Lecture 2.1

Institutions and Development

Emmanuel Teitelbaum

Institutions

What is an Institution?

“Humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions and codes of conduct), and formal rules (constitutions, laws, property rights).”

    - Douglas North

Inclusive Institutions

• Inclusive institutions…“allow and encourage participation by the great mass of people in economic activities that make the best use of their talents and skills and enable individuals to make the choices they wish.”
• Economic: private property, unbiased legal system, banks, legally binding contracts, etc.
• Political: can take a variety of forms but must be pluralistic (constrained) with centralized and powerful state

Extractive Institutions

• Extractive institutions are…“designed to extract incomes and wealth from one subset of society to benefit a different subset.”
• Economic: limited or non-existent property rights, biased legal system, slavery
• Political: absolutist, repressive, may or may not be centralized

Key Arguments

• Hypothesis 1: Inclusive economic institutions promote investment and economic growth, while extractive institutions discourage investment and hamper economic growth

• Hypothesis 2: Inclusive political institutions encourage the development of inclusive economic institutions and vice-versa

Additional Considerations

Distribution of Authority

Acemoglu & Robinson, figure 3

• Institutional change/progress depends on distributed authority
• Pulls power away from monarch/dictator
• Broad coalitions counter narrow interests

Persistence and Change

• Why do extractive institutions persist?
  • Industrial progress threatens the interests of dictators and other elites
  • Polany’s “double movement”
  • Schumpeter’s theory of “creative destruction”
• When do institutions change?
  • Critical junctures (and small differences)
  • e.g. disease \(\rightarrow\) shift in labor market dynamics
  • Revolution gives a group new power

• A&R give the example of bubonic plague leading to shift in labor market dynamics
  • Maybe something similar is going on with COVID?
• Revolution leads to assertion of power for one class or another
  • Glorious Revolution lead to permanent assertion of power of parliament over the crown
  • French revolution led to greater power for lower classes, established constitution that limited power of the monarchy
  • Other examples?

Reversal of Fortunes

• Extractive institutions make a region wealthy in one period, but poor in the next
• Examples?

slavery; the encomienda system (forced labor); child labor

Comparisons and Cases

North Korea vs. South Korea

North Korea nighttime lights

The United States vs. Mexico

Nogales Sonora (left), Nogales Arizona (right) in 2021

Regime Shifts

Acemoglu & Robinson, Figure 4

Zimbabwe, South Africa & China

Source: Maddison Project Database, version 2018.

Discuss in this order: Zimbabwe, South Africa and China Use China to transition to growth under dictatorship. China and S. Africa represent different authoritarian growth trajectories. China has inclusive economic institutions while S. Africa has inclusive political institutions.

Growth Under Dictators

Some Famous Dictators

Mobutu Sese Seko

Park Chung Hee

Nikita Khrushchev

All three are dictators; did their countries grow at the same rate under their leadership?

Growth Under Famous Dictators

Source: Maddison Project Database, version 2018.

How do we explain variation in growth rates under repressive regimes?

DRC is purely extractive; USSR directs resources towards productive sectors; while South Korea (and China) adopt inclusive political institutions

Growth Under Repressive Regimes

• Growth under extractive institutions is possible
  • When elite funnel resources to high productivity areas (e.g. USSR)
  • When authoritarian regimes permit inclusive economic institutions (e.g. S. Korea under Park, China)
• But this growth is inherently limited
  • Lack of incentives for innovation and production
  • Resistance to creative destruction
  • Infighting among the elite

Discussion

• Pick one country that you think has inclusive institutions and one with extractive institutions
• Based on that country’s history and A&R’s theory, what do you expect it economic performance to have been over the past half century?
• Visit the World Development Indicators
• Select your countries
• Select GDP per capita in constant US$
• Select all the years
• Update and select “Chart”
• Do your countries fit your expectations? A&R’s theory?
• If there are discrepancies, why do you think that is?

Remaining Challenges

Extractive Institutions in the U.S.

National Memorial for Peace and Justice

What About Colonialism?

Girls rolling roads in India, 1930

• How does colonialism factor into A&R’s theory of institutions and development?
• If a country engages in colonialism, can we really call it “inclusive”? How much of Britain’s wealth can be attributed to its colonies?
• This is a crucial question because Britain lies at the heart of A&R’s theory.

Economic Impact of Colonialism

Source: Maddison Project Database, version 2018.

• Relatedly, India is an interesting case because it the British ruled with extractive institutions but also established some inclusive political and economic institutions (e.g. railroads, legal system, property rights, parliament)
• India’s fortunes as a global power declined under the British
• India had the world’s leading economy until the 18th century
• India’s share of the global economy feel from 24% of global GDP to around 4% when the British left
• India saw a decline under the British until the middle of the 19th century, at which point it began to grow again, but the growth was uneven and steady upward growth only resumed after the British left
• India’s economy stagnated because the British extracted raw materials and sold finished products (mainly textiles and garments) back to India as a captive market
• The British enacted laws that prevented Indian industry from competing with British imports, killing India’s textile sector, which it had a huge comparative advantage in before the British arrived
• There are some caveats:
  • Although its GDP was lower, India grew at a faster pace under the British than under the Mughals
  • Mughals were also pretty brutal as far as rulers go and hoarded most of India’s wealth
  • The Mughal empire was already on the decline when the British came
• However the fact remains that the British adoped and heavily relied upon extractive institutions to transfer wealth back to Britain

Endogeneity

• A relationship is “endogenous” when the direction of causality is unclear
• A&R hypothesize that inclusive institutions drive development
• But could inclusive institutions be the result of development?
• Or could there be a third factor driving both?
  • What are some possibilities?