems associated to the traditional parametric models. In our opinion, this verification is crucial in an empirical application and it should be always done in order to verify and corroborate the adequacy of the parametric results. In our specific application we use a Genetic Programming called DARWIN (Álvarez et al., 2001) to realize this verification and, additionally, to model what factors explain the institutional quality in different countries. To this purpose, we compare the GP results with those obtained from the traditional parametric point of view and analyse their differences and similitude.

The paper is presented as follows. After this introduction, Section 2 presents a brief explanation of the method used in our study. In Section 3, the data are described. In Section 4, the results obtained for each method are presented. Finally, in Section 5, we draw our conclusions.

Section snippets

Genetic programming

Genetic Algorithms, originally developed by Holland (1975) and later spread by Goldberg (1989) and Mitchell (2001), enclose a whole series of computing procedures inspired in biological concepts based on the Theory of Evolution of Species: survival of the fittest individuals, reproduction, and birth of offspring with a good genetic heritage. The basic characteristic of these procedures is to use some evolutionary rules observed in nature as inspiration for solving certain mathematical

Data

This paper analyses the functional relation between the quality of institutions and a set of historical, geographical, economical, religious and social variables. In Table 1 a brief description of the considered variables is showed. The General Institutional Quality Index (IG) is the endogenous variable, while the other nine variables are considered as explanatory variables. In this way, the database constructed for our study contains complete information about 117 countries.

Regarding the

Results

In order to study the institutional determinants and their temporal dynamics, we estimate our model for different years of the dependent variable. Table 4 depicts the results obtained using OLS regression and GP. At a first glance, we should highlight the temporal consistency in the results for both methods. In spite of considering different years, the results in terms of Adjusted R-Square, the explanatory variables finally chosen and their effects on quality index do not show a huge temporal

Conclusions

The general procedure to model the quality of institutions has been based almost exclusively on a linear and parametric point of view. Therefore, a-priori and rigid functional forms are discretionally imposed by the researcher rather than observed in the data. This leads to a possible misspecification problem and, in consequence, a bias in the results. In order to validate the results obtained in a parametric framework, it is relevant to open an avenue of research on the determinants of the

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    This paper was presented at the Annual Conference of the International Society for New Institutional Economics (Barcelona, 2005), the Annual Meeting of Public Choice Society (New Orleans, 2006), the Meeting of Applied Economics (Jaen, 2006) and the Simposium of Economic Analysis (Oviedo, 2006). A previous version was presented at FUNCAS as a working paper (Colección de Documentos de Trabajo de la Fundación de las Cajas de Ahorro (FUNCAS), Número 239, Madrid, 2006). We thank the anonymous referees for their useful comments.

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