Econ growth and hist development

Institutions as a fundamental cause of economic

growth

Acemoglu et al. (2005)

Sections 2-4

Casper Worm Hansen

Department of Economics, UCPH
 Introduction
• Solow model: in which differences in income are due to
different savings rates and population growth rates.

• UGT model: in which differences in income are due to

differential timing of take-off.

• Chapter 6 in Galor explored how some of the deeper

lying determinants influenced human capital and
technological progress (read yourself).

• Handbook chapter explores the role of economic

institutions, which could affect both incentives to invest
in education and incentives to innovate.

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 Introduction
• Endogenous growth models explain innovation
process

• However, none of the models give what Acemoglu et

al. call ”a fundamental explanation” for economic
growth and income differences

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 Introduction
• Capital accumulation and innovation are thought
of as proximate causes of growth.

• This means there are causes that are deeper or

more fundamental.

• UGT also builds on proximate causes of growth.

– But highlights fundamental factors as being important

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 Introduction

• Institutions are the rules of the game in a society

or, more formally, the humanly devised
constraints that shape human interaction.
– Definition by Douglass North.

• Institutions structure incentives in human

exchange, whether political, social, or economic.

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 Introduction
• Economic institutions are related to the
structure of property rights and presence and
perfection of markets.

• If there were no property rights, would

anybody ever want to set up a business?

• What if market forces are ignored? (as in e.g.,

the Soviet Union).
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 Introduction
• In the article by Acemoglu et al. a case is
made for the proposition that economic
institutions matter for income differences and
growth.

• They also theorize about why some countries

have bad institutions (not covered).

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The institutional argument
 The argument/model
Argument of the chapter is summarized in 6 steps.
• Step 1:

• Economic institutions determine incentives for people’s

decision about investing in physical, human capital and
innovating and thus determine output.

• Also determine how society’s resources is divided between its

members.

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 The argument
• Distribution of political power determines
economic institutions, because different
economic institutions often have different
distributional effects:

• Conflict of interest between groups.

• Step 2:

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 The argument
• Step 3 asks: If there are groups with different interests, why do they
not get together and settle on a plan that will make the best for
everybody?

• They could divide this maximized income according to their political

power.

• Acemoglu et al. (2005) argue that if you have the necessary political
power, you will choose the economic institutions that makes you as
well off as possible - no matter the distributional consequences.

• Exercise of political power can lead to inefficiencies and poverty.

(Think about Mugabe in Zimbabwe).

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 The argument
• Step 4: de jure political power is the power that
originates from the political institutions in society.

• In an absolutist monarchy all de jure power is

assigned to the king; Similarly a dictatorship.

• In a constitutional monarchy de jure power is

reallocated from the king and given to the
parliament.

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 The argument
• Step 5: Some people have power, even if the
political system does not allocate any power
to them.

• People can e.g. revolt, peacefully protest.

• de facto political power.

• Determined partly by distribution resources.
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 The argument
• Step 6: Political power also influences political
institutions.

• Those who have de jure power will tend to

maintain the current political system.

• But e.g. the threat of revolution in Western

Europe in the 19th century gave workers more de
facto power, and may have led to
democratization (de factor power).

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The argument

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 Fundamental causes of income
indifference
Fundamental causes

• Economic institutions

• Geography

• Culture

• Luck?

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 Economic Institutions
• Idea is that the organization of society determine
people’s willingness to work, invest and innovate.

• Claim: some societies do not encourage work,

investment and innovation.

• J.S. Mill: Good institutions enforce property rights

for the majority of people; there should be
equality of opportunity; equality before the law.

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 Economic institutions
• Spread of markets also important. (Adam
Smith)

• Many economic models stressing some role

for ”good” institutions.

• Acemoglu et al. stress the role of secure

property rights and equality of opportunity as
being key for economic development.
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 Geography
• Differences in geography, climate and ecology
crucial for income differences.

• Montesquieu: warm and cold climate.

• Climate and agriculture.

• Temperate-zone technologies more productive

than tropical-zone technology in agriculture.

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 Geography
• ”Disease burden” higher in the tropics.

• Partly caused by a lack of frost.

• Malaria kills millions of children every year in sub-

Saharan Africa.

• Prevalence of malaria reduces annual growth in sub-

Saharan Africa by 1.3% according to Sachs.

• If Malaria had been eradicated in 1950, income would

have doubled by now in sub-Saharan Africa (claim).

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 Culture
• When economists think about culture, they often
mean religion (often the leading example).

• determines values, preferences and beliefs of

societies.

• Protestant work ethic (Max Weber, 1930).

• Protestantism is based on the idea that success

through hard work is consistent with being
chosen by God.

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 Culture
• Well-suited for capitalism.

• Catholicism does not promote capitalism according to Weber.

• Also caste system in India not good for capitalism (no social
mobility).

• Religion also stressed by more recent researchers (e.g. Landes,

Barro and McCleary).

• Evidence on the role of social capital given by Tabellini (2010) for

western European countries.

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Institutions matters
 Institutions matter
• Protection of property rights positively associated with
GDP per capita.

• Does this mean that better economic institutions

causes growth?

• Correlation is not causation!

• For example, Montesquieu argued that warm climate

made people lazy and likely to live in dictatorships

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 Institutions matter
• Geography could be the factor explaining the positive
relationship between GDP per capita and better
institutions.

• In fact, latitude (absolute distance from the equator)

is positively related to GDP per capita.

• “Identification problem”.

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 Solutions?
• Find a natural experiment.

• A case in which culture and geography are held

fixed, and institutions change.

• Suggestion: The division of Korea into North and

South Korea.

• Another interesting case is East and West

Germany.

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 Korea experiment
• After World war WII:

• Communist leader Kim Il Sung supported by

Soviet Union.

• Nationalist leader Syngman Rhee supported by

US.

• Korean war (1950s).

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 Cultural and Geographical differences?

• Same language, history and cultural roots.

• Climate similar.

• Terrain similar.

• Natural resources similar (North Korea

actually somewhat better endowed).

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 Institutional differences?
• North Korea abolished private property rights of
land and capital.

• Economic decisions made centrally (plan

economy).

• South Korea enforced private property rights.

• Relied on markets (especially after 1961).

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 Institutional differences
• Around 1970, the two countries’ path for GDP
per capita diverge!

• South Korea is today an OECD member.

• North Korea is in terms of income per capita

near sub-Saharan Africa!

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 Institutional differences
• Only one case.

• Few would disagree that communism doesn’t

work! (extreme case)

• What about the German experiment?

• Income differences between East and West

Germany less pronounced.

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 The colonial experiment
• Colonization changed institutions in the colonies.

• Europeans did not impose the same institutions

on all their colonies.

• For example, in the Northeast of America

relatively free societies were established,
whereas in the Caribbean, plantation societies
were established.

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 The colonial experiment

The Reversal of Fortune: Acemoglu et al. (2002)

Settler mortality: Acemoglu et al (2001)

 The reversal of fortune
• Mughals in India, Aztecs and Incas in America were rich
in 1500. North America, New Zealand and Australia were
poor.

• Urbanization rates and population density used as

proxies for prosperity in 1500.

– Argument: Only economies with a certain level of agricultural

productivity and developed systems of transport and commerce
can sustain large urban centers and a dense population
(Malthusian).

– Positive association between Urbanization and GDP per capita in

present day data. 

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01-03-2023
 The reversal of fortune
• For former European colonies: GDP per capita
today is negatively related to urbanization in
1500.

• Similar association with population density.

• For non-colonies we observe a positive

relationship.
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01-03-2023
 The reversal of fortune
• The reversal of fortune refers to the fact that if a
country was rich in 1500 and then became a
European colony, it is (likely) to be poor today,
whereas those former colonies that were poor in
1500 are (likely) to be rich today.

• The reversal took place in the the 19th century.

• US, NZ, AUS had economic ”take offs” (relation to

UGT?).

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 Interpretation
• The countries in the tropics were richer in 1500!

• Geography is not a good candidate.

• ”latitude specific” technology (sophisticated geography

hypothesis).

• Techologies must have been industrial (because of the

timing of the reversal).

• Industrial technologies have worked in Hong Kong and

Singapore (tropics).

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 Interpretation
• Culture argued not to be a natural explanation.

• Institutions?

• The former colonies that were rich in 1500 ended

up with worse institutions.

• In densely populated and developed areas, it was

in the interest of Europeans to set up institutions
that facilitated extraction of resources.

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 Interpretation
• In sparsely populated and undeveloped areas,
it was in the interest of Europeans to set up
institutions that protected property rights.

• Institutional reversal and the institutions-

matter-for-growth hypothesis can explain the
reversal of fortune.

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 Interpretation
• Europeans would introduce institutions that facilitated
extraction of resources, where-ever they would benefit from
doing so.

• This would typically happen in areas in which there was a

small group of Europeans and areas offering resource
extraction (e.g. gold, sugar and people).

• In areas with large indigenous populations, Europeans could

exploit the population by taxing them or using them as forced
labour in mines or plantations.

– Incompatible with individual rights and property rights for the majority
of the population.

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 Interpretation
• In areas without resources to extract and
sparsely populated areas in which the
Europeans were the majority, individual rights
and property rights would be introduced.

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 Settler mortality and institutions
• Disease environment may have mattered for the
attractiveness of European settlement.

• If this is so, then settler mortality should affect the

type of institutions being introduced in the colony.

• If settler mortality 200 years ago only affects

institutions, it can be used to obtain the effect of
institutions on GDP per capita.

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 Settler mortality and institutions
• Acemoglu et al. argue that this is the case.

• They do a lot of econometric work suggesting that only

institutions matter for growth

• Also, the view that e.g. British colonies do better is

refuted, because the same reversal of fortune can be
observed for British colonies.

• Also, the reversal seems not to be due to Europeans

settling in particular areas, as the reversal also holds
when areas with only a small fraction of Europeans are
considered.

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01-03-2023
01-03-2023
 Conclusions
• Economic institutions have been argued to be
important for cross-country levels of
prosperity.

• ”Institutions are [therefore] THE fundamental

cause of income differences.”

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