Final Report Summary - INST&GLOB (Institutions and Globalization) This goal of this project was to analyze both theoretically and empirically the economic role of institutions in a globalizing world, in which different countries and regions interact with one another. The project examined three specific arenas for such interaction. The first is globalized capital markets, in which the financial institutions of a country interact with foreign investors. The second is military competition, in which the taxation apparatus of different countries compete with one another in financial wars. The third is globalized product markets in which firms produce and compete while being located in particular geographical units characterized by different institutional arrangements.Conventional wisdom holds that in all these three arenas, globalization should improve economic outcomes and foster institutional development. Globalized capital markets discipline domestic financial systems, inducing financial institutions such as banks, to develop profitable and sustainable business models. Military competition, as stressed by historians, favored the development states capable of raising taxes and mobilizing economic resources, laying the foundations for the modern nation states. Finally, economic globalization would foster trade in goods and migration, increasing opportunities for workers and firms everywhere, improving economic growth.The results of the project challenge this optimistic perspective, theoretically and empirically. With respect to capital markets, it is shown that financial globalization can give the banking system of capital receiving countries the incentive to introduce financial innovations that capitalize on investors’ misperception of risk. Accordingly, financial globalization can increase the fragility of domestic banking sectors by exposing them to sovereign default risk. These mechanisms, which are dissected and documented in the project, offer a parsimonious perspective on recent financial crises in developed and emerging economies alike. With respect to military competition, the project studies the case of state building in early modern Europe. By combining rigorous economic-theoretic reasoning with historical data collection, we show that military competition created strong divergence, encouraging already strong states to become even stronger, while inducing initially states to give up, abandoning any attempt to centralize. Finally, with respect to economic integration, we collected extensive data on economic growth in subnational regions in most countries around the world and on the productivity of firms operating in these regions. We then document that economic integration does not provide a strong force to reduce inequality standards of living and productivity around regions in the world. Standards of living remain persistently higher in regions with better institutions and higher levels of education. In sum, the project shows that in different arenas of economic interaction the competitive forces of globalization shape economic outcomes but not in the direction usually thought: globalization can worsen economic outcomes in countries with weak financial, fiscal and legal institutions.
