Institutions and the Scale Effect

Endogenous growth models that imply a relationship between scale and growth are commonly refuted on the basis of empirical evidence. A focus on the extent of the market as opposed to the scale of the country has led recent studies to reconsider the role that scale plays when by conditioning on measures of openness. We develop a variant of a simple learning by doing model with endogenous market extent to include a role for institutions in determining the strength -- and direction -- of the scale effect. Using cross-country data, we find a significant interaction between property rights institutions and long-run growth: In countries with poor property rights institutions, scale is positively related with income per capita; where property rights institutions are good, higher scale is associated with lower per capita incomes. We find no evidence of such role for contracting institutions.