Working Paper No. 200. Elert, Niklas & Halvarsson, Daniel (2012) ”Economic Freedom and Institutional Convergence”

Abstract: Francis Fukuyama argues that liberal democracy is the final form of human government and will become more and more prevalent in the long term. If this prediction is true, countries should converge in their political and economic systems toward liberal democracy, a form of institutional convergence. In this paper, we examine whether there is convergence in economic institutions, drawing on the literatures of economic convergence and of industrial organization. We use the Economic Freedom of the World-index over the period 1970-2009 to proxy for economic institutions. Our results indicate that countries with lower institutional quality experience faster institutional change than countries with higher quality, i.e., we observe institutional convergence. But countries with lower institutional quality have higher variability of institutional change. Using distributional analysis, we examine institutional transition probabilities, and find that the probability of a country ending up with high-quality institutions is high in the long-run. These findings support Fukuyama’s prediction.