## Forging Strength: Exploring the Dynamic Interplay between Institutions and State Capacity

_IMF Working Papers, June 13, 2025_

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**Canonical URL:** [Forging Strength: Exploring the Dynamic Interplay between Institutions and State Capacity](https://www.imf.org/en/publications/wp/issues/2025/06/13/forging-strength-exploring-the-dynamic-interplay-between-institutions-and-state-capacity-567254)

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## Bibliographic details
- Authors: Patrick A. Imam, João Tovar Jalles
- Published: June 13, 2025
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798229011280.001

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### Summary
- Paper examines the distinct and interactive effects of state capacity (SC) and institutional quality (IN) on real GDP per capita growth.
- Sample: up to 130 countries over the period 1970–2022.
- Main result: SC and IN shocks yield positive and persistent growth effects, particularly in emerging and developing economies where governance gaps are most binding.
- Institutional reforms generate the strongest gains; SC shocks are weaker on average but highly effective when implemented alongside institutional improvements (strong complementarity).

### Methods and Identification
- Novel identification strategy isolates large, exogenous governance shocks via both residual-based and percentile-based approaches.
- Dynamic responses estimated using local projections.
- Endogeneity concerns addressed using a two-stage least squares (2SLS) approach.
- Instruments used in IV analysis: income-group-based democratization waves and natural disasters.
- IV estimates closely track the baseline, except for government effectiveness (GEE) shocks where the IV point estimate is significantly larger.

### Key Findings
- SC and IN shocks both produce positive and persistent effects on real GDP per capita growth.
- Institutional quality (IN) shocks generate the strongest gains on growth.
- State capacity (SC) shocks show weaker average effects but are highly effective in combination with institutional improvements, indicating complementarity between SC and IN.
- Effects are most pronounced in emerging and developing economies.
- Robustness: results hold across alternative shock definitions and when addressing endogeneity via IV; IV confirms shock validity.

### Policy Implications and Recommendations
- Targeted institutional reforms should be prioritized to deliver substantial economic dividends.
- Strengthening capable state structures enhances the effectiveness of institutional reforms; coordinated reforms in both IN and SC yield larger growth benefits.
- Policy sequencing and complementarity matter: institutional improvements increase the payoff to investments in state capacity.

### Robustness, Validation, and Limitations
- Results robust to alternative shock definitions and endogeneity checks.
- 2SLS IV strategy using democratization waves and natural disasters supports baseline findings.
- Notable exception: IV point estimate for government effectiveness (GEE) shocks is significantly larger than the baseline, indicating heterogeneity across governance dimensions.
- IMF Working Papers are research in progress and aim to elicit comments and encourage debate.

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_Source: https://www.imf.org/en/publications/wp/issues/2025/06/13/forging-strength-exploring-the-dynamic-interplay-between-institutions-and-state-capacity-567254_