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Introduction to Modern Economic Growth This definition encapsulates the three important elements that make up institutions First, they are “humanly devised”; that is, in contrast to geography, which is outside human control, institutions refer to man-made factors Institutions are about the effect of the societies’ own choices on their own economic fates Second, institutions are about placing constraints on individuals These not need to be unassailable constraints Any law can be broken, any regulation can be ignored Nevertheless, policies, regulations and laws that punish certain types of behavior while rewarding others will naturally have an effect on behavior And this brings the third important element in the definition The constraints placed on individuals by institutions will shape human interaction and affect incentives In some deep sense, institutions, much more than the other candidate fundamental causes, are about the importance of incentives The reader may have already noted that the above definition makes institutions a rather broad concept In fact, this is precisely the sense in which we will use the concept of institutions throughout this book; institutions will refer to a broad cluster of arrangements that influence various economic interactions among individuals These economic, political and social relations among households, individuals and firms The importance of political institutions, which determine the process of collective decision-making in society, cannot be overstated and will be the topic of analysis in Part of this book But this is not where we will begin A more natural starting point for the study of the fundamental causes of income differences across countries is with economic institutions, which comprise such things as the structure of property rights, the presence and (well or ill) functioning of markets, and the contractual opportunities available to individuals and firms Economic institutions are important because they influence the structure of economic incentives in society Without property rights, individuals will not have the incentive to invest in physical or human capital or adopt more efficient technologies Economic institutions are also important because they ensure the allocation of resources to their most efficient uses, and they determine who obtains profits, revenues and residual rights of control When markets are missing or ignored (as was the case in many former socialist societies, for example), gains from trade go 172