Douglas North: ”Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints1, informal constraints2 and their enforcement characteristics. Together they define the incentive structure of societies and specificially economies”.
1) rules, laws, constitutions
2) norms, behavior, conventions
… or simply ’the rules of the game’
Institutions defined (again) cont.
Can also be useful to distinguish between:
Economic institutions (individual property rights, contracts that can be written and enforced, patent laws etc.)
Political institutions (democracy vs non-democracy, electoral rules, extent of checks and balances etc.)
Large literature documenting positive correlations between certain institutions and economic performance.
The identification problem
But this hardly demonstrates a causal effect of institutions on economic performance.
The kind of question we are interested in answering is:
”… if the UK were to switch its electoral rule from majoritarian to proportional, how would this affect the size of its welfare state or its budget deficitis?” (PT)
”If Argentina were to abondon its presidential regime in favor of a parliamentary form of government, would this facilitate the adoption of sound policy towards economic development?” (PT).
How would changing institutions in Nigeria to those of Chile affect economic performance? (AJR)
How would incresing the ’social infrastructure’ of Zaire to that of Switzerland affect productivity? (HJ)
How did the introduction of universal suffrage affect redistribution levels in western Europe? (AR)
Does inequality cause underdevelopment? (Easterly)
Hard questions to answer empirically
Institutions are endogenous to economic performance.
Causality runs both ways
Omitted variable bias
Fundamental problem: cannot observe the counterfactual
The identification problem cont.
Figure from Przeworski04 (’institutions matter?’)
The identification problem cont.
What we can learn from correlations and OLS regressions is limited.
Acemoglu (2005) makes this argument forcefully in a review of Persson and Tabellini (2003).
Agents understand that different policies will map into different outcomes
”If state policy making is purposeful action, responsive to economic and political conditions within the state, then it may be necessary to identify and control for the forces that lead policies to change if one wishes to obtain unbiased estimates of a policy’s incidence” (Besley and Case 2000,EJ)
Agents understand that different institutions will map into different policies and outcomes.
Endogeneity of institutions
Large literature treat institutions as exogenous (e.g. institutions are ’predetermined’ or ’given by history’)
However, the political economy approach suggests that the same factors that make policies unappealing to treat as exogenous is relevant for institutions.
E.g. The introduction of democracy was not ’random’
Papers that try to deal with this problem includes Mauro (1995), Hall and Jones (1999), Acemoglu, Johnson and Robinson (2001) and Persson and Tabellini (2003)
Controlling for current prevalence of malaria and life expectancy
Only using yellow fever as an instrument (eradicated today)
Conditions in the colonies
A key aspect of AJR is that it is not the identity of the colonizer that matters, but conditions in the colonies.
Clearly depart from HJ where European influence in itself is deemed beneficial
Related to the work of Engerman and Sokolof (1997).
The Caribbean islands illustrate the adverse affects of Europeans, which set up repressive regimes based on slavery and forced labor.
Factor endowments such as geography, climate and soil conditions help explain the builings up of ’good institutions’ in nortern am. And ’poor institutions’ in Lat. Am.
From ES 2000 JEP
North am. Of relatively ”marginal econ. Interest compared with the extraordinary opportunities available in the Caribbean and Lat. am” (ES2000)
Haiti probably richest country in the world (on per cap basis) in 1790
Why did US/CAN experience sustained econ. Growth in 18th and early 19th century?
(while others did not attain this goal until late 19th or 20th century, if ever…)
Some econ. Historians have explained the divergence due to the identity of the colonizer.
But striking differences within the identity of the colonizer (e.g. US, Can vs. Barbados, Jamaica, e.g. Argentina vs Peru) calls for other explanation.
AJR explain the divergence as a result of institutions.
ES: Factor endowments (incl. Climate, soil, density of native population)
Predisposed North am. Colonies towards relatively equal distributions and corresponding institutions favoring a broad range of the population in commercial activity.
Predisposed Lat. Am, Caribbean colonies to highly unequeal distributions and institutions that protected the elite.
The suitability for cultivating sugar and other highly valued commodities
economics of scale extensive use of slaves, and the densely populated native population.
”In those societies that began with extreme inequality, elites were better able to establish a legal framework that insured them disproportionate shares of political power, and to use that greater influence to establish rules, laws, and other government policies that advantaged members of the elite relative to non-members – contributing to persistence over time of the high degree of inequality”.(ES2000)