Political Institutions and Distributive Politics

Ping WangDepartment of Economics

Washington University in St. Louis

April 2019

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A. Introduction

It is not until recent that economists have devoted effort toward understanding therole of institutions played in the process of economic development in a moresystematical manner.! Institutional development:

" classic: North (1990), Rogoff (1990)" voting and political equilibrium: Glomm-Ravikumar (1992), Perotti (1993),

Alesina-Spolaore (1997), Bolton-Roland (1997)" new literature: Acemoglu-Robinson (2000, 2008), Acemoglu-Robinson (2000,

2001, 2008), Acemoglu-Johnson-Robinson (2001, 2002, 2005),Galor-Moav-Vollrath (2009), Cheung-Palivos-Wang-Wang-Yip (2017)

! The Importance of Institutions: institutional factors can" affect laws and regulations under which households and firms function" shape the incentives individuals have for various decision-making" then, individuals’ decisions can, in turn, affect the establishment of political

and economic institutions" distortions created by bad institutions can cause resource misallocation

! Institutions and growth: Acemoglu-Naidu-Restrepo-Robinson (2017), Acemoglu-Robinson-Verdier (2017), Wang-Wong-Yip (2017)

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B. Trade, Institutions and the Rise of Europe: Acemoglu, Johnson and Robinson(2005)

! The rise of Europe after 1500 is believed due largely to strong growth incountries involving cross: Atlantic trade with the New World, particularly overthe period of 1500-1850

! Such substantial trade and associated colonialism changed institutions (inEngland and the Duchy of Burgundy), strengthening merchant groups byconstraining the power of the monarchy and by protecting property rights

! Improved institutions led to faster and more sustained economic growth! A notable phenomenon accompanying such development is rapid urbanization:

Atlantic traders (UK, Netherlands, Portugal, Spain) were not as urbanized asnon-Atlantic traders in Western Europe during 1300-1700, but becomeurbanized rapidly afterwards

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!

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1. The Hypothesis

! Four subhypotheses:" political institutions constraining state power are essential for the incentives

for merchants to undertake investment " such institutions were not welcome by the monarchy earlier in Europe" institutions favored by economically and politically powerful groups are

more likely to prevail" in countries with nonabsolutist initial political institutions, Atlantic trade

and colonization strengthened commerce, including new groups without tiesto the monarchy

! These subhypotheses imply that, in countries with easy access to the New Worldvia Atlantic and without an absolutist monarchy, " Atlantic trade provided substantial profits and hence political power for

commerce outside the monarchy circle" the rise of this merchant group demanded and obtained favorable political

institutions protecting their property rights" with such newly gained power and favorable institutions, these Atlantic

trading merchants had higher incentives to invest and continued growing,fueling the first Great Divergence of cross-country per capital real income

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2. Empirical Findings

! The difference in success between UK/Netherlands and Portugal/Spain: theformer had political institutions placing sufficient checks on the monarchy" key institutional development in UK:

- the Civil War of 1642-1649 with Parliamentarians defeating Charles I- the Glorious Revolution of 1688-1680 with James II deposed by

Parliament since then a parliamentary regime was formed" key institutional development in the Netherlands:

- the establishment of the independent Dutch Republic replacing theHabsburg monarchy, starting 1570 and ending 1648

! Significance of Atlantic trade in the UK and the Netherlands:" UK: mostly known the East India Company founded in 1600, since then

Atlantic trade created large profits, about:- 0.2m (pounds) per year, 1601-1650- 0.5m per year, 1651-1675- 0.9m per year, 1676-1700- 1.7m per year, 1701-1750, growing to about 5.0m per year by 1800

" Netherlands: mostly known the Dutch West India Company created byPhilip III in 1609

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C. Mortality and Colonial Institutions: Acemoglu, Johnson and Robinson (2001)

! European settlements: " in places with high

mortality rates, Europeansettled by setting upshort-term extractiveinstitutions: colonizationof Congo under Belgian

" in places with lowmortality rates, Neo-Europes were created(Western EuropeanOffshore) in whichinstitutions such asprivate propertyprotection were established: colonization of Australia/New Zealand/USunder English

! The institutions established in colonial eras persisted even after independence! So neo-Europes post-independence per capita income turned out to be higher

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D. Institutional Reversal: Acemoglu, Johnson and Robinson (2002)

! Many countries which were initially rich in 1500AD became relatively poor now:Australia, New Zealand & US

! In initially poor places, there were more opportunities, which induced Europeansto establish institutions to encourage investments

! Measure of prosperities: urbanization" those with lowest levels of urbanization in 1500, such as Australia, Canada,

Hong Kong, New Zealand,Singapore & US, achievedhighest (PPP adjusted) percapita income in 1995

" those with highest levels ofurbanization in 1500, such asAlgeria (DZA), Egypt, India,Morocco (MAR) andTunisia, stagnated

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! the reversal can be best seen from the time series plot below" countries with low urbanization outperformed those with high urbanization

(also see US vs.India)

" reversal occurredbetween 1750 and1850

" it coincided with- widespread of

industrialtechnologies

- intensity oftrade

- establishmentof privatepropertyprotection

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E. Political Transition: Acemoglu and Robinson (2001)

! In Western Europe and Latin America, nondemocratic societies were controlledby a rich elite

! The initially non-elite poor could challenge the elite by threatening revolution! Would such a political transition toward democracy occur?

" When the opportunity cost of revolution facing the poor was low (e.g.,during recessions), such a threat could force the elite to permitdemocratization

" Yet the redistribution from elite to the poor lowered the incentives of theelite for democratization

" The latter could dominate when the loss by the elite turned out to be big" Yet if the elite could benefit from having a better motivated group of poor,

the associated loss would become more bearable! Examples:

" Chin Dynasty in 200BC" Robin Hood in the 14th century" Louis XVI in the 18th century

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F. Societal Hierarchy and Institutions: Acemoglu and Robinson (2008)

! While Acemoglu-Johnson-Robinson (2005) provide convincing empiricalevidence and informal arguments on the role of institutions played in thedevelopment of Western European Atlantic traders, a formal modelingframework has been absent

! This paper makes crucial progress toward filling the gap by constructing a modelto study how changes in political institutions can lead to subsequent changes ineconomic institutions

1. The Model

! Total population L within which there is a small elite (E) group of size M with theremaining as general citizen (C)

! Preference: , linear over private/public goods, h 0 {E, C}

! In each period, only 2 types of public goods are provided:" gt+j = e (elite type) => GE

t+j = γE > 0, GCt+j = 0

" gt+j = c (citizen type) => GEt+j = 0, GC

t+j = γC > 0

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! Ricardian technology: each citizen owns one unit of labor (supplied inelastically),capable of producing A units of good

! Institutions: τt 0 {e, c} (pro-elite or pro-citizen)" τt = c => wc = A, Rc = 0" τt = e => we = λ(1-δ)A, Re = (1-λ)(1-δ)AL/M

where δ = inefficiency loss due to labor repression under e-institution" labor wage and elite rent differentials under the two institutions:

- Δw = wc - we = [1-λ(1-δ)]A > 0- ΔR = Re - Rc = (1-λ)(1-δ)AL/M > 0- since L/M is very large, ΔR >> Δw

! Political regimes s 0 {N, D} (nondemocracy/monarchy or democracy)! De facto political power depends on the investment in power-gaining:

" elite:

" citizen: , with

- ω iid, drawn from a given distribution F with support (ω, 4), ω < 0, andsingle-peaked density

- η measuring citizens’ de jure power in democracy" indicator of power π 0 {e, c}: π = e iff , and = c otherwise

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! Timing of events:" the group in power at t decides gt 0 {e, c}" each elite i 0 E and each citizen i 0 C choose their investment in gaining

power and PEt is determined

" ω is drawn from F and PCt is determined

" if π = e, a representative elite chooses current institution and future regime(τt, st+1); otherwise, a representative citizen chooses

" given τt, Rt and wt are determined and consumption takes place! Symmetric Markov perfect equilibrium (MPE):

" equilibrium strategies are mappings from payoff-relevant states s 0 {N, D}" all agents in the same group behave symmetrically

! Symmetry implies:"" PC = " pr(e in power) =

! Backward induction within each stage implies the following best responses:" g(N) = e, g(D) = c" τ(e) = e, τ(c) = c" sN(e) = N, sN(c) = D

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! Values under N (using one-step-ahead deviation principle a la Fudenberg-Tirole1994):" elite:

" citizen:

where is theconditional probability for e in power given all elite members choosing θE

and all other citizens choosing θi

! First-order conditions for power-spending θ under N:" elite:" citizen:

where and measure value differentials between two political regimes

! Values under D and the associated first-order conditions:" elite:

(FOC)

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" citizen:

(FOC)

2. Results

! Power-gaining investment: Any symmetric MPE involves: " θC(N) = θC(D) = 0: this is because the elite group has much larger gains from

power than citizens (ΔR >> Δw), implying two of the 4 FOCs hold forinequality

" {θE(N), θE(D)} solve the remaining 2 FOCs:--

! Condition R: The additional rent by elite from labor repression is sufficientlylarge such that

! State Dependence: Under Condition R, a symmetric MPE features:" Markov regime switch with the society fluctuating between {N,e} and {D,c}

- with the regime probabilities p(N) > p(D) if - with invariance p(N) = p(D) if

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! Condition I: › s.t.

(interior power-gaining investment)! Condition D: Democracy creates a substantial advantage in favor of citizens s.t.

η > -ω! Nondemocracy as Absorbing State: Under Conditions I and P, there exists a

symmetric MPE in which p(N) 0 (0, 1) and p(D) = 0! Comparative Statics: Under Condition R with , a symmetric

MPE features:" equilibrium power-gaining investments {θE(N), θE(D)} are increasing in ΔR,

β and η, and decreasing in M" the equilibrium probability for the elite to be in power is increasing in ΔR, β,

η, and " more patient (β) or greater de jure power advantage for citizens (η) causes

the elite to have greater incentive to invest in power-gaining and raises thelikelihood of labor repression institution

! Meeting the facts: M was sufficiently large while η was sufficiently low in UK andthe Netherlands, thereby destroying the elite incentive to invest in its de facto powerand leading to the eventual establishment of the democracy regime

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G. Institutions and Growth: Acemoglu-Naidu-Restrepo-Robinson (2017)

! Simple cross-country regressions show the absence of a robust relationshipbetween democracy and growth

! This paper uses a consolidated dichotomous measure of democracy and controlsfor country fixed effects and the rich dynamics of GDP (long lagged dependent)

! A country is called democratic in a given year if Freedom House codes it as freeor partially free and if Polity IV assigns a positive score to it; with missing data, itis called democratic if either Cheibub-Gandhi-Vreeland (2010) or Boix-Miller-Rosato (2012) codes it as democratic

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! Empirical findings

" democracy always has a significantly positive effect on output growth

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! Potential channels

" significant channels: democracy promotes physical, knowledge and healthcapital accumulation and leads to less unrestness

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H. Institutions and Development: Wang-Wong-Yip (2017)

! Over the past half-century, world income disparities have been widened! The gap in real GDP per capita relative to the U.S. between advanced and poor

countries has been rising over time! The ratio of average real GDP per capita of the top 10% to the bottom 10% has

increased from less than 20 in 1960 to over 40 in 1990 and to more than 50 sincethe turn of the new millennium

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! Consider a simple reduced form setting (Basu-Weil 1998; Acemoglu 2009; Wang-Wong-Yip 2017):

" Per capita output:

" Global technology frontier:

" Assimilation of global technology:

- ζj = 0 (no barriers)

- ζj = 1-α (maximum barrier)

" Relative income:

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! Development accounting: fast growing countries

" average growth 2.9%; average TFP about 88% of the U.S.

" average ζj about 44%

" institutions account for over 50%; TFP contributes less than 10%

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! Development accounting: trapped countries and development laggards

" average growth 0.05%; average TFP about 61-86% of the U.S.

" average ζj about 42.5-50%, slightly higher than fast growing countries

" institutions account for 2/3 - 100%; TFP contributes negatively