Political Regimes, Institutions and
Growth
Daron Acemoglu
Charles P. Kindleberger Professor of
Economics
Massachusetts Institute of Technology
June 2005
TÜSİAD-KOÇ UNIVERSITY ECONOMIC
RESEARCH FORUM
The Wealth of Nations

Tremendous growth in income per capita in many parts of the
world over the past 200 years.
–
–

E.g.: income per capita in the U.S. rose from $1200 in 1990 dollars in
1820 almost $30,000 today.
Average income in Western Europe during the same time arose from
$1200 to over $18,000.
But changes not uniform; large disparities across countries.
–
–
–
Average income per capita in Africa is around $1300.
And much less in some countries; around $550 in Tanzania, Sierra
Leone, Niger, and less in Zaire.
Smaller, but still substantial gap between the U.S. and “middleincome” countries like Portugal.
Why?

“Proximate” answers (channels and mechanics):
1.
2.
3.




Physical capital
Human capital
“Efficiency”---Solow Residual
Growth accompanied with more physical and human
capital, and greater efficiency.
Poor countries have less physical capital, human
capital and lower efficiency.
Physical capital, the mere quantity of machines, only
explains a relatively small part of the variation.
Most important factor seems “efficiency” (e.g., TFP).
Output and Efficiency
1.2
TFP vs. output per worker
HKG
SGP SPA
UKG
AUT
ISL
1
SY R
JOR
MEX
BAN
.2
.4
.6
TFP
.8
VEN
TRI
ALGPOR
BRBTWN
GUAMRS BRA
MLT
EGY
TUN
GRE
ARG
CY P
IRN
COL URU
SLE PAK
KOR
REU
CRI
ELS TUR
DOM
URS
SAF
MLS
SWZ
FIJ
PER
CHI
SRL
CON
PAR ECU
THA
SEN HON
PAN Y UG
MOZ
BOL
BEN NIC
HUN
RWA
CAM
GMB
IND
HAI
IDN
POL
SUD
JAM CZE
UGA
GHA
PAPPHL
MAL
LES ROM
BOT
ZBW
KEN
ZAI
CAF
GUY
BRM
NGR
TOG
CHN
MLW
ZAM
0
.2
ISR
IRE
JPN
.4
.6
output per w orker
ITA
FRA
CAN
BEL
NET
GER
SWE
SWI
AUS
DENFIN
NOR
NZE
.8
1
USA
Understanding Efficiency


Why do some countries produce much more and
generate more wealth out of their machines and labor
force?
Two facets of efficiency
–
–

Different quality and types of machines available to different
countries.
Different use of available resources, including technology.
While lacking access to new machines and techniques
of production potentially important for some poor
countries, for middle-income countries like Turkey, the
key is making good use of existing technology.
Improving Efficiency


How can use of resources and technology be
improved?
Three important levers:
–
–
–
Human capital.
Incentives.
Selection.
Fundamental Causes



1.
2.
Human capital, physical capital and technology are
proximate causes of economic growth.
Why do some countries have better technologies and
more human capital?
Most likely answer:
because they provide better incentives to those who
can invest in new technologies and human
capabilities.
because they select the rights type of individuals and
firms to become the key investors and players.
Incentives and Institutions



Sources of incentives?
Incentives determined by institutions (rules of the game
of society).
For businesses, most important “security of property
rights”.
–
–

No investment will be forthcoming if businesses expect
expropriation, high taxes or inefficient regulation.
Institutions have to make a credible commitment to reward
investments.
Two major threats:
–
–
Theft by others
Inefficient intervention or taxation by government.
Institutional Variation

Big differences in institutions across countries.
–
–
–
–
Democracy vs. dictatorship.
Enforcement of property rights.
Legal systems and contracting institutions (e.g., how
easy it is to enforce contracts---in Turkey, about 10
times as expensive to enforce a simple contracts as
in the U.S., but on the bright side, relatively fast).
Entry barriers (e.g., cost of opening a new business
over 70 times in Turkey compared to the U.S.).
Institutions and GDP
HKG
10
ARE
KWT
log GDP per capita in 1995
ARG
9
PAN
IRN
8
SDN
HTI
ZAR
MLI
ISR
QATBHR
MLT
GRC
BHS CHL
OMN SAU
VEN
URY
MEX GAB
MYS
ZAF
BWA
CRICOL
THABRA
TTO
TURPOL
TUN
ECU
PER DOM DZA
ROM
PRY
JAM
JOR
PHL SYR
IDN
MAR
SUR SLV
EGY
BOLGUY
CHN
AGO
LKA
ZWE
HND
NIC
CMR
GIN
CIV
COG
SEN
GHA
PAK
VNM TGO MNG
KEN
UGA
BGD NGA
BFA
MDG
ZMB
NER
YEM
MOZ MWI
SLE
TZA
ETH
KOR
CZE
HUN
RUS
GTM
7
LUX
USA
CHE
JPNNOR
DNK
BEL
CAN
AUT
ISL NLD
AUS
ITA FRA
GBR
SWE
FIN
IRL
NZL
ESP
PRT
SGP
BGR
IND
GMB
6
3
4
5
6
7
8
Average Protection Against Expropriation Risk, 1985-1995
9
10
Causal Effect?

Of course, correlation does not may causation.
–


Institutions are endogenous, partially caused by income, and
determined by only did factors simultaneously influencing income.
Do we know that institutions are important for long-run economic
development?
Answer is yes, but we have to use different econometric
techniques, in particular, instrumental variables.
–
–
–
One strategy: exploit sources of variation in institutions that are not
directly related to income, e.g., features of history.
Example: exploiting the “natural experiment” of colonization.
These strategies typically show very important effects of institutional
features on long-run growth, investment and efficiency.
Providing Incentives to Investors



Private sector impetus is only possible if potential investors have
the right incentives.
Government policy have to take these into account.
Potential pitfalls for well-meaning policies: ignoring the importance
of incentives in devising redistributive programs or regulation.
–

Even more important, pure rent seeking policies.
–

Even more so today because capital is footloose, and can easily
move internationally.
Corruption by political and economic elites.
On these scores, Turkey potentially deficient.
–
According to the Heritage Foundation, Turkey 106th in the world in
terms of economic freedoms (underneath Mali, Azerbaijan and
Algeria!)
Why Not Efficient Institutions?



If institutions, and the incentives they provide,
so important, why do countries choose “wrong”
institutions?
Answer related to distributional conflict and
commitment problems.
Brings us to political regimes (political
institutions) and political power.
Distributional Conflict




Every set of (economic) institutions creates different
losers and beneficiaries.
– E.g.: a monopolist would be opposed to a reduction
in entry barriers even if they are efficient.
Difference between potential and actual Pareto
improvements.
Conflict over economic institutions.
Efficient institutions would emerge either when the
losers can be compensated or when the beneficiaries
to impose their choice because they have sufficient
political power.
Commitment Problems and Limits
to Efficiency

Key barrier to buying off losers: commitment.

Promise of compensation after institutional change not credible.
Monopoly of political power creates commitment problems.
Contrast contracting between two private citizens versus political
contracting between two parties one of whom holds political
power.
– Two private citizens can write contracts enforced by a third
party.
– 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.
– Also promise of payments to a dictator after he relinquishes
power is not credible.


Importance of Political Power


If losers cannot be bought off, i.e., if potential Pareto
improvements cannot be turned into actual, how are
collective choices made?
Importance of political power
–


Political power: the power to impose or secure social choices
against the wishes of other groups.
Political power  economic institutions
Key questions to be addressed later;
–
Where does political power come from?
Political Institutions (Regimes)

Where does political power come from?
–

Association between economic and political institutions
–
–

Political institutions determine the distribution of political power
and regulate its use  sources of political power.
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:
–
–
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.
Sources of Political Power

Two types of political power:
–
De jure (formal) political power


–
De facto political power




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.
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.
–
–
–
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.
Towards 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

–
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.
Toward a theory of institutional change
political power  institutions  political power

Source of persistence.
Dynamic linkages (summary)
De jure power
(Political institutions)t
De facto powert
Economic institutionst
political
powert
Economic policiest
Political institutionst+1
Application: Rise of Constitutional
Regimes in Europe




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
Rise of Constitutional Regimes (2)


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
–
–
–
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
Rise of Constitutional Regimes (3)

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.
–
–
–
–
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.
Rise of Constitutional Regimes (4)

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


–
–
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.
Rise of Constitutional Regimes (5)


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.
–
Political institutions, by regulating the future allocation of de jure
political power, influence future economic institutions, outcomes

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
–
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.
Limits to Pro-Business Policies





So far the emphasis on providing the right incentives to
businesses (e.g., secure property rights, good
contracting institutions and environment).
But incentives alone are not sufficient.
We also need “selection”.
The right firms and people to undertake the
investments.
In other words : level playing field.
Selection and the Incumbents




Existing firms have to be given the right incentives to
undertake investments, adopt new technologies,
expand their operations, etc..
But almost always will also demand protection against
competitors, especially more efficient competitors.
The process of economic growth requires
“Schumpeterian creative destruction”, in other words
the selection of new and more efficient firms and
individuals to replace incumbents.
Without this, the process of growth will slowdown or
even stop.
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.
But slows down creative destruction because it creates
a non-level playing field and a potential hold-up
problem because power is monopolized by the rich.
–

More efficient producers do not enter and invest enough.
Problem of institutional reform: how to transition from
oligarchy to a democracy?
Implicit Barriers

In addition to explicit barriers protecting incumbents,
implicit barriers are important; e.g., barriers created in
the credit market.
–
–

If only existing large companies can raise loans, this creates a
very effective entry barrier.
Lower competition will slow down of the process of creative
destruction and prevent the introduction of new technologies.
Turkish banking sector until recently not playing the
role of providing loans to new businesses.
–
Because of bad regulation, highly monopolistic structure and
corruption.
The Balance

The balance therefore has to be found
between providing incentives to existing
businesses, but also limiting their power to
create a non-level playing field.
–

An important area both for academic research and
actual policy.
Need for the rights type of regulation and
especially opening up of the economy to both
foreign and domestic competition.
The Current Context

1.
Two major economic trends of the past 30 and next 30
years:
Skill-biased technical change
–
2.
New technologies replacing tasks previously performed by
unskilled labor, and complementary to indicated, skilled and
specialized workers
Globalization; international trade, outsourcing, foreign
direct investment and financial integration
–
A more integrated world, through trade, within-company
outsourcing, increasing foreign direct investment and capital
market liberalization.
Skill-Biased Technical Change


Technical change, such as introduction of computers,
robotics, new information processing systems, require
a more skilled workforce.
More educated workers and countries with sufficient
supply of educated unskilled workers are the economic
winners.
–

Increased demand for skills and wage premium to skilled
workers in both high and middle-income countries.
Slower transfer of technology to countries without a
sufficient supply of skilled managers and engineers.
Globalization



Greater competition in the world economy.
Although standard international trade theory predicts
that globalization may reduce demand for skills in
middle and low-income countries, the current wave
associated with transfer of technologies and
outsourcing, typically increasing the demand for skills.
Skill-upgrading as a result of international trade,
especially associated with outsourcing
–
A process similar to skill-biased technical change, favoring
countries with skilled managers and engineers.
Globalization Challenges


Globalization an opportunity for most countries, but
also a challenge.
Incorporation of China, India, Pakistan and Indonesia
into the world economy means competition for low-cost
producers for middle-income countries like Turkey.
–
–
–
No longer possible to be competitive with low wages alone.
Need to move up the quality ladder towards more skillintensive products
Again, pitfalls of shortage of skills.
Institutions Now More Important

These two developments necessitate
–
–
–
–

greater creative destruction
greater investment in human capital by non-elites
more technology transfer from abroad, thus greater
investments by groups outside the traditional elites
greater political stability
Becomes even more important to reform the
political regime and institutions in Turkey.
Incentives and FDI


In a globalized world, foreign direct investment is an
increasingly an important lever for transfer of
technology to middle-income countries.
But incentives are even more important for FDI than for
domestic investment.
–

Foreign companies have many options and have to incur costs
to undertake investments in new countries.
Because of the general economic environment, military
and political risk and regulations, Turkey has been very
slow in attracting FDI.
Natural Synergies in Reform



Various reforms towards this new environment are
potentially synergistic.
Political reform will make a level playing field easier.
Level playing field not only for businesses, but also for
individuals.
–
–
Tremendous talent often lost for the society because the best
education and jobs limited to the elite.
Also a natural synergy between more and better quality
investment in human capital and creating a level-playing field
for individuals.
Conclusions(1)

Proximate causes of economic growth:
–
–
–

human capital, physical capital and technology.
human capital’s special role in enabling
technological progress.
potential pitfalls for middle-income countries
Fundamental causes:
–
–
incentives
selection
Conclusions (2)



Globalization and new technologies: both opportunities
and pitfalls.
For a country like Turkey, institutional reform to create
economic freedoms but also limit the power of
incumbents (both and economic and political arena)
very important.
Opportunities presented by European Union:
–
–
Most important, an engine of institutional reform
Paving the way to FDI and import of new technologies.