“As institutions influence behavior and incentives in real life, they forge the success or failure of nations.”
In economics and economic history, the transition to capitalism from earlier economic systems was enabled by the adoption of government policies that facilitated commerce and gave individuals more personal and economic freedom.
These included new laws favorable to the establishment of business, including contract law and laws providing for the protection of private property, and the abolishment of anti-usury laws. When property rights are less certain, transaction costs can increase, hindering economic development. Enforcement of contractual rights is necessary for economic development because it determines the rate and direction of investments. When the rule of law is absent or weak, the enforcement of property rights depends on threats of violence, which causes bias against new firms because they can not demonstrate reliability to their customers.
Much of this literature was built on the success story of the British state that after the Glorious Revolution of 1688 combined high fiscal capacity with constraints on the power of the king generating some respect for the rule of law.
However, others have questioned that this institutional formula is not so easily replicable elsewhere as a change in the Constitution—and the type of institutions created by that change—does not necessarily create a change in political power if the economic powers of that society are not aligned with the new set of rule of law institutions. In England, a dramatic increase in the state's fiscal capacity followed the creation of constraints on the crown, but elsewhere in Europe, increases in state capacity happened before major rule of law reforms.
There are many different ways through which states achieved state (fiscal) capacity and this different capacity accelerated or hindered their economic development. Thanks to the underlying homogeneity of its land and people, England was able to achieve a unified legal and fiscal system since the Middle Ages that enabled it to substantially increase the taxes it raised after 1689.
On the other hand, the French experience of state building faced much stronger resistance from local feudal powers keeping it legally and fiscally fragmented until the French Revolution despite significant increases in state capacity during the seventeenth century. Furthermore, Prussia and the Habsburg empire—much more heterogeneous states than England—were able to increase state capacity during the eighteenth century without constraining the powers of the executive.
Nevertheless, it is unlikely that a country will generate institutions that respect property rights and the rule of law without having had first intermediate fiscal and political institutions that create incentives for elites to support them. Many of these intermediate level institutions relied on informal private-order arrangements that combined with public-order institutions associated with states, to lay the foundations of modern rule of law states.
In many poor and developing countries much land and housing are held outside the formal or legal property ownership registration system. In many urban areas the poor "invade" private or government land to build their houses, so they do not hold title to these properties.
Much unregistered property is held in informal form through various property associations and other arrangements. Reasons for extra-legal ownership include excessive bureaucratic red tape in buying property and building. In some countries it can take over 200 steps and up to 14 years to build on government land. Other causes of extra-legal property are failures to notarize transaction documents or having documents notarized but failing to have them recorded with the official agency.
Not having clear legal title to property limits its potential to be used as collateral to secure loans, depriving many poor countries one of their most important potential sources of capital. Unregistered businesses and lack of accepted accounting methods are other factors that limit potential capital.
Businesses and individuals participating in unreported business activity and owners of unregistered property face costs such as bribes and pay-offs that offset much of any taxes avoided.
"Democracy Does Cause Growth", according to Acemoglu et al. Specifically, "democracy increases future GDP by encouraging investment, increasing schooling, inducing economic reforms, improving public goods provision, and reducing social unrest."
Policymakers and scholars frequently emphasize the importance of entrepreneurship for economic growth.
However, surprisingly few research empirically examine and quantify entrepreneurship's impact on growth. This is due to endogeneity - forces that drive economic growth also drive entrepreneurship. In other words, the empirical analysis of the impact of entrepreneurship on growth is difficult because of the joint determination of entrepreneurship and economic growth. A few papers use quasi-experimental designs, and have found that entrepreneurship and the density of small businesses indeed have a causal impact on regional growth.
Capital in economics ordinarily refers to physical capital, which consists of structures (largest component of physical capital) and equipment used in business (machinery, factory equipment, computers and office equipment, construction equipment, business vehicles, medical equipment, etc.). Up to a point increases in the amount of capital per worker are an important cause of economic output growth. Capital is subject to diminishing returns because of the amount that can be effectively invested and because of the growing burden of depreciation.
In the development of economic theory the distribution of income was considered to be between labor and the owners of land and capital.
In recent decades there have been several Asian countries with high rates of economic growth driven by capital investment.
New products and services
Another major cause of economic growth is the introduction of new products and services and the improvement of existing products. New products create demand, which is necessary to offset the decline in employment that occurs through labor-saving technology (and to a lesser extent employment declines due to savings in energy and materials). In the US by 2013 about 60% of consumer spending was for goods and services that did not exist in 1869. Also, the creation of new services has been more important than invention of new goods.
Growth phases and sector shares
Economic growth in the U.S. and other developed countries went through phases that affected growth through changes in the labor force participation rate and the relative sizes of economic sectors. The transition from an agricultural economy to manufacturing increased the size of the sector with high output per hour (the high-productivity manufacturing sector), while reducing the size of the sector with lower output per hour (the lower productivity agricultural sector).
Eventually high productivity growth in manufacturing reduced the sector size, as prices fell and employment shrank relative to other sectors. The service and government sectors, where output per hour and productivity growth is low, saw increases in their shares of the economy and employment during the 1990s.The public sector has since contracted, while the service economy expanded in the 2000s.
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