L6: History, Geography and Institutions

Dilip Mookherjee

Ec320 Lecture 6, Boston University

Sept 18, 2014

DM (BU) 320 Lect 6 Sept 18, 2014 1 / 1

More Predictions of the Solow Theory:History Does Not Matter in the Long Run

In the Solow model, history/initial conditionsmatters in the short run, but not in the long-run

Countries end up eventually at steady statescorresponding to their fundamentals: savings,demographics, TFP

Living standards in the long run depend on thesefundamentals

Hence disparities in long-run living standards areexplained by disparities in fundamentals, nothistorical conditions (such as colonial history)

DM (BU) 320 Lect 6 Sept 18, 2014 2 / 1

Does Geography Matter in the SolowTheory?

Yes, through possible dependence of TFP ongeography, e.g., climate which affects laborproductivity

Alternatively, unfriendly terrain (high altitude) orlandlocked regions may have higher investmentcosts, which translates into low TFP

Alternatively, if there is some natural resourceconstraint (such as energy source)

Hence geography is included in fundamentals (viaTFP)

DM (BU) 320 Lect 6 Sept 18, 2014 3 / 1

Why Does History Not Matter in theSolow Theory?

One reason: Solow assumptions regarding thetechnology/production function:

Absence of increasing returns (in the long run)Absence of externalities in investment

Other reason: it ignores the role of institutions suchas nature of governance, property rights

Alternative, recent theories stress these factors,argue these imply that history does matter, andprovide supporting evidence

DM (BU) 320 Lect 6 Sept 18, 2014 4 / 1

Why Does History Not Matter in theSolow Theory? contd.

One way to view these theories in relation to Solow,which treats savings/investment rates as anexogenous ‘fundamental’:

savings/investment rates are not exogenoushistory helps explain persistent differences in investmentrates across countries with the same ‘true’ fundamentals(culture, geography, policies)Countries can fall into low level development traps owingto adverse historical conditions

DM (BU) 320 Lect 6 Sept 18, 2014 5 / 1

Theories Based on Increasing Returns andExternalities

One set of theories focus on the role ofcomplementarities in investment

QWERTY keyboard example

Returns to adoption of new technology depend onhow many others are adopting it

Complementarity (technology standards) versussubstitutability (traffic congestion)

DM (BU) 320 Lect 6 Sept 18, 2014 6 / 1

Rosenstein-Rodan’s Theory ofUnderdevelopment Traps

Demand-Side Complementarities: the parable of theshoe factorySupply-Side Complementarities:

Linkages across Different Intermediate GoodsComplementarities Between Skilled Labor and CapitalInvestment

Arguments for ‘Big Push’

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More Contemporary Examples ofComplementarities

R&D and Technology Spillovers e.g., semiconductorindustry, Silicon Valley

Green Revolution: adoption of HYV seeds:experimentation and social learningSocial norms:

trust and honesty in business relationshipscorruption among govt officialsfertility, schooling norms

DM (BU) 320 Lect 6 Sept 18, 2014 8 / 1

Alternative Approach Stressing Role ofHistory: Persistence of Institutions

Acemoglu-Johnson-Robinson andEngerman-Sokoloff use historical examples to stressthe role of institutions: governance, inequality

Argue institutions exhibit high degree of historicalpersistence and strongly affect investment rates andtechnical progress

Provide historical evidence of reversal of fortunesacross countries, which cannot be explained bygeography but can be explained by evolution ofhistorical institutionsDM (BU) 320 Lect 6 Sept 18, 2014 9 / 1

What Do ‘Institutions’ Mean?

Broadly speaking, ‘rules of the game’ governingpolitics and economics

governance: which impacts infrastructure,regulations, public schooling and health

rule of law: property rights, corruption whichimpacts private investment incentives

DM (BU) 320 Lect 6 Sept 18, 2014 10 / 1

What Do ‘Institutions’ Mean?, contd.

I wouldn’t include democracy versus autocracy inthe definition, because many autocracies performequally well as democracies in these respectsHowever, AJR include in their definition:

constraints on elites to prevent expropriationbroad measure of equal opportunity for acquiring humancapital and making investments

DM (BU) 320 Lect 6 Sept 18, 2014 11 / 1

Recent Examples Which Show InstitutionsMatter

Countries with the same culture, geography, accessto technology, but different institutions:

West versus East GermanySouth versus North Korea

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AJR Evidence on History versusGeography

Reversal of Fortunes: South versus North Americaprimary-product-abundant versus deficient regions

Countries that were most urbanized and highestpopulation densities in 1500, have (on average) lowper capita income and urbanization in 1995

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Cross-Country Regression: 1995 p.c.i.versus 1995 urbanization rates

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Cross-Country Regression: 1995 p.c.i.versus 1500 urbanization rates

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AJR Evidence on History versusGeography, contd.

These were countries where European settlers set upextractive institutions: unequal property rights,absence of rule of law, prevented access of commonpeople to land and education

In 19th century with advent of Industrial Revolution,these institutions were ill-suited to promote neededinvestments in infrastructure and human capital,and fell behind

DM (BU) 320 Lect 6 Sept 18, 2014 16 / 1

Geography Mattered Indirectly, byAffecting Colonial Institutions

Colonial institutions differed markedly acrosscolonies

Even for same colonial power: e.g., Britishsettlements in Central America vs elsewhereExtractive institutions more likely where:

colonial settlements were small relative to localpopulation, owing to high settler mortality (malaria,yellow fever)there were lucrative natural resources to exploitthere was a large captive population of native workers, oropportunity to import slaves

DM (BU) 320 Lect 6 Sept 18, 2014 17 / 1

Geography Mattered Indirectly, byAffecting Colonial Institutions, contd.

Cross-country regression in AJR shows that effect ofthese geography variables on present day livingstandards are not significant, if the regressionincludes the nature of institutions as controls

Hence historical institutions are the more importantdeterminant, rather then geography

Why places close to the tropics in the Americasused to be wealthier on average in 16th-18thcentury, and fell behind thereafter

DM (BU) 320 Lect 6 Sept 18, 2014 18 / 1

Role of Inequality in Persistence ofExtractive Institutions

Engerman-Sokoloff provide more details of theNorth-South America divide in nature of institutions,and why it persisted into 19th and 20th centuryExtractive institutions in the South created highinequality in distribution of political power and assetownership between small colonial elite and the restof societyElites deliberately prevented spread of democracy(Table 3.1), land (Table 3.4) and education (Table3.2) to the masses in the South, compared withNorthCaused inequality to perpetuate in the South: elitesblocked efforts to provide public goods andeducation that were important for achieving highproductivity in agricultural cultivation andindustrialization

DM (BU) 320 Lect 6 Sept 18, 2014 19 / 1

Similar Divide within N America

See similar (but less intense) dichotomy within theUS, between Northeastern/Midwestern states andSouthern states

What the US Civil War was about

Echoes in current-day politics within the US: blueand red states

DM (BU) 320 Lect 6 Sept 18, 2014 20 / 1

Summary

Key qualification concerning Solow model: it didn’tsay anything about determinants of investment,population growth or technical progress

Ignored possible coordination problems ininvestment, resulting in underdevelopment traps(Rosenstein-Rodan)

Ignored role of ‘institutions’ such as rule of law,property rights, provision of key public goods andschooling, which also affect investment,demographics and technical progress

DM (BU) 320 Lect 6 Sept 18, 2014 21 / 1

What Should ‘Trapped’ UnderdevelopedCountries Do?

If the problem is lack of coordination ininvestments, while the country’s institutions aregood, and inequality is relatively low (Japan, EastAsia, China, Vietnam):governments can jumpstart the economy :

imparting a ‘big push’help coordinate private investmentsprovide infrastructure and schooling

DM (BU) 320 Lect 6 Sept 18, 2014 22 / 1

What Should ‘Trapped’ UnderdevelopedCountries Do? contd.

If the problem is poor institutions and highinequality, problem is very difficult

Need institutional reforms, which current elites willresist

Serious problem in sub-Saharan Africa and MiddleEast

Nevertheless, S America provides hope that theseinstitutional problems can slowly and eventually beovercome

DM (BU) 320 Lect 6 Sept 18, 2014 23 / 1