The Reversal of Fortune:
Geography and Institutions in the
making of the modern world
income distribution
Acemoglu D., Johnson S., Robinson J. A.
Introduction
• Reversal in relative incomes among former
European colonies
• Richest civilizations vs. less developed in 1500
• ie. Mughals in India vs. North America
• Today the U.S. is wealthier than countries
occupying territory of Mughal
Introduction
Main measure of economic prosperity in 1500 is
urbanization including
• high productivity per capita (ie. agricultural prod.)
• transportation network (support of population)
• does not consider welfare or social conditions
Alternative measure of urbanization is
population density
• Only prosperous areas could support dense
populations
Introduction
Introduction
Geography hypothesis accounts for certain
geographic characteristics (i.e. climate and
disease on work effort and productivity)
• Hypothesis predicts that prosperous nations in
1500 should be rich today
-> adapted version of hypothesis accounts for
time-varying effects of geography (i.e.
temperate drift hypothesis)
Introduction
• Temperate drift hypothesis asserts that
tropical regions had the early advantage of a
hotter climate
• As agricultural technologies developed (i.e.
heavy plow and crop rotation systems) more
temperate areas were favoured shifting
fortune.
• Introduction of new technologies does not
correspond to the reversal of relative incomes
-> happened earlier than income reversal
Introduction
Institution hypothesis relates differences in
economic performance to organization of
society
• private property vs. extractive institutions
Idea behind hypothesis:
Expansion of European empires starting at
end of C15 causing major changes in
organization of societies
Introduction
Historical evidence suggest that European
colonialism caused “ institutional reversal”
• development of institutions of private
property in previously poor and sparsely
populated areas -> European settlement
• Extractive institutions in previously
prosperous and urbanized areas -> easy
exploitation made them more profitable
– ie. native population forced into mining
Geography Hypothesis
Differences in economic performance is due to
differences in geographic and climatic
characteristics across countries
– ie. temperature, soil, animals, vegetation
Sachs (2001) emphasizes importance of
geography as it effects transport costs,
technology and disease environment
– access to key natural resources (ie. coal, sea)
Geography Hypothesis
However modified geography hypothesis may
account for reversal in relative incomes
-> certain geo. characteristics that were not useful
in 1500 may turn out beneficial later on
Temperate drift hypothesis accounts for shift
(away from equator) in center of economic
gravity
-> technological interaction with geography
-> technologies were less useful in tropical zones
Geography Hypothesis
Evidence not supportive of the temperate drift
geography hypothesis:
-> European agricultural technology spread to
colonies between C16 and C18
-> Reversal in relative incomes is largely an early
C19 and industry-based phenomenon
Institutions Hypothesis
Societies with social organization providing
encouragement for investment will prosper
-> property rights important for success of nations
A well organized society has a cluster of
institutions (ie. political, economic) ensuring
majority society has property rights.
-> cluster of institutions of private property
-> contrast is extractive institutions
where majority of population faces high risk of
expropriation by ruling elite (ie. India)
Institutions Hypothesis
Extractive institutions do not encourage
economic development because they are
shaped by politically powerful groups:
-> fear of losing their political power if institutional
development occurs
-> fewer rents with institutions of private property
-> no direct benefits of resulting economic gains
from initiating institutional change
European colonists were able to maximize the
rents but not long-run growth through
extractive institutions
Institutions Hypothesis
Institutions hypothesis suggests that societies
that are prosperous today should tend to be
prosperous in the future.
-> unless a major shock disrupts the
organization of a society affecting economic
performance
Institutional reversal
European colonialism disrupted existing social
organizations and established new/continued
the existing extractive organizations in
previously prosperous areas
-> ie. Central America and India
There was a development of institutions of
private property in previously poor areas
-> ie. US, Canada, NZ, Singapore
Institutions Hypothesis
What determined whether European pursued an
extractive strategy or introduced institutions of
private property?
1. Economic profitability of alternative policies
• High population density provides high supply of labor
that could be forced to work in agriculture or mining,
making extractive institutions more profitable for
Europeans
• Existing tax systems: the large population made it
profitable for the Europeans to take control of system
and introduce/continue to levy high taxes
Institutions Hypothesis
2. Whether Europeans could settle or not
• Europeans more likely to develop institutions of
private property when they settled in large numbers
-> Self affected by these institutions (good econ.
performance)
• Settlers demanded rights and protection, similar or
better than home country
-> making development of effective property rights for
a broad cross section of society more likely
Institutions Hypothesis
Institutions hypothesis combined with
institutional reversal predicts that countries in
areas that were relatively prosperous and
densely settled in 1500 ended up with relatively
worse institutions after European intervention!
-> Less prosperous today
Reversal in relative incomes that was seen is
consistent with this prediction
Institutions and Industrialization
Why did reversal in relative incomes take place
during the C19?
• Problems with arrival of a new technology:
1. Entrepreneurial skills may not be possessed by
members of the elite -> do not undertake
investment due to no secure property rights
2. Elites may block investment in new industrial
activities because society will benefit and not
the elites themselves
3. Block new activities, fearing loss of political
power
Institutions and Industrialization
If hypothesis is correct we expect societies with
good institutions to take better advantage of the
opportunity to industrialize starting in the late
C18
-> Results provide support that institutions played
important role in process of economic growth
and in industrialization among poor colonies
-> accounts for a significant fraction of current
income differences
Conclusion
Key factors that led to the reversal of fortune of
former European colonies (rich -> poor) from
1500 to present day:
• European intervention (economic and political
development)
• Effect of different institutions (given their local
demographics i.e. population density) on
countries’ econ. performance
• Opportunity to industrialize during C19