political system. Exogenous factors, by definition, cannot be subject to change in order to
achieve better institutional settings and thus, provide little insight for policy recommendations.
Looking at institutions from a choice perspective allows identifying factors that can be subject
to political reforms and therefore lead to institutional change.
In particular, the paper identifies contemporaneous factors that have hindered institutional
reforms in Central Asia and that the lack of reforms in Central Asia is the result of a lack
of incentives for policy makers and individuals. Secondly, we provide stylised evidence that
external factors can provide important commitment devices for Central Asian economies to
reform existing institutional arrangements.
Based on the findings it is argued that deficiencies in the education system and preferences
about institutional reforms are responsible for the persistence of institutional settings in Central
Asia. Both, preferences and the education received under the old socialistic system are two main
channels through which historical factors affect current institutional arrangements and provide
an obstacle for implementing more efficient, market-based institutions.
We also provide stylised evidence that factors related to the degree of openness of the economy
provide important incentives for policy makers in conducting institutional reforms. External
factors such as real and financial openness, fixed exchange rates, non-trade related international
agreements, and external shocks have helped to reform economic institutions in Central Asia
and have made the reform process more dynamic in recent years.
A high degree of trade and financial openness may provide an incentive to reform institu-
tional settings as countries have a larger share of revenues per gross domestic product (GDP)
from external trade and a larger share of foreign investment in total investment. Therefore,
opportunity costs in terms of forgone business opportunities as a result of bad governance pro-
vide incentives to improve the institutional set-up. Similarly, financial openness provides an
incentive to remedy deficiencies in the regulatory framework, and thereby making the economy
less prone to sudden capital outflows which may result in financial turmoil and painful economic
recessions. Pegging the exchange rate, in combination with financial openness has the same
effect or amplifies the effect of financial openness, as undesirable domestic policy measures may
result in speculative attacks against the currency regime. We also find that external agreements,
such as the TACIS-programme is likely to contribute as an incentive as it explicitly aims for in-
stitutional change and more market-oriented institutions which are essential for closer ties with