The organizations that come into existence will reflect the opportunities
provided by the institutional matrix. That is if the institutional framework
rewards piracy then piratical organizations will come into existence; and if
the institutional framework rewards productive activities then organizations- firms – will come into existence to engage in productive activities.
(1994:361)
People will opt for those occupations that offer them the highest returns on
their abilities and these choices will in turn impact on economic growth. When
talented people become entrepreneurs they promote economic growth and
when they become rent-seekers private returns come from the redistribution,
not the creation of wealth. There is empirical evidence that the number of
(wealth-creating) engineers is positively and the number of (wealth-redistrib-
uting) lawyers is negatively associated with economic growth (Murphy et al.,
1991). Institutions may also fail to evolve efficiently. Family businesses based
on informal institutions such as family and kinship networks often fail to
evolve into formal institutions based on contracts and commercial law, and
professionally managed firms. This represents one impact of culture on insti-
tutional change (see the discussion in Chapter 12 relating to the family firm).
The most widely studied institution is an aspect of the legal system, that of
property rights. Property rights not only impact on the efficiency of economic
exchange, but also on economic growth through investment and productivity.
Property rights can exist over land or buildings (a title deed), over a business
(share certificates),ov er images and trademarks (copyrights) or even over
ideas and production processes (patents). Douglass North and others have
argued property rights are a pre-condition for the long-term investment in and
the conservation of assets that are necessary to drive economic growth. There
are three principal mechanisms through which property rights impact on
growth. These are incentives to invest, re-allocation of assets between users
and the compulsion to use assets efficiently.
First, to undertake long-term investment in physical capital a business needs
both long-term secure ownership of its factory and the certainty that profit
taxes won’t be raised to ‘confiscate’ higher profits if the investment is success-
ful. To undertake the huge R&D costs that can run into hundreds of millions of
pounds to develop a new drug or treatment a pharmaceutical company will
need assurance that their drug will be protected by copyrights and not dupli-
cated by other firms (see the discussion on WTO later in this chapter). Without
well-protected property rights resources may be allocated to short-term and
less productive investments such as money-lending and property speculation
that can be easily shifted and hidden or sent overseas in the form of ‘capital
flight’. Empirical work has found that the risk of investing in Sub-Saharan
Africa due to weak property rights has led to 40 per cent of the region’s wealth
being held overseas (Collier, 2007).
Second, defining and registering property rights makes it easier to re-
allocate those rights over time to the most productive user through a market
Institutions 213