Institutions and Economic Growth

Institutions and Economic Growth 1) Theoretical papers: • North 1994 • Przeworski and Limongi 1993 2) Empirical papers: • Rodrik, Subramanian & Trebbi 2004 • Sachs 2003 Email: victor.lapuente@pol.gu.se Office: B532

1st seminar: summary of the readings • Ideal Institutions are logically impossible • Incumbents will always find ways of taking advantage of them • The best (or “least bad”) institutions are those that limit as much as possible their incumbents • E.g. constitutions, check and balances

1st seminar: some problems of readings (I) • Miller & co.: ‘toy’ models too abstract and few non-systematic empirical examples (e.g. anglo-saxon biased) • Interesting insights for local governments: the professional bureaucrat could work • e.g. city-manager cities > strong mayor cities, both in US and across countries • …but regarding national governments, not so clear: only some “Madisonian solutions” work • US > LA; 17th Britain > 17th Poland, Hungary • “Small efficient residual” sounds so nice on paper: • Constitutional ban on deficit, McCain..

1st seminar: some problems of readings (II) • …but in practice (some US states, some EU members) • North and Weingast: original, elegant,…but two different stories: on one hand, a description of political events; on the other, interests rates dropping, and no narratives of what is going on in the middle • We know little of the millions of decisions by investors • Clark dismantles what is left of N&W: property rights were as protected before the Glorious Revolution as after • ..but he does not offer alternative explanations: • what does explain the industrial revolution in Britain?

Theoretical starting pointTransaction Cost Economics (TCE) • Coase (1937): Why do Firms Exist? • Transaction costs are pervasive (45 % US GNP?) • TCE  New Institutional Economics (Williamson 1975, Markets vs. Hierarchies) • TCE  Politics (North, Weingast, T. Moe, Horn 1995, Williamson 1999, Moe,) • Political markets have more TC > standard markets

Douglass C. North receives the 1993 Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel from King Carl XVI Gustaf of Sweden.

North 1994: Economic Performance Through Time • Critic to Neoclassical Economic Theory: • NET focuses on the operation of markets, but doesn’t address Why (some) markets (in some parts of the world) develop • rejects the role of Institutions and Time • markets are efficient only if it is costless to transact, but there are so many transaction costs…

North’s definition of Institutions • Institutions are the humanly devised constraints that structure human interaction • They are made up of formal constraints (e.g., rules, laws, constitutions), informal constraints (e.g., norms of behavior, conventions, self-imposed codes of conduct), and their enforcement characteristics • Do you like it? Any problem?

Assumptions of his theory • “necessary to dismantle the rationality assumption” (1993) • Humans # homo economicus • Politicians may be less self-interested than regular economic agents…or not? • Evidence that we are not homo economicus? • Divide the dollar game • What drives us then, if not self-interest? • “ideas, ideologies, myths, dogmas, and prejudices matter” • How? How can we measure them? Operationalize? • Instead of the rationality assumption, he prefers Simon’s “bounded rationality”

Mental Models + Time  Institutions • “models that formed the informal constraints that defined the institutional framework of the tribe and were passed down intergenerationally as customs, taboos, and myths that provided cultural continuity…” • “The key to the foregoing story is the kind of learning that the individuals in a society acquired through time…” • Hayek (1960): "the transmission in time of our accumulated stock of knowledge"

Path dependence • Term used to describe the powerful influence of the past on the present and future • Example of “bad” path dependence: Spain • The long decline of Spain from the glories of the Habsburg Empire of the 16th century to its sorry state under Francisco Franco in the 20th century was characterized by endless self appraisals and frequently bizarre proposed solutions • Agree with this? And in general with PD?

Conclusion It is the admixture of formal rules (e.g. constitution), informal norms (e.g. trust), and enforcement characteristics (e.g. police) that shapes economic performance It is everything…it is nothing? Informal norms provide “legitimacy” to a set of rules Legitimacy, Path dependency…concepts in the top ten of problematic terms

Przeworski & Limongi 1993 • “Does democracy foster or hinder economic growth?” • Remember their critical review of North (1990) & Olson (1993)? • OK, autocrats have problems to offer credible commitment, but North does not offer clear mechanisms of how democracy provides that commitment (e.g. 4-year terms…) • Encompassing arguments “Against” and “In favor of” democracy • Why Autocracies are better? • Democracies: consumption (shoes) > investment (education) • Electoral platform # current sacrifices for a bright future (Vargas Llosa vs. Fujimori; Social-democracies in 80s, Thatcher 79) • “Developmentalist dictators”: longer time horizon • Developmentalist dictators”: isolated from particularistic interests, which ones? (Evans: “embedded autonomy”)

Przeworski & Limongi 1993 • Why Democracies are better? • Rulers not entitled to fiscal residuum (e.g. Somoza, Trujillo, Marcos and other “personalistic” dictatorships. Here, we see distinction personalistic  developmentalist) • What does statistical evidence show? Who wins, Democracy or Autocracy? • Why social scientists have little statistical knowledge on Regime  Growth if there is so much data available? • P&L: Politics matter for growth, but not Democracy/Dictatorship • Fine, but then which political factors matter? • “State autonomy”: effective to do the necessary and isolated from pressures. Examples?

Rodrik, Subramanian & Trebbi 2004 The Big Question: What accounts for the differences between the world’s richest and poorest nations? The 3 Big Answers: • Geography (Diamond 1997, Sachs 2001) • International Trade (Dollar and Kraay 2004) • Institutions (North 1990, Acemoglu et al. 2001) The Big Problem: How to Test Them?

RST empirical test:

Results • When we include Institutions, Geography and Integration don’t have any additional explanatory power (in fact, they have the wrong sign!) • The Quality of Institutions Trumps Everything Else…

Problems? • Correlations, not Causal Relations.. • Lack of “micro-foundations” • Reverse Causality? Tautology • Omitted variables? • No clear policy implications

Test the robustness of the results I • Institutions also  accumulation of capital (human and physical) • Eliminate “too influential” cases (Singapur, Ethiopia) and “special” ones (the neo-European countries) • Introduce regional dummies (Latin America, Sub-Saharan Africa, Asia)

Test the robustness of the results II • Introduce standard variables in the literature: • Legal origin: Common Law (British) vs. Civil Law (French) • Former British Colony vs. French Colony • Religion: Muslim, Catholic and Protestant

Conclusion of RST empirical analysis • Institutions, even controlling for the traditional variables used in the literature, stay significant and if anything, their explanatory power increases

Quality of Institutions Acemoglu, Johnson, and Robinson 2001 Easterly and Levine 2002 Rodrik, Subramanian, and Trebbis 2002 Geographical and Ecological Variables Economic Growth (e.g. climate zone, disease ecology, distance from the coast) Sachs 2003

The standard institutional model • ln(Yi) = B0 + B1 QIi + B2 Zi + Ei • QI = quality of institutions • Z = geography variables (distance from equator, mostly)

Sachs: Malaria matters • How can we measure the effect of Malaria in a country? • MAL94: % of population with risk of malaria transmission (WHO: reports of malaria cases) • Malaria Ecology: climate and mosquito abundance

Results • Institutions matter • Some geographical and ecological variables also matter: • Malaria • % population living within 100km of the coast

Institutions and Economic Growth