Investigating the Effect of Institutional Quality Shock on Economic Performance and Environmental Quality

Document Type : Research Paper

Authors

1 PhD student, Department of Economics, Faculty of Economics and Management, Shiraz Branch, Islamic Azad University, Shiraz, Iran.

2 Associate Professor Department of Economics, Faculty of Economics and Management, Shiraz Branch, Islamic Azad University, Shiraz, Iran.

Abstract

Abstract
Introduction
Institutional economists have long emphasized the critical role of institutions in shaping the trajectory of economic growth. Institutions—both formal (such as contract enforcement and property rights) and informal (such as traditions, beliefs, and trust)—constitute the “rules of the game” that define the social, economic, and political structures of a society. The profitability of economic activities is determined by these institutions alongside technology; however, overall economic performance fundamentally depends on institutional quality. Institutional quality reflects the strength, stability, and effectiveness of institutions in reducing uncertainty, lowering transaction costs, and facilitating coordination among economic agents. Empirical evidence shows that nations with strong institutions—those that uphold property rights and encourage free investment—have experienced economic “miracles,” whereas countries with weak institutions have endured prolonged stagnation and persistent poverty.
In developed economies (the Global North), institutions characterized by transparency and accountability foster economic growth through investment protection, political stability, and adherence to the rule of law. In contrast, institutions in developing economies (the Global South) often fail to provide adequate support for productive investment. In these contexts, property rights are frequently insecure, economic and political power is concentrated among elites, and access to education and productive opportunities is limited. As a result, weak institutional performance exerts a negative influence on economic growth and productivity.
At the same time, higher levels of economic growth are often associated with greater environmental degradation, as intensified production and consumption exert mounting pressure on ecological systems. One of the most pressing concerns worldwide is climate change and global warming, primarily driven by the rapid accumulation of greenhouse gases (GHGs), particularly carbon dioxide (CO₂). Factors such as rapid population growth, industrial expansion, and reliance on non-renewable energy sources significantly contribute to CO₂ emissions. Therefore, achieving sustainable development necessitates policy instruments that balance economic growth, environmental preservation, and social equity. High-quality institutions are essential for designing and enforcing effective environmental policies that mitigate ecological degradation. Given these considerations, the present study aims to examine the effects of institutional quality on economic growth and environmental quality.
Method
This study employs a Dynamic Stochastic General Equilibrium (DSGE) model that incorporates a product expropriation mechanism to analyze the economic and environmental effects of institutional quality shocks in Iran from March 21, 2001, to September 23, 2022. In the model, rent-seeking behavior is endogenously determined, meaning that households allocate their time between productive activities and rent-seeking. Improvements in institutional quality reduce available rent opportunities and discourage opportunistic behavior. Model parameters were estimated using the Bayesian approach in conjunction with the Random Walk Metropolis–Hastings algorithm. The observable variables include seasonally adjusted data on Gross Domestic Product, private consumption, investment, government expenditure, and oil revenues, all of which were detrended using the Hodrick–Prescott (HP) filter.
Results
The model estimation results indicate that enhanced institutional quality increases the productivity and supply of both labor and capital by reducing corruption and fostering greater motivation and effort. Consequently, factor participation rises while rent-seeking behavior declines. Furthermore, due to the complementary relationship between production inputs, investment expands, leading to higher economic growth. Reductions in corruption and rent-seeking also strengthen the implementation of environmental protection initiatives, thereby improving overall environmental quality.
Conclusion
Based on the model’s findings, it is recommended that governments and policymakers implement comprehensive anti-corruption and anti-bribery measures to promote optimal resource allocation and reduce rent-seeking activities. Strengthening institutional quality enables economies to achieve the dual objectives of sustained economic growth and environmental sustainability, contributing to long-term sustainable development.
 

Keywords

References

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Journal of Environmental and Natural Resource Economics
Volume 5, Issue 11
November 2025
Pages 95-127

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History

  • Receive Date: 16 June 2025
  • Revise Date: 07 July 2025
  • Accept Date: 16 July 2025

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