Institutions Hypothesis. Economic growth is shaped by institution Geography only plays a role indirectly if it shapes them

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1 Institutions Hypothesis Economic growth is shaped by institution Geography only plays a role indirectly if it shapes them Institutions: formal (i.e. laws) and informal (i.e. culture) Better institutions Lower transaction costs Most relevant: Property rights and economic distortions Suggestive evidence: N and S Korea (1948) E and W Germany (1949)

2 Difficult to test empirically: reverse causality institutions income income institutions European colonization 1. colonial origins 2. reversal of fortune Evidence against the geographic hypothesis

3 Colonial Origins (Acemoglu, Johnson and Robinson, 2001) Summary: Step 1: mortality of settlers determines the type of colony High differences in mortality rates across colonies: > 50% in West Africa on the 1 st year First inland expeditions everyone died Pilgrims: US vs. Guyana British convicts in Australia Public Information in France and Britain

4 Step 2: type of colony institutions built Two extreme cases Extractive institutions (i.e. Belgian Congo) Maximum transfer of resources from colony to colonizer Neo-Europes (i.e. Canada, Australia, US) Replicate the European model Property rights and checks to government (representative) When large settlements European-like institutions Small settlements extractive institutions

5 Step 3: Persistence of Institutions With the independence the control structures, law and order, and private property in place at the time of the settlement survived Small domestic elite inherited the European power Little incentives to reform Examples: Monopolies and regulation in Latin America Forced labor in America and Africa

6 Mortality in the colony and Institutions today

7 Step 4: Institutions matter for development Growth theory and empirics: Property rights, corruption, economic distortions matter for investment (K and HC) and foster economic growth Small differences in economic growth for a long time are then translated into huge difference in income Differences in institutions have been there for long time Institutions manage to explain large part of the variation in income in the world. Example: if NGA would have CHL institutions 7 times richer!

8 Institutions and Level of Income

9 Reversal of Fortune (Sokoloff and Engerman, 2000) (Acemoglu, Johnson, and Robinson, 2001) : North America mainland was of marginal economic interest relative to Caribbean and LAAM (Example, Seven Years war) XX Century: US and Canada a lot more successful economies than the rest of America. Why reversal? Divergence takes place when industrialization Origin of the colonizer? No. British empire did not guarantee success (i.e. Jamaica)

10 Under geography hypothesis: persistence of income over time Colonization introduced different institutions income Two extreme situation in the American continent 1. Regions for high productivity for coffee, sugar and staple crops large plantations with slaves Very lucrative and integrated in the world economy Highest income per capita (including slaves) Power in the hands of minority (land owners) High inequality Similar experience when presence of mines (gold, silver)

11 2. Disperse population and no so good soil for large plantations (North America) no economies of scale Characterized by more equal societies Income inequality Different institutions Unequal societies: elites secure disproportionate share of political power, and establish laws and policies to maintain advantage over majority nonmembers Allows persistence of inequality over time Example: Extension of Franchise US and Canada removed restrictions and introduced secret voting By 1900, no other American state had secrecy of vote Only Argentina had no wealth or literary restrictions

12 Effects on Economic Growth 1. Universal Primary Education In 1800 colonies are rich enough to spread public schools US and Canada locally managed to do so British Caribbean was rich but not interested Even progressive Latin American countries were 75yrs late

13 2. Industrial Revolution Note the timing of the reversal of fortune: early XIX Why then? Pre-industrial revolution big investments in agriculture Elite has the land and decides to invest Rest of population works the land But extractive institutions and inequality will fail when new technologies require to invest from society Talent and power are different. Elite has incentive to avoid progress from social sectors

14 Reversal of Fortune