ECON 450 Development Economics Long-Run Causes of Comparative Economic Development Institutions University of Illinois at Urbana-Champaign Summer 2017
Outline 1 Introduction 2 3
The Korean Case
The Korean Case Before WWII, North and South Korea shared the same history and cultural roots. In fact, Korea exhibited an unparalleled degree of ethnic, linguistic, cultural, geographic and economic homogeneity. There are few geographic distinctions between the North and South, and both share the same disease environment.
The Korean Case However, since separation, the two Koreas have experienced dramatically diverging paths of economic development. By the late 1960 s South Korea was transformed into one of the Asian "miracle" economies, experiencing one of the most rapid surges of economic prosperity in history while North Korea stagnated.
The Korean Case
The Korean Case Therefore, neither the Geography nor the Culture hypotheses are able to explain such different paths in income per capita. Korea was split into two, with the two halves organized in radically different ways: South Korea as a democratic and market-oriented economy; North Korea as a dictatorial and closed country. Thus any differences in economic performance can plausibly be attributed to differences in institutions.
Institutions Introduction What are institutions, exactly? Douglass North (1990, p. 3) offers the following definition: "Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction"
Institutions Economic Institutions Determine the aggregate economic growth potential of the economy and an array of economic outcomes, including the distribution of resources in the future. Political Institutions Include the form of government, for example, democracy vs. dictatorship or autocracy, and the extent of constraints on politicians and political elites.
Institutions Of primary importance to economic outcomes are the economic institutions in society such as the structure of property rights and the presence and perfection of markets. Economic institutions are important because they influence the structure of economic incentives in society. Without property rights, individuals will not have the incentive to invest in physical or human capital or adopt more efficient technologies.
Institutions Political institutions, similarly to economic institutions, determine the constraints on and the incentives of the key actors, but this time in the political sphere. Examples of political institutions include the form of government, for example, democracy vs. dictatorship or autocracy, and the extent of constraints on politicians and political elites.
Outline 1 Introduction 2 3
AJR use the European colonization period as a quasi-experiment to estimate the effect of institutions on economic performance. According to them, the colonization of much of the world by Europeans transformed the institutions in many diverse lands conquered or controlled by them. Most importantly, Europeans imposed very different sets of institutions in different parts of their global empire.
This is exemplified by the contrast to the economic institutions in the northeast of America to those in the plantation societies of the Caribbean. As a result, while geography was held constant, Europeans initiated large changes in economic institutions, in the social organization of different societies.
Types of colonies: At one extreme, European powers set up "extractives states", exemplified by the Belgian colonization of the Congo. These institutions did not introduce much protection for private property, nor did they provide checks and balances against government expropriation. In fact, the main purpose of the extractive state was to transfer as much of the resources of the colony to the colonizer.
Types of colonies: At the other extreme, many Europeans migrated and settled in a number of colonies, creating what the historian Alfred Crosby (1986) calls "Neo-Europes". The settlers tried to replicate European institutions, with strong emphasis on private property and checks against government power. Primary examples of this include Australia, New Zealand, Canada, and the United States.
The purpose of the paper is to find a causal relationship between current institutions and current income. That is, the hypothesis being tested is that the strength of institutions in different countries will affect economic performance in these countries. Empirical problem: The relationship is endogenous. Solution: Instrumental Variables estimation.
The choice of the instrument for current institutions: European settlers mortality rates in colonies. In order to be valid, this instrument must: 1 be correlated with the institutions introduced in each colony; 2 have no effect on GDP per capita today other than its effect on institutional development.
The idea of the stream of effects is the following: In places where Europeans found high mortality rate, they could not settle and were more likely to set up extractive institutions. (E.g., Latin America and Africa). These institutions persisted to the present. Current institutions shape current economic performance.
The equation we address here is: log y i = µ + αr i + X i γ + ε i (1) The coefficient of interest is α, the effect of institutions on income per capita.
Overall, the OLS results show a strong correlation between institutions and economic performance. Nevertheless, we cannot interpret this relationship as causal. Reversal causality: Rich economies may be able to afford (or prefer) better institutions; Ommited variables: Many different unobserved variables that may be correlated with institutions; Measurement error in the institutions variables.
Determinants of Current Institutions Equation (1) describes the relationship between current institutions and current economic performance. The additional relationships of the analysis are expressed below: R i = λ R + β R C i + X i γ R + ν Ri (2) C i = λ C + β C S i + X i γ C + ν Ci (3) S i = λ S + β S log M i + X i γ S + ν Si (4)
Determinants of Current Institutions Equations (2)-(4) express the same stream of thought as the diagram previously shown. R is the measure of current institution; C is the measure of early institution (around 1900); S is the measure of European settlements in the colony; M is the mortality rate faced by settlers.
Determinants of Current Institutions Figure 3 illustrates the relationship between settler mortality rates and institutions. The relationship shows that ex-colonies where Europeans faced higher mortality rates have substantially worse institutions today.
Determinants of Current Institutions
Determinants of Current Institutions Table 3 shows OLS regressions of equations (2), (3), and (4). Panel A shows the effect of both institutions in the past and European settlements on institutions today. Panel B provides evidence in support of the hypothesis that early institutions were shaped by settlements, and that settlements were affected by mortality. In general, the results present a strong association between the variables analyzed, supporting the mechanism argument.
Introduction Determinants of Current Institutions
Institutions and Economic Performance Now we move to the main results of the paper: the 2SLS estimation. The equation we use for the first stage is R i = η + β log M i + X i δ + ν i (5) The equation for the second stage is (1) with the difference that we use ˆR i instead of R i. Table 4 presents the results.
Introduction Determinants of Current Institutions
Institutions and Economic Performance Overall, the results show a large effect of institutions on economic performance. In the rest of the paper, the authors perform several different exercises to show that the results hold for a variety of different settings.
Outline 1 Introduction 2 3
In another paper, Acemoglu, Johnson, and Robinson argue that European colonization has led to a reversal of fortune in former colonies. The argument is presented next.
Societies like the Mughals in India, and the Aztecs and the Incas in the Americas were among the richest civilizations in 1500, yet the nation states that now coincide with the boundaries of these empires are among the poorer societies of today.
In contrast, countries occupying the territories of the less-developed civilizations in North America, New Zealand and Australia are now much richer than those in the lands of the Mughals, Aztecs and Incas.
The explanation for this reversal of fortune is that the relatively densely settled and highly urbanized colonies ended up with worse (or extractive ) institutions, while sparsely settled and non-urbanized areas received an influx of European migrants and developed institutions protecting the property rights of a broad cross-section of society.
European colonialism therefore led to an institutional reversal, in the sense that the previously richer and more-densely settled places ended up with worse institutions.
Understanding the Colonial Experience Why did Europeans introduce better institutions in previously-poor and unsettled areas than in previously-rich and densely-settled areas?
Understanding the Colonial Experience Europeans were more likely to introduce or maintain economic institutions facilitating the extraction of resources in areas where they would benefit from the extraction of resources. These resources included gold and silver, valuable agricultural commodities such as sugar, but most importantly people. In places with a large indigenous population, Europeans could exploit the population, be it in the form of taxes, tributes or employment as forced labor in mines or plantations.
Understanding the Colonial Experience This type of colonization was incompatible with institutions providing economic or civil rights to the majority of the population. Consequently, a more developed civilization and a denser population structure made it more profitable for the Europeans to introduce worse economic institutions. In contrast, in places with little to extract, and in sparsely-settled places where the Europeans themselves became the majority of the population, it was in their interests to introduce economic institutions protecting their own property rights.
Evidences
Evidences
Evidences