Kaldor–Verdoorn’s law and institutions: evidence from Brazilian municipalities

Abstract Recent works on economic growth stress the importance of institutions as the main determinant of productivity growth. Yet, this literature disregards the effects of demand growth on productivity growth, as suggested by Kaldor–Verdoorn’s law. The objective of this paper was to test the direct and indirect impacts of institutions on productivity growth, controlling for human and physical capital, as well as for demand growth. Tests were performed for Brazilian municipalities and two measures of institutions were explored. Instrumental variables were used to cope with the endogeneity between economic performance and institutions. The regression results suggest that both supply-side factors and demand growth are important to explain productivity growth. Most importantly, by considering the interaction between demand growth and institutions, the results indicate that in municipalities with inclusive institutions and higher human capital, productivity growth responds more strongly to demand growth.