Institutions, colonialism, and development

Acemoglu, Johnson, and Robinson, “Reversal of fortunes: geography and institutions in the making of the modern world income distribution,” QJE 2002, pp1231-84

Do institutions cause long-run economic growth?

Naïve empirical approach

y

  *

I

 

where y

economic developmen t

I

measure of institutio ns

OLS

:  ˆ  (

I

'

I

)  1 (

I

'

y

) (1)

H

0 :   0 Conditions for unbiased estimation of (1)  Institutions should be exogenous to economic development  No omitted variables  No systematic measurement error

Solution

   Find good measures of economic development y and quality of institutions I Include all relevant controls into the growth regression Find good instruments that effect economic development only through the institutional channel: o instruments should be correlated with I but not with ε o to demonstrate the causality form good institutions to better economic development a good story should supplement the choice of IV variable

Stating the problem: reversal in relative incomes among the former European colonies • Stylized fact: – the Mughalas in India and the Aztecs and Incas in the Americas were amongst the richest civilizations in 1500, while the civilizations of the North America, New Zealand, and Australia were less developed – Today US, Canada, New Zealand, and Australia are much richer than India, Peru, Mexico • How to measure prosperity in 1500?

– AJR use urbanization as a proxy for economic development – urbanization (% of population living in towns with more than 5000 inhabitants) in 1500 == high agricultural productivity and developed transportation network (Bairoch 1988, Vries 1976) – additional proxy is population density

Is urbanization a good proxy for income per capita?

More evidence on reversal

• Relationship is robust to – inclusion of controls for continent dummies, the identity of the colonial power, religion, distance from the equator, temperature, humidity, resources, and whether the country is landlocked, – exclusion of the “neo-Europes” (the United States, Canada, New Zealand,and Australia) from the sample.

• Relationship provides an opportunity to distinguish between two theories of the determinants of long-run development: – “geography hypothesis” (Diamond [1997] and Sachs [2000, 2001]) – “institutions hypothesis,” relating differences in economic performance to the organization of society

Interpretation of results

• 10 percentage point lower urbanization in 1500 is associated with approximately twice as high GDP per capita today • Uruguay had no urbanization in 1500, while Guatemala had an urbanization rate of 9.2 percent • According to estimate in column (1) of Table III, AJR expect Uruguay today to be 105 percent richer than Guatemala

Additional evidence on reversal

• 500 years ago many parts of Asia were highly prosperous and civilizations in Meso-America and North Africa were relatively developed Pomeranz [2000]) • Australia at this time is “an unchanging [1978, p. 322]) • Canada is a “few acres of snow” (Voltaire) than the United States in 1500 and 1700 (Maddison 2001) (see, e.g., Braudel[1992], Chaudhuri [1990], Hodgson [1993], McNeill [1999], palaeolithic backwater.” (McEvedy and Jones • India, Indonesia, Brazil, and Mexico were richer

The Timing and Nature of the Reversal

Timing of reversal

• A theory that the reversal is linked to extraction of natural and human resources from the colonies by European powers does not have empirical support • Reversal in relative incomes took place during the late eighteenth and early nineteenth centuries and was linked to industrialization

Hypotheses and explanations

• (1) Simple geography hypothesis – timing of the Neolithic revolution has had a long lasting effect on economic and social development (Diamond 1997) – importance of geography through its effect on the disease environment, transport costs, and technology. Sachs (2000, 2001) • “Certain parts of the world are geographically favored. Geographical advantages might include access to key natural resources, access to the coastline and sea conditions for human health” [ Sachs 2000, p. 30].

— navigable rivers, proximity to other successful economies, advantageous conditions for agriculture, advantageous

Hypotheses and explanations

• (2) Sophisticated geography hypothesis: •

Certain geographic characteristics that were not useful, or that were even harmful, for successful economic performance in 1500 may turn out to be beneficial later on

– “temperate drift hypothesis”: shift in the center of economic gravity over time away from equator with development of agriculture – certain geographic characteristics facilitate industrialization • First, one can imagine that there is more room for specialization in industry, but such specialization requires trade. If countries differ according to their transport costs, it might be those with low transport costs that take off during the age of industry. • Second, countries may lack certain resource endowments, most notably coal, which may have been necessary for industrialization (e.g., Pomeranz [2000] and Wrigley [1988]).

Hypotheses and explanations

• (3) Institutions hypothesis •

Societies with a social organization that provides encouragement for investment will prosper.

–

Institutions of private property: A good organization of society that corresponds to a cluster of (political, economic, and social) institutions ensuring that a broad cross section of society has effective property rights

–

Extractive institutions: the majority of the population faces a high risk of expropriation and holdup by the government, the ruling elite, or other agents

What determines whether Europeans pursued an extractive strategy or introduced institutions of private property?

•

(1)

The economic profitability of alternative policies.

– High population density, by providing a supply of labor that could be forced to work in agriculture or mining, made extractive institutions more profitable for the Europeans.

– Densely settled areas had an existing system of tax administration or tribute; the large population made it profitable for the Europeans to take control of these systems and to continue to levy high taxes (see, e.g. Wiegersma [1988, p. 69], on French policies in Vietnam, or Marshall [1998, pp. 492 –497], on British policies in India)

What determines whether Europeans pursued an extractive strategy or introduced institutions of private property?

•

(2)

Whether Europeans could settle or not

– Europeans were more likely to develop institutions of private property when they settled in large numbers – when a large number of Europeans settled, the lower strata of the settlers demanded rights and protection similar to, or even better than, those in the home country. This made the development of effective property rights for a broad cross section of the society more likely. – Population density had a direct effect on settlements, since Europeans could easily settle in large numbers in sparsely inhabited areas. – The indirect effect worked through the disease environment, since malaria and yellow fever, to which Europeans lacked immunity, were endemic in many of the densely settled areas [Acemoglu, Johnson, and Robinson 2001a].

Institutions and reversal

• How do we demonstrate that urbanization in 1500 had an impact on prosperity today only through the institutions?

– instrumental variable • mortality rates faced by soldiers, bishops, and sailors in 17 th – 19 th centuries • correlated with likelihood of Europeans settling in great numbers in areas with low mortality • more likely to introduce institutions of private property in those areas

Conclusions

• Among the areas colonized by European powers during the past 500 years, those that were relatively rich in 1500 are now relatively poor but the intervention of Europe reversed this pattern • This reversal in relative incomes is inconsistent with the simple geography or sophisticated geography hypotheses but reflect the effect of institutions (and the institutional reversal caused by European colonialism) on income today

Conclusions

• The scale of the reversal and the subsequent divergence in incomes are due to the emergence of the opportunity to industrialize during the 19 the society th century. – While societies with extractive institutions or those with highly hierarchical structures could exploit available agricultural technologies relatively effectively, the spread of industrial technology required the participation of a broad cross section of property.

—the smallholders, the middle class, and the entrepreneurs. – The age of industry, therefore, created a considerable advantage for societies with institutions of private