Social Infrastructure and Long-Run Economic

Performance

Jahen Rezki
Universitas Indonesia
Week 2

1
Outline

• Introduction

• Information about the class

• Social Infrastructure and Long-Run Economic Performance

• Questions

2
Introduction
Who am I?

• My Name: Jahen F. Rezki

• I am a lecturer at the Faculty of Economics and Business at Universitas

Indonesia and the Head of Macroeconomics and Political Economy Research
Group at LPEM FEB-UI

• Email: jahen.fr@ui.ac.id or jahen@lpem-feui.org.

• Ph.D. University of York in Economics ’19

• Research interests: Development economics, political economy, economics of

media, and applied macroeconomics
3
Information about the class
Objective from this class

• Students understand the difference of economic development across

countries

• What are the determinants of economic growth across countries

4
Source

• Jones, Charles I., Vollrath, Dietrich. (2013). Introduction to Economic

Growth, 3rd edition. London: W. W. Norton & Company, Inc.

• Acemoglu, D. (2009). Introduction to Modern Economic Growth.

Princeton: Princeton University Press. [more advanced]

5
Social Infrastructure and
Long-Run Economic
Performance
Topic

• Social infrastructure and long run economic performance

• Why some countries are rich while other are poor?

• Why is it that some countries invest more than others, and why do
individuals in some countries spend more time learning to use new
technologies?

6
Several possible explanations

7
A business investment problem

• There is no “canonical” model to help us outline an answer

• This class will try to answer based on simple investment problem faced by
business managers every day

• One approach to evaluating an investment project → cost-benefit analysis

• Suppose that launching the business subsidiary involves one-time setup cost
F

• Once the business is set up, let’s assume that it generate a profit every year
that the business remains open

• If π denotes the expected present discounted value of the profit stream, then
π is the business subsidiary once it has been set up 8
A business investment problem

• How to make a decision?

• The manager’s decision is:

π ≥ F → Invest,
π < F → Do not invest

• This example can be also applied to:

• The determination of domestic investment by a local business
• The transfer of technology by a multinational corporation
• The decision to accumulate skills by an individual

9
A business investment problem

• Next question: What determines the magnitudes of F and π in various

economies around the world?
• The hypothesis we will pursue in here is that:
• There is a great deal of variation in the costs of setting up a business
• The ability of investors to reap return from their investments

• Such variation arises in large part from differences in government policies

and institutions → what we might call social infrastructure

• A good government provides the institutions and social infrastructure that

minimize F and maximize π (or, more correctly, maximize π − F ) →
encouraging investment
10
Determinants of F

• There are several steps to be taken in establishing business, which involves

interacting with another party

• If that party has the ability to ‘hold up’ the business, problems can arise →
each of the steps offers an opportunity for a crafty bureaucrat to seek a
bribe or for the government to charge a licensing fee

• If the ‘fee’ is equal to π → rational manager will cancel the investment

• However, these conditions vary in different countries
• Advanced countries provide a dynamic business environment, full of
investment and entrepreneurial talent, exactly because such concerns are
minimal
• In general, the fixed costs F are much higher in poorer countries that they
11
are in the developed world
Determinants of π

• The size of the market

• The extent to which the economy favors production instead of diversion

• Diversion → takes the form of the theft or expropriation of resources from
productive units

• The 1st effect of diversion → it acts like a tax

• The 2nd effect of diversion → it it encourages investment by the

entrepreneur in finding ways to avoid the diversion

• The stability of the economic environment

12
Which Investments to Make?

• Economies in which the social infrastructure encourages diversion instead of

production have:
• Less investment in capital
• Less foreign investment that might transfer technology
• Less investment by individuals in accumulating productive skills
• Less investment by entrepreneurs in developing new ideas that improve the
production possibilities of the economy

• An economy in which theft is a serious problem, managers may invest capital

in fences and security systems instead of productive machines and factories

13
Empirical Evidence

• A country that attracts investments in the form of capital for businesses,

technology transfer from abroad, and skills from individuals will be one in
which the:
• institutions and laws favor production over diversion
• economy is open to international trade and competition in the global
marketplace, and
• economic institutions are stable

• A good social infrastructure encourages domestic investment by firms in

physical capital, investment by foreign entrepreneurs that may involve the
transfer of better technologies, and the accumulation of skills by individuals

14
Empirical Evidence

• There is some relatively recent research that provides some assurance that it
is social infrastructure that is in fact causing differences in economic
outcomes

• Index to measure social infrastructure has been developed by Kaufmann et

al. (2010) → accountability of politicians, political stability, government
effectiveness, regulatory quality, the extent of the rule of law, and the
control of corruption

• This average index is closely correlated with different measures examined in

Hall and Jones (1999); Sachs and Warner (1995); Acemoglu et al (2001);
Easterly and Levine (2003); and many others
15
Empirical Evidence

• Acemoglu et al. (2001) take the colonization of countries around the world
by Europeans as this kind of experiment
• They find that the exogenous differences in social infrastructure put in place
by colonists had effects on income per capita even after the colonies
obtained their independence much later

• Dell (2010) examines areas in Peru and Bolivia that were part of the mita,
the forced labor systems used by the Spanish from 1573 to 1812
• She compares these to areas outside of the mita but sharing a similar
cultural and geographic background, and she finds that the mita led to much
lower investment in public goods and poor economic outcomes

16
Empirical Evidence

17
Empirical Evidence

18
Empirical Evidence

19
Misallocation and Productivity

• One of the ways it may lower TFP is by creating frictions in the economy
that prevent capital and labor from being allocated to their most productive
uses

• A central conclusion from different literatures is that countries vary not in

the technology they have access to, but in how efficiently they allocate
resources to the firms using the best techniques

• Social infrastructure matters for whether resources move to the best firms or
remain stuck in low productivity ones

• Policies that subsidize low-productivity firms or limit the mobility of capital

and labor → will result in a misallocation of resources → lowering TFP
20
The Choice of Social Infrastructure

Why is the social infrastructure in some economies so much better than in

others? In the history of economic thought, the answers range far and wide
• Max Weber argued in The Protestant Ethic and the Spirit of Capitalism
(1976 [1920]) that belief systems were important and emphasized
Protestantism’s teachings regarding the individual
• Other answers that have been proposed include culture or even climate and
geography
• Acemoglu and Robinson (2005, 2012) shows that the problem is one of
commitment → the ruling elite cannot credibly commit to the promotion of
production versus diversion, because once output has risen they would have
an incentive to return to diversion and extract a large fraction of the larger
output available 21
Growth Miracles and Disasters

• Fundamental changes in social infrastructure can generate growth miracles

and growth disasters

• Two classic examples are Japan and Argentina

• Question: Why do such fundamental changes in social infrastructure occur?

The answer probably lies in political economy and economic history

22
Question
Question

1. What determines the decision to invest in capital?

2. What are the examples of good social infrastructure?

3. Why social infrastructures is important for economic growth and

productivity?

4. Why is the choice of social infrastructure differ across countries?

23
Thank You