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This background paper revisits the question of causality between institutions and economic development with the notion that development is a broad concept that encompasses more than simply income growth. We use three different measures of development: Human development index (HDI), human capital and real GDP per capita and examine the causal effect between development and institutions using panel Granger causality procedure in 158 countries disaggregated by income level. We also examine whether the presence of natural resource endowments can drive this causal effect.

We find a uni-directional causality running from institutions to economic development at all stages of economic development. Different income groups, however, experience different effects depending on the employed measures of economic development. Better institutions lead to economic development in low-income countries when HDI is employed, whereas institutions are more important for economic growth in high-income countries as measured by GDP. The quality of institutions is important for middle-income countries for all aspects of economic development. Furthermore, by looking at the effect of oil endowments, we find that economic development promotes institutions in terms of better government effectiveness and rule of law in high-oil dependent countries. In low-oil dependent countries, the causal effect is reversed, with institutions leading economic development specifically voice and accountability.