The effect of institutional quality on economic efficiency: Evidence from European countries

Purpose This study aims to investigate the relationship between institutional quality and economic efficiency, which is crucial for policymaking, as improvements in governance structures can significantly increase a nation’s productive performance and reduce systemic inefficiencies. Using data from 14 European nations from 1996 to 2014, this research explores the influence of institutional quality on aggregate economic efficiency. We examine two major issues: whether institutional quality reduces inefficiency and whether institutional quality must be viewed as exogenous or endogenous. Design/methodology/approach We use the Karakaplan and Kutlu (2017) endogenous stochastic frontier model, which allows us to account for the endogeneity of institutional quality and assess whether greater institutional quality reduces aggregate inefficiency. Findings The evidence implies that institutional quality is endogenous and serves as a pathway for lowering national inefficiency, with regulatory quality, voice and accountability playing a particularly important role. Our findings, which remain consistent across various technological specifications, indicate a strong recommendation for the implementation of policies that foster a conducive environment for business. Originality/value This research attempts to analyse the influence of institutional quality on aggregate economic efficiency in Europe using a recent empirical approach to account for the endogeneity of institutional quality.