Risk Sharing and Institutional Quality: Evidence from OECD and Emerging Economies
| Author | Pierucci Eleonora,Balli Faruk |
| DOI | http://doi.org/10.1111/sjpe.12212 |
| Published date | 01 February 2020 |
| Date | 01 February 2020 |
RISK SHARING AND INSTITUTIONAL
QUALITY: EVIDENCE FROM OECD
AND EMERGING ECONOMIES
Balli Faruk* and Pierucci Eleonora**
ABSTRACT
In this paper, we investigate the impact of institutional quality on risk sharing
across Organisation for Economic Co-operation and Development (OECD) and
emerging economies (EMEs). It has been found that the quality of institutions
and risk sharing are significantly interrelated among OECD members (mostly
through credit market channel), but not for the EMEs. Our results are consis-
tent when we control for pre- and post-GFC periods. The reason why the impact
of institutional quality on risk sharing is limited among EMEs might be due to
the significant monetary injections from advanced economies in the form of
remittances and financial aid which might understate other factors that influence
risk sharing.
II
NTRODUCTION
The global financial crisis (GFC) dragged many countries into extensive reces-
sion and had a deep impact not only on the financial sector but also on other
main sectors such as the government (Acharya et al., 2009). Only for the Uni-
ted States, the unemployment rate increased from 4.7% in September 2007 to
7.4% in December 2008 that made many people unexpectedly lose their jobs
affecting their current income and consumption (Hurd and Rohwedder, 2010).
When it comes to the issue of income and consumption smoothing, the
national response against the devastating shocks, such as GFC, may vary
depending on the level of economy. For the United States, for instance, the
Economic Stimulus Act of 2008 was urgently passed to inject some public
funds to sustain consumption expenditures by households and individuals
(Taylor, 2009). In contrast, remittances, foreign aid and trade transfers from
the developed countries can be important for developing economies to buffer
output shocks (Griffith-Jones and Ocampo, 2009).
As a practical idea against the hazard, risk sharing in society can be a sig-
nificant factor. It appears from individual behaviour without external inter-
vention, and relies on the individual capacity such as the cooperation
*Massey University
**Roma Tre University
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12212, Vol. 67, No. 1, February 2020
©2019 Scottish Economic Society.
53
(Fafchamps and Lund, 2003). A strand of literature (Iyer et al., 2005; Tor-
tosa-Ausina and Peir
o, 2012; Pericoli et al., 2015) provide analysis of the cor-
relation between quality of institutions, social capital and economic growth to
advocate the importance for economic well-being. Specifically, it may repre-
sent the social response among people at times of economic downturn, when
one member of a family or community can lose their job unexpectedly and
other one can provide financial support.
Similarly, the link between individual and community may be expressed by
participation in communities to develop the society. Brehm and Rahn (1997)
emphasize the importance of the relationship between an individual and the
government, which can represent the alliance between an individual and his
community, whereby trust in government serves as a base for institutional
quality. According to Keele (2007), trust in government is crucial, since people
arrange their expectations and consumption plans depending on its actions
and economic policies. Understanding the relation between these two elements
makes the basis of this paper, where we identify the influence of the quality of
institutions on consumption decisions and its impact on risk sharing. We use
specific factors engaged in national aggregates such as the rates of consump-
tion and GDP growth, and several governance indicators such as measure-
ments of institutional quality.
Despite existing works on the institutional quality and economic growth
nexus, the impact of institutional quality on risk sharing is still underinvesti-
gated. In particular with respect to heterogeneity in quality of institutions
among countries.
Our empirical analysis show that institutional quality contributes to greater
risk sharing and considerably affects the response against the output shocks
for OECD members, but only little for the emerging economies (EMEs).
However, EMEs have strong monetary injections in the form of remittance or
foreign aid, which might undermine institutional quality impact on risk
sharing.
II LITERATURE REVIEW
Over the past few decades many researchers have attempted to find out a cor-
relation between the level of consumption and institutional quality. Their
interaction with the economic growth appears to be common. Apparently, the
purpose of most investigations was to exhibit the extent to which institutional
quality has influenced consumption behaviours in different economies because
the change in economic climate tends to impact people’s mentality and beha-
viours to some extent. In a similar context, there are some studies which
include the influence of interactions on risk sharing between institutional qual-
ity and consumption changes, between institutional quality and economic
growth, and between consumption changes and economic growth in turn. In
relation to risk sharing, it is worth noting that risk sharing helps to prevent
those poorer and unsafe from the significant and unexpected damages such as
natural disaster and global recession. Indeed, weak groups in the society have
Scottish Journal of Political Economy
©2019 Scottish Economic Society
54 BALLI FARUK AND PIERUCCI ELEONORA
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