Essays on Institutions and Economic Development in Kenya By Emmanuel Maluke Letete UniversityA Thesis Presented of for Cape the Degree of Town DOCTOR OF PHILOSOPHY School of Economics, UNIVERSITY OF CAPE TOWN Date: April, 2015 Supervisor: Dr. Mare Sarr The copyright of this thesis vests in the author. No quotation from it or information derived from it is to be published without full acknowledgement of the source. The thesis is to be used for private study or non- commercial research purposes only. Published by the University of Cape Town (UCT) in terms of the non-exclusive license granted to UCT by the author. University of Cape Town Contents 1 Introduction 1 1.1 Background and Thesis Overview . 1 1.2 Thesis Conceptual Framework . 16 1.3 Contribution to the Related Literature . 17 1.4 Thesis Outline . 18 2 Evolution and Measurement of Institutions in Kenya 20 2.1 Introduction . 20 2.2 Theory . 25 2.2.1 Evolution of Economic Institutions . 25 2.2.2 Measurement of Institutions . 27 2.2.3 Criticisms of Existing Institutional Indicators . 30 2.3 Empirical Methods . 31 2.3.1 Identification of an Ideal State of Rights . 33 2.3.2 Scaling and Rating . 35 2.3.3 Validation of De-jure Indices and their Relation to the De-facto Evidence . 36 2.3.4 Assumptions underlying our Indices . 37 2.4 Results and Discussions . 37 2.4.1 Political Institutions in Kenya: a Historical Perspective . 37 2.4.2 Evolution of Property Rights Institutions and the Question of Land in Kenya . 51 2.5 Political Instability Index . 72 1 2.5.1 Scaling and Rating of Political Instability Index . 73 2.5.2 Political Instability during the Pre-Independence Era . 74 2.5.3 Political Instability during the Post-Independence Era . 76 2.6 Comparison of Institutional Indices . 77 2.6.1 Correlation between our indices and widely used institutional indices . 77 2.7 Conclusion . 81 3 Persistence of Institutions and Causality between Institutions and Economic Development in Kenya 90 3.1 Introduction . 90 3.2 Theory . 95 3.2.1 Persistence of Institutions Hypothesis . 95 3.2.2 Political Institutions vs. Economic Institutions Hypothesis . 98 3.2.3 Institutions vs. Economic Development Hypothesis . 99 3.3 Empirical Methods . 101 3.3.1 Methods To Test Persistence (Path Dependence) of Institutions . 101 3.3.2 Methods to Test Causality Between Institutions, and Institutions and Economic Development . 103 3.3.3 Variables, Data and Stylized Facts . 112 3.4 Empirical Evidence . 114 3.4.1 Are Institutions Persistent? . 114 3.4.2 Do Political Institutions cause Economic Institutions? . 120 3.4.3 Institutions and Economic Development-Causality Revelations from Alternative Proxies . 126 3.5 Summary and Conclusion . 132 4 Foreign Direct Investment and Institutions in Kenya: Are Institutions A Binding Constraint? 139 4.1 Introduction . 139 4.2 Overview of Foreign Direct Investment and Policy Reforms in Kenya . 144 4.2.1 FDI During the Period of Growth Acceleration . 144 4.2.2 FDI During the Period of Stagnation and the Muted Reforms . 146 4.2.3 FDI During the Period of Recovery and the Institutional Reforms . 148 2 4.3 Review of the Related Literature . 152 4.3.1 Barriers to Foreign Direct Investment in Developing Countries . 152 4.4 The Model . 155 4.4.1 Characterising the Equilibrium Solution under Conditions of Institutional Certainty (f = 0) . 158 4.4.2 Characterising the Equilibrium Solution under Conditions of Institutional Uncertainty (0 < f < 1) .............................................. 159 4.5 Empirical Methods and Data Issues . 162 4.5.1 Empirical Model . 162 4.5.2 Variables and Data Issues . 163 4.6 Estimation Results and Discussions . 168 4.6.1 Unit Root Tests . 168 4.6.2 Cointegration and Long-run Relationships . 169 4.6.3 Do Property Rights Institutions affect FDI in Kenya in the Short-run? . 176 4.7 Conclusion . 180 5 Illicit Financial Flows and Institutions in Kenya: To What Extent Do Political Institutions Matter? 191 5.1 Motivation . 191 5.2 Historical Context and the Stylized Facts . 196 5.2.1 Dismantling Checks and Balances and the evolution of Corruption in the Kenyan State . 197 5.2.2 Illicit Financial Flows and the Regime Change . 204 5.3 Review of Related Literature . 206 5.3.1 The Neoclassical View of Capital Flight . 206 5.3.2 Capital Flight and Social Controls . 208 5.3.3 The Political Economy View of Illicit Financial Flows and Corruption . 209 5.4 Econometric Framework . 212 5.4.1 The Baseline Empirical Model . 212 5.4.2 Data, Time Series Properties of Data and Stylized Facts . 216 5.5 Estimation Results and Discussions . 219 5.5.1 Robustness Checks Using Alternative Indicators of Political Institutions . 223 5.6 Conclusion . 225 3 6 Conclusion 238 6.1 Summary of Findings . 238 Bibliography 243 4 List of Figures 1.1 Map of Kenya Showing Colonial Land Capture . 19 2.1 Evolution of Political Rights and Civil Liberties in Kenya, 1884-2010 . 41 2.2 Evolution of Non-freehold Property Rights in Kenya, 1884-2010 . 53 2.3 Evolution of Freehold Property Rights in Kenya, 1884-2010 . 67 2.4 Evolution of Political Instability in Kenya, 1884-2010 . 75 2.5 Sub-components of non-freehold property rights for Kenya, 1884-2010 (A) . 84 2.6 Sub-components of non-freehold property rights for Kenya, 1884-2010 (B) . 84 2.7 Sub-components of freehold property rights for Kenya, 1884-2010 (A) . 84 2.8 Sub-components of freehold property rights for Kenya, 1884-2010 (B) . 84 2.9 Sub-components of political rights and civil for Kenya, 1884-2010 . 84 2.10 Sub-components of political rights and civil liberties for Kenya, 1884-2010 . 84 3.1 Evolution of GDP per capita growth in Kenya and Sub-Saharan Africa, 1963-2011 . 113 4.1 Net FDI Inflows to Kenya and the Other Selected African Countries (% of GDP-1970 to 2011) . 145 5.1 Real Illicit Financial Flows in Constant 2010 Prices and Institutions in Kenya (1970-2010) 205 5 List of Tables 2.1 Correlations between Institutional Indicators . 80 2.2 Scaling Matrix for the Political Instability Index . 86 2.3 Definition of the Main Variables . 87 2.4 Scoring of Freehold and Non-freehold Property Rights Index . 88 2.5 Scoring of Political Rights and Civil Liberties (PRCL) Index . 89 3.1 Tests results for Persistence of Institutions/Path Dependence . 116 3.2 Results of Johansen’s Cointegration Procedure (maximum lag in the VAR =2) . 119 3.3 Bivariate Causality between Political Institutions and Economic Institutions, 1960- 2010 . 123 3.4 Bivariate Causality between Political Institutions and Economic Institutions, 1884- 2010 . 124 3.5 Bivariate Causality between Political Institutions and Economic Institutions, 1884- 1960 . 125 3.6 Results for Unit Root Tests . 128 6 3.7 The ARDL Cointegration test results and the Longrun-Relationship between In- stitutions and Economic Development (1960-2010) . 129 3.8 Test results.