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www.elsevier.com/locate/worlddev
doi:10.1016/j.worlddev.2009.10.008
Formal and Informal Institutions and Development
MARK C. CASSON, MARINA DELLA GIUSTA and UMA S. KAMBHAMPATI *
University of Reading, UK
Summary. — Our paper presents a critical review of the literature on institutional change and the role of institutions in economic devel-
opment. We discuss the roles and interrelationships of formal and informal institutions and introduce a collection of papers addressing
this topic in a variety of development settings.
Ó 2009 Elsevier Ltd. All rights reserved.
Key words — formal and informal institutions, development, intra-country studies
The recent literature on the impact of institutions on devel-
opment has largely concentrated on the impact that institu-
tions, generally understood as formal and informal rules and
regulations governing economic activity, including tax laws,
legal regulations, political freedoms, ethnolinguistic fractional-
ization, religion, and infrastructure (democracy, authoritari-
anism, etc.), have on economic growth (Acemoglu &
Johnson, 2005; Acemoglu, Johnson, & Robinson, 2001; Agh-
ion, Howitt, & Mayer-Foulkes, 2005; Hall & Jones, 1999;
Knack and Keefer, 1997; Miguel & Gertler, 2005; Miguel,
Gertler, & Levine, 2006). Writing in 2005, Pande and Udry ar-
gued that while the findings of this literature are “of funda-
mental importance for development economists and policy
practitioners in that they suggest that institutional quality
may cause poor countries and people to stay poor,” (Pande
& Urdy, 2005, p. 2) it is also plagued by the endogeneity of
institutions to growth. We therefore need on the one hand
to provide precise descriptions of the mechanisms through
which institutions play a role in determining development out-
comes, and on the other hand to move beyond cross-country
studies to explore the heterogeneity of institutions in different
countries, which is best achieved through studies based on mi-
cro-data.
This Special Issue aims to address both issues by drawing on
insights from institutional theory (e.g., North, 1990) and social
theory (Coleman, 1988, 1990; Dasgupta & Serageldin, 2000;
Putnam, 1993; Taylor, 1990) for studying institutions and
development (Della Giusta, 1999, 2008; Della Giusta &
Kambhampati, 2006). In the process, it presents a selection
of papers highlighting the relationships between formal and
informal institutions and development outcomes, concentrat-
ing largely on intra-country studies.
There exist different approaches to institutions and their
evolution. According to the contractarian perspective, histor-
ically institutions emerged through a social contract between
citizens and the state which delegated the use of violence to
the latter in exchange for protection and social order. In this
context, firstly defense, and subsequently political institutions
began to become important, particularly those relating to gov-
ernance. Over time, these institutions were supplemented by
economic institutions like private property rights and markets,
all of which stimulate economic growth (see Rodrik, 2000,
2005; Savoia et al., this volume). Of course, it is not only
growth-igniting institutions that are required. Healthy sys-
tems, as Savoia et al. (this volume) argue, also require
growth-sustaining institutions which will reinforce long-term
economic development (as opposed to growth alone) and con-
flict management institutions, which will relieve social conflict.
137
Electronic copy available at: http://ssrn.com/abstract=1800009
World Development Vol. 38, No. 2, pp. 137–141, 2010
Ó 2009 Elsevier Ltd. All rights reserved.
0305-750X/$ - see front matter
Rather than concentrating solely on the ways in which for-
mal institutions and organizations shape socio-economic out-
comes, a development-orientated institutional perspective also
needs to emphasize more explicitly the role of informal institu-
tions in shaping formal ones (e.g., the law). 1 It therefore needs
to analyze the ways in which informal institutions (customs)
gradually change the actions and interactions of agents in all
sorts of social organizations (households, groups, villages, as
well as firms and governments). It has long been clear that
the evolution of institutions is driven by social institutions like
gender, class, caste, and social capital. Pateman (1988), for
instance, explains how within the social contract as nor-
mally described a contract that validates gender inequality is
hidden. Mies (1999) raises a similar point in relation to caste
and class.
North’s theory of institutional change explains that formal
institutions are a crystallization of informal ones (North,
1990), and that both co-evolve through the operation of orga-
nizations (informal and formal social groups, from households
and villages to networks, firms, parties, and governments).
However, in his framework, institutions are designed by indi-
viduals who are acting rationally and free of constraints:
“institutions are a set of rules, compliance procedures and
moral and ethical behavioural norms designed to constrain
the behaviour of individuals in the interests of maximising
the wealth or utility of the principals” (pp. 201–202). Pande
and Urdy (2005) contest the notion of “agency” embodied in
this definition by arguing that institutions are often not
“designed” and even when they are, their operation may be
different to what was originally intended. They therefore argue
that we should concentrate on de facto institutions rather than
de jure ones. Extending this point, we argue that North’s
“moral and ethical behavioural norms” are often embodied
in informal institutions like religion and caste that determine
the quality and sustainability of formal institutions like
schools, labor markets, and the rules and regulations govern-
ing economic activity. Our approach in this Special Issue,
therefore, sees informal institutions as norms and customs reg-
ulating socio-economic life, and we argue that crucially they
determine each individual’s position relative to others (in the
same way in which capabilities and functionings are con-
structed in Sen’s framework). These informal institutions must
therefore be included in all socio-economic analyses of institu-
tions.
* Final revision accepted: December 3, 2008.
138 WORLD DEVELOPMENT
It is clear that informal institutions in developing countries
play a very significant role in shaping formal institutions and
in the operation of markets, and can emerge as the preponder-
ant rules of interaction when formal institutions and markets
fail. Jean-Philippe Platteau argues that economic specializa-
tion requires well-defined property rights, which must evolve
over time. Practices and rules as well as the public agencies
and moral environment which sustain trust are determined
at least in part, if not largely, by the cultural endowment of
societies as they have developed over their particular histories
(Platteau, 1994). In our framework we would therefore say
that an individual’s position vis-a-vis others and therefore
their ability to access resources depends on historically and
culturally determined power relations, which are continuously
changed by people pushing the boundaries of what is feasible
(empowerment processes, but also social and economic entre-
preneurship). In this context, social capital becomes central
because the “power of an actor” is directly measured by “the
social capital” available to the actor within that system, which
is ruled by both informal and formal institutions: some actors
only have access to primary and non-cross-cutting social net-
works which limit their sphere of action (e.g., poor, low-caste,
or women in some contexts 2), others can access both cross-
cutting social networks and institutional capital. 3
In the context of such an approach, the existing literature on
institutions and development is limited in three ways:
1. It does not precisely define the respective roles of formal
and informal institutions in development processes. Institu-
tions are seen in very broad terms as relating to certain
political or economic rules of behavior (e.g., protection
against expropriation risk or government anti-diversion
policies (Acemoglu et al., 2001) or country’s openness (Hall
& Jones, 1999) or bureaucratic efficiency (Mauro, 1995).
Very few authors consider informal institutions like caste,
ethnicity (Esfahani & Ramirez, 2003; Mauro, 1995), or
trust (Knack & Keefer, 1997).
2. It concentrates on the impact that institutions have on
growth, rather than on development in broader terms.
Thus, most of the existing papers are concerned with the
impact on log GDP per capita (Acemoglu & Johnson,
2005; Acemoglu, Johnson, & Robinson, 2002; Acemoglu
et al., 2001; Aghion et al., 2005) or output per worker (Cla-
gue, Keefer, Knack, & Olson, 1999; Hall & Jones, 1999).
They concentrate on growth-igniting institutions rather
than on growth-sustaining or conflict management institu-
tions (Savoia et al., this collection). It is therefore not sur-
prising that there are fewer papers on the impact on health
(except for Djankov, La Porta, Lopez-de-Silanes, & Shleif-
er, 2002) or education (Glaeser, La Porta, Lopez-de-
Silanes, & Shleifer, 2004) or even broader measures of
development like sustainability.
3. While this literature accepts the reverse causality that is
from development to the quality of institutions within a
country, it does so in the context of cross-country regres-
sions and therefore attempts to instrument for such endoge-
neity. It is unable to analyze the impact of institutions on
the quality and sustainability of other institutions and
through them on broader development goals like poverty,
inequality, or general well-being.
The papers in this Special Issue address the above-men-
tioned limitations of the existing literature in a number of
ways. First, these papers investigate the relationship between
formal and informal institutions. How do informal institutions
like religion, caste, and gender influence formal institutions as
well as access to resources? This is considered in the context of
education (Asadullah and Chaudhury; Crost and Kambham-
Electronic copy available at: http://ssrn.com/abstract=1800009
pati), community organizations (Adhikari and Goldey), and
the labor market (Harriss-White). Second, they investigate
how formal institutions like property rights and market insti-
tutions (Granville and Leonard) and schools (Asadullah and
Chaudhury; Crost and Kambhampati) influence broader
growth (Granville and Leonard) and development outcomes
(Harriss-White, Asadullah and Chaudhury, Adhikari and
Goldey and Crost and Kambhampati) like access to public
goods, social security provision, education, and the sustain-
ability of community groups.
We begin the Special Issue by providing an overview of the
existing literature and the gaps in this literature (Savoia et al.).
We then move onto consider the traditional institutions like
economic rules and regulations including property rights
(Granville and Leonard) before extending beyond this to
broader socio-cultural institutions like caste (Harriss-White;
Crost and Kambhampati), religion (Asadullah and Chaudhu-
ry; Crost and Kambhampati), social capital and elite groups
(Adhikari and Goldey). The Special Issue therefore aims to
provide a broad view of institutions while at the same time
extending the remit of these institutions away from purely eco-
nomic outcomes toward broader socio-economic development
outcomes.
1. PAPERS IN THIS VOLUME
We begin with a wide-ranging paper by Savoia et al. on
inequality, democracy and institutions in which the authors
provide a critical review of the existing research. While it is
true that “institutional quality may cause poor countries and
poor people to stay poor” (Pande & Urdy, 2005), Savoia
et al. argue that institutional quality itself is determined by
lack of equity in a society. Their basic thesis is that inequitable
economies develop exploitative and inefficient institutions.
They argue in this context that democracy matters because it
could contribute to setting up institutions that guarantee equal
opportunities for all. However, unfair wealth distributions can
block the emergence of effective democracy because it makes
redistribution too costly for the elites in power. In particular,
the relationship between political democracy and inequality is
important, because inequality shapes, and is shaped by, polit-
ical institutions. The paper provides a useful framework for
the papers that follow, highlighting as it does, the impact that
inequality, in both economic and socio-political terms, has on
the quality of institutions, a theme that is picked up by other
papers in this issue including Harriss-White, Crost and Kamb-
hampati and Adhikari and Goldey.
Granville and Leonard provide a more traditional analysis
of the role played by growth-igniting institutions in a transi-
tional economy, where new institutions are emerging and
replacing existing ones. They argue that the spread of profit-
making mentality in Russia has resulted in an increasing
acceptance of market institutions. However, the pace of the
transition has been uneven with some regions continuing to
be dominated by the “old” institutions while others have al-
most fully transited to the new, market-oriented institutions.
The authors draw on these regional differences to consider
the role played by local protection of property rights and ab-
sence of federal laws and regulations in leading to increased
innovation and growth in these regions. The institutions they
are particularly interested in are legal protection for property
rights like the Basic Law of 1993 and the Civil Code of 1994,
strengthening of shareholder’s rights, corporate transparency,
and a range of structural reforms like taxation and labor mar-
ket rules. All these have been encapsulated into a weighted
 FORMAL AND INFORMAL INSTITUTIONS AND DEVELOPMENT
investment risk measure of institutions, which in turn is
hypothesized to determine technological change as measured
by R&D expenditure. The paper therefore provides an analy-
sis of the evolution of growth-igniting, market-oriented insti-
tutions across Russia and the impact they have on
technological change.
Harriss-White’s paper provides an interesting contrast, both
in its central concerns and in the approach used. The paper
concentrates on informal institutions (the informal labor mar-
ket as well as socio-cultural rules and regulations that domi-
nate it) to the exclusion of the formal sector. It considers the
role of the informal labor market as a conflict management
institution which provides an element of social welfare in an
economy where a more formal and comprehensive welfare net-
work does not exist. Harriss-White categorizes the informal
sector as the small firms that are not regulated as well as the
activity that takes place in and around the registered, formal
sector but is itself unregulated. She argues, as does the Special
Issue, that the non-state institutions (gender, class and caste)
express the identity of individuals and in the process influence
the institutions of the state. The scope of social policy is there-
fore the outcome of tripartite politics between the tax payers,
the state’s administrative bureaucracy and the constraints im-
posed by electoral politics. This argument is more formally
tested in the papers by Crost and Kambhampati and Asadul-
lah and Chaudhury on state policy relating to schools. Exem-
plifying this in the context of caste reservation in the labor
market, Harriss-White argues that reservations have helped
to entrench the importance of caste as a social institution for
access to jobs and have reinforced the caste-based segmenta-
tion of the labor market, a result that is further corroborated
in relation to the public provision of schooling in India (Crost
and Kambhampati). She finds that social institutions pervade
(re)distributive practices and determine well-being. The con-
nections between institutions of identity and their regulation
of informal work and informal obligations with respect to pro-
viding help in times of need is explored and Harriss-White
finds that the social institutions (gender, life cycle, caste, class)
structuring work also structure informal entitlements to care
and support when people are unable to work. Out of direct
reach of the state, regulative order as well as practices of
well-being and security in many markets depends upon institu-
tions of social identity.
Adhikari and Goldey are concerned with the sustainability
of institutions in Nepal. They find as Savoia et al. hypothesize
that in the context of inequality within villages, community-
based groups are less sustainable than they would be if greater
equality in terms of social capital networks were to prevail.
They begin with the implicit assumption that community
groups perform a useful function and therefore their contin-
ued survival is “good” for development. In this context, they
argue that the enhancement of social capital in the villages
and in the groups is expected to help resolve problems in sys-
tems of collective governance. Such a social capital therefore
performs a conflict management role. They define social capi-
tal as trust, norms of reciprocity, sanctions and networks,
which allow co-operation at three levels—between individuals,
at village level and at group level. The role of social capital in
decreasing transaction costs of organizing activity and in
allowing certain activities (like insurance, credit and even la-
bor market monitoring) to function in the absence of formal
market mechanisms is clear. Thus, having good links within
a village allows the monitoring of loans or even allows the
informal monitoring and enforcement of labor contracts,
which formal institutions like banks and formal labor con-
tracts may not be able to achieve. However, access to social
139
capital may depend on the power position and location of
the members and this power and inequality may sustain priv-
ilege and underpin disadvantage, which may in turn under-
mine the sustainability of the community groups. This
echoes Savoia et al.’s argument that inequality will determine
the quality of institutions. Adhikari and Goldey argue that
this downside of social capital might help reinforce inequality
or support anti-social behavior.
Crost and Kambhampati are concerned with the role of
informal institutions (caste and religion) and formal institu-
tions (the nature of democracy in the villages, extent of reser-
vation) in the existence and quality of the public provision of
education infrastructure, itself being an institution. Schools
represent, as Asadullah and Chaudhury et al. also reiterate,
a very significant aspect of most economies because of the con-
sciousness building role that they perform in most societies. In
this sense, schools represent institutions that will influence
both growth and wider development outcomes. They therefore
can be seen as growth-sustaining as well as conflict manage-
ment institutions (see Asadullah and Chaudhury). Crost and
Kambhampati consider whether school allocation in India is
mechanistically determined by the size of the village and its
prosperity or whether ethnic composition and local democracy
also play a role. They find that upper caste villages have more
primary schools and also have better equipped schools. At-
tempts to overcome such biases by reserving legislative seats
for Scheduled Caste and Scheduled Tribe (SC/ST) groups de-
pend, for their success, on whether the seat is reserved in a vil-
lage that is itself a majority SC/ST village. In the latter case,
schooling provision improves but if the village is not a major-
ity SC/ST village, then schooling provision worsens. This re-
flects the possibility that access to public goods depends not
only on the provision but also upon the perceived social and
political entitlement to these goods. In this case, groups with-
out such perceived entitlements may prefer direct transfers.
The authors also find that the extent of political competition
as reflected in turnover amongst the governing parties is
consistently significant in determining schooling provision in
a village. This result is reinforced by the fact that a higher
margin of victory results in fewer teachers in the schools in
the village.
Asadullah and Chaudhury analyze the impact of religion
on schools as well as the impact of these schools on social
decisions. In a context where socially ignited violence is
increasing, the role played by madrasas in managing conflict
or reinforcing it is considered in some detail. This is done
particularly with a view to considering whether graduates
from these schools are more progressive or less. The paper
examines the social impact of a madrasa (Islamic religious
school) reform program in Bangladesh. Two key features of
the reform that are considered are the change of the curricu-
lum and the introduction of female teachers. The authors
analyze whether the reform has contributed to improving so-
cial cohesion in rural areas or not. Using new data on teach-
ers and female graduates from rural Bangladesh, they explore
attitudes toward desired fertility, working mothers, higher
education for girls vis-à-vis boys, and various political re-
gimes. They find that modern religious education is associ-
ated with attitudes that are conducive to democracy.
However, in comparison with their secular schooled peers,
madrasa graduates continue to have a perverse attitude to-
ward working mothers, desired fertility, and higher education
for girls. The authors also find that young people’s attitudes
are linked with those of their teachers. Exposure to female
and younger teachers leads to more favorable attitudes
among graduates.
140 WORLD DEVELOPMENT
2. CONCLUSION
This Special Issue attempts to argue that the quality of insti-
tutions in a country will influence its development process,
while at the same time, the process of development will influ-
ence the quality of these institutions. This inherent circularity
between institutions and development is highlighted by all the
papers in the Issue and is addressed in different contexts and in
different ways by them. The Issue covers a range of institutions
(formal and informal) as well as a range of outcomes (growth,
development, and sustainability of institutions themselves).
The volume begins with a critical review of the literature in
the inequality, democracy, and institutions area (Savoia
NOTES
1. This is a crystallization of informal rules of behavior and customs and
therefore always potentially out of date, as argued by institutionalist law
scholar Simon Deakin in the Handbook of Trust (Deakin, 2006).
2. It is clear that exclusive loyalty within primary social groups is not per se
able to ensure material and immaterial benefits and can sometimes hinder the
very possibility, as witnessed by the work on intra-household conflicts and
unequal allocation (Chen & Woolley, 2001; Dobbelsteen & Kooreman, 1997;
Lundberg & Pollak, 1994; Lundberg & Pollak, 2003; Schultz, 1990), by the
exclusion at village level of the poorest from group-based microfinance
(Morduch, 1999; Rogaly & Roche, 1998; Gomez & Santor, 2001; Paxton,
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