ABSTRACT
Economic performance and standards of living vary considerably across nations, and the gap between many rich and poor nations is widening. Many theories have been proposed to explain this phenomenon, including dependency theory and neoclassical growth theory. Institutions are the key factor in determining nation's economic performance. Ronald Coase first directed attention to institutions by observing that the exchange process is costly. Transaction costs—the costs of negotiating, measuring, and enforcing contracts—are significant. It is the institutional framework of a nation that determines the level of transaction costs. With a fixed level of technology, a nation will approach its production possibilities frontier only by having an institutional framework that results in low transaction costs. Over time, a nation increases its wealth via technological advancements. Over the past five decades, many nations have followed inward-looking import substitution polices while others have adopted export-led policies. Both strategies have strengths and weaknesses, but the dynamic incentives of export-led policies have been much more powerful.
