Step 8: Institutions, Conflict and Governance
MatchesA-level barriers to development · IB Economics institutional factors · undergraduate political economy and institutions
In 30 seconds
- Institutions are the “rules of the game” (Douglass North): property rights, contracts, courts, and how power is held and checked.
- Acemoglu and Robinson contrast inclusive institutions, which spread opportunity, with extractive ones, which let a small elite take the gains.
- Corruption, insecure property rights and weak rule of law cut investment and growth.
- Conflict destroys capital, kills and displaces people and can trap countries in poverty (the “conflict trap”).
- Recovery is possible: post-genocide Rwanda became one of Africa’s fastest-growing economies.
Why institutions matter
People invest, save and start firms only if they expect to keep the returns. Secure property rights, courts that enforce contracts and limits on government seizure all raise that expectation. Where elites can expropriate, or where bribes are needed for every permit, investment goes elsewhere or into hiding. Many economists now see institutions as the deepest cause of differences in income between countries, with geography and culture playing smaller roles.
Key termsInclusive institutions: secure property rights, rule of law and open markets for most people, under a state with checks on power. Extractive institutions: arrangements that concentrate power and income in a narrow elite. Conflict trap: the tendency for poverty to raise the risk of conflict, and conflict to deepen poverty.
Worked example
An entrepreneur considers a $100,000 investment returning 15% a year. In Country X there is a 10% yearly chance the government seizes the business. Is the investment worth it if a safe bond pays 6%?
1Expected return each year ≈ 15% × 0.9 (if not seized) − loss of capital × 0.1.
2Expected loss from seizure = 10% of capital a year, so expected return ≈ \( 0.9 \times 15\% – 10\% = 3.5\% \).
33.5% is below the 6% safe return.
ResultThe investment does not happen. Weak property rights destroy projects that would be profitable in a country with secure rights. Multiply this across an economy and growth stalls.
Conflict and recovery
War reduces GDP directly, but its long-run costs (lost schooling, flight of skilled people, damaged trust, debt) often matter more. Recovery depends on security, credible institutions, investment in people and, often, aid. Argentina shows the opposite problem: no war, but repeated policy reversals, defaults and inflation that make long-term investment risky.
Case studies for this step (in the 100 Case Studies pack)
- Case 92: Rwanda’s Economic Transformation. How a country that experienced genocide in 1994 became one of Africa’s fastest-growing economies: state capacity, low corruption, FDI and the debate over political freedoms.
- Case 67: Argentina’s Boom and Bust Cycles. The country that was once as rich as France, and has repeated the same mistakes for a century: political economy, default and inflation.
Read the Rwanda and Argentina cases in full: 100 Economics Case Studies for $9 (was $15).Get the 100 cases · $9
Going deeper on conflict? See the Economics of War and Conflict collection.Explore · $9
Common mistakeWriting “corruption causes poverty” without a mechanism. Explain how: it raises the cost and risk of investment, diverts public spending and discourages tax payment.
Exam tipRwanda is a good evaluation point: strong state capacity and low corruption with limited political freedom. Ask whether growth under such a model is sustainable and whether it counts as development in Sen’s sense (step 1).
Practise: 6 questions
Try each one on paper first, then check the worked answer.
EasyQ1. Define institutions in the economic sense. Show worked answer
The formal and informal rules that shape economic and political behaviour, such as property rights, laws, courts, norms and constraints on government.
EasyQ2. What is the difference between inclusive and extractive institutions? Show worked answer
Inclusive institutions spread opportunity and protect property for most people; extractive institutions concentrate power and income in a small elite.
MediumQ3. Explain how insecure property rights reduce investment. Show worked answer
If returns may be seized, the expected return falls below what investors could earn safely elsewhere, so they invest less, invest abroad or keep assets in hidden, unproductive forms.
MediumQ4. Describe the conflict trap. Show worked answer
Poverty, low growth and dependence on resources raise the risk of civil war; war then destroys capital and institutions, deepening poverty and raising the chance of further conflict.
MediumQ5. Give two reasons for Argentina’s repeated crises. Show worked answer
Persistent budget deficits financed by borrowing or money creation; repeated defaults and policy reversals that destroyed credibility; dependence on commodity exports; swings between protectionism and liberalisation.
ExamQ6. “Good institutions matter more than resources or geography for development.” Evaluate. [10] Show worked answer
For: Rwanda’s recovery; Botswana vs resource-cursed neighbours; North vs South Korea share geography but differ in institutions [4]. Against: geography affects disease, transport costs and farming; institutions may themselves result from history and geography [3]. Judgement: institutions are probably the strongest single factor, but they interact with geography and history, and they are hard to change quickly [3].
Check yourself
1. Douglass North described institutions as
Institutions are the constraints that shape interaction.
2. North and South Korea are often used to show the effect of
Same geography and culture, very different institutions and incomes.
3. Corruption mainly reduces growth by
Bribes and uncertainty make projects less profitable.
Your score: 0 out of 3
The short version
- Institutions set incentives to invest and innovate.
- Inclusive institutions support lasting growth; extractive ones block it.
- Conflict and policy instability destroy the confidence investment needs.
- Use Rwanda (case 92) and Argentina (case 67).
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100 case studies with data, theory, evaluation and exam guidance, 21 of them on development.