Institutions and long-term growth
Capital, labor and technological progress are well-known factors behind economic growth. However, those factors usually do not fully explain the differences between the prosperity of countries. Scholars Douglas North and Daron Acemoglu were among the first to recognize the importance of institutions. Acemoglu sees them as a fundamental cause behind economic development. They can be inclusive, generating prosperity by supporting investments and innovation with secure property rights and balanced distribution of power, or exclusive, dampening growth prospects.
It is not only the type of institutions that influences growth prospects, but also the effectiveness of those institutions and the redistribution of power in society. The CEE region has been continuously lagging behind Western Europe in the quality of institutions for the obvious reasons. Although a Western-like legal system was adopted by CEE countries in the early ’90s, changes in culture, traditions, norms and codes of conduct seem to be a gradual and lengthy process. The Baltic countries, however, are an example of how dynamic changes are possible. Latvia and Lithuania have progressed the most in terms of improving their rule of law ranks (Worldwide Governance Indicators), while Estonia is ranked top among former communist countries. Estonia also scored the best among its peers in the Corruption Perception Index in 2019.
All in all, positive developments after transition cannot be questioned; however, recently observed increase in populism and weakening rule of law might take a toll on long-term growth prospects. We recognize, for example, that lack of structural reforms weighs on long-term potential growth in Romania. Digitalization of the fiscal authority, streamlining of the education system to bring it closer to labor market needs, better capacity of the public administration to absorb EU funds and constitutional reform require solid political support, however. The effects are not likely to be immediate, but should become apparent over time.