Macroeconomics – institutions by Acemoglu

In Progress. Abstract In this paper, we dispute how and wherefore cosmoss broadly, the frugal and governmental organization of societies run into frugal incentives and forthcomes. After shortly surveying a number of theories of institutional differences crosswise countries, we focus on two questions why societies whitethorn convey institutions that atomic number 18 non honest for economic evolution, and why institutions, level(p) bad Institutions, persist.In light of the Ideas we develop, we discuss iii case studies of Institutions alluding and persistence the united States, India and Guatemala. L. Introduction Institutions, defined broadly as the semipolitical and economic organization of societies, differ markedly across countries and all over time. For example, until recently, a adult number of societies were organized along kindist lines, with far-flung collective avouchership of the means of production and centrally planned imaging allocation, while much of the detain of the world was capitalist, with predominantly underground ownership and resources allocated Vela markets.For much of the 1 8th and 9th centuries, a number of societies, Including the Caribbean, much of important and Latin the States, and parts of Asia, were organized with political and economic exerciseer gruelling in the hands of a atomic elite, and relied on productive relationships base on sla really and magnated cranch. In contrast, economic and political power was to a greater extent than equally distri just nowed in parts of Europe, North America and Australia, and the absolute majority of laborers were free.Similarly, as emphasized by North and Thomas (1973), North and Whiniest (1989) and cashbox (1 990), there were Important differences In the organization of the European societies during the 17th coke. spell England and the Netherlands had unquestionable unsexed governments, France and Spain had absolutist regimes.Economic surmise and basi c common instinct suggest that differences in the organization of nightspot should subscribe to an effect on economic outcomes when institutions check up on that a potential investor has position rights over the yield from his Investments, he Is more likely to invest than when he turn outs the fruits of his efforts to be interpreted by early(a) parties In the economy or by the government. An obvious dead reckoning is then to link variations in economic execution across countries to their institutions. We refer to this blame of ruling as the institutions hypothesis.According to one version of this hypothesis, what is polar is whether the organization of the society ensures that a broad cross-section of the society produce in effect(p) stead rights, so that those with productive emphasis on a broad cross-section of the society is meant to capture the nonion that it is non sufficient for the rights of a small elite, landowners, dictators or Politburo members, to be e nforced. Citizens motivating to encounter effective plaza rights, and be involved in politics, at least around degree, to ensure the continuation of these repertory rights in the future.Do we see marked differences in the economic performance of societies with several(predicate) institutions? The examples mentioned in the first off paragraph suggest so while West Ger many an(prenominal) prospered with a capitalist ashes, East Germany did much little good under brotherlyism. While Western Europe, North America and Australia grew quickly, the elite-dominated societies of the Caribbean, telephone exchange America and India stagnated doneout the 18th and 19th centuries. As emphasized by North and Thomas (1973), while England and the Netherlands prospered during the 17th century, Spain and France failed to do so.Also telling atomic number 18 cases where coarse changes in institutions be correlated with radically changed growth paths. Examples of this atomic number 18 Arg entina in the sasss with the rise of populism and Person, South Korea during the early sasss with the handing over from the rhea to the Park regime, and Indonesia in 1965 with the transition betwixt Saguaro and Short. In rundown to these selective examples, much empirical evidence suggests that institutional differences be a major source of the differences in economic performance across countries.For example, cross country work by a number of economists and political scientists found a first-order effect of institutions on growth or the level of income (e. G. , Knack and Keeper, 1995, or Hall and Jones, 1999). More recently, in Guacamole, Johnson and Robinson (2000) we found that as much as % of the income gap between the top and bottom of the world income distri yetion may be due to differences in their institutions. 4 But these findings pose as many questions as they answer 1 . If many institutions generate more income and growth, why do a large number of societies adopt institutions that argon bad for economic development? . Why do institutions that are poisonous to economic performance persist rather than being overhauled at the first opportunity? Despite the importance of these questions for understanding differences in economic performance across countries, there is proportional degreely little research on this topic. In this paper, we develop a number of conjectures related to these questions. Then, in light of these ideas, we discuss triple case studies of institution building and persistence the U. S. , India and Guatemala.In the process, we to a fault nominate a brief survey of a number of theories of comparative degree institutions. II. Institutions As emphasized in the introduction, our focus is on the prepare of institutions the organization of society that model economic incentives. Why such(prenominal) institutions and social arrangements go forth demand economic outcomes is clear economic actors provide only vouch enthroni zations when they yield to be rewarded for their spending and effort. In a society where plaza rights are non well enforced, investing and output leave be low.We and so take the degree of enforcement of piazza rights to be a central disport of the institutions and the broad organization of a society. To of hush-hush property, which we take to correspond to a crash of institutions ensuring that a broad cross-section of society have effective property rights. 2. Extractive institutions, which place political power in the hands of a small elite. With extractive institutions, the majority of the population does not have effective property rights, since the political power of the elite means that they trick hold up the citizens after they undertake their enthronements.We expect institutions of private property to encour advance investment and development, while extractive institutions are less likely to dead to eminent investment and successful economic outcomes. Notice that there is more to institutions than the legal law or the formal definition of property rights at a organize in time in particular, political institutions matter. This is for the simple reason that in a society where there are few constraints on political elites, these agents clear change the legal code or manipulate the exist property rights to their advantage. therefore, effective constraints on political elites are an essential agent of institutions of private property. In reality, there are many intermediate cases teens the extremes of institutions of private property and extractive institutions, and a complex interaction between the exact form of the political and economic institutions and whether they provide effective property rights protection to citizens. There is too a deep and difficult question of how the state set ups to providing property rights to the citizens (see Whiniest, 1997, for a discussion of this problem).To limit the discussion, we do not focus on the se issues. So what determines whether a society ends up with institutions of private property or extractive institutions? Let us distinguish four broad theories, which we call 1. The efficacious institutions view. 2. The incidental institutions view. 3. The rent- pursuance view. 4. The in suppress institutions view. We now discuss what we mean by these opposite views, and examine some selective examples of institutional theories falling within to each one category. . The Efficient Institutions look According to this view, societies leave alone choose the institutions that maximize their natural surplus. How this surplus will be distributed among divergent companys or agents does not affect the choice of institutions. The underlying reasoning of this view comes from the Cease Theorem. Ronald Cease (1960) argued that when different economic parties could conduct costless, they will be able to sight to internalize potential externalities.The farmer, who suffers from the pol lution created by the nearby pulverisation, can pay the positionory owner to reduce pollution. The same reasoning can be utilise to political situations. If the current laws or institutions eudaimonia a sure group while creating a disproportionate cost for another, these two groups can negotiate to change the institutions. By doing so they will emergence the size of the complete surplus (the pie that they have to divide between themselves), and they can hen bargain over the distribution of this additional surplus.Many different versions of the in force(p) institutions view have been stick outd. Demesne (1967) argued that private property emerged from common property when land extend sufficiently scarce and valuable that it was effectual to privative it. Other famous examples are Cases (1936) earlier work and the more formal analysis by Grossman and hart (1986), is more c erstrned with the governance of firms or markets than the political organization of societies, but hi s reasoning was guided by the same principle.North ND Thomas utilise this reasoning to the spirit of feudal institutions arguing that they were an efficient contract between serfs and Lords. While Williamson and North and Thomas do not specify how different parties will reach agreement to achieve efficient institutions, Becker (1960) and Whitman (1989) have investigated how democracies can reach such agreements via competition among pressure groups and political parties.In their view, an inefficient institution cannot be stable because a political entrepreneur has an incentive to propose a better institution and with the extra surplus generated will be able to make him more attractive to voters. We believe that, despite right on emphasizing certain forces that are likely to be at work, the efficient institutions view does not provide the right framework for an analysis of the differences in institutions across countries. Both historical and econometric evidence suggests that the economic be to societies of extractive institutions have been substantial.For example, our estimates in Guacamole, Johnson and Robinson (2000) suggest that changing Insignias or Sierra Lenss institutions to those of chilli loud lead, in the long run, to a more than 7-fold increase in these countries income. It is difficult to argue that these institutions are therefore efficient for Nigeria, Sierra Leone or many other less-developed countries in Africa or Latin America. In the rest of the paper, we therefore focus on theories of institutions where societies may end up with institutions that are not optimal for aggregate growth or income. 2.The Incidental Institutions assimilate The efficient institutions view is explicitly based on economic reasoning the costs and benefits of different institutions are weighed over against each other to determine which institutions should prevail. power arises because individuals calculate according to the social costs and benefits. Institutions are therefore choices. A different approach, popular among many political scientists and sociologists, is to downplay choices over institutions, but think of institutions as the byproduct of other social interactions. Here, we discuss three such theories.The first is the possibleness developed by Barrington Moore (1966) in his well-disposed Origins of Dictatorship and Democracy, the second is Tills (1990) and Herbs (2001) possibility of state makeup, hill the third is Burners (1976) theory of the emergence of capitalist economy in England. Barrington Moore constructed his famous theory in an tone-beginning to explain the different paths of political development in Britain, Germany and Russia. In particular, he investigated why Britain had evolved into a democracy, while Germany succumbed to fascism and Russia had a communist revolution.Moore stressed the goal of centralization of floriculture and resulting labor relations in the countryside, the strength of the bourgeoisie, a nd the nature of class concretions. In his theory, democracy emerged when there was a strong, politically assertive, patriarchal middle class, and when agriculture had commercialese so that there were no feudal labor relations in the countryside. Fascism arose when the middle classes were weak and set downed into a political coalition with landowners.Finally, a agriculture was not commercialese and rural labor was repressed through feudal relationships. In Moors theory, therefore, class coalitions and the way agriculture is organized determine which political institutions will emerge. Although Moore is not explicitly concerned with economic development, it is a direct implication of his analysis that societies may end up with institutions that do not maximize income or growth, for example, when they take the communist revolution path.While this theory is highly suggestive and clearly captures some of the potentially significant comparative facts there are clear problems with it. For instance, though Moors remark no bourgeoisie, no democracy is famous, it is not clear from his analysis whether this is Just an empirical correlation or a causal theory. More generally, Moore does not clarify the connection between the formation of class coalitions and political outcomes. It is also not clear whether this theory is empirically successful.There are many examples of societies with sex actly strong capitalist classes in Latin America, such as Argentina and Chile, which did not make the transition to a consolidated democracy until recently. In fact, in these societies capitalist classes advance to have supported the coups against democracy, suggesting that the role of the poor segments of the society (the working class) in inducing demagnification could be more important than that of the bourgeoisie (see Archduchesses, Stephens and Stephens, 1992, Guacamole and Robinson, Bibb).In a very different vein, Till (1990), building on the Hibernia tradition, proposed a th eory of the formation of advanced states. He argued extensively that modern state institutions such as fiscal systems, bureaucracy and parliaments are closely related to the contain to deepen resources to fight wars and thus arose in places with incessant inter-state competition. Herbs (2001) has recently provided a all important(p) extension of this line of research by applying it to the evolution of state institutions in Africa.He argues that the poor functioning of many modern African states is due to the fact that they caked the featureshigh population density and inter-state warfare requirement for the emergence of the modern state. Although bear oning and sweeping, this theory does not seem to accord well with a number of major facts. In Guacamole, Johnson and Robinson (2001 a), we documented that among the former colonies, it was the less thick settled places that became richer.In fact, North America, Australia and New Zealand were very sparsely settled in 1 500, espec ially when compared to West Africa around the same time. Despite this, they developed effective states and institutions of private property. This suggests that the issues stressed by Till and Herbs are not the major determinants of institutions, at least, in the linguistic context of the development of institutions among the former European colonies, including Africa. Burners (1976) theory of the rise of capitalist economy in Europe can also be thought as an example of the incidental institutions view.Although Brenner subscribes to the Marxist view of feudalism as an extractive institution (see next subsection), he interprets the rise of capitalism as the byproduct of the collapse of existent social institutions after the disastrous Death. Brenner argues that the decline of feudalism resulted from the successful class struggle by the relatively correctly British peasantry. Brenner, however, believes that the peasantrys aim was not to build capitalism capitalism just emerged like a n incidental phoenix from the ashes of feudalism.Because, economic growth undeniable this set of (extractive) institutions to be replaced by capitalist institutions. Therefore, Burners work also gives us an incidental- institutions theory for why some societies grow faster. None of these theories provide a framework that is at the same time consistent tit the first-order facts of comparative development and multipurpose for generating predictions. Therefore, it is difficult to apply these theories to understand why some countries develop extractive institutions.Moreover, being trained as economists, we find it to be a shortcoming of this group of theories that institutions and political outcomes arise as byproducts, not as the direct consequences of actions taken by rational agents. The fact that the key outcomes are byproducts of other interactions, not choices, leads to the additional problem that these theories often do not generate tight empirical predictions (I. E. Comparativ e placid). But an analysis of comparative development, above all else, strikes comparative static results regarding when institutions of private property will emerge.In the remainder of the paper, we therefore focus on the rent-seeking and in detach institutions views to build a simple framework for comparative development. 3. The Rent-seeking View According to this view, institutions are not always chosen by the whole society (and not for the benefit of the whole society), but by the groups that control political power at the time (perhaps as a result of conflict with other groups demanding more rights). These groups will choose the institutions that maximize their own rents, and the institutions that result may not coincide with those that maximize total surplus.For example, institutions that enforce property rights by limit state predation will not be in the interest of a pattern who wants to appropriate assets in the future. By establishing property rights, this ruler would be reducing his own future rents, so may well prefer extractive institutions to institutions of private property. Therefore, equilibrium institutions will not be those that maximize the size of the overall pie, but the slice of the pie taken by the strong groups. Why doesnt a Cease theorem type reasoning apply?Although a large literature, especially in industrial organization, has emphasized how informational problems may limit the empirical applications of the Cease theorem, we believe that the main reason for the non-applicability of the Cease theorem in politics is perpetration problems (see Guacamole, 2001, for a more detailed discussion of this issue). If a ruler has political power concentrated in his hands, he cannot commit not to expropriate assets or r make upues in the future. Effective property rights require that he credibly relinquishes political power to some extent.But according to the crossroads bargain, he has to be compensated for what he could have received em ploy this power. Herein lies the problem. When he relinquishes his power, then he has no guarantees that he will receive the promised payments in the future. Therefore, by their very nature, institutions that regulate political and social power create commitment problems, and prevent Occasion bargains that are necessary to reach efficient outcomes. As an application, consider the decision of a flop rich elite to mount a coup in a populist redistributive regime, such as that of Salvador Allendale in Chile in 1973.By labour a coup, the rich will ensure that economically. Why wouldnt the elite enter into a Occasion bargain with Allendale who would wish to place future restrictions on taxes so as to remove the threat of the coup? The problem, as evidenceed out and crumbled in Guacamole and Robinson (2001 a), is that the democracy cannot promise not to increase taxes again once the threat of the coup disappears. By its very nature, taxes are set by the politically virile agents, det ermined by the institutions at that time.Promises do at the past may be worthless when they are not natural coveringed by political power. The first systematic development of this point of view is the economics literature is North (1981), who argued in the chapter on A Neoclassical Theory of the State that agents who controlled the state should be modeled as self-interested. He then argued that the set of property rights which they would choose for society would be those that maximized their payoff and because of transactions costs these would not necessarily be the set which maximized social welfare.Though his analysis does not clarify what he meant by transactions costs, problems of commitment might be one mispronunciation for this. The notion that elites may opt for extractive institutions to increase their incomes is of course also present in much of the Marxist and dependence theory literature. For example, Dobb (1948), Brenner (1976) and Hilton (1981) saw feudalism, contrary to North and Thomas (1976)gs model, as a set of institutions intentional to extract rents from the peasants at the expense of social welfare.Dependency theorists such as Wholesalers (1974-1982), Rodney (1972), Frank (1978) and Cards and Falsetto (1979) argued that the international trading system was knowing to extract rents from developing countries to the benefit of developed Mounties. Perhaps, the earliest, and often ignored, ploughshare to this line of reasoning is in the book by Beard (1913). Anticipating many of the insights of rational choice political science literature, Beard argued that the U. S.Constitution was an institution designed to benefit those who wrote it (such as James Madison) at the expense of the rest of society. some other important example of inefficient institutions designed to extract rents from the society is the Spanish colonial system (Stein and Stein, 1970, Coauthors, 1978, Lockhart and Schwartz, 1983). Finally, the notion that leaver is an ineff icient institution designed to extract rents from slaves is also widespread (for example, Williams, 1944, Geneses, 1963, Beckoned, 1972).More recent, and for our purposes more relevant, contributions in this tradition have sought to explain comparative development. For example, in the context of Africa, Bates (1981) formulated an important and important theory based on rent-seeking by elites. Bates argued that when elites were not invested in the productive sectors of the economy, mostly agriculture in the context of Africa, and had to rely on urban interests to remain in power, they were likely to distort prices, for example by using marketing boards to transfer resources from the rural areas to the cities.The implications of this for political stability and economic growth were disastrous. Anger and Soulful (1997, 2000) have used related ideas to analyze long-term development in the Americas. They argued that the different paths of development observed in North and Latin America in the last 300 days were due to institutional differences. In North America institutions promoted development, in Latin America they did not. Why did Latin America develop a set of institutions that impeded Caribbean, the factor endowments were adapted for growing crops such as sugarcane.Such crops had large technical scale economies and could be cultivated by slaves, factors that led to large concentrations of landownership and repressive institutions designed to control labor. Therefore, despite their costs for economic development, extractive institutions were follow by elites who benefited from the system. On the other hand, in North America, factor endowments were suitable for growing crops with limited scale economies such as wheat, and this led to an classless distribution of land, income and political power.Their theory therefore emphasizes the impact of factor endowments and engineering on inequality and institutions building, and ultimately economic development. In G uacamole, Johnson and Robinson (2000, 2001 a), we developed a complementary theory, emphasizing how European colonialists set up institutions of private property in areas where they settled in large numbers, since these institutions were directly affecting their own investments and well-being. This led us to emphasize how European resolving powers ere often conducive to the development of institutions of private property in the colonies.In contrast, European colonists introduced or took over existing extractive institutions in other colonies. They were more likely to do so when they did not settle, for example due to an adverse disease environment, and when extractive institutions were more lucrative, for example, as in Central America where the densely settled large population could be forced to work for low wages in plantations or mines. These extractive institutions did not benefit the society as a whole, but they were inefficacy for the Europeans, who held the political power and were the extractors.We believe that the rent-seeking view provides the best framework for thinking roughly why certain countries ended up with extractive institutions, and provides a number of useful comparative static, which will be discussed in office Ill. 4. The Inappropriate Institutions View According to this view, institutions may be efficient when they are introduced, but they are also dear(p) to change (see below on this). Therefore, institutions that are efficient for a set of circumstances may no longer be efficient once the environment hinges. Nevertheless, it may be difficult or too dearly-won to change these institutions at this point.The idea here goes back to Crosschecking (1963). In the context of financial institutions, Crosschecking argued that certain arrangements, such as bank building finance, might be more appropriate for backward countries trying to mates up. This is widely thought to be a good bill for why banks are more prevalent in Germany, even today when Germany is no longer a backward country. So perhaps, social arrangements that were introduced at some point as an optimal response to the resistances may continue to prevail, even after they cease to be the optimal response.In the context of financial institutions, this point is developed in Guacamole, Action and Kilobit (2001). Another economic example is the QWERTY typewriter keyboard. David (1986) argued that this was appropriate at the time because it slowed down the speed of typing, when the rudimentary nature of typewriters meant that rapid typing would make them Jam. However, despite the fact that the QWERTY arrangement was inefficient once the basic technology improved soon after, it has similar thesis.Perhaps, extractive institutions were appropriate for certain resistances, but they continue to apply even after they cease to be the efficient institutional arrangement. Related ideas have been suggested in the literature. For example, Wittingly (1957) argued that change despotism, which may not have been very costly in name of economic outcomes in China before the 1 5th century and arose as the result of providing desirable public goods such as irrigation, persisted close to the present, creating a substantial economic and social burden.Given how long institutions persist (see Section V) the view that institutions of a different age ay continue to apply even when they become costly to economic success is highly plausible. Nevertheless, in the context of comparative development, it appears more useful to combine the inappropriate institutions view with the rent-seeking view, explicitly allowing for political elites to introduce inefficient institutions. In fact, in Guacamole, Johnson and Robinson (2001 a), we suggested a hypothesis combining the rent-seeking and inappropriate institutions views, and provided evidence in favor of this hypothesis.We argued and empirically demo that extractive institutions, tit power concentrated in the hand of a small elite, were much less costly during the age of agriculture than during the age of industry. When agriculture is the main source of income, and the political elite owns the land, this elite will have, to a first approximation, adequate incentives to increase the productivity of the land. In contrast, in the age of industry, many different agents, not previously part of the ruling elite, need to undertake investments and be involved in productive activities.Without effective property rights, these agents are unlikely to invest, so extractive institutions become much more costly once industrialization opportunities arrive on the scene. This explains why the sugar colonies of Barbados, Haiti and Jamaica were amongst the richest places in the world in 1700 but rapidly fell behind when industrial technologies became available. Overall, we therefore conclude that to understand the significant differences in how countries are organized, we need to move away from the pure efficie ncy view.Moreover, existing series of institutional differences based on the incidental institutions view cannot provide a satisfactory tarring point, and make less sharp empirical predictions, since institutions are only when byproducts of other social actions. Instead, we believe that conflict over the distribution of rents matters, and the rent seeking view provides the best starting place for an analysis of institutional differences across countries.In addition, there may be an important element of the inappropriate institutions view, so that institutions that were introduced at a certain point in time may become less appropriate and more harmful in the future, but may still remain in place. Ill. Institutional Origins The rent-seeking and inappropriate institutions views do not immediately generate a theory of comparative institutions. They simply point out that inefficient institutions may be chosen by political elites, and the institutions in place may become more costly for growth over time.As discussed above, by the institutions hypothesis, we mean that differences in the development experiences of countries can be explained by differences in their institutions. To make this hypothesis operational, we need to choose institutions of private property. In other words, we need to develop comparative static on institution building. This is not an easy task. In fact, some of the pioneering theories of institutions, such as North (1981), give us few clues about when we should expect extractive institutions to prevail.Here, we highlight a few potential determinants of what type of institutions politically powerful groups will choose 1. Economic Interests A first determinant of whether institutions of private property will emerge is whether they will lead to outcomes that are in interests of the politically powerful agents. For example, institutions that restrict state predation will not be in the interest of a ruler ho wants to appropriate assets in the futur e.Yet this strategy may be in the interest of a ruler who recognizes that only such guarantees will encourage citizens to undertake substantial investments or lend him money, or will protect his own rents. They will also be in the interest of the major groups that can undertake investment in production activities in the future. Anger and Solidify explanation for why extractive institutions emerged in the Caribbean but not in North America falls within this category. In the Caribbean, the factor endowments made extractive institutions more profitable for the elite.In particular, sugar production, which could exploit economies of scale and profitably employ slave labor, was conducive to a society where a small elite would control some(prenominal) political and economic power. Our argument in Guacamole, Johnson and Robinson (2000) for why European settlement in the colonies led to institutions of private property is also based on the same reasoning. When a large number of Europeans se ttled in an area, they like institutions enforcing property rights, since these property rights would enable them to undertake investments.Our argument in Guacamole Johnson and Robinson (2001 a) is also related. There, we suggested that high population density and relative prosperity (I. E. , GAP per capita) of the colonise territory encouraged European colonialists to set up extractive institutions. The reasoning is that high population density implied a large labor force that Europeans could force to work for low wages, and both high population density and the relative prosperity of the population provided Europeans with a greater resource base for origin or taxation. Economic interests therefore suggest that we should expect extractive institutions to develop when the powerful agents have little to gain from enforcing property sights because they have few investment opportunities themselves and are not linked to other productive agents in the society, and when there are resourc es, such as crops or abundant labor, that can be effectively exploited by extractive 2.Political Losers Another important factor is whether institutional development will destabilize the system, making it less likely that elites will remain in power after reforms. An institutional setup supporting investment and adoption of new technologies may be blocked by elites when they fear that this process of growth and social change will