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# **Box 1. What drives institutional change?**

The International Monetary Fund’s _World Economic Outlook, September 2005_ (IMF 2005) investigates the main factors driving such institutional transitions as strengthening property rights, lowering corruption, and improving accountability. An econometric analysis based on transitions in some 65 countries uses a probit model linking the probability of transition to several possible explanatory factors. The findings suggest that while a country’s institutions are shaped by a combination of history, economic structure, political system, and culture, they are not immutable. A range of factors can help bring about institutional change:

- Trade openness is significantly associated with a greater likelihood of institutional transitions and with greater institutional quality. A move from complete autarky to full liberalization increases the probability of transition by about 15 percentage points. Greater openness allows a greater role for export sectors that are rent-proof and require innovation, creating momentum for positive institutional changes. It also reduces the ability of domestic producers to sustain monopolistic rents, which impede improvements.

- Transitions are also more likely in countries with high levels of press freedom, a broad indicator of political accountability. With the political leadership answerable to a broad cross-section of the population, policies are more likely to be beneficial to the broader economy. Greater accountability is also associated with higher institutional quality.

- Improvements are more likely in countries whose neighbors have higher institutional quality. This is consistent with the view that a strong regional effect exists: transitions are more likely to happen in clusters of countries within a region around the same time, reflecting competition and the demonstration effects of regional success stories.

- By contrast aid appears to have a negative impact on the probability of transition. This may reflect the fact that countries that receive more aid are also those that suffer from disadvantageous initial conditions that impede change. The empirical evidence on the net effect of aid on institutions is mixed.

_<u>Source:</u>_ IMF 2005, <u>chapter 3.</u>

# **_Generating new information to create demand for change_**

New information about a specific policy problem provides another impetus in creating demand for policy change. In Colombia the 2002 labor market reforms originated in a 1999 study led by a small group of technocrats in the Ministry of Labor supported by private think tanks and academia. By benchmarking regulatory performance against that of neighbors and OECD countries for the first time, the study helped spark a national debate and laid the groundwork for the passage of the new labor law in 2002 (Echeverry and Santa Maria 2004, p. 12). In Vietnam detailed diagnostic studies by the Central Institute for Economic Management, a government think tank, exposed the costs of doing business (including corruption) under the old Company Law. These analyses, providing the first measures of the potential growth and employment gains from reform, were used to counter opposition to the new Enterprise Law from vested interest groups (Mallon 2004, p. 30). In all the cases of land market reform new information about the costs and