Why are some governments more effective in promoting economic change than others? We develop a theory of the institutional sources of economic transformation. Domestic institutions condition the ability of policymakers to impose costs on consumers and producers. We argue that institutions can enable transformation through two central mechanisms: insulation and compensation. The institutional sources of transformation vary across policy types—whether policies impose costs primarily on consumers (demand-side policies) or on producers (supply-side policies). Proportional electoral rules and strong welfare states facilitate demand-side policies, whereas autonomous bureaucracies and corporatist interest intermediation facilitate supply-side policies. We test our theory by leveraging the 1973 oil crisis, an exogenous shock that compelled policymakers to simultaneously pursue transformational change across OECD countries. Panel analysis, case studies, and discourse network analysis support our hypotheses. The findings offer important lessons for contemporary climate change policy and low-carbon transitions.