Introduction
Institutions
st tut o s a
and
d de
development
e op e t –
Week 15 and 16
• Vast differences in p
prosperity
p y across countries today.
y
– Income per capita in sub-Saharan Africa on average 1/20th of
U.S. income per capita
– In Mali
Mali, Democratic Republic of the Congo (Zaire)
(Zaire), and Ethiopia
Ethiopia,
1/35th of U.S. income per capita
• Why?
Wh ?
Readings:
Benabou & Mookherjee: Chapter 2 and 3
Acemoglu, Johnson and Robinson: ”Institutions as a
f d
fundamental
t l cause off long-run
l
growth”
th”
• Standard economic answers:
– Physical capital differences
– Human capital
p
differences
– “Technology” differences
1
Sources of prosperity
2
Outline of the lecture
• These are p
proximate causes of differences in p
prosperity.
p y
• What are good institutions?
– Why do some countries invest less in physical and human
capital?
– Why do some countries fail to adopt new technologies and to
organize production efficiency?
• Institutions, geography, or culture?
• Th
The answer to
t these
th
questions
ti
is
i related
l t d to
t the
th
fundamental causes of differences in prosperity
• Whyy differences in Institutions?
• Potential fundamental causes:
– Institutions ((humanly-devised
y
rules shaping
p g incentives))
– Geography (exogenous differences of environment)
– Culture (differences in beliefs, attitudes and preferences)
• Inequality and the development of institutions
3
4
What are institutions?
What are institutions?
• Institutions: the rules of the game in economic, political
and
d social
i l iinteractions.
i
• A broad cluster including
g many
y sub levels:
– Institutions determine “social organization”
• Economic institutions: e.g., property rights, contract
enforcement, etc.
• North (1990, p. 3):
"Institutions are the rules of the g
game in a society
y or,,
more formally, are the humanly devised constraints that
shape human interaction.“
• shape economic incentives, contracting possibilities,
distribution.
• Political institutions: e.g.,
g form of g
gov., constraints on
politicians and elites, separation of powers, etc.
• Key point: institutions
• shape political incentives and distribution of political power.
– are humanly devised
– set constraints
– shape incentives
5
6
What do we mean with good institutions?
What do we mean with good institutions?
•
Three crucial elements of good institutions are:
• Some societies are organized in a way that
–
–
–
–
–
–
•
1. Enforcement of property rights for a broad cross-section of society, so that
a variety
y of individuals have incentives to invest and take part
p in economic
life.
upholds
pholds the rule
r le of law
la
encourages investment in machinery
encourages investment in human capital
encourages investment in better technologies
facilitates broad-based participation in economic and political life
supports market transactions
transactions.
2. Constraints on the actions of elites, politicians and other powerful groups
so that these people cannot expropriate the incomes and investments of
others in the society
society.
Loosely speaking, we can refer to these societies as possessing (or
as having developed) "good institutions".
3. Some degree of equal opportunity for broad segments of the society, so
that they can make investments, especially in human capital, and
participate in productive economic activities.
7
8
Institutions?
E
Economic institutions and economic performance (1)
i i i i
d
i
f
(1)
Institutional variation
.
• Big differences in economic and political
institutions across countries.
ARE
KWT
ISR
Log GD
DP per capita
a, PPP, in 19
995
QAT BHR
– Enforcement of property rights
rights.
– Legal systems.
– Corruption.
C
ti
– Entry barriers.
– Democracy vs. dictatorship.
– Constraints on politicians and political elites.
– Electoral rules in democracy.
LUX
USA
CHE
JPNNOR
DNK
BEL
CAN
AUT
FRA
ISL NLD
AUS
ITA
GBR
SWEFIN
IRL
NZL
ESP
PRT
SGP
HKG
10
MLT
ARG
PAN
IRN
GTM
AGO
HND
NIC
SDN
HUN
BGR
RUS
IDN
CHN
EGY
LKA
ZWE
CMR
GIN
SEN
PAKGHA
VNM
COG
HTI
CIV
TGO
IND
GMB
MNG
KEN
UGA
BFA
MDG
ZAR
CZE
ROM
JAM
JORPRY
MAR
PHL
SYR
BOL GUY
SUR SLV
8
TUN
ECU
DOM DZA
PER
KOR
GRC
CHL
BHS
SAU
OMN
VEN
URY
MEX GAB
ZAF
BWAMYS
CRI COL
TTOTHA BRA
TURPOL
BGD
NER
NGA
ZMB
YEM
MOZ MWI
MLI
S
SLE
ETH
TZA
6
4
6
8
Avg. Protection Against Risk of Expropriation, 1985-95
10
9
10
Institutions?
Political institutions and economic performance
Political institutions and economic performance
Institutions?
E
Economic institutions and economic performance (2)
i i tit ti
d
i
f
(2)
.
.
KOR
CZE
ARG
URY
MEX
MYS
ZAF
SVK
PAN
HUN
COL
THA
BRA
POL
TUR
LBN
TUN
ECU
BGR
HRV
PER
DOM RUS ROM
JAM LTUJOR
LVA
KAZ
PHL
IDN
MAR
EGY
BOL CHN
UKR
ZWE LKA
ARM
GRC
10
CHL
SVN
VEN
8
SEN
GHA
IND
VNM
GEO
PAK
KEN
NGA
UGA
ZMB MDGBFA
MLI
MOZ
LUX
USA
CHE
JPN
NOR
DNK
BEL
CAN
AUT
ISL
DEU
AUS
NLD
ITA
GBR
SWE
FIN
ISR
IRL
NZL
ESP
PRT
KOR
GRC
CHL
SGP
SGPCHE
DNK
CAN
NLD
SWE
FIN
NZL
Log GDP
P per capita
a, PPP, in 19
995
10
Log GDP
P per capita, PPP, in 19
995
USA
HKG
NOR
FRA AUT AUS
DEU
GBR
ISR
IRL
ESP
PRT
JPN
BEL
ITA
FRA
ARG
VEN
MEX
GAB
THA
POL
TUN
DZA
SWZ
SYR
8
GIN
SDN
TGO
ZAR
TCD
NGA
UGA
LSO
CAF
GTM
BFA
SLV
MWI
MOZ
GMB
HTI
ZMB
YEM
DOM
PRY
LKA
HND
NIC
COG COM
PAK
KEN
SLE
TZA
PER
EGY
CHN GUY
AGO
ZWE
CIV CMR MRT
SEN
GHA
BDI
RWA
MWI
JOR
MAR
IDN
MUS
URY
MYS
ZAF
BWA
PAN
HUN
COL
CRI
TTO
BRA
TUR
ECU
FJI
JAM
PHL
BOL
IND
BEN
MDG
NPL
BGD
NER
MLI
TZA
ETH
6
6
0
.5
Control of Corruption
0
1
11
2
4
Constraint on Executive in 1990s
6
8
12
Geography?
If we want to believe that geography matters, it is enough to look at a world
map.
poorest p
places in the world, we will find almost all of them
1. If we locate the p
close to the equator.
2 If we look at some recent writings on agricultural productivity
2.
productivity. Ecologists and
economists claim that the tropical areas do not have enough frost to clean
the soil and are suffering from soil depletion because of heavy rains.
•
The geography hypothesis maintains that the geography, climate, and
ecology
l
off a society's
i t ' location
l
ti shape
h
both
b th its
it ttechnology
h l
and
d th
the iincentives
ti
of its inhabitants.
•
There are at least three main versions of the geography hypothesis:
1. Climate may
y be an important
p
determinant of work effort, incentives, or even
productivity. The heat of the climate can be so excessive that the body there will
be absolutely without strength.
2. Geography may determine the technology available to a society, especially in
agriculture.
3. Given the word tropical disease, areas infested with these diseases are at
the tropics and much poorer than the United States and Europe, where
such diseases are entirely absent
absent.
3. The third variant links poverty in many areas of the world to their "disease
burden“.
13
14
The Geography Factor
g p y
Geography?
Geography and economic performance
.
USA
SGP
10
Geography
g p y
Physical:
Economic:
Climate
distance to equator
land area
latitude
Distance to market access,
natural resources,
resources
factor endowment
Log GDP per capita, P
PPP, in 1995
5
•
Geography?
HKG QAT
AUS
LUX
CHE
NOR
AUT BEL
FRA
NLD DNK CAN
ISL
DEU
FIN
GBR
SWE
ITA
IRL
ARE
ESP
NZL
GRC
KOR
PRT
MLT
ARG
CZE
SVN
SAU
HUN
EST
MUS
SVK
CHL
MYS
MEX
URY
TTO
POL
OMN LBY ZAF
BLR LTU RUS
LVA
FJI
THA
TUR
KNA BWA
BRA
CRI
IRNTUN
GAB COL VEN
ROM
BGR
PAN
KAZ
DOM
HRV
DZA
PER LCA
PRY
GEO
GUY
NAM SWZ
PHL
GTM
GRD
DMA
EGY MAR
SLV JAM
UKR
TKM
CHN
JOR
BLZ
LKA
SYR
ECU IDN
AZE
BTN
VCT
MDA
ARM
NICHND
BOL
LSO
IRQ
UZB YUG
PNG
ZWE
IND
PAK
VNM MRT
GHA
CMR
SEN
CAF
CIV
BIH
TGO
BGD NPL
CPV HTI
KEN
GIN
MMR
STP
UGA
TJK
GMB
SDN MOZ
LBR BEN BFA
TCD
COG
NGA
GNB
MWINER
DJI
ZMBMLI MDG
YEM
AFG
AGO
COM
RWA TZA
BDI
ZAR
ETH
SLE
SOM
ISR
BHS
BHR KWT
BRB
8
JPN
6
0
.2
.4
Latitude
.6
.8
16
Culture?
Culture?
•
Culture is a relatively fixed characteristic of a group or nation,
affecting beliefs and preferences. Example: religion
•
At some level, culture can be thought to influence equilibrium
given set of institutions.
outcomes for a g
•
The most famous link between culture and economic development is
that proposed by Weber (1930) who argued that the origin of
industrialization in western Europe could be traced to the Protestant
reformation and particularly the rise of Calvinism.
•
“The set of beliefs about the world that was intrinsic to
Protestantism were crucial to the development of capitalism”
•
“Economic activity was encouraged, enjoying the fruits of such
activity was not.”
“Waste of time is . . . the first and in principle the
deadliest of sins. The span of human life is infinitely
short and precious to make sure of one’s
one s own election
election.
Loss of time through sociability, idle talk, luxury, even
more sleep
p than is necessary
y for health . . . is worthy
y of
absolute moral condemnation . . . Unwillingness to work
is symptomatic of the lack of grace” (pp. 104–105).
17
18
Culture?
Institutions geography,
Institutions,
geography or culture?
• Thus Protestantism led to a set of beliefs which emphasized
hard work, thrift, saving, and where economic success was
interpreted as consistent with (if not actually signaling) being
chosen by God
God.
•
Although
g there is correlation between institutions and economic
development, this does not establish that this is a causal
relationship.
• Weber contrasted these characteristics of Protestantism with
those of other religions, such as Catholicism, which he argued
did not promote capitalism.
•
Why?
• Barro and McCleary (2003) provide evidence of a positive
correlation between the prevalence of religious beliefs
beliefs,
notably about hell and heaven, and economic growth.
19
20
Potential problems
Potential problems
• Institutions could vary because underlying factors differ
across countries
countries.
– Geography, ecology, climate
– Culture
– Perhaps
P h
other
th ffactors?
t ?
• It is true there is a correlation between geography and
prosperity,
it ii.e., a simple
i l statistical
t ti ti l association.
i ti
B
Butt
statistical association does not prove causation.
• Montesquieu’s
q
story:
y
– Geography determines “human attitudes”
– Human attitudes determine both economic performance and political
y
system.
– Institutions potentially influenced by the determinants of income.
• Most important, there are often omitted factors driving
the associations we observe in the data
data.
• Identification problem
problem.
– We can learn only a limited amount from correlations and ordinary least
square (OLS) regressions.
21
Malaria Example:
Correlation is not the same as causality.
22
Natural Experiments of History
• In tthe
e natural
atu a sc
sciences,
e ces, causa
causal ttheories
eo es a
are
e tested by
conducting controlled experiments.
•
IIn the
th nineteenth
i t
th century
t
d
doctors
t
did nott understand
d t d what
h t caused
d malaria.
l i
To make progress towards protecting European troops in the tropics, they
developed an "empirical theory" of malaria by observing that people who
li ed or tra
lived
traveled
eled close to sswamps
amps ca
caught
ght malaria
malaria.
•
In other words, they turned the association between the incidence of
malaria and swamps into a causal relationship, that the incidence of malaria
was caused by swamps, and elaborated on this theory, by arguing that
malaria was transmitted by mists and bad airs emitted by swamps.
•
Of course they were wrong, and a few decades later, other scientists proved
that this statistical association was caused by
y an omitted factor, mosquitoes.
q
Malaria is caused by parasites transmitted by mosquito bites.
23
• Controlled experiments are much harder to conduct in
the social sciences. We cannot change a country's
institutions and watch what happens to the incomes and
welfare of its citizens.
• But history offers many natural experiments, where we
can argue that one factor changes while other potential
determinants of the outcomes of interest remain
constant.
24
The Korean experiment
Need for exogenous variation
•
Exploit “natural
natural experiments
experiments” of history,
history where some
societies that are otherwise similar were affected by
historical processes leading to institutional divergence.
–
• Separation in 1948:
• Democratic’s People Republic of Korea:
– abolishment of private property of land and capital
– economic decisions mediated by the communist state
A source of variation that affects institutions, but has no other effect,
independent or working through omitted variables, on income.
•
Examples of potential natural experiments of history:
1.
2
2.
South versus North Korea
European colonization
• Republic of Korea:
– private property
– markes and private incentives, especially after 1961
25
26
North and South Korea
North and South Korea
The Korean experiment
The Korean
•
Before 1948:
•
•
Same cultural and historical roots
Strong degree of ethnic, linguistic, cultural and economic
homogeneity
Few geographic distinctions,
distinctions same disease environment
Man-made initial conditions similar, or to advantage of North:
GDP per
G
pe capita
cap ta
14000
•
•
12000
10000
8000
South Korea
North Korea
6000
– industrialization during colonial period - more in North
– Ch’ongjin (North): largest sea-port on sea of Japan
4000
2000
• Madddison (2001): same income per capita in 1948
0
1950
27
1960
1970
1980
1990
1998
28
The Korean experiment
Colonization
By late 60’s:
y
• South Korea one of the Asian ”miracle” economies
• North Korea: stagnation
North Korea: stagnation
By late 2000:
By
late 2000:
• GDP per capita in South Korea 16000 dollars, OECD member
• GDP per capita in North Korea 1000 dollars as typical in Sub‐
• GDP per capita in North Korea 1000 dollars, as typical in Sub
Saharan Africa
Conclusive experiment, but need of larger scale ”natural experiment” in institutional divergence:
•
C l i i transformed
Colonization
f
d the
h iinstitutions
i i
iin many countries
i
conquered by Europeans, but had no effect on their geographies.
•
If geography is the key factor determining the economic potential of
a country, the places that were rich before the arrival of the
Europeans should continue to be rich after the colonization
experience as well, in fact also today.
•
If it is institutions that are central, then those places where good
institutions were introduced or developed should get richer
compared to those where Europeans introduced or maintained
extractive institutions.
29
The History of colonisation
•
30
The History of colonisation
Historical
Hi
t i l evidence
id
suggests
t th
thatt Europeans
E
indeed
i d d pursued
d very diff
differentt
colonization strategies in various colonies.
• So what happened to economic development after
colonization?
1. At one extreme, Europeans set up extreme extractive institutions, exemplified by the
Belgian colonization of the Congo, slave plantations in the Caribbean or forced labor
systems in the mines of Central America. These institutions introduced neither
protection for the property rights of citizens nor constraints on the power of elites
elites.
2. At the other extreme Europeans replicated and often improved the European form of
institutions. Primary examples of this mode of colonization include Australia, New
Zealand, Canada, and the United States. The settlers in these societies managed to
place significant constraints on elites and politicians.
• Did places
l
th
thatt were rich
i hb
before
f
colonization
l i ti remain
i rich,
i h
as suggested by the geography hypothesis?
• O
Or was there
th
a systematic
t
ti change
h
in
i economic
i ffortunes
t
associated with the changes in institutions?
31
32
The Reversal of Fortune
European colonization as a “natural
natural experiment”
experiment
•
• Id
Idea: European
E
colonialism
l i li
as a ”natural
” t l
expriment”
Approximating a “natural
natural experiment”
experiment because
– Many factors, including geographic, ecological and climatic ones, constant, while
big changes in institutions.
– Changes in institutions not a direct function of these factors.
– Analogy to a real experiment where similar subjects have different “treatments”.
• Reversal of fortune within former European
colonies
– Mughals, Aztecs, Incas
– North America, New Zeland and Australia
•
Consequences?
•
Look at changes in prosperity from before colonization (circa 1500)
to today in the former colonies sample.
33
Measuring prosperity before national accounts
•
34
Urbanization and income today
.
To answer these questions, we need a measure of prosperity before the
modern era.
USA
CAN
10
•
•
•
Urbanization is a good proxy for GDP per capita
Only societies with agricultural surplus and good transportation network can
be urbanized
urbanized.
Urbanization is highly correlated with income per capita today and in the
past.
t
GDP p
per capita, PP
PP, in 1995
•
9
LCA
NAM
GRD
FJI
GTM
8
LKA
SWZ IDN
GUY
AGO
ZWE
TUN
ECU
DZA DOM
PRY
JAM
PHL
MAR
SUR
CPV BOL
EGY
SLV
BLZ
VCT
7
BRA
PER
DMA
HND
CMR
GIN
CIV
SEN
COMPAK
SDN GHA
VNM LSOIND
GMB
TGO
CAF
HTI
BEN
LAO
KEN
MRT
NIC
COG
UGA
NPL
BGDTCDMDG
ZAR
BFA
NGAZMB
NER
ERI
MLI
MWI
MOZ
We can construct data on urbanization in the past
BDI
RWA
TZA
•
GABMYS
ZAF
CRI PAN BWA
KNA
MEX
COL
TTO
SGP
CHL
BHS
S
ARG
VEN URY
BRB
MUS
HKG
AUS
NZL
SLE
6
In addition, use population density as a check.
– Useful also because related to the causal mechanism.
mechanism
0
35
50
Urbanization in 1995
100
36
Results: until 1500
Reversal since 1500 (1)
.
• Persistence is the usual state of the world.
USA
– There is “mean reversion” and rise and decline of nations, and
certainly of cities.
– But countries that are relatively rich at a point in time tend to
remain relatively rich.
10
CAN
AUS
SGP
HKG
GDP per capita, P
PPP, in 1995
5
NZL
• The
Th data
d t confirm
fi thi
this persistence.
i t
– After the initial spread of agriculture, there was remarkable
persistence in urbanization and p
p
population
p
density.
y
– Largely true from 1000 BC to 1500 AD, and also for subperiods.
– More important, true also in the former colonies sample.
CHL
9
ARG
VEN
URY
MYS
COL
BRA
BLZ
GTM
DOM
PRY
8
MEX
PAN
CRI
JAM
PHL
ECU
PER
TUN
DZA
IDN
SLV
GUY
BOL
EGY
MAR
LKAHND
NIC
VNM
HTI
PAK
IND
LAO
7
BGD
0
5
10
Urbanization in 1500
15
20
37
38
Reversal since 1500 (2)
Reversal of Fortune
.
CAN
AUS
10
USA
SGP
HKG
•
The strong negative relationship indicate a reversal in the rankings
in terms of economic prosperity between 1500 and today.
•
In fact, the figures show that in 1500 the temperate areas were
generally less prosperous than the tropical areas.
•
This reversal is evidence against the most standard versions of the
geography hypothesis discussed earlier.
•
It cannot be that the climate, ecology or disease environments of the
tropical areas condemn them to poverty today, since these areas
with the same climate, ecology and disease environments were
richer than the temperate areas 500 years ago.
GDP
P per capita, P
PPP, in 1995
NZL
CHL
ARG
URY
BWA
BRA
9
VEN
ZAF
NAM
SUR
GUY
8
7
BHS
BRB
GAB MEX
MYS
KNA
PAN
COL TTO
CRI
PRY
SWZ
CPV BOL
LCA
ECU
GRD
PER
BLZ
DOM
DMA
VCT
GTM
DZA
TUN
JAM
PHL
IDN
MAR
SLV
AGO
LKA
ZWE HND
NIC
CMR
GIN
CIV
COG MRTGHA
SEN
COM
IND
LSO
SDN PAK
VNM
GMB
TGO
CAF
HTI
LAO KEN BEN
UGA NPL
BGD
ZAR
BFA
TCD
MDG
NGA
ZMB
NER
ERI
MLI
BDI
RWA
MWI MOZ
TZA
EGY
SLE
6
-5
0
Log Population Density in 1500
5
39
40
What’ss happening?
What
happening?
When did the reversal happen?
Urbanization in excolonies with low and high urbanization in 1500
(averages weighted within each group by population in 1500)
•
25
F
Former
colonies
l i with
ith hi
high
h urbanization
b i ti and
d population
l ti d
density
it iin
1500 have relatively low GDP per capita today, while those with
low initial urbanization and population density have generally
prospered.
prospered
20
•
15
(Simple) Geography hypothesis?
–
It cannot be geographical differences; no change in geography.
10
•
5
0
800
1000
1200
1300
1400
1500
1600
low urbanization in 1500 excolonies
1700
1750
1800
1850
1900
Sophisticated geography hypothesis? Certain geographic
characteristics that were good in 1500 are now harmful?
–
no evidence to support this view; reversal related to
industrialization and no empirical link between geography and
industrialization,
industrialization.
1920
high
g urbanization in 1500 excolonies
41
Understanding the patterns from 1500 to 2000
42
The institutional reversal (1)
The institutional reversal (1)
Contrast: Urbanization in 1500 and GDP per capita are positively correlated among non‐colonies
•
Reversal related to changes in institutions/social organizations.
•
Relatively better institutions “emerged” in places that were
previously poor and sparsely settled.
– E.g.,
E
compare the
h U
United
i dS
States vs. the
h C
Caribbean
ibb
or P
Peru.
•
Thus an institutional reversal
– Richer societies ended up with worse institutions.
– Europeans introduced relatively good institutions in sparsely-settled and
poor places, and introduced or maintained previously-existing bad
institutions in densely-settled and rich places.
• E.g.; slavery in the Caribbean, forced labor in South America, tribute
systems in Asia, Africa and South America.
•
Institutions have persisted and affected the evolution of income,
especially during the era of industrialization
43
44
The institutional reversal (2)
Institutions matter
Contrast: urbanization persistent before 1500
• Reversal in prosperity resulting from the institutional
reversal, combined with persistence in institutions
– C
Countries with ““better” institutions prosper, while those with ““bad”
institutions stagnate or decline.
– Th
The reversall also
l emphasizes
h i
th
thatt the
th differences
diff
are nott only
l b
between
t
capitalist and communist systems.
– What
Wh t matters
tt
more is
i the
th “type”
“t
” off capitalism.
it li
45
46
Why differences in institutions?
The role of culture
The role of culture
•
Can all this be related to culture?
•
Culture not useful in understanding the Korean divergence
Four meta-theories of institutions:
– North and South were culturally homogeneous.
•
1.
y institutions that are efficient for societyy (e.g.,
( g , for
Efficiency:
aggregate growth or welfare) will be adopted.
2
2.
Ideology: differences in beliefs determine institutions (societies
choose radically different institutions because citizens or elites
have different beliefs about what’s good for economic growth).
Possible that the reversal related to culture.
– But the growth trajectories of British colonies similarly to Spanish
Spanish, Portuguese
and French colonies once we control for differences in local conditions.
•
•
Reversal also not related to the p
presence of Europeans.
p
3
3.
– Examples of prosperity in Singapore and Hong Kong, where population is now
almost entirely non-European, but institutions protect investment.
History: institutions determined by historical accidents or unusual
events, and are unchanging except for random events and further
accidents.
•
•
Overall, no evidence that European values or culture played a
special role.
4.
47
Perhaps North Korea chose planned economy because its leaders believed it
was “better”.
Legal system today determined by past historical accidents
accidents.
Social conflict: institutions chosen for their distributional
consequences by groups with political power
power.
48
Which approach? (1)
Which approach? (2)
Which approach? (2)
•
Ideology view: not a useful framework by itself either
– Every set of institutions creates different losers and beneficiaries.
q
either the losers to be compensated
p
Efficient institutions require
or the beneficiaries to impose their choice.
•
Clearly, beliefs across societies differ, and existing regimes remain
in place by gaining some degree of approval.
– But in practice,
practice losers generally not compensated ex post
post, and
often can be powerful enough to block institutional change that is
beneficial in the aggregate.
•
• Efficient institutions view: not a useful framework
– Empirically, efficient institutions view cannot help us understand
why some societies adopt institutions that were disastrous for
economic growth.
growth
– Propaganda and media extremely important for regime survival.
But many empirical patterns cannot be explained by ideology
ideology.
– In the Korean case, the original divergence in institutions partly related
to ideology, but the persistence of communist system not only because
of ideology;
gy; those with political
p
power
p
want the continuation of the
system that is good for them.
•
For the reversal,
reversal same or similar groups of colonists opting for very
different sets of institutions in colonies with different local conditions.
Clearly not related to their beliefs about what’s good for the society
as a whole.
49
50
Which approach? (4)
Which approach? (4)
Which approach? (3)
• History: ample evidence that institutional choices persist.
• But they are also choices, not simply dictated by history.
•
Institutions and social conflict:
•
(Economic) Institutions shape incentives and determine the
allocation of resources
– Each set of institutions creates beneficiaries and losers; certain groups
obtain high incomes, rents and privileges.
– Thus “distributional” implications from institutional choices.
– Preferences over institutions determined by their distributional
implications.
• E.g.: a monopolist would be opposed to a reduction in entry barriers
even if these increase aggregate income.
• Need to understand why institutions persist, and why,
and how,
how they change
change.
p
• Examples:
– While the communist system persisted in North Korea, it
collapsed in Eastern Europe and Russia.
– Persistence in China until 1978 and change thereafter
thereafter.
– Very different institutions in North and South America during the
early colonial era and after independence.
• Empirically more promising:
– We can explain inefficient
ff
choices, even when their consequences are
understood by the key actors.
– Also we can investigate when institutions will be more or less efficient,
that is,
is “comparative
comparative static”
static exercises.
exercises
51
52
Sources of inefficiency: commitment
problems in politics
Institutions and social conflict
•
Institutions chosen for their economic consequences.
• Why doesn’t
doesn t society buy off politically powerful losers?
– IIn particular,
ti l economic
i iinstitutions
tit ti
which
hi h shape
h
iincentives
ti
and
dd
determine
t
i
distribution of resources.
•
commitment.
• Key problem: commitment
But also taking account of their “distributional
distributional implications”
implications
•
How does society make decisions in conflictual situations (i.e., when
th
there
iis no agreementt on what
h t should
h ld b
be d
done?)
?)
•
Importance
p
of p
political p
power
– Political power: the power to impose or secure social choices against the wishes
of other groups.
•
•
– Promise of compensation after institutional change not credible.
– Political power creates commitment problems.
– Contrast
C t t contracting
t ti between
b t
two
t
private
i t citizens
iti
versus political
liti l
contracting between two parties one of whom holds political power
The two private citizens can write contracts enforced by a third party with
enforcement power.
y with political power cannot commit to refrain from
In contrast, in politics, the party
hold up; promise of a dictator not to expropriate after investments is not credible.
Political power  social choices
Political power  economic institutions
There is also no credible transfer of political power in exchange for future payments;
promise of payments to a dictator after he relinquishes power is not credible
credible.
53
Towards a theory of institutions: comparative statics
•
When do we expect a society to adopt good
i i i
institutions?
?
54
The Institutions view of the reversal
The Institutions
• Densely populated and urbanized countries in 1500
ended with worse institutions
1 Wh
1.
When th
those h
holding
ldi political
liti l power also
l will
ill b
benefit
fit
from well enforced property rights (and financial
development,
p
, free entry,
y, functioning
g markets etc.))
• In densely-settled and relatively-developed places,
g or to be created
extractive institutions existing
2. When there are relatively few resources to be
extracted or exploited using political power
• In sparsely-settled
p
y
areas,, institutions protecting
p
gp
private
property rights
55
56
History ideology and social conflict in the colonial experience
History,
•
Those with p
political p
power,, the “Europeans”,
p
, set up
p different
economic institutions in different colonies.
• M
More profitable
fit bl tto sett up good
d iinstitutions
tit ti
when
h E
Europeans
themselves will benefit.
– Smallholder production in northeastern U.S., slavery in the Caribbean,
forced labor in Central America.
•
– Better institutions in p
places where Europeans
p
settle and become
a significant fraction of population (typically places with low initial
population density).
Not historical accident.
– Europeans did restructure existing institutions
institutions, and introduce new
institutions in many colonies.
•
• More profitable to set up good institutions when little to
expropriate.
Not ideology
– Better institutions in places with low population density and/or
fewer resources to extract (i.e., low prosperity, low urbanization).
– the same British groups, opting for different structures and different
colonies; e.g., the U.S. vs. Caribbean, Massachusetts Bay vs.
Providence Island.
•
The colonial experience
Social conflict and political power are key.
– Europeans monopolized political power and set up institutions for their
own benefit, even if not beneficial for the society at large.
57
58
Institutions view
Hierarchy of institutions
• What
Wh t about
b t political
liti l iinstitutions?
tit ti
?
– Political institutions determine the distribution of political power
g
its use  sources of p
political p
power.
and regulate
• Association between economic and political institutions
– E
E.g., democratic
d
ti systems
t
emerged
d iin E
European colonies
l i which
hi h
were smallholder societies with secure property rights.
– Coercive states with few constraints emerged in societies with
slave production, forced labor and tribute systems.
59
60
Understanding the timing of the reversal
Institutions view
•
Why did the reversal take place in the 19th century?
•
Coercive institutions imposed by Europeans not extremely costly
when they dominated the major productive opportunities.
– E
E.g., the
h plantation
l
i complex
l generated
d iinvestment iin sugar production;
d i
Barbados, Cuba, Haiti, Jamaica among the richest places in the world at
some point between 16th and 19th centuries.
•
The major cost of these institutions arises when new opportunities,
in this instance in industry and commerce, require investment by
new groups and
db
broad-based
db
d participation.
ti i ti
– 19th century was a period of industrialization, and societies with
relatively democratic institutions were the ones allowing free-entry by
new entrepreneurs
entrepreneurs.
– Highlights that the same set of institutions can have very different
effects under different circumstances.
61
Economic and political institutions
Sources of political power
• Two types of political power:
.
Average Protection A
Against Risk o
of Expropriattion, 1985-95
5
62
USA
NZL
CAN
10
SGP
AUS
GAB
MEX
ISR
CYP
IND
MYS
BRA
CHL
BWA
TTO
COL
PNG
JAM
CRI
URY
ZAF
ECU
GMB
BHR
8
SAU
ARE
TGO
IDN
6
SYR
MMR
NGA
MAR
CIVKWT
PRY
MWI JOR EGY
TZA
ZMB
TUN MOZ
CMR YEM
GHA
G
KEN
PAK
LKA
ZWE
SEN GUY
SLE
PER
ETH
AGO
HND
NIC
GTM
UGA BFA
GNB
COG
ARG
DOM
– Allocated by political institutions
– E.g., political power allocated to a party or Prime Minister by an election.
• De
D ffacto
t political
liti l power
PAN
BOL
PHL
– Determined by economic and military power, or access to extra-legal
means
– E.g., the political power of rebel groups in a Civil War, or of masses who
can create social unrest or a revolution.
– De facto political power typically relies on military superiority or on
solving
l i th
the ““collective
ll ti action
ti problem”.
bl ”
BGD
NER
SLV
MDG
SDN
4
VEN
OMN
GIN DZA
• De jure (formal) political power
MLI
HTI
ZAR
SOM
2
IRQ
0
2
4
Constraint on Executive in 1990s
6
8
• Distribution of political power in society determined by
the distribution of de jure and de facto political power.
63
64
Political institutions and political power
Economic institutions and political power
• The interplay between economic institutions and political
power adds to institutional persistence
persistence.
• Political institutions are highly persistent; thus de jure
political power is persistent.
Political p
power  economic institutions
Economic institutions  distribution of resources
Distribution of resources  de facto political power
• De facto political power, which relies on military
superiority and solution to the collective action problem
problem,
is by its nature transient.
• Example: colonialism in the Caribbean;
– Planters monopolized political power
power, which enabled them
to capture the majority of the gains from sugar and other
products.
– The planters’ incomes enabled them to dominate military
power and control the state  persistence of the system
65
66
Dynamic linkages (summary)
Dynamic linkages (summary)
A theory of institutions
In the presence of social conflict;
– political power economic and political institutions.
• good institutions emerge when they benefit those with political
power
– political institutions  de jure political power
De jure power
(P li i l iinstitutions)
(Political
i i
)t
• Constraints
C
t i t on elites
lit often
ft conducive
d i tto b
better
tt iinstitutions.
tit ti
– de facto political power  political institutions  de jure political
power both today and in the future
power,
future.
De facto powert
Economic institutionst
political
powert
Economic policiest
Political institutionst+1
• Toward a theory of institutional change
– political power  institutions  political power
• Source of persistence.
67
68
The causal effect of institutions on prosperity
Theory in action: back to the colonial experience
•
– those with political power more likely to opt for good institutions when
they will benefit from property rights and investment opportunities
opportunities.
– better institutions more likely when there are constraints on elites.
• Evidence so far that institutions important
p
for crosscountry differences in prosperity and long-run growth
–
Theory 
But what is the magnitude of the effect? How much of differences in prosperity can be
explained as a result of institutions?
•
– Europeans more likely to benefit from good institutions when they are a
significant fraction of the population, i.e., when they settle
– Europeans place constraints on elites when there are significant
settlements.
• We need an empirical framework to estimate causal
effect of institutions on economic outcomes
outcomes.
– We need a source of exogenous variation; an instrument for institutions.
– Instrument: affects institutions, but no direct effect, or effect through
other
th channels,
h
l on economic
i performance.
f
Thus: European settlements  better institutions
•
• Historyy + theory
yp
potential instruments.
Th colonial
The
l i l context:
t t
But Europeans settlements are endogenous.
– They may be more likely to settle if a society has greater resources or
more potential for growth.
– Or less settlements when greater resources; East India Company and
Spanish crown limited settlements.
69
Settlements mortality and development
Settlements,
70
The theory in action: back to the colonial experience
• In some colonies, Europeans faced very high death rates
because of diseases for which they had no immunity
immunity, in
particular malaria and yellow fever.
• Disease environment
– lots of variations across colonies
– consequences for attractiveness of European
settlement
– subsequent impact on institutions
– institutions
i tit ti
persistent
i t t
• Potential mortality of European settlers  settlements 
institutions
• Moreover, for many reasons, already discussed above,
i tit ti
institutions
persist;
i t so
p
potential
mortalityy of European
p
settlers  settlements  p
past
institutions  current institutions
• Instrument: settler mortality in 1500
71
72
Instrument negatively correlated with GDP per capita
“Settler mortality and income per capita today”
Instrument negatively correlated with institutions
.
Log GDP perr capita, PPP, in 1995
10
AUS
NZL
USA
SGP
HKG
CAN
CHLBHS
ARG
VEN
URY
MEX
COL
CRI
BRATTO
MYS
ZAF
TUN
ECU
PER
DZA
GTM
PRY
MAR
EGY
SLV
BOL
SUR
GUY
8
PAN
DOM
JAM
IDN
AGO
LKA
HND
PAK IND
SDN
BGD
GAB
NIC
SEN
VNM
HTI
KEN
CMR
COG
GIN
UGA
ZAR
BFA
NER
CIV
GHA
TGO
GMB
MDG
NGA
MLI
TZA
SLE
6
2
4
6
8
Log Settler Mortality
74
73
Engerman and Sokoloff
“Colonialism, Inequality, and Long‐Run Paths of Development” • Some
So e former
o e co
colonies
o es a
are
e ccharacterized
a acte ed with
t high
g
inequality while other former colonies are more
homogenous and equal, and this pattern seem to be
quite persistent since colonization.
Engerman and Sokoloff divide the
colonies into three groups:
1 Those
1.
Th
with
ith factor
f t endowments
d
t suited
it d to
t the
th
production of valuable cash crops like sugar—
tended to import large numbers of slaves (e
(e.g.
g
West Indies).
• What led to such substantial differences in inequality
across colonies in the Americas?
2. Those with rich mineral resources and large
native populations that could be used to extract
this wealth—e.g. Mexico, Peru.
• The article argues that one of the most fundamental
impacts of European colonization may have been in
altering the composition of the populations in the areas
colonized.
3. Those with neither—e.g. New England.
75
76
Diagram of Engerman and Sokoloff
Diagram of Engerman
and Sokoloff’ss Argument
Engerman and Sokoloff
Sokoloff’s
s Model:
• Factor endowments in the rich colonies led to highly
unequal distributions of wealth.
Factor Endowments → High Inequality
• Elites in these rich colonies established institutions that
would perpetuate their dominance.
dominance
→ Institutions that Perpetuate Inequality → Low Human Capital → Low Growth
→ Low Human Capital → Low Growth
• These institutions hampered subsequent
industrialization — both in and of themselves and
because they kept levels of human and physical capital
in the general population low.
77
Colonialism Inequality,
Colonialism,
Inequality and Long-Run
Long Run Paths of Development
• Th
The argumentt is
i that
th t greater
t equality
lit among th
the
population led, over time, to more democratic political
institutions more investment in public goods and
institutions,
infrastructure, and to institutions that offered relatively
broad access to property rights and economic
opportunities.
• Where there was extreme inequality, political institutions
were less democratic, investments in public goods and
i f t t
infrastructure
were far
f more limited,
li it d and
d th
the iinstitutions
tit ti
that evolved tended to provide highly unbalanced access
to property rights and economic opportunities.
opportunities
79
78