Thresholds: Finance, Growth & Institutions

By Ferdinand Folland

Pierson's Politics in Time (2004) outlines several forms of long-term processes, one of which is “Threshold Effects”. Threshold effects are a category of long-term processes in which the causal time horizon is long, while the time horizon for their outcomes are “short” or rapidly unfold. Essentially it is a process in which there is a slow build-up, during which the effects are small or non-existent, until one passes a threshold at which the effects drastically change and/or rapidly unfold. One case which illustrates such mechanisms may be the influence of institutions on the relationship between financial development and economic growth.

This is based on a paper by Law, Azman-Saini and Ibrahim. In their paper they start by review some of the literature on the topic of financial development and its effects on economic growth. They highlight the fact that most research display substantively different results for high-income and low-income countries. The authors proceed to suggest institutions as the omitted variable. Through regression analysis and threshold estimation techniques they research the interaction effects between financial development and the subsequent effect on economic growth. In this research they show how financial development, or development of the financial sector, does not affect economic growth, in any noteworthy or statistically significant sense, unless the institutional quality is at a particular level. Their empirical results provide interesting insight into why financial development can have such different effects across countries, while also illustrating threshold effects in the case of institutions.

The European Monetary Union and Historical Institutionalism

By Ferdinand Folland

The financial crisis that hit the European Monetary Union (EMU) is a case which illustrates both the benefits of Historical Institutionalism (HI) and its limitations. Since its inception the EMU has strived for a more interconnected European economy. In attempting this through the EMU and various other treaties that followed, both before, during and after the crisis, it has also created limitations for political actors in terms of fiscal and monetary policy. With sunk costs going into such interstate institutions and continued belief in the ideals of the EU and EMU this severely limited the actions of political actors. Verdun shows this in her paper by going through the actions that were committed, in particular the rise of new institutions, in the wake of the financial crisis.

Verdun's paper highlights the benefits of looking at problems through the theoretical lens of HI. By looking at the design of the EMU it provides insight into some of the origin of the problems Europe experienced and the nearly path dependent sequence of events that follows. Thus she highlights the importance of historical and institutional context, and the value in viewing history not as a series of independent events. One aspect which is not covered extensively enough is the political process which occurred in affected countries. The unfortunate result of focusing too much on institutions is that it becomes easy to neglect the societal explanations when embedded political actors, such as politicians, and interest groups ranging from bottom-up populist movements to powerful actors from the financial sector interact. It is possible for HI to incorporate a societal framework into its focus on institutions, however it is a regrettable outcome that a tradition relying on institutional explanations at times forget to analyse the actors within them.