POLITICAL ECONOMY Economic Institutions (2)

FOR DEVELOPMENT
COMPARING CHARACTERISTICS AMONG DEVELOPING
COUNTRIES
Ten points of comparison - both among developing countries, and
between developing and developed countries:
1. Lower levels of income and productivity
2. Lower levels of human capital
3. Higher levels of inequality and absolute poverty
4. Higher population growth rates
5. Greater social fractionalization
6. Larger rural population - rapid migration to cities
7. Lower levels of industrialization and manufactured exports
8. Adverse geography
9. Underdeveloped financial and other markets
10. Colonial Legacies – quality of institutions
Income & Productivity - The 12 Most- and Least-
Populated Countries and Their Per Capita
Income, 2017

Source: World Bank World Development Indicators

Human Capital Attainments - Under-5 Mortality
Rates, 1990 and 2017

Source: World Development Indicators

Human Capital Attainments - Primary School
Enrolment and Pupil–Teacher Ratios, 2017

Source: World Development Indicators

Population Growth - Crude Birth Rates Around
the World, 2018

Source: Population Reference Bureau: Births per 1,000 population

 Share of the Population Employed in the Agricultural, Industrial,
and Service Sectors in Selected Countries, 1990–92 and 2008–
2011 (%)

Source: World Bank, World Development Indicators, 2013 (Washington, D.c.: World Bank, 2013), tab. 2.3
 ARE LIVING STANDARDS CONVERGING ACROSS
COUNTRIES?
A Great Divergence followed the Industrial Revolution
Two reasons to think (re-)convergence likely
1) Diminishing returns to capital (though as economies develop they often find
ways to compensate)
2) Diffusion of ideas across countries, so can skip trial and error and grow fast
while catching up
Latter elated to “advantages of backwardness” (Gerschenkron), or “the latecomer’s
advantage”
But - at least until this century - evidence of unconditional national average income
convergence has been unconvincing
Continued evidence of divergence between middle and low income countries
There is also evidence of “per capita income convergence,” weighting changes in
per capita income by population size
Divergence – Convergence Trend
The growth of real output per person since 1750

Source: Data from Maddison Project Database

Relative Country Convergence: World, Developing Countries, and
OECD

Data Source: Penn World Table

Absolute Income Convergence vs Growth Convergence

Data Source: Penn World Table

SOURCES OF PROSPERITY (1)

 Vast differences in prosperity across countries today.

– Income per capita in sub-Saharan Africa on average 1/20th of
U.S. income per capita
– In Mali, Democratic Republic of the Congo (Zaire), and
Ethiopia, 1/35th of U.S. income per capita.
 Why?
 Standard economic answers:
– Physical capital differences (poor countries don’t save enough)
– Human capital differences (poor countries don’t invest enough
in education and skills)
– “Technology” differences (poor countries don’t invest enough
in R&D and technology adoption, and don’t organize their
production efficiently)

1
2
SOURCES OF PROSPERITY (2)

 These are, however, proximate causes of differences

in prosperity.
– Why do some countries invest less in physical and human
capital?
– Why do some countries fail to adopt new technologies and to
organize production efficiency?
 The answer to these questions is related to the
fundamental causes of differences in prosperity.
 Potential fundamental causes:
– Institutions (humanly-devised rules shaping incentives)
– Geography (exogenous differences of environment)
– Culture (differences in beliefs, attitudes and preferences)

1
3
WHAT ARE INSTITUTIONS? (1)

 Institutions: the rules of the game in economic, political

and social interactions.
– Institutions determine “social organization”
 "Institutions are the rules of the game in a society or,
more formally, are the humanly devised constraints
that shape human interaction.“ North (1990, p. 3)
 Key point: institutions
– are humanly devised
– set constraints
– shape incentives

1
4
WHAT ARE INSTITUTIONS? (2)

– Economic institutions: e.g., property rights, contract enforcement, etc.

 shape economic incentives, contracting possibilities, distribution.
– Political institutions: e.g., form of gov., constraints on politicians and
elites, separation of powers, etc.
 shape political incentives and distribution of political power.

 Important distinction between:

– Formal institutions: codified rules, e.g. in the constitution
– Informal institutions: related to how formal institutions are
used, to distribution of power, social norms, and equilibrium.
 Constitutions in U.S. and many Latin American countries similar,
but the practice of politics, and constraints on presidents and
elites very different.
 Why? Because distribution of political power can be very different
even when formal institutions are similar.

10
INSTITUTIONAL VARIATION

 Big differences in economic and political

institutions across countries.
– Enforcement of property rights.
– Legal systems.
– Corruption.
– Entry barriers.
– Democracy vs. dictatorship.
– Constraints on politicians and political elites.
– Electoral rules in democracy.

11
INCLUSIVE VS EXCLUSIVE INSTITUTIONS

‒ Political institutions → shape who has power in society → how power is used
‒ Absolutist Political Institutions: power distribution is narrow & unconstrained
‒ Pluralist Political Institutions: power distribution is broad & constrained
‒ Effective centralized state vs failed state
‒ Effective centralized state + Pluralist political institutions = Inclusive Political
Institutions → Inclusive Economic Institutions → Successful development
performance
‒ Exclusive Political Institutions → power to narrow elites → few restrictions →
Extractive Economic Institutions

‒ https://www.youtube.com/watch?v=jsZDlBU36n0
ECONOMIC INSTITUTIONS AND ECONOMIC PERFORMANCE (1)

.
LUX
USA
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Log GDP per capita, PPP, in 1995

MLT GRC KOR

BHSSAUCHL
OMN CZE
ARG
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12 Avg. Protection Against Risk of Expropriation, 1985-95
ECONOMIC INSTITUTIONS AND ECONOMIC PERFORMANCE (2)

USA
SGP CHE
BEJLPN HKG NOR CANDNK
10 FRA AUT ADUESUGBR
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ISR IRL NZL
ESP
Log GDP per capita, PPP, in 1995

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POLITICAL INSTITUTIONS AND ECONOMIC PERFORMANCE (3)

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Log GDP per capita, PPP, in 1995

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Constraint on Exec. 1990s
GEOGRAPHY HYPOTHESIS: MONTESQUIEU

 Montesquieu:
– “The heat of the climate can be so excessive that the body
there will be absolutely without strength. So, prostration will
pass even to the spirit; no curiosity, no noble enterprise, no
generous sentiment; inclinations will all be passive there;
laziness there will be happiness,”
– "People are ... more vigorous in cold climates. The inhabitants
of warm countries are, like old men, timorous; the people in
cold countries are, like young men, brave".
 Moreover, Montesquieu argues that lazy people tend to
be governed by despots, while vigorous people could
be governed in democracies; thus hot climates are
conducive to authoritarianism and despotism.
GEOGRAPHY HYPOTHESIS: MODERN VERSIONS

 Jared Diamond:
– Importance of geographic and ecological differences in
agricultural technology and availability of crops and animals.
 Jeff Sachs:
– "Economies in tropical ecozones are nearly everywhere poor, while
those in temperate ecozones are generally rich" because "Certain
parts of the world are geographically favored. Geographical
advantages might include access to key natural resources, access to
the coastline and sea…, advantageous conditions for agriculture,
advantageous conditions for human health."
– "Tropical agriculture faces several problems that lead to reduced
productivity of perennial crops in general and of staple food crops in
particular" …
– "The burden of infectious disease is similarly higher in the tropics than
in the temperate zones"
 MONTESQUIEU’S STORY?

.
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SGP HKG QAT CHE NOR

JPN FRAAUT BEL DNK CAN
AUS DENULDGBR SWEFIN
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10 ARE ISR ECSNPZL
KORGR
PRT
Log GDP per capita, PPP, in 1995

BRB BHSBHR KWT MLT

ARG CZE
SAU SVHNUN
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MYS MEX
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6
0 .2 .4 .6 .8
Latitude
18
NORTH KOREA VS SOUTH KOREA

 Korea: economically, culturally and ethnically homogeneous at the

end of WWII.
 If anything, the North more industrialized.
 “Exogenous” separation of North and South, with radically
different political and economic institutions.
– Exogenous in the sense that institutional outcomes not related to the
economic, cultural or geographic conditions in North and South.
– Approximating an experiment where similar subjects are “treated”
differently.
 Big differences in economic and political institutions.
– Communism (planned economy) in the North.
– Capitalism, albeit with government intervention and early on without
democracy, in the South.
 Huge differences.
NORTH AND SOUTH KOREA

GDP per capita

14000

12000

10000

8000
SouthKorea
NorthKorea
6000

4000

2000

0
1950 1960 1970 1980 1990 1998
THE ROLE OF CULTURE

 Can all this be related to culture?

 What is culture?
– Culture is a relatively fixed characteristic of a group or nation,
affecting beliefs and preferences. Example: religion
 Useful distinction between culture and informal institutions.
 Informal institutions are related to how society shapes incentives,
and are related to equilibrium of a given game (typically defined
by formal institutions, distribution of income, political power etc.).
 Informal institutions are not fixed, and change with economic
conditions and distribution of power, though they are typically
highly persistent.
 Culture not useful in understanding the Korean divergence
– North and South were culturally homogeneous.
THE ROLE OF CULTURE (2)

 The Chinese experience informative about the role of

culture versus institutions.
– China, Hong Kong, Singapore and Taiwan many cultural and
ethnic similarities.
– While China adopted state planning and communist political
institutions, Hong Kong, Singapore and Taiwan followed a
capitalist path with relatively well-enforced property rights.
– While Hong Kong, Singapore and Taiwan prospered, China
stagnated.
– After the Mao’s death and 1978 reforms, especially the
introduction of some basic property rights, changes in
economic incentives in China, and now very rapid growth rate.
ROLE OF CULTURE (3)

GDP per capita in China, Taiwan, and Hong Kong, 1950-2001

25,000

20,000

15,000

10,000

5,000

China Taiwan Hong Kong Singapore

Long-run Causes of Comparative Development - Schematic
Representation of Leading Theories of Comparative Development
 EXPLAINING LONG-RUN CAUSES OF COMPARATIVE
DEVELOPMENT: FIG. 2.10 SUMMARY
Arrow 1: Geography: Important in pre-modern era; limited effect in
modern era
Arrow 2: However, exogenous geography affected how colonists viewed
opportunities they could exploit in colonies; and so in part…
Arrow 3: Geography was a determinant of whether colonists created
extractive or inclusive institutions; this fact facilitates analysis of role of
institutions
Arrow 4: Geography presumably affected indigenous institutions…
Arrow 5: A Note: Difficult to quantify; but colonial institutions may have
been influenced by indigenous institutions
Arrow 6: Geography affected comparative advantages: resources and
people
EXPLAINING LONG-RUN CAUSES OF COMPARATIVE
DEVELOPMENT: FIG. 2.10 SUMMARY (CONTINUED)
Arrow 7: Geography helps explain “motivation” for institutions: extractive
when comparative advantage (CA) was in activities with (a range of)
increasing returns (e.g. sugar cane, mining); inclusive when CA was in
constant returns activities (e.g. wheat)
Arrow 8-9: Reflects that state of development of the colonizer also had an
effect
Arrow 10: Key: Institutions were persistent from colonial to post-colonial
periods
Arrow 11: Bad institutions created high inequality which also had bad
effects on growth and development outcomes
Arrow 12: Especially difficult to reform institutions with high inequality
Results (arrows 14-22): “Bad” institutions and high inequality led to slower
growth and slow improvement of human capital and other development
outcomes