Lionel Robbins Lectures,
London School Economics, Feb.23-25
Understanding Institutions
Daron Acemoglu
(based on joint work with
Simon Johnson and
James Robinson)
1
The Argument


Institutions---organization of society, “rules of the game”--- are a
major determinant of economic performance and a key factor in
understanding the vast cross-country differences in prosperity.
Institutions are not exogenous, but there are potential sources of
exogenous variation in history.
–
–

Institutions are not typically chosen for the good of society, but
imposed by groups with political power for their economic
consequences.
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–
2
Example: the “natural experiment” of European colonization.
Use of history to estimate the causal effect of institutions on growth.
Understanding institutions necessitates understanding the dynamics
of political power.
Institutional reform possible, but many potential pitfalls;
 e.g., dealing with the symptoms rather than deep causes.
Plan of the lectures (1)

Lecture 1: Institutional Causes of Economic
Performance.
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–
–
–
–
–
–
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3
Sources of prosperity.
What are institutions? Brief discussion.
Sources of cross-country differences in prosperity.
Geography versus institutions and the identification problem.
Learning from the Korean experiment.
The colonial experiment and the Reversal of Fortune.
Reassessing geography versus institutions.
Are British colonies different?
The role of culture.
Plan of the lectures (2)

Lecture 2: Towards a Theory of Institutions.
–
–
–
Different meta-theories: efficiency, history, ideology and
social conflict.
Economic institutions, political institutions and political power
Historical examples:
1.
2.
3.
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–
–
Dynamics of political power and political institutions.
A theory of institutions.
Historical examples:
1.
2.
4
Land relations in the Dutch East Indies
Early financial development in the U.S. and Mexico
Price regulation in Ghana, Kenya and Colombia
Atlantic trade and rise of constitutional regimes.
Emergence of mass democracy in Western Europe.
Plan of the lectures (3)

Lecture 3: Institutions, Prosperity and Change
–
Estimating the causal effect of institutions on income per
capita.


–
–
–
–
From the long run to the short run: the effect of institutions on
volatility, instability and crises.
Institutions and policies.
Institutional change; putting the theory to work
Institutional change; pitfalls:


–
5
Making further use of the colonial experience.
Reassessing geography, culture and religion.
The seesaw effect: dealing with the symptoms not causes.
Ignoring internal dynamics.
Where to go from here?
Lecture 1: Institutional Causes of
Economic Performance

Plan of Lecture 1:
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–
6
Sources of prosperity.
What are institutions? Brief discussion.
Sources of cross-country differences in prosperity.
Geography versus institutions and the identification problem.
Learning from the Korean experiment.
The colonial experiment and the Reversal of Fortune.
Reassessing geography versus institutions.
Are British colonies different?
The role of culture.
Sources of prosperity (1)

Vast differences in prosperity across countries today.
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–


Why?
Standard economic answers:
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–
–
7
Income per capita in sub-Saharan Africa on average 1/20th of
U.S. income per capita
In Mali, Democratic Republic of the Congo (Zaire), and
Ethiopia, 1/35th of U.S. income per capita.
Physical capital differences (poor countries don’t save enough)
Human capital differences (poor countries don’t invest enough
in education and skills)
“Technology” differences (poor countries don’t invest enough in
R&D and technology adoption, and don’t organize their
production efficiently)
Sources of prosperity (2)

These are, however, proximate causes of differences in
prosperity.
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–


The answer to these questions is related to the
fundamental causes of differences in prosperity.
Potential fundamental causes:
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–
–
8
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 (humanly-devised rules shaping incentives)
Geography (exogenous differences of environment)
Culture (differences in beliefs, attitudes and preferences)
What are institutions? (1)

Institutions: the rules of the game in economic, political
and social interactions.
–


North (1990, p. 3):
"Institutions are the rules of the game in a society or,
more formally, are the humanly devised constraints that
shape human interaction.“
Key point: institutions
–
–
–
9
Institutions determine “social organization”
are humanly devised
set constraints
shape incentives
What are institutions? (2)

A broad cluster including many sub levels:
–
–

economic institutions: e.g., property rights, contract enforcement, etc.
 shape economic incentives, contracting possibilities, distribution.
political institutions: e.g., form of gov., constraints on politicians and
elites, separation of powers, etc.
 shape political incentives and distribution of political power.
Important distinction between:
– Formal institutions: codified rules, e.g. in the constitution
– Informal institutions: related to how formal institutions are
used, to distribution of power, social norms, and equilibrium.


10
Constitutions in U.S. and many Latin American countries similar,
but the practice of politics, and constraints on presidents and
elites very different.
Why? Because distribution of political power can be very different
even when formal institutions are similar.
Institutional variation

Big differences in economic and political
institutions across countries.
–
–
–
–
–
–
–
11
Enforcement of property rights.
Legal systems.
Corruption.
Entry barriers.
Democracy vs. dictatorship.
Constraints on politicians and political elites.
Electoral rules in democracy.
Economic institutions and
economic performance (1)
.
H KG
10
AR
KW
TE
ISR
QATBH R
Log GDP per capita, PPP, in 1995
LU X
U SA
CHE
J
PN
N OR
D
NA
K
BEL
C
AN
AU
T
F
R
AUSW
ITA
S EISL
N LD
GBR
F
IN
IR
N
ZLL
ESP
PR T
SGP
AR G
PAN
IR N
GTM
MLT
GR C
BH
S CHL
SAU
OMN
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MEX GAB
MY S
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BW A
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TH A BR A
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TU RPOL
TU
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D OM D Z A
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PRJYAM
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PH L
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SY R
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BOLGU Y
CHN
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ZLKA
WE
HND
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C MR
GIN
C IV
SEN
PAKGH A
MN G
VN M
TGO
KOR
CZE
HUN
RUS
BGR
SU R SLV
8
SD N
C OG
H TI
U GA
BF A
MD
G
Z AR
IN D
GMB
KEN
BGD
N ER
N GA
MLI
SLE
ETH
Z MB
Y EM
MOZ MW I
TZA
6
4
12
6
8
Avg. Protection Against Risk of Expropriation, 1985-95
10
Economic institutions and
economic performance (2)
.
Log GDP per capita, PPP, in 1995
10
KOR
AR G
VEN
MEX
CPAN
OL
TH A
TU R
LBN
EC U
BGR R V
PER
R OM
D OM R U S H
8
U SA
H KG
N OR
F R A AU T AU
D EU
S
GBR
ISR
IR L
ESP
PR T
J PN
BEL
ITA
GR C
CZE
URY
Z AF
SGPC H E
DNK
C AN
N LD
SW
F INE
NZL
CHL
SVN
MY S
HUN
POL
SVK
BR A
TU N
J AM LTUJ OR
LVA
PH L
MAR
BOL CEGY
HN
Z W E LKA
KAZ
ID N
U KR
AR M
SEN
GH
INM
DA
VN
GEO
PAK
KEN
N GA
U GA
BF A
Z MB MD G
MLI
MOZ
MW I
TZA
6
0
13
.5
Control of Corruption
1
Political institutions and economic
performance
.
LU X
U SA
CHE
J
PN
N
OR
D
NT
K
BEL
C
AN
AU
ISL
D
EU
AU
N
ITA
LD
S
GBR
SW
E
F
IN
ISR
IRZLL
N
ESP
PR T
KOR
GR
C HC
L
SGP
Log GDP per capita, PPP, in 1995
10
FRA
ARVEN
G
MEX
GAB
TH A
POL
TU N
DZA
SW Z
SY R
8
ID N
J OR
MAR
EGY
C H N GU Y
AGO
ZWE
C IV C MR MR
T
SEN
GH A
LSO
C AF
KEN
U GA
Z
AR
BF A
TC
D
N
GA
Y EM
BD I
RWA
MW I
MOZ
GIN
SD N
TGO
SLE
PER
GTM
D OM
PR Y
SLV
H NLKA
D
N IC
C OG C OM
PAK
GMB
H TI
Z MB
MU
S
U
RY
MY
S
Z AF
BW
PAN
C OL
H
U
N
C RA
I
TTO
BR
A
TU R
EC U
F JI
J AM
PH L
BOL
IN D
BEN
MD G
N PL
BGD
N ER
MLI
TZA
ETH
6
0
14
2
4
Constraint on Executive in 1990s
6
8
But institutions are endogenous

Institutions could vary because underlying factors differ
across countries.
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–
–

Montesquieu’s story:
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–
–

Geography determines “human attitudes”
Human attitudes determine both economic performance and political
system.
Institutions potentially influenced by the determinants of income.
Identification problem.
–
15
Geography, ecology, climate
Culture
Perhaps other factors?
We can learn only a limited amount from correlations and ordinary
least square (OLS) regressions.
Geography hypothesis:
Montesquieu

Montesquieu:
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–

16
“The heat of the climate can be so excessive that the body
there will be absolutely without strength. So, prostration will
pass even to the spirit; no curiosity, no noble enterprise, no
generous sentiment; inclinations will all be passive there;
laziness there will be happiness,”
"People are ... more vigorous in cold climates. The inhabitants
of warm countries are, like old men, timorous; the people in
cold countries are, like young men, brave".
Moreover, Montesquieu argues that lazy people tend to
be governed by despots, while vigorous people could
be governed in democracies; thus hot climates are
conducive to authoritarianism and despotism.
Geography hypothesis:
modern versions

Jared Diamond:
–

Jeff Sachs:
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–
–
17
Importance of geographic and ecological differences in
agricultural technology and availability of crops and animals.
"Economies in tropical ecozones are nearly everywhere poor, while
those in temperate ecozones are generally rich" because "Certain
parts of the world are geographically favored. Geographical
advantages might include access to key natural resources, access to
the coastline and sea…, advantageous conditions for agriculture,
advantageous conditions for human health."
"Tropical agriculture faces several problems that lead to reduced
productivity of perennial crops in general and of staple food crops in
particular" …
"The burden of infectious disease is similarly higher in the tropics than
in the temperate zones"
Montesquieu’s story?
.
U SA
Log GDP per capita, PPP, in 1995
10
8
LU X
CHE
N OR
SGP
H KG QAT
AU
J PN
FR
A T BEL
N LD D N K C AN
ISL
D EU
AU S
F IN
GBR
SW E
ITA
IR
L
AR E
ESP
ISR
NZL
GR
C
KOR
PR T
BR B
BHBH
S R KW T
MLT
AR G
CZE
SVN
SAU
HUN
EST
MU S
SVK
C
H
L
MY S
MEX
URY
TTO
POL
OMN LBY Z AF
BLR LTU R U S
LVA
F JI
TH
A
TU
R
KN
A
BR
A
CRI
TU N
BW A
IR N
GABC OL VEN
R
OM
BGR
PAN
D OM
KAZ
HRV
DZA
PER LC A
PR Y
GEO
GU Y
N AM SW Z
PH
L
GTM
GR
D
DSLV
MA
EGY
U KR
TKM
J AM
MARC H N
J OR
BLZ
LKA
SY
R
ID
N
EC U
AZ E
BTN
VCHTN D
MD A
AR M
N IC BOL
LSO IR Q
U Z BY U G
PN G
ZIN
WDE
PAK
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VN M
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MLI MD G
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AF G
AGO
R W A TZA
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OM
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ETH
SLE
SOM
6
0
18
.2
.4
Latitude
.6
.8
Empirical pitfalls of correlations
and ordinary least square estimates

Montesquieu’s story example of omitted variables bias
and identification problem.
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–

Reverse causality:
–

Income affects institutions.
Attenuation bias:
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19
Other omitted factors---human nature, culture, geography--vary across countries and affect economic performance.
They also are correlated with or have a causal effect on
institutions.
Similar problem affects inferences about geography on
income; potentially correlated with omitted variables.
Measures of institutions very coarse, poorly correspond to
conceptual measures, creating “errors in variables” problem.
Need for exogenous variation
Exploit “natural experiments” of history, where some
societies that are otherwise similar were affected by
historical processes leading to institutional
divergence.

–
Building towards an “instrument” for institutions (Lecture 3);


1.
2.
3.
20
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:
South versus North Korea
European colonization
Chinese experience
The Korean experiment



Korea: economically, culturally and ethnically homogeneous at the
end of WWII.
If anything, the North more industrialized.
“Exogenous” separation of North and South, with radically different
political and economic institutions.
–
–

Big differences in economic and political institutions.
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–

21
Exogenous in the sense that institutional outcomes not related to the
economic, cultural or geographic conditions in North and South.
Approximating an experiment where similar subjects are “treated”
differently.
Communism (planned economy) in the North.
Capitalism, albeit with government intervention and early on without
democracy, in the South.
Huge differences.
North and South Korea
GDP per capita
14000
12000
10000
8000
South Korea
North Korea
6000
4000
2000
0
1950
22
1960
1970
1980
1990
1998
European colonization as a “natural
experiment”


After the discovery of the New World and the rounding
of the Cape of Good Hope, Europeans dominated
many previously diverse societies, and fundamentally
affected their social organizations (institutions).
Approximating a “natural experiment” because
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–
–
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
23
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”.
Consequences?
Look at changes in prosperity from before colonization
(circa 1500) to today in the former colonies sample.
Measuring prosperity before
national accounts






24
To answer these questions, we need a measure of prosperity
before the modern era.
Urbanization is a good proxy for GDP per capita (Bairoch,
Kuznets, de Vries).
Only societies with agricultural surplus and good transportation
network can be urbanized.
Urbanization is highly correlated with income per capita today
and in the past.
And we can construct data on urbanization in the past (Bairoch,
de Vries, Eggimann)
In addition, use population density as a check.
– Useful also because related to the causal mechanism in
Lecture 2.
Urbanization and income today
.
U SA
C AN
GDP per capita, PPP, in 1995
10
MU S
S BW A
ZGAB
AF MYPAN
CRI
KN A
NLC
AMA
GR D
F JI
GTM
SW Z ID N
8
LKA
GU Y
AGO
ZWE
TU N
EC U
D Z A D OM
PR
Y
J AM
PH L
MAR
SU
R
C
PV BOL
EGY
SLV
BLZ
VC T
AU S
NZL
MEX
C OL
TTO
AR G
VEN U R Y
BR A
PER
D MA
HND
CIV
MR
GIN
C
SEN
C OMPAK
GH A
IN
D
LSO
SD
N
VN M
GMB
TGO
C AF
H TI
LAO
BEN
KEN
7
SGP
C HBH
L S
BR B
9
H KG
MR T
N IC
C OG
U GA
N PL
BFBGD
A TC DMDZGAR
N GAZ MB
N ER
ER I
BD I
MLI
RWA
MW I
MOZ
TZA
SLE
6
0
25
50
Urbanization in 1995
100
Results: until 1500

Persistence is the usual state of the world.
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–

The data confirm this persistence.
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–
–
26
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.
After the initial spread of agriculture, there was remarkable
persistence in urbanization and population density.
Largely true from 1000 BC to 1500 AD, and also for
subperiods.
More important, true also in the former colonies sample.
Reversal since 1500 (1)
.
U SA
10
C AN
AU S
SGP
H KG
GDP per capita, PPP, in 1995
NZL
CHL
9
AR G
VEN
U
RY
MY S
C OL
BR A
BLZ
GTM
D OM
PR Y
8
J AM
PH L
EC U
PER
TU N
DZA
ID N
SLV
GU Y
BOL
EGY
MAR
LKAH N D
N IC
VN M
H TI
PAK
IN D
LAO
7
BGD
0
27
MEX
PAN
CRI
5
10
Urbanization in 1500
15
20
Reversal since 1500 (2)
.
C AN
AU S
10
U SA
SGP
H KG
GDP per capita, PPP, in 1995
NZL
CHL
AR G
URY
BW A
BR A
9
VEN
Z AF
GAB
MY
KN
S A MEX
PAN
C OL TTO
CRI
N AM
SU R
GU Y
8
7
BH B
S
BR
PR Y
SW Z
C PV BOL
LC A
GR
DEC U
PER
BLZ
D
OM
D
MA
VC
T
GTM
DZA
TU N
J AM
PH L
ID N
MAR
SLV
AGO
LKA
ZWE HND
N
IC
C MR
GIN
C
C OG MR T
SEN
C IV
OM
GH
A
IN D
LSO
SD N PAK
VN M
GMB
TGO
AF
HCTI
LAO KEN BEN
U GA N PL
BGD
BF
A
TC
MD
DZGAR
Z MB
N
GA
N ER
ER I
MLI
BD I
RWA
MW I MOZ
TZA
EGY
SLE
6
-5
28
0
Log Population Density in 1500
5
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
20
15
10
5
0
800
1000
1200
1300
1400
1500
1600
low urbanization in 1500 excolonies
29
1700
1750
1800
1850
high urbanization in 1500 excolonies
1900
1920
The nature of the reversal:
industrialization
Industrial Production Per Capita, UK in 1900 = 100
(from Bairoch)
400
350
300
250
200
150
100
50
0
1750
1800
US
30
1830
Australia
1860
Canada
1880
New Zealand
1900
Brazil
1913
Mexico
1928
India
1953
What’s happening?
Former colonies with high urbanization and population density
in 1500 have relatively low GDP per capita today, while those
with low initial urbanization and population density have
generally prospered.

–
(Simple) Geography hypothesis?

–

31
But gains in the growing societies not always equally shared.
Native Indians and aborigines in the New World have all but
disappeared.
It cannot be geographical differences; no change in geography.
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.
Understanding the patterns from
1500 to 2000


Reversal related to changes in institutions/social organizations.
Relatively better institutions “emerged” in places that were
previously poor and sparsely settled.
–

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
–
32
E.g., compare the United States vs. the Caribbean or Peru.
why to be discussed more below.
Resids Cons. Executive First Year Indep on Years Since Indep
The institutional reversal (1)
33
.
U SA
5
C AN
AU S
GU Y
NZL
SGP
J AM
MY S
LKA
IN D
BGD
LAO
C OL H
CN
SLV
RD
I
D OM
0
MEX
BOL
EC
U
PAN
PR
Y
C HG
L
BR
A
AR
U
VEN
RY
H TI
N IC
GTM
EGY
PER
DZA
ID N
VN
M
PAK
TU N
-5
-10
0
10
Resids from Regress Urbanization in 1500 on Years Since Indep
MAR
Resids Cons. Executive First Year Indep on Years Since Indep
The institutional reversal (2)
34
.
U SA
5
NZL
C AN
AU S
SGP
MY
S
TTO
GU Y
AM U GA
NJGA
GMB
LKA
SD
N IN D
BGD
LAOKEN
MR T
MEX
BOL
C OLH
CN
SLV
RD
I EC U
D OM
Z AF
MDCG
OG
PAN
0
BR
GA
UAR
R
Y
BD I
MAR
N
ERC MR
MLI
BEN
SEN
TGO
BF A
TZA
AGO PR YC H L HPER
TI
VEN
N IC
GTM
GAB
TC DZ
CAR
AF
EGY
DZA
ID N
GIN
GH
C
IVAVN M TU N
PAK
RWA
-5
-5
0
Resids from Regress Log Pop Density in 1500 on Years Since Indep
5
Institutions matter

Reversal in prosperity resulting from the institutional
reversal, combined with persistence in institutions.
–
–
–

But then why different institutions?
–

And what are “good” and “bad” institutions?
For now, take good institutions to be those that
encourage investment in physical, human capital, and
in technology, and bad institutions in the opposite
–
35
Countries with “better” institutions prosper, while those with “bad”
institutions stagnate or decline.
The reversal also emphasizes that the differences are not only
between capitalist and communist systems.
What matters more is the “type” of capitalism.
Are the same institutions always good and bad? Discussed later.
Are British colonies special?



Popular view going back to Adam Smith and Winston
Churchill that British cultural and political influence was
beneficial, certainly better than that of Spanish and
French influence.
Does the evidence support this view?
The answer is no.
–
–
36
The patterns shown above are robust to controlling for the
identity of colonial power.
Similar patterns when we look at only British colonies.
The Reversal among former British
colonies (1)
USA
10
CAN
AUS
SGP
HKG
GDP per capita, PPP, in 1995
NZL
9
MYS
BLZ
JAM
8
EGY
GUY
LKA
PAK
IND
7
BGD
0
5
10
Urbanization in 1500
37
15
The Reversal among former British
colonies (2)
CAN
AUS
10
USA
SGP
HKG
GDP per capita, PPP, in 1995
NZL
BHS
BRB
9
MYS
KNA
TTO
ZAF
BWA
LCA
GRD
BLZ
DMA
VCT
NAM
JAM
SWZ
8
EGY
GUY
LKA
ZWE
GHA
GMB
LSO
KEN
7
ZMB
IND
SDN PAK
UGA
NGA
NPL BGD
MWI
SLE
6
-5
38
0
Log Population Density in 1500
5
The role of culture (1)


Can all this be related to culture?
What is culture?
– Culture is a relatively fixed characteristic of a group or nation,
affecting beliefs and preferences. Example: religion




Culture not useful in understanding the Korean divergence
–
39
Useful distinction between culture and informal institutions.
Informal institutions are related to how society shapes incentives,
and are related to equilibrium of a given game (typically defined
by formal institutions, distribution of income, political power etc.).
Informal institutions are not fixed, and change with economic
conditions and distribution of power, though they are typically
highly persistent.
North and South were culturally homogeneous.
The role of culture (2)

Possible that the reversal related to culture.
–
–
–
But the growth trajectories of British colonies similarly to
Spanish, Portuguese and French colonies once we control for
differences in local conditions.
Moreover, no econometric evidence that religion matters for
understanding the reversal or for long-run growth (to be
discussed more in Lecture 3)
Reversal also not related to the presence of Europeans.


40
Examples of prosperity in Singapore and Hong Kong, where
population is now almost entirely non-European, but institutions
protect investment.
Overall, no evidence that European values or culture
played a special role.
The Reversal for colonies with less
than 1% Europeans in 1900
.
9
MYGAB
S
BW A
GDP per capita, PPP, in 1995
N AM
SW Z
ID N
8
EGY
LKA
C MR
C OG
LSO
GIN
C IV
MR TSEN
GH A
GMB VN M
TGO
C AF
H TI
LAO KEN
7
U GA
MLI
ER I
TZA
PAK
IN D
BEN
BF
A
N
GA
TCMD
D G
N ER
SD N
N PL
BGD
BD I
RWA
SLE
6
-2
41
0
2
Log Population Density in 1500
4
6
The Reversal for colonies with less than
1% of European descent in 1975
.
GDP per capita, PPP, in 1995
10
9
SGP
H KG
BW A
MYGAB
S
DZA
TU N
ID N
8
EGY
AGO
LKA
C MR
C OG
H TI
7
GIN
C IV
SEN
GH
A
GMB
TGO VN M
KEN
GAR
Z MB MDZ
N ER
MLI
MW I
TZA
U GA
BF
A
N
GA
SD N
PAK
IN D
BGD
SLE
6
-2
42
0
2
Log Population Density in 1500
4
6
The role of culture (3)

The Chinese experience informative about the role of
culture versus institutions.
–
–
–
–
43
China, Hong Kong, Singapore and Taiwan many cultural and
ethnic similarities.
While China adopted state planning and communist political
institutions, Hong Kong, Singapore and Taiwan followed a
capitalist path with relatively well-enforced property rights.
While Hong Kong, Singapore and Taiwan prospered, China
stagnated.
After the Mao’s death and 1978 reforms, especially the
introduction of some basic property rights, changes in
economic incentives in China, and now very rapid growth rate.
Role of culture (4)
GDP per capita in China, Taiwan, and Hong Kong, 1950-2001
25,000
20,000
15,000
10,000
5,000
China
44
Taiwan
Hong Kong
Singapore
20
00
19
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
82
19
80
19
78
19
76
19
74
19
72
19
70
19
68
19
66
19
64
19
62
19
60
19
58
19
56
19
54
19
52
19
50
0
Lecture 2: Towards a Theory of
Institutions

Outline:
–
–
–
–
Recap of Lecture 1.
Different meta-theories: efficiency, history, ideology and
social conflict.
Economic institutions, political institutions and political power
Historical examples:
1.
2.
3.
–
–
–
Dynamics of political power and political institutions.
A theory of institutions.
Historical examples:
1.
2.
45
Land relations in the Dutch East Indies
Early financial development in the U.S. and Mexico
Price regulation in Ghana, Kenya and Colombia
Atlantic trade and emergence of constitutional regimes
Emergence of mass democracy in Western Europe.
Recap of Lecture 1
–
–
–
Sources of income differences and proximate versus
fundamental causes.
Institutions as humanly-devised rules affecting incentives,
potentially determining cross-country differences in prosperity
But identification problem; we can learn only a limited amount
from correlations and OLS regressions.

–
–
–
–
Empirical strategy: exploit natural experiments of history.
The Korean experiment.
The colonial experiment and the Reversal of Fortune.
Reassessing geography versus institutions.

46
Alternative fundamental determinants: geography, culture.
Little evidence of the primary role of geography, and strong
evidence that institutions matter for long-run performance.
Four meta-theories of institutions
1.
2.
•
3.
•
4.
47
Efficiency: institutions that are efficient for society (e.g., for
aggregate growth or welfare) will be adopted.
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).
Perhaps North Korea chose planned economy because its
leaders believed it was “better”.
History: institutions determined by historical accidents or
unusual events, and are unchanging except for random events
and further accidents.
Legal system today determined by past historical accidents.
Social conflict: institutions chosen for their distributional
consequences by groups with political power.
Which approach? (1)

Efficient institutions view: not a useful framework
–
–
–
–
48
Although,everything else equal, there would be a tendency to
adopt efficient institutions, everything else far from equal in
practice.
Every set of institutions creates different losers and
beneficiaries. Efficient institutions require either the losers to
be compensated or the beneficiaries to impose their choice.
But in practice, losers generally not compensated ex post, and
often can be powerful enough to block institutional change that
is beneficial in the aggregate.
Empirically, efficient institutions view cannot help us
understand why some societies adopt institutions that were
disastrous for economic growth.
Which approach? (2)

Ideology view: not a useful framework by itself either
–
Clearly, beliefs across societies differ, and existing regimes
remain in place by gaining some degree of approval.

–
But many empirical patterns cannot be explained by 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; those with political power want the
continuation of the system that is good for them.
For the 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
Propaganda and media extremely important for regime survival.
Example: the Puritan colonies in Massachusetts Bay and
Providence Island.
Which approach? (3)




History: ample evidence that institutional choices
persist.
But they are also choices, not simply dictated by
history.
Need to understand why institutions persist, and why,
and how, they change.
Examples:
–
–
–
50
While the communist system persisted in North Korea, it
collapsed in Eastern Europe and Russia.
Persistence in China until 1978 and change thereafter.
Very different institutions in North and South America during
the early colonial era and after independence.
Which approach? (4)


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.
–
Empirically more promising:
–
–


51
We can explain inefficient 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, “comparative static” exercises.
Institutions and social conflict
–
Institutions chosen for their economic consequences.

–
–
–
But also taking account of their “distributional implications”
How does society make decisions in conflictual situations (i.e.,
when there is no agreement on what should be done?)
Importance of political power

–
–
–
Political power: the power to impose or secure social choices
against the wishes of other groups.
Political power  social choices;
Political power  economic institutions
Key questions to be addressed later;


52
In particular, economic institutions which shape incentives and
determine distribution of resources.
Where does political power come from?
What about political institutions?
Sources of inefficiency:
commitment problems in politics


Why doesn’t society buy off politically powerful losers?
Key problem: commitment.
–
–
–
53
Promise of compensation after institutional change not credible.
Political power creates commitment problems.
Contrast contracting between two private citizens versus political
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.
 In contrast, in politics, the party with political power cannot
commit to refrain from hold up; promise of a dictator not to
expropriate after investments is not credible.
 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.
Endogenous (economic)
institutions from history

1.
2.
3.
4.
54
Examples of economic institutions chosen not
because of overall efficiency, or because of ideology,
or resulting from historical accidents, but chosen for
their economic consequences by groups with political
power:
Land relations in the Dutch East Indies
Early financial institutions in the Americas: Mexico vs.
United States.
Price regulation in Ghana, Kenya and Colombia.
Back to the colonial experience.
Land relations in Dutch Indies (1)



Dutch East India Company (V.O.C.) monopolizing the
production of valuable spices (nutmeg, cloves and
mace) in the Moluccas, in particular, in Ambon and
Banda islands.
Different indigenous organization between the islands.
van Zanden (1993):
“[in Ambon] The Company … took over the existing feudal
structure of raising tribute,” monopolizing supply (excluding the
British and Portuguese).

55
They also used this feudal structure to increase the
output of cloves.
Land relations in Dutch Indies (2)

In Banda, in contrast, there were many small
autonomous city states, but
“…There was no hierarchical social and political structure that
could impose the will of the V.O.C…”, especially stopping
locals from selling nutmeg to the British and the Portuguese.

The V.O.C. decided to change the economic
institutions on Banda, via a radical solution:
“Through military action, the V.O.C. killed most of the
population in 1621…” and completely reorganized the
production of nutmeg and established a slavery system, with
the slaves supplied by the V.O.C. and its former employees as
planters.
56
Financial institutions in Mexico and
the U.S. (1)


Big differences in the structure of banking between the
U.S. and Mexico in the 19th century, during the critical
period of divergence.
Haber (2001)
“Mexico had a series of segmented monopolies that were
awarded to a group of insiders. The outcome, circa 1910,
could not have been more different: the U.S. had roughly
25,000 banks and a highly competitive market; Mexico had 42
banks, two of which controlled 60 percent of total banking
assets, and virtually none of which actually competed with
another bank.”

Adverse consequences for Mexican industry.
–
57
Lending by monopoly banks to inefficient firms of friends and
associates.
Financial institutions in Mexico and
the U.S. (2)





58
Why?
Power of insiders and state governments in Mexico, supported by
the dictatorship of Porfirio Diaz.
In 1789, the U.S. structure also similar.
– Haber: [in the U.S. in late 18th century] “… it was not in the
interest of state governments to charter large number of banks
and create a competitive market for banking services”
– Many U.S. politicians, including Alexander Hamilton, wanted to
create monopolies.
But expanding frontier, which caused interstate competition, and
universal male suffrage made this system unsustainable.
Insiders did not have enough political power to impose their
preferred institutions, which would have been inefficient for society
at large.
Price regulation (1)

Another form of economic institution: marketing boards
regulating agricultural prices.
–



59
Originally, introduced to prevent large fluctuations in farm
revenues
Bates (1981): very different form of price regulation in
LDC agricultural markets.
Ghana and Zambia: low prices paid to farmers through
marketing boards, surplus transferred to politicians or
urban groups.
Kenya and Colombia: much more pro-farmer policies
and institutions.
Price regulation (2)


Why?
In Ghana and Zambia, but not in Kenya and Colombia,
farmers had little political power.
–
–
–
In Ghana, cocoa farmers small and unorganized, and also
from different ethnic group than the ruling party, while urban
groups politically more powerful.
In Kenya, larger farmers with greater political power.
In Colombia, farmers with greater power through more
democratic and competitive politics.

60
Interestingly, during the military regime of the ‘50s when
democratic politics suspended, pricing was set to extract surplus
from farmers.
Summary of the three cases


Institutions not dictated purely by history, but chosen by
society.
Moreover, they are chosen, not for efficiency nor
because of differences in beliefs, but for their
distributional consequences.
–
–
–
61
Social conflict and political power important.
In all cases economic institutions chosen for their
consequences, and particularly the rents created for the
politically powerful groups.
In almost all cases, the resulting economic institutions harmful
for certain groups, and in many cases harmful for society at
large.
Further lessons from the examples

Key lesson:
political power  economic institutions

Kenya vs. Ghana suggests a link between economic
institutions and political power;
Kenyan farmers that were larger and wealthier had political
power, while small farmers in Ghana did not.
economic institutions  political power
–

Mexico vs. U.S. and Colombia vs. Ghana show the
influence of political institutions on political power
political institutions  political power

And we will see below:
political power  political institutions.
62
Towards a theory of institutions:
comparative statics

When do we expect a society to adopt good institutions?
1.
2.
3.

Question: why use political power to protect others’ property
rights?
–
–
63
When those holding political power also will benefit from well
enforced property rights (and financial development, free entry,
functioning markets etc.)
When there are relatively few resources to be extracted or exploited
using political power
When constraints on political power preclude expropriation or the
imposition of institutions detrimental to excluded groups.
Reputation: protection will generate greater investments and thus
greater revenues in the future, but hard to sustain.
Oligarchic solution: protect only the rights of the elite, good for
investment by the elite, but not for the rest (to be discussed below).
History, ideology and social conflict
in the colonial experience

Those with political power, the “Europeans”, set up different
economic institutions in different colonies.
–

Not historical accident.
–

the same British groups, opting for different structures and different
colonies; e.g., the U.S. vs. Caribbean, Massachusetts Bay vs.
Providence Island.
Social conflict and political power are key.
–
64
Europeans did restructure existing institutions, and introduce new
institutions in many colonies.
Not ideology
–

Smallholder production in northeastern U.S., slavery in the
Caribbean, forced labor in Central America.
Europeans monopolized political power and set up institutions for
their own benefit, even if not beneficial for the society at large.
Comparative statics in action in the
colonial experience (1)


Why the institutional reversal?
“Europeans” monopolizing political power opted for very
different institutions in different colonies.
–

Comp. Stat. 1: more profitable to set up good institutions when
Europeans themselves will benefit.
–

Better institutions in places where Europeans settle and become a
significant fraction of population (typically places with low initial
population density).
Comp. Stat. 2: more profitable to set up good institutions when
little to expropriate.
–
65
In practice, Europeans not a monolithic entity; considerable
heterogeneity and conflict, e.g., between Lord Baltimore and
indentured servants in Maryland.
Better institutions in places with low population density and/or fewer
resources to extract (i.e., low prosperity, low urbanization).
Comparative statics in action in the
colonial experience (2)

Comp. Stat. 3: better institutions more likely to emerge when there
are constraints on political elites.
–

But Europeans also structured the political institutions differently to
support the different economic institutions.
–


66
In colonies of settlement (where population density low), lower strata
of the settlers, the indentured servants in the U.S. and children of exconvicts in Australia, put constraints on the use of power by elites and
demanded equal treatment and protection before the law; emergence
of democracy.
More democratic in U.S., repressive in Caribbean, Central America.
Comp Static 3 again: once political institutions constrain the use of
political power, good institutions likely to persist.
Conversely, when the state structure is highly hierarchical,
coercive and without checks and balances, persistent incentives
to expropriate and fight to control the state apparatus.
Understanding the timing of the
reversal


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.
–

The major cost of these institutions arises when new
opportunities, in this instance in industry and commerce, require
investment by new groups and broad-based participation.
–
–
67
E.g., the plantation complex generated investment in sugar
production; Barbados, Cuba, Haiti, Jamaica among the richest places
in the world at some point between 16th and 19th centuries.
19th century was a period of industrialization, and societies with
relatively democratic institutions were the ones allowing free-entry by
new entrepreneurs.
Highlights that the same set of institutions can have very different
effects under different circumstances.
Problems of Oligarchy

Oligarchic structures, where the rich dominate politics,
may generate investment, because the rich will have
incentives to protect their own property rights.
–
–

Costly because it creates a non-level playing field and
a potential hold-up problem because power is
monopolized by the rich.
–

68
However, oligarchy also costly
What is there to stop oligarchs from expropriating others, or erecting
entry barriers to protect their monopoly positions.
More efficient producers do not enter and invest enough.
Problem of institutional reform: how to transition from
oligarchy to a democracy?
Hierarchy of institutions

What about political institutions?
–

Association between economic and political institutions
–
–

E.g., democratic systems emerged in European colonies which
were smallholder societies with secure property rights.
Coercive states with few constraints emerged in societies with
slave production, forced labor and tribute systems.
This is what theory predicts:
–
–
69
Political institutions determine the distribution of political power
and regulate its use  sources of political power.
If political power is the monopoly of the few, the property rights of
the rest cannot be entirely secure.
Conversely, if economic institutions lead to unequal distribution
of resources, political institutions cannot be democratic.
Economic and political institutions
Average Protection Against Risk of Expropriation, 1985-95
.
U SA
C
NAN
ZL
10
SGP
GMB
BH R
8
SAU
AR E
TGO
6
SY R
MMR
N GA
GAB
MEX
ID N
OMN
MAR
T
C IVKW
MW I J OR
C MR
GIN D Z A
GH A
SLE
ETH
KEN
Z
SEN
W E GU Y
Z MB
PAK
GN B
C OG
H
D
NN
IC
ISR
CY P
IN D
MY
S
BR
C HA
L
BW
A
TTO
C OL
PN G
J
CAM
RYI
U
R
Z AF
EC U
PAN
BOL
PH L
BGD
N ER
SLV
MD G
SD N
4
AR G
D OM
LKA
PER
AGO
U GA BF A
VEN
PR Y
EGY
TZA
TU
N MOZ
Y
EM
GTM
MLI
H TI
Z AR
SOM
2
IR Q
0
70
AU S
2
4
Constraint on Executive in 1990s
6
8
Sources of political power (1)

Two types of political power:
–
De jure (formal) political power


–
De facto political power




71
Allocated by political institutions
E.g., political power allocated to a party or Prime Minister by an
election.
Determined by economic and military power, or access to extralegal 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 the “collective action problem”.
Distribution of political power in society determined by
the distribution of de jure and de facto political power.
Sources of political power (2)



The power of the Dutch colonists in Indonesia: de
facto, since decided by their military superiority.
The limits on the power of politicians in the United
States and in Colombia was de jure, since the political
system legislated the control of politicians by citizens.
The power of European colonists was originally de
facto (e.g., Cortés versus Moctezuma).
–
–
72
But turned into de jure power by setting up the coercive and
hierarchical political institutions of the colonial system.
Why did Europeans want to set up political institutions turning
their power from de facto into de jure?
Political institutions and political
power


Political institutions are highly persistent; thus de jure
political power is persistent.
De facto political power, which relies on military
superiority and solution to the collective action
problem, is by its nature transient.
–
–
–
73
If a group uses its de facto political power to change economic
allocations or economic institutions for immediate gain, these
changes might be reversed when the distribution of de facto
political power changes.
If a group uses its de facto political power to change political
institutions, then it can secure more durable gains.
It therefore makes sense to use de facto power to change
political institutions and to regulate the future distribution of de
jure political power.
Economic institutions and political
power

The interplay between economic institutions and
political power adds to institutional persistence.
Political power  economic institutions
Economic institutions  distribution of resources
Distribution of resources  de facto political power

A non-level playing field in the economy favors those
with political power, which in turn increases their
political power further
–
Example: colonialism in the Caribbean;


74
planters monopolized political 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
A theory of institutions

Economic institutions essential for the prosperity of nations
–

But also benefit different groups and individuals  social conflict
In the presence of social conflict;
– political power economic and political institutions.

–
political institutions  de jure political power

–
Toward a theory of institutional change
political power  institutions  political power

75
Constraints on elites often conducive to better institutions.
de facto political power  political institutions  de jure
political power, both today and in the future.

–
good institutions emerge when they benefit those with political
power.
Source of persistence.
Dynamic linkages (summary)
De jure power
(Political institutions)t
De facto powert
76
Economic institutionst
political
powert
Economic policiest
Political institutionst+1
The rise of constitutional regimes:
the background




77
Major issue in early modern Europe: security of
property rights for merchants and control of entry into
overseas trade.
These economic institutions determined by the
distribution of political power.
In absolutist monarchies, less security of property
rights and crown monopoly of foreign trade.
Thus:
political power  economic institutions
The rise of constitutional regimes:
a major shock (1)
Voyages per year: Atlantic Trade (to Americas, African coast and Asia via Cape), and Mediterranean
(W.Europe, excluding Britain and Netherlands, to Levant)
800
700
600
500
Atlantic voyages per year
400
Mediterranean voyages per year
300
200
100
0
1300
78
1400
1500
1600
1700
1750
1800
The rise of constitutional regimes:
a major shock (2)
120.00
Average population in Atlantic ports, Mediterranean ports, and West European cities
not ports (balanced panel)
100.00
80.00
60.00
40.00
20.00
0.00
1300
79
1400
1500
1600
1700
1750
Inland West European cities
Atlantic ports
Mediterranean ports
1800
1850
The rise of constitutional regimes:
the effect of institutions


Changing environment: opening of trade routes to New
World and Asia via the Atlantic.
Different effects of this new economic opportunity
depending on economic and political institutions
–
–
–
80
In countries with access to the Atlantic and with some degree
of entry into foreign trade (i.e., Britain and the Netherlands):
new groups of merchants enriched.
In countries with tight crown monopoly of trade (i.e., Spain,
Portugal, France), the monarchy and its allies became the
main beneficiaries
For countries without access to the Atlantic; no direct benefits
and indirect costs through diversion of trade
The rise of constitutional regimes:
implications for social conflict

Social conflict: in Britain and the Netherlands,
merchants and segments of landowners demand
greater security of property rights, lower taxes and free
entry into foreign trade.
–
–
–
–
81
New merchants’ greater economic fortunes increased their
political power.
Secure victory in the English Civil War and Glorious
Revolution, and the Dutch War of Independence.
In all three cases, forces against the monarchy led and largely
financed by mercantile interests, especially those benefiting
from overseas trade.
In Spain and Portugal, the monarchy remains strong.
The rise of constitutional regimes:
interpretation

Thus:
economic institutions  (economic outcomes) political power.
political power  economic institutions
– But note the role of de facto political power in determining
political and economic institutions.
– Merchants’ political power in the Civil War, in the Glorious
Revolution or in the Dutch revolt was not granted by political
institutions, but obtained because


–
–
82
the “Atlantic shock” improved their economic situation and their
greater incomes enabled them to acquire military power and
they could coordinate and solve the collective action problem.
This was de facto political power, by its nature transient.
In fact, merchants and their allies demanded not only changes
in economic institutions but changes in political institutions.
The Rise of Europe: changes in
political institutions


Why fight to change political institutions?
Because they care about the future as well as the present and
their de facto political power is transient.
–

Thus:

de facto political power  political institutions
political institutions  political power
These changes consolidate because now merchants and groups
in favor of a constrained monarchy are richer and more powerful,
thus command both greater de facto and de jure political power
–
83
Political institutions, by regulating the future allocation of de jure
political power, influence future economic institutions, outcomes
In Spain and Portugal, economic institutions implied a different
distribution of gains, and therefore the distribution of de facto political
power was very different, hence no regime change.
Understanding the emergence of
democracy (1)


Another example of institutional change as a way of regulating the
distribution of future de jure political power and consequently
economic outcomes.
In the early 19th century Western Europe: political power in the
hands of rich elite.
–


Policies and economic institutions looking after the interests of the
rich elite.
Challenge from excluded groups, threat of revolution, making
concessions necessary.
–
–
–
84
E.g.; in Britain extremely limited franchise with less than 2 percent of
the population with the vote.
Industrialization increased power of workers and the poor.
Unusual circumstances and solution to collective action problem
further increased de facto political power for excluded masses.
Social unrest, possible revolution; some response necessary
Understanding the emergence of
democracy (2)


What can the elites do when de facto political power of excluded
masses threatens the system?
Promises of pro-poor policies and changes in economic
institutions within the non-democratic system not credible.
–
–


Democracy  the poor have more political power than in nondemocracy.
Political institutions, here democracy, also harder to reverse than
policies. Thus:
–
85
Standard problem of commitment with political power
Credible commitment to future pro-poor policies  change political
institutions to increase the political power of the poor, democratization
temporary de facto political power  change in political institutions 
change in future political power  change in policies, economic
institutions and outcomes.
Lecture 3: Institutions, Prosperity
and Change
–
–
Recap of Lectures 1 and 2.
Estimating the causal effect of institutions on income per
capita.


–
–
–
From the long run to the short run: the effect of institutions on
volatility, instability and crises.
Institutions and policies.
Institutional change; pitfalls:


–
–
86
Making further use of the colonial experience.
Reassessing geography, culture and religion.
The seesaw effect: dealing with the symptoms not causes.
Ignoring internal dynamics.
Institutional change; putting the theory to work
Where to go from here?
Recap of Lecture 1
–
–
–
Sources of income differences and proximate versus
fundamental causes.
Institutions as humanly-devised rules affecting incentives,
potentially determining cross-country differences in prosperity
But identification problem; we can learn only limited amounts
from correlations and OLS regressions.

–
–
–
–
Empirical strategy: exploit natural experiments of history.
Learning from the Korean experiment.
The colonial experiment and the Reversal of Fortune.
Reassessing geography versus institutions.

87
Alternative fundamental determinants: geography, culture.
Little evidence of the primary role of geography, and strong
evidence that institutions matter for long-run performance.
Recap of Lecture 2
–
–
–
Different meta-theories: efficiency, history, ideology and
social conflict.
Towards the right framework; social conflict, political power
Historical examples:
1.
2.
3.
–
–
–
Comparative statics and the colonial experience
Towards a theory of institutions; sources of political power,
dynamics of political power and political institutions.
Historical examples:
1.
2.
88
Land relations in the Dutch East Indies
Early financial development in the U.S. and Mexico
Price regulation in Ghana, Kenya and Colombia
Atlantic trade and rise of constitutional regimes
Emergence of mass democracy in Western Europe.
The causal effect of institutions on
prosperity

Evidence so far that institutions important for crosscountry differences in prosperity and long-run growth.
–
–

We need an empirical framework to estimate causal
effect of institutions on economic outcomes.
–
–
–

89
But what is the magnitude of the effect? How much of differences in
prosperity can be explained as a result of institutions?
The causal effects of geography and culture?
OLS estimation biased; omitted variables, reverse causality and
errors-in-variables problem.
We need a source of exogenous variation; an instrument for
institutions.
Instrument: affects institutions, but no direct effect, or effect through
other channels, on economic performance.
History + theory  potential instruments.
Theory in action: back to the
colonial experience (1)

Theory 
–
–

The colonial context:
–
–

Europeans more likely to benefit from good institutions when they are
a significant fraction of the population, i.e., when they settle
Lower strata of Europeans place constraints on elites when there are
significant settlements.
Thus: European settlements  better institutions
But Europeans settlements are endogenous.
–
–
90
those with political power more likely to opt for good institutions when
they will benefit from property rights and investment opportunities.
better institutions more likely when there are constraints on elites.
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.
The theory in action: back to the
colonial experience (2)

Look for exogenous variation in European settlements:
the disease environment
–

In some colonies, Europeans faced very high death rates
because of diseases for which they had no immunity, in
particular malaria and yellow fever.
potential mortality of European settlers  settlements 
institutions
Moreover, for many reasons, already discussed above,
institutions persist; so
potential mortality of European settlers  settlements 
past institutions  current institutions
91
Empirics: colonial origins of
comparative development (1)

Empirical setup: Two Stage Least-Squares (2SLS)
Second stage: log income per capita = f(current economic institutions)
First stage: current economic institutions = g(settler mortality)

Data on potential European settler mortality
–
–

Current economic institutions proxied by protection against
expropriation risk
–
–
92
Work by the historian Philip Curtin provides us with mortality rates of
soldiers stationed in the colonies in the early 19th century
Supplemented by data on mortality of Catholic bishops in Latin
America
Useful to bear in mind that history generates variation in a cluster of
broad institutions;
Protection against expropriation risk proxying for many other sources
of institutional variation
Empirics: colonial origins of
comparative development (2)

Is the empirical approach valid?
–
–
–
93
Clearly no reverse causality, mortality rates refer to
two centuries ago
Is the exclusion restriction of the 2SLS valid?
Plausible: yellow fever, malaria and gastrointestinal
diseases affecting Europeans had much less effect
on native inhabitants, who had acquired and genetic
immunity.
 Mortality rates of local troops very similar in
different regions despite very large differences in
European mortality rates.
Empirics: colonial origins of
comparative development (3)

Is the empirical approach valid? (continued)
–
–
–
–


94
Check validity further by controlling for potential sources of
direct effect, including latitude, measures of geography, current
prevalence of malaria and life expectancy.
Use only variation due to yellow fever, which is now mostly
eradicated, thus less likely to have direct effect.
Use over identification tests to check validity of instrument.
Also note that if the instrument is valid, it solves the errors-invariables problem.
These checks all support the validity of the approach.
Note: not estimating the causal effect of being
colonized vs. not colonized
Preview of results



95
Very large causal effects of institutions on long-run growth.
– Differences in institutions account for over ¾ of the variation in
income per capita today (long-run effect)
Results highly robust.
– Robust in different subsamples
– Robust to controlling for continent dummies
– Robust to controlling for latitude, whether landlocked, temperature,
humidity
– Robust to controlling for current prevalence of malaria and life
expectancy
– Robust when exploiting only yellow fever
– Overidentification tests supportive.
Also no evidence of any effect of geography or religion on long run growth
Settler mortality and current
institutions
Average Expropriation Risk 1985-95
10
USA
NZL
AUS
CAN
SGP
DNI
HKG
MYS
8
GMB
BRA
CHL
GAB
MEX
BHS
TTO
COL
VEN
MAR
CRI
URY
PRY
EGY
ECU
DZA
TUN
ARG
MLT
ZAF
PAK
GUY
ETHMMR
6
LKA
PER
BOL
IND
PNG
JAM
VNM
DOM
KEN
SEN
PAN
CIV
TGO
TZA
CMR
GIN
GHA
SLE
NGA
HND
GTM
BGD
SLV
SUR
NIC
AGO
NER
GNB
COG
UGA
BFA
MDG
SDN
4
MLI
HTI
ZAR
2
96
3
4
5
Log Mortality
6
7
8
The first stage
First Stage Regressions:
Dependent variable is protection against risk of expropriation
All former
All former
All former
Without neocolonies
colonies
colonies
Europes
Settler Mortality
-0.61
(0.13)
Latitude
-0.5
(0.15)
[0.25]
0.26
63
0.29
63
Standard errors in parentheses
Sample limited to countries for which have GDP per capita data
97
-0.37
(0.14)
2.34
(1.37)
Continent Dummies (p-value)
R-Squared
Number of Observations
-0.43
(0.19)
0.31
63
0.11
59
The reduced form: settler mortality
and income per capita today
.
Log GDP per capita, PPP, in 1995
10
AU S
NZL
U SA
SGP
H KG
C AN
C H LBH S
AR G
VEN
UR
Y
MEX
C OL
CTTO
RI
BR A
MY S
Z AF
TUEC
N U
PER
DZA
GTM
PR Y
MAR
EGY
SLV
BOL
SU R
GU Y
8
PAN
D OM
J AM
ID N
AGO
LKA
HND
PAK IN D
SD N
BGD
GAB
N IC
SEN
VN M
H TI
KEN
C MR
C OG
U GA
Z AR
BF A
GIN
N ER
C IV
GH A
TGO
MD G
GMB
N GA
MLI
TZA
SLE
6
2
98
4
6
Log Settler Mortality
8
The causal effect of institutions:
basic 2SLS estimates
Second Stage Regressions:
Dependent variable is log GDP per capita in 1995
All former
All former
All former
Without neocolonies
colonies
colonies
Europes
Protection Against Risk of
Expropriation, 1985-95
0.99
(0.17)
Latitude
1.11
(0.26)
99
1.43
(0.45)
-1.61
(1.57)
Continent Dummies (p-value)
Number of Observations
1.19
(0.39)
[0.09]
63
63
63
59
The causal effect of institutions:
robustness
Second Stage Regressions: all former colonies
Dependent variable is log GDP per capita in 1995
Instrument is:
Log Settler
Log Settler
Log Settler
Log Settler
Mortality
Mortality
Mortality
Mortality
Protection Against Risk of
Expropriation, 1985-95
1.07
(0.27)
Temperature (p-value)
[0.71]
Humidity (p-value)
0.98
(0.17)
0.87
(0.32)
0.82
(0.22)
-0.014
(0.07)
62
63
-0.28
(0.59)
Life Expectancy
100
1.18
(0.84)
[0.64]
Malaria
Number of Observations
Yellow Fever
63
63
62
The role of geography



No causal effect of geography.
How do we think of the correlation between geography
(e.g., latitude) and income?
This is caused by omitted factors;
–
–
Geography correlated with institutions because of the natural
experiment of European colonialism.
Tropical areas ended up with worse institutions, because



Also no universal causal effect of geography on
institutions.
–
101
they tended to be richer and more densely-populated circa 1500.
they attracted fewer European settlers.
Relationship created in a particular historical juncture.
Revisiting the British effect (1)

We saw above that
–
–



But we have not answered the question of whether
there is any effect of being colonized by the British
versus by the French, Spanish, Portuguese and others.
The framework here enables us to answer this
question once we condition on local conditions:
No beneficial effect of the British (relative to others):
–
–
102
there is a reversal of fortune among the British colonies alone
the British also introduced institutions to extract resources from
the native population and set up plantation complexes.
either through different colonization strategy, or
through the import of British institutions or culture
Revisiting the British effect (2)
Dependent variable is log GDP per capita in 1995
Former Colonies
Former Colonies
Second Stage
Protection Against Expropriation
British Colony Dummy
1.12
(0.23)
-0.96
(0.39)
English Legal Origin Dummy
First Stage
Log Settler Mortality
British Colony Dummy
-1.05
(0.37)
-0.53
(0.14)
0.67
(0.35)
English Legal Origin Dummy
103
R-Squared in First Stage
Number of Observations
1.17
(0.22)
0.30
63
-0.53
(0.13)
0.70
(0.34)
0.30
63
Revisiting the British effect (3)

British colonies have somewhat better
institutions than other European colonies
–
–

But British colonies also have lower income
controlling for institutions
–


104
0.67 higher protection against expropriation
0.67 times 1.12 = 0.75 positive effect on log GDP
- 0.96; negative effect on log GDP
Overall effect weakly negative.
Same conclusion for English legal origin vs.
French legal origin.
Revisiting culture and religion (1)

What is the effect of culture?
–
–


Empirical strategy: look at the effect of religion on longrun economic growth once we take differences in
institutions into account (that is, estimate the causal
effect of institutions simultaneously).
Answer: no evidence of any effect of religion (therefore
culture) on cross-country differences in income.
–
105
Even though no comprehensive measures of broad cultural
differences, evidence not favorable for importance of culture.
Proxies for culture: religion, identity of colonizer, presence of
Europeans.
Also recall that no effect of identity of colonizer or direct effect
of presence of Europeans.
Revisiting culture and religion (2)
All former colonies
Institutions
(Protection Against Expropriation)
Dependent
variable is log
GDP per capita
in 1995
Second stage
0.96
(0.16)
Dependent
variable is
institutions
First Stage
Percent Catholic
0.006
(0.01)
-0.01
(0.01)
Percent Muslim
-0.002
(0.01)
-0.002
(0.01)
Percent "Other"
-0.011
(0.01)
-0.01
(0.01)
Percent of European Descent in 1975
Log Settler Mortality
106
R-Squared in First Stage
Number of Observations
63
For religion regressions, base category is percent Protestant.
Dependent
variable is log
GDP per
capita in 1995
Second stage
1.13
(0.35)
-0.008
(0.01)
Dependent
variable is
institutions
First Stage
-0.58
(0.14)
0.019
(0.006)
-0.40
(0.15)
0.30
63
0.35
63
63
Unbundling institutions (1)




Digging into the black box of institutions.
Political institutions  economic institutions
economic outcomes.
But which economic institutions?
Distinguish between:
1.
2.
107
“Property rights” institutions: protect citizens from various
forms of expropriation by elites: e.g., risk of gov.
expropriation, entry barriers protecting large firms. (quite
closely linked to political institutions).
“Contracting” institutions: determine the terms and ease of
contracting between citizens: e.g., legal formalism, judicial
efficiency, bankruptcy law (partly, but not entirely!,
historical).
Unbundling institutions (2)


Property rights institutions more important than
contracting institutions for economic growth,
investment and financial development.
Contracting institutions important only for the form of
financial development (debt vs equity)
–

Plausible: without protection against elite and
government expropriation, little that good contracts
between citizens can achieve.
–
108
Conclusion related to the lack of an effect of British colonialism, since
contracting institutions vary strongly with English versus French legal
origin.
Perhaps also, when there are relatively mild contractual
imperfections, producers and investors can change the terms of
contracts, or build trust-based relations
Unbundling institutions (3): first
stages
N ZL
A US
2
Residuals from Check Measure Formalism on Eng. Legal Orig.
US A
CA N
S GP
HK G
MY S
0
ZA F
BH
RLA
C
ID N
ME X
C OL
V
E
N
MA
R
CR
RY
I IN D
UP
R
Y
E GY
EC
U
TU
V N M TTO
AN
RDGZA
D OM
SA
EN
N
P
PER
B OL
HND
N IC
GTM
SPLV
AK
LK A
C IV
C MR
JA M
TZA
GH A
NE R
KEN
B FA
-2
MD G
N GA
B GD
MLI
U GA
-4
-2
109
Res. from Regress Av.Protect.Exprop. on Log Settler Mort.
.
0
2
Residuals from Regressing Log Settler Mort. on Eng. Leg. Orig.
.
2
VEN
PPRAYK
B OL
GTM
PER
C R I IN D
A RG
1
TZA
LK
AN
PA
B GD
N GA
KEN
US A
S GP
MY S
0
EH
CN
UD
N IC
ME
MA
XR
DLLV
ZA
S
CH
SEN
C MR
B FA
U GA
GH A
MLI
JA M
N E R MD G
CA N
A US
-1
N ZL
ZA F
C OL
TUUNR Y
E GY
D OM
IDTTO
N
C IV
V NM
B RA
HK G
-2
-2
0
2
Residuals from Regressing Log. Sett. Mort. on Eng. Leg. Or ig
2
C IV
4
US A
CA N
ID N
N GA
S GP
N ZL
B RA
CHL
1
TZA
C OL
V
EN
MA
C RR
I
UPRRYY V N M
0
GH A
IN D
TTOJA M
A US
C MR
ME X
MLI
H MY
K GS
E GY
SEN
D OM
PAN
ED
CZA
U
KEN
NE R
AR
TU
NG
MD G
LK A
N IC
-1
PER
B OL
ZA F
B FA
U GA
PAK
HND
GTM
S LV
B GD
-2
4
-.5
Residuals from Check Measure Formalism on Log Sett. Mort.
Res. from Regress Av. Protect. Exprop. on Eng. Leg. Orig.
.
4
0
.5
Residuals from Regressing Eng. Leg. Orig. on Log Settler Mort.
1
.
VEN
P RY
B OL
GTM
PER
RI
AC
RG
2
EHCNUD
ME
MAXR
D
CS
HZA
L
LV
CR
OL
TU
NY
U
PAN
N IC
SEN
C MR
B FA
PAK
E GY D OM
0
ID N
LK A
NE R
MD G
IN D
MLI
US A
S GP
MY S
B RA V NM
C IV
TZA
B GD
KEN
A US CA N
N ZL
ZA F
JA M
-2
U GA
TTO
GH A
N GA
HK G
-.5
0
.5
Residuals from Regressing Eng. Leg. Orig on Log. Sett. Mort.
1
110
.
A
NU
ZL
S
C
U
BH
R
OL
CLYR I
E IN
CU
D
UZA
C
SA
A
FN
C OL
P RY
B RA
VEN
PAK
TTO
Resid. from Regress Cons. on Exec on Log Settler Mort.
.
2
JA M
PAN
D OM
A RG
H
SN
LV
D
0
LK A
MY S
ME X
GTM
B GD
PER
SEN
-2
S GP
TU
EN
GY
MA R
V NM
ID N K E N
GH A
TZA
C IV
U GA
N GA
-4
-2
0
2
Residuals from Regressing Log Settler Mort. on Eng. Leg. Orig.
.
2
PAN
VEN
GTM
1
A RG
PAK
PER
ZA F
LK A
IN D
B OL
P
CR
RY
I B GD
MY S
S GP
US A
ME
C
H
MA
LX R
HU
ND
EC
N GA
KEN
0
TZA
GH A
D OM
S LV
CA N
A US
-1
URY
TUCNOL
B RA
U GA
JA M
EN
TTOSID
C IV
E GY
N ZL
V NM
-2
-2
0
2
Residuals from Regressing Log. Sett. Mort. on Eng. Leg. Or ig
JA M
R
U
BC
R
OL
YI
C
EH
CL
U
2
4
TTO
PAN
IN D
C OL
P RY
B RA
D OM
VEN
C
AA
ZA
FN
U
S
GH A
AH
GD
SRN
LV
0
PAK
LK A
B GD
A
NU
ZL
S
C IV
N GA
ME X
GTM
TZA
SEN
PER
V ID
NM
N
K E NU GA
MY S
-2
EMA
GY
TU
NR
S GP
-4
4
-.5
Residuals from Eviction Measure Formalism on Log Sett. Mort.
Residuals from Eviction Measure Formalism on Eng. Legal Orig.
Residuals from Regressing Constraint on Exec on Eng. Leg. Orig.
Unbundling institutions (4): first
stages
0
.5
Residuals from Regressing Eng. Leg. Orig. on Log Settler Mort.
1
.
V E NP A N
GTM
2
A RG
PER
B
OLY
P
CR
RI
ME
C
HX
LR
MA
EHCNUD
D OM
S LV
0
U
Y
CR
OL
TU
N
B RA
ZA F
SID
EN
N
LK A
PAK
E GY
IN D
C IV
MY S
S GP
US A
B GD
K E NTZA
V NM
N GA
CA N
A US
JA M U GA
TTO
GH A
-2
N ZL
-.5
0
.5
Residuals from Regressing Eng. Leg. Orig on Log. Sett. Mort.
1
Unbundling institutions (5): 2SLS
estimates
Second stage regressions: all former colonies
Dependent variable is:
Average Protection Against
Risk of Expropriation
Legal Formalism (Check Measure)
Number of Observations
111
GDP per capita Investment-GDP ratio Credit-GDP ratio
1.01
4.86
0.28
(0.15)
(1.05)
(0.07)
Stock Market
Capitalization
0.22
(0.07)
0.37
(0.15)
0.74
(1.03)
-0.01
(0.07)
-0.10
(0.07)
50
50
50
49
From long-run to the medium-run

Institutional differences not only important for long-run
growth, but also for medium-run outcomes.
–
–
–


Causal effect of institutions on these outcomes.
Also opportunity to investigate the channels through
which institutions matter.
–
–
112
Postwar economic growth
Economic and political instability
Crises
For crises and volatility, is it macroeconomic policies that need
to be fixed as suggested by the Washington consensus?
Or are distortionary macroeconomic policies symptoms of
deeper causes?
Institutions and economic growth:
the reduced form
.
Annual Growth GDP p.c., 1970-97
10
SGP
H KG
5
ID N
MY S
MU S
PAK IN D
AU S F JI UC
AN
SA
NZL
Z AF
0
MMR
GU Y
EGY
TU
LKA
N
C
HL
BR A
EC
UY
CPR
OL
MAR
TTO
MEX
BR
U
R
CY
RI B
BGD
SD N
GTM
H
N
AR
DG
ZD
A
PER
BOL
SLV
VEN
D OMBLZ
KEN
PAN
PN G
J AMSEN
H TI
C OG
GAB
BF
A
C
MR
GMB
BEN
BD I
RWA
MR T
TC D
C AF
N GA
MLI
C IVA
GH
TGO
MD G
N ERSLE
N IC
Z AR
-5
2
113
4
6
log settler mortality
8
Institutions and volatility: the
reduced form
.
Standard Deviation of Growth Rates, 1970-97
10
TCD
8
NIC
SDN
6
FJI
GUY
MUS
HKG
MY S
ZAF
4
SGP
SLV
MAR
BRA
BGD
URY
VEN
PRY
BRB
MMR
MEX
TUN
CRI
HND
BOL
IND EGY
TGO
BDI
SLE
MLI
KEN
PNG ZAR
JAM
SEN
HTI PAN
MRT
DOMBLZ
CAF
IDN
GHA
CIV
MDG
BFA
BEN
GMB
PAK
CAN
USA
COL
LKA
AUS
2
NGA
NER
GTM
NZL
2
114
DZA
TTO
PER
CHL
ARG
ECU
CMR
COG
4
6
Log Settler Mortality
8
The effect of macroeconomic
policies: ignoring institutions
Government Consumption
OLS regressions
Dependent variable is: Volatility of growth rate, 1970-97
Former Colonies
Former Colonies
Former Colonies
8.09
(3.81)
0.12
(0.19)
Log Inflation
0.028
(0.006)
Real Overvaluation
R-Squared
Number of Observations
115
0.07
61
0.01
61
0.35
44
The effect of macroeconomic
policies: symptoms vs. causes
Institutions
(Constraint on Executive)
Government Consumption
Second stage regressions: all former colonies
Instrumenting for institutions and macro variables
Dependent variable is: Volatility of growth rate, 1970-97
Former Colonies
Former Colonies
Former Colonies
-0.92
-0.86
-0.62
(0.25)
(0.22)
(0.44)
-5.13
(5.19)
Log Inflation
-0.14
(0.42)
Real Overvaluation
Number of Observations
116
0.013
(0.03)
60
48
32
Interpretation

Deep institutional problems lead to bad performance
–
–


These problems manifest themselves via a variety of channels.
Bad institutions lead to:
–
–
–
–

weak property rights enforcement
non-level playing field
political instability as different groups fight to take control of the state
worse macroeconomic policies, budget deficit, high inflation, etc.
Important: these policies are partial causes of bad performance,
but they are in turn symptoms of deeper institutional problems.
–
117
Deep institutional problems related to political institutions and
distribution of political power as well as to weak property rights.
Differences in settler mortality a source of variation in institutions.
Institutions are not necessarily purely historical and unchangeable.
Potential implication: the seesaw effect.
The seesaw effect (1)

Trying to improve incentives and economic
performance by dealing with policy symptoms (or even
symptomatic economic institutions) might have limited
benefits or even backfire.
–
–
–
Suppose problems are institutional, and related to politics.
Imagine political power in the hands of a small elite exploiting
the rest using a variety of instruments, including expropriation,
taxation, non-level playing field and inflation.
Now take away inflation (make central bank independent),
one of two possibilities:
1.
2.
118
less distortions in the economy or
alternatively, they may start using expropriation, taxation and
other extractive means more heavily, leading to even worse
performance.
The seesaw effect (2)

The seesaw effect: pressing on one side of will raise
the other.
–
–

When the problem is institutional, related to political
institutions and the distribution of political power,
dealing with the source of the problem rather than the
symptoms more effective
–
–
119
Potential caveat for the Washington consensus (which focuses
on macro policy reform)
Potential caveat also for policy and institutional reforms more
generally.
but only if possible!
and at the moment we know little about how to change deep
institutions…
Seesaw effect in action: reforms in
Colombia (1)


Colombian democracy re-created in 1958 after 5 years
of military rule on basis of rigid power sharing
arrangement by Liberal and Conservative parties (the
National Front agreement).
All seats in legislature, bureaucratic appointments split
50-50, parties took turns with presidency.
–


120
Officially lasted until 1974 but many elements persisted (cabinet
bi-partisan until 1986).
Stopped inter-party conflict, but highly exclusionary and
oligarchic.
1980’s rising social conflict, drug mafias, left-wing
guerillas (M-19, FARC, ELN).
Seesaw effect in action: reforms in
Colombia (2)


Colombian Reforms 1988-1992 in response to rising
political crisis and assassination of three candidates for
president in 1990.
Economic Reforms:
–

Also Political Reforms
–
121
trade liberalization, end of capital controls, financial
liberalization, fiscal decentralization, mandated spending on
public goods, independence of Central Bank
introduction of Australian ballot, direct election of mayors,
Senate elected from nationwide constituency, Constitution rewritten in 1991.
Seesaw effect in action: reforms in
Colombia (3) Inflation rate, 1956-2003
35
30
25
20
15
10
5
122
Inflation
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
0
Seesaw effect in action: reforms in
Colombia (4) Central Government Surplus % GDP.
2.00
1.00
-1.00
-2.00
-3.00
-4.00
-5.00
-6.00
-7.00
Central Government Superavit (% of GDP)-with privatiizations
Central Government Superavit (% of GDP)-without privatiizations
123
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
0.00
Seesaw effect in action: reforms in
Colombia (5)
Real GDP Growth in Colombia (annual % increase), 1978-2002
10,00
8,00
6,00
4,00
2,00
-2,00
Source: DANE
-4,00
-6,00
124
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
0,00
Seesaw effect in action: reforms in
Colombia (6)
Unemployment rate in Colombia, 1986-2003
Urban areas
25
20
15
10
Source: DANE
5
125
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
0
Seesaw effect in Colombia:
Interpretation




Deep-seated distributional conflict in Colombian society.
Since independence search for a stable political order,
but one which excluded large segments of society.
– E.g. National Front, barriers to entry of third party.
Conflict manifests itself in political instability and in an
institutional structure the aim of which is to redistribute
rather than promote prosperity.
Constitution of 1991 – political crisis leads to an assembly
designed to represent wide range of preferences,
–
–
126
Result: inconsistent claims on the social product, the see-saw.
Making the Central Bank independent removes a redistributive
instrument which will be substituted with something else in
equilibrium. E.g. fiscal problem.
Seesaw effect in action:
reforms in Argentina (1)







127
Argentina democracy re-created in 1983 after Falklands
Radical Party defeats Peronists, Raúl Alfonsín president.
Argentina caught in debt crisis, negative growth,
government unsuccessful at coping, by late 1980’s
hyperinflation develops.
1989 election won by Carlos Menem on traditional
Peronist platform emphasizing redistribution, protection.
Once in power Menem embraces pro-market reforms.
Currency board, liberalization of capital flows and FDI,
central bank independence, privatization
1995 Menem re-elected, 2001 Crash.
Seesaw effect in action:
reforms in Argentina (2)
Inflation in Argentina, consumer prices (annual %)
1980-2003
3500
3000
2500
2000
1500
Source: World Bank
Development Indicators
1000
500
years
128
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
-500
1980
0
Seesaw effect in action:
reforms in Argentina (3)
Government Surplus in Argentina, % of GDP
-2
-3
-4
-5
-6
Source: World Bank
-7
-8
-9
-10
129
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
-1
1983
0
Seesaw effect in action:
reforms in Argentina (4)
Real per Capita GDP Growth in Argentina, 1980-2001
10
8
6
4
2
-4
-6
-8
-10
130
Source: Maddison-ECLAC
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
-2
1980
0
Seesaw effect in action:
reforms in Argentina (5)
Unemployment rate in Argentina, 1974-2003
Urban areas
25
20
15
10
Source: INDEC
5
131
2003
2001
2000
1999
1998
1996
1995
1993
1992
1990
1989
1987
1986
1984
1983
1981
1980
1978
1977
1975
1974
0
Real Overvaluation of the Argentine
Peso
132
The seesaw effect in Argentina:
Interpretation

Deep seated distributional conflict in Argentine society.
–

Conflict manifests itself in political instability and fighting
over redistribution
–


E.g. Argentina has the most malapportioned legislature in the world.
Menem weakens links with workers but strengthens links
to interior provinces for support.
Reforms under Menem removes traditional tools of
redistribution, monetary policy, tariffs, industrial subsidies,
employment in parastatals.
–
–
133
Since independence search for a stable political order, polarization
between Buenos Aires and the interior provinces, between Peronist
coalition and the traditional landed elites and the military.
But other instruments remain and are used more heavily
No labor market deregulation, privatization to reward supporters, and
fiscal problem with large transfers to interior provinces  seesaw effect.
What to do? Reform of deep
institutions

Deep institutions determined in history, but are changeable;
–
–


Let us use our theory of institutions; understand institutional
persistence and institutional change.
But two pitfalls:
1.
2.
134
Institutions “humanly devised”; in this sense contrast to geography
and culture theories.
Examples of recent successful institutional change; Botswana,
South Korea, partially China, Eastern Europe (shall we mention
others?)
The seesaw effect; reform only part of institutions, and the rest of
the institutions become worse as a consequence. Back to Colombia
and Argentina.
Ignoring internal dynamics; attempts at reform backfire because of
resistance by potential losers or subversive action by other groups.
Institutional persistence: some
things we know

Institutions are by their nature durable:


Bad institutions create bad incentives and self-sustain


e.g., if controlling the state is a major source of rents, there will be
infighting to control the state as in Ghana.
Bad institutions affect the composition of assets and
distribution of income, contributing the persistence:

135
e.g., an extractive state apparatus will give incentives to political
elites to use it for extraction.
Bad institutions create instability and self-replicate


e.g., democracy more likely tomorrow if today there is democracy
than if dictatorship today.
e.g., bad institutions  greater inequality  political power of the
rich to sustain bad institutions.
Institutional change (1)
Towards a theory of institutional change:

–
–
–

1.
2.
136
Recall:
political institutions  economic institutions
Thus important to understand change in political
institutions
Political institutions a way of regulating the
allocation of future political power
Two axes:
Elite-driven versus conflict-driven
Internal versus external
Institutional change (2)
Elite-driven: when the politically powerful elite wish to
change institutions in order to increase its
rents/utility.

–

E.g., the U.S. Constitution or the imposition of different
systems of land relations in the Dutch East Indies.
Conflict-driven: when institutional change forced from
the non-elites. E.g.:
1.
2.
137
Rise of democracy because of the threat of revolution.
Rise of constitutional monarchy resulting from the fight between
the crown and groups of merchants in Britain and the
Netherlands.
Institutional change (3)
Internal: because of internal shocks or dynamics.

–
External: because of external imposition, shocks, or
external incentives.

–
–

138
E.g., rise of democracy.
E.g., colonial imposition of institutions, Korean response to
threat of communism.
E.g., EU incentives for East European reform.
Even with external imposition, internal dynamics are
very important  the pitfall of ignoring internal
dynamics.
Conclusions (1)




139
Institutions matter.
Although ideology and history influence institutions, in
many many cases institutions emerge because of their
distributional consequences.
Although everything else equal more efficient
institutions more likely to arise, there will typically be
major social conflict over institutions.
Then the choices benefiting politically powerful groups,
not the society as a whole, more likely to emerge.
Conclusions (2)

Summary: towards a dynamic theory
De jure power
(Political institutions)t
De facto powert
140
Economic institutionst
political
powert
Economic policiest
Political institutionst+1
Conclusions (3)



Progress towards a useful framework for thinking
about institutions and fundamental causes of
differences in prosperity across countries.
Much research left to be done
Future areas:
1.
2.
3.
4.
Unbundling institutions
Institutional persistence
Institutional change
Policy to influence institutions? (further further in the future!)
This presentation should not be reported as representing the views of the IMF. The views expressed are those of the authors and
do not necessarily reflect the views of the IMF or IMF policy.
141