Institutions Versus Policies: a Tale of Two Islands

American Economic Review: Papers & Proceedings 2009, 99:2, 261–267 http://www.aeaweb.org/articles.php?doi 10.1257/aer.99.2.261 =

MACROECONOMIC NARRATIVES FROM AFRICA AND THE DIASPORA†

Institutions versus Policies: A Tale of Two Islands

By Peter Blair Henry and Conrad Miller*

A long line of work emphasizes the correla- origins enables researchers to estimate the causal tion between institutions and economic perfor- impact of property rights on long-run economic mance Adam Smith 1776; W. Arthur Lewis outcomes. Differences in the legal tradition that 1955; Douglass( C. North 1990 . Rich countries countries inherited from their colonial masters have laws that provide incentives) to engage in also have a long-run impact on economic out- productive economic activity. Investors rely on comes. Countries with English common law ori- secure property rights, facilitating investment in gins provide investors with stronger protection human and physical capital; government power and are less prone to government ownership and is balanced and restricted by an independent regulation than countries with civil law origins judiciary; contracts are enforced effectively, Rafael La Porta, Florencio Lopez-de-Silanes, supporting private economic transactions. and( Andrei Shleifer 2008 . In turn, common law Recent research moves from correlation to countries have greater financial) development, causation by observing that countries whose less corruption, smaller informal economies, colonizers established strong property rights and lower unemployment. hundreds of years ago have, on average, much Case studies seem to suggest that institutions higher levels of income today than countries also exert a causal influence on economic out- whose colonizers did not Daron Acemoglu, comes over periods of time somewhat shorter Simon Johnson, and James A.( Robinson 2001 . than the centuries-long span emphasized by Since a country’s colonial origin—literally) the colonial and legal origins literature. For determined centuries ago—can in no meaning- instance, following the Armistice of 1953, Korea ful way be said to be caused by its present-day broke into two separate nations with similar lev- level of income, the nature of countries’ colonial els of income, almost identical ethnic and cul- tural makeup, but starkly different institutional arrangements of the economy. North Korea † resorted to central planning while South Korea Discussant: William A. Darity, Jr., Duke University. relied on property rights and markets with a ( * Henry: Graduate School of Business, Stanford Uni healthy dose of state intervention . More than 50 versity, Stanford, CA 94305–5015, Brookings Institution, years later South Korea’s income) per capita is and National Bureau of Economic Research e-mail: more than ten times as large as North Korea’s. [email protected] ; Miller: Department of Economics,( Stanford University, ) Stanford, CA 94305 e-mail: The divergence of the East and West German [email protected] . Henry gratefully acknowledges( economies following the partition of Germany financial support from) the John A. and Cynthia Fry Gunn after World War II ostensibly provides another Faculty Fellowship, the Stanford Institute for Economic piece of evidence in favor of the view that insti- Policy Research, the Stanford Center for International tutions play the dominant role. Development, and the Freeman Spogli Institute. Miller gratefully acknowledges financial support from the Mellon While institutions undoubtedly affect eco- Mays Undergraduate Fellowship. We thank Jonathan nomic outcomes, the macroeconomic policies Bendor, Sir Courtney Blackman, Renee Bowen, Eleanor that governments choose to implement may Brown, Cecilia Conrad, William A. Darity Jr., Kevin Davis, exert just as much influence on the trajectory Chad Jones, John Rapley, Tracy Robinson, Paul Romer, members of the Caribbean Policy Research Institute, and of their economies as the broader institutional seminar participants at Brookings, MIT, and Stanford for framework within which those policy decisions very helpful comments and discussions. take place. As a matter of arithmetic, long-run 261

1.2

0.8

Barbados 0.6 Jamaica

0.4

0.2

Natural log of index real GDP per capita 0

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 19881990 1992 1994 1996 1998 2000 2002 Year

Figure 1. Standards of Living in Barbados and Jamaica Diverge after Independence

income levels are the sum of a series of short- Figure 1 plots the natural logarithm of an and medium-run growth rates that are heavily index of real GDP per capita measured in US influenced by fiscal, monetary, and exchange dollars in Barbados and Jamaica( from 1960 rate policy to name a few . This article demon- through) 2002. By construction, the value of the strates the relevance( of the) point by examining index is one in 1960 so that the natural log of a very different kind of policy experiment from the index is zero in 1960. While Barbados has the ones in the existing literature on institutions not exactly experienced a growth miracle, its and growth. economy performed reasonably well over the In contrast to the examples of North and South 42-year period and substantially better than Korea and East and West Germany, we examine Jamaica’s. To be exact, by 2002, the natural log a pair of countries—Barbados and Jamaica— of the index is 0.917 for Barbados and 0.356 for whose income levels diverge over a 40-year Jamaica, so that the average growth rate of real stretch in spite of no obvious differences in the GDP per capita for Barbados over the entire institutional arrangements of their economies at sample is 2.2 percent per year 0.917 divided the beginning of the observation period. by 42 versus 0.8 percent per year( for Jamaica 0.356) divided by 42 . I. Standards of Living in Barbados and Jamaica ( One particularly striking) feature of Figure 1 is the sharp decline in Jamaica’s standard of liv- Barbados and Jamaica are both former British ing that sets in after 1972. Of course, the first oil colonies, small island economies, and predomi- price shock in 1973 precipitated a general slow- nantly inhabited by the descendants of Africans down in world economic growth, but the central who were brought to the Caribbean to cultivate point laid out in more detail later in the paper sugar. As former British colonies, Barbados and is that( growth in Jamaica slowed more dramati-) Jamaica inherited almost identical political, cally than it did in Barbados. While Jamaica’s economic, and legal institutions: Westminster economy contracted at a rate of 2.3 percent per Parliamentary democracy, constitutional protec- year from 1972 to 1987, Barbados, whose econ- tion of property rights, and legal systems rooted omy has a similar structure see Table 1 and was in English common law. Yet, as Figure 1 demon- subject to the same external( shocks, grew) by 1.2 strates, the standard of living in the two countries percent per year. In other words, for a 15-year diverged in the roughly 40-year period following period income per head in Barbados grew by 3.5 their independence from Great Britain. percentage points faster than it did in Jamaica. VOL. 99 NO. 2 Institutions Versus Policies: A Tale of Two Islands 263

Table 1—Barbados and Jamaica Have Similar Economies

Barbados Jamaica Exports as percent GDP 58.4 50.0 Imports as percent GDP 68.6 60.7 Agriculture as percent GDP 3.7 5.7 Industry as percent GDP 18.0 33.1 Services as percent GDP 78.3 61.2 Population 300,000 2,700,000 Area (square miles) 166 4,244

Turning from growth rates to levels gives a 85 percent of the populations of Barbados and tangible sense of the impact of these growth-rate Jamaica. Slavery was abolished in the British differentials on long-run standards of living. In West Indies in 1834, and following World War 1960 real GDP per capita was $3,395 in Barbados I the region began a process of “constitutional and $2,208 in Jamaica. In 2002 Barbados’s decolonization” that led the islands down a grad- GDP per capita was $8,434 while Jamaica’s ual, if difficult, path toward greater self-govern- was $3,165. The $1,187 income gap that existed ment (Trevor Munroe 1972). Reporting on his between Barbados and Jamaica around the time visit to the region in 1922, Major E. F. L. Wood, of independence now stands at $5,269 dollars. Britain’s Under Secretary of State for Colonies Put another way, the income gap between the wrote: two countries now exceeds Jamaica’s level of GDP per capita. “The whole history of the African popula- Since their initial conditions were similar at tion of the West Indies inevitably drives the time of independence, it stretches credulity them towards representational institu- to argue that Barbados and Jamaica diverged tions fashioned after the British Model. because of differences in colonial origins, legal Transplanted by the slave trade or other origins, geography, or some other exogenous circumstances to foreign soil, losing in the feature of their economies. We argue below process their social system, language and that the explanation for the divergence lies not traditions. … Small wonder if they look for with differences in institutions but differences political growth to be the only course and in macroeconomic policy. pattern that they know, and aspire to share in what has been the particularly British gift of representational institutions” II. Institutions (Wood 1921). Jamaica won its independence from Britain in 1962, Barbados in 1966. At the time they became Three subsequent empirical observations sovereign nations, both countries possessed the demonstrate the accuracy of Wood’s predic- two institutional characteristics that the litera- tion that the British West Indies (Barbados and ture identifies as critical to long-run prosperity: Jamaica in particular) were destined to establish strong constitutional protection of private prop- institutions that mirrored the mother country. erty and English common law. A brief review of First, as sovereign nations, both Barbados the islands’ colonial histories verifies the state- and Jamaica organized their governments as ment in the preceding sentence. parliamentary democracies in the Westminster- The English settled Barbados in 1627 and Whitehall tradition (Anthony Payne 1993). wrested Jamaica from the Spanish in 1655. Since independence, Barbados and Jamaica Both islands entered the modern era as planta- have maintained two-party political systems tion economies that produced sugar and other and consistently held free and fair elections with agricultural commodities using slave labor (Eric no unconstitutional transfers of power. While Williams 1970). By the end of the eighteenth sporadic violence often accompanies elections century, African slaves comprised more than in Jamaica, neither Barbados nor Jamaica has 264 AEA PAPERS AND PROCEEDINGS MAY 2009 suffered a coup or civil war, and both countries For most of their histories, both countries shared have a free and vocal press. Four postindepen- the Judicial Committee of the Privy Council in dence elections in Jamaica resulted in the ruling England as their highest court of appeals. party peacefully turning over power to the Because Barbados and Jamaica possess simi- opposition. Three such transitions occurred in lar economic institutions and legal systems, nei- Barbados. ther the property-rights nor legal-origins theory Second, the constitutions of Barbados and of long-run income determination can explain Jamaica explicitly protect private property. The their postindependence divergence. Although joint parliamentary committee that drafted the institutional structures of Barbados and Jamaica’s constitution was chaired by Norman Jamaica are very close, the same cannot be said Manley—a lawyer, Rhodes Scholar, and father of their approaches to macroeconomic policy. of the nation’s future prime minister. Discussing the constitution in front of Jamaica’s House of III. Macroeconomic Policies Parliament on 23 January 1962, Manley says: When Jamaica gained independence in 1962 “We have put into this constitution a clause the Jamaican Labor Party (JLP) held a parlia- which provides that property may not be, mentary majority. For the next ten years the JLP in effect, arbitrarily acquired. Property remained in power and GDP per capita grew at a is protected in that it can only be taken rate of 5.4 percent per year, with the lion’s share under a law which has been passed. And of growth stemming from two principal sources: when so taken, it must be taken in accor- dance with the terms of that law. What the strong US growth in the 1960s created a robust law provides for compensation, you must export market for Jamaican bauxite; and rising get. … I t is of the highest importance for a incomes in North America boosted growth in country[ ] like Jamaica to let the world know Jamaica’s tourism industry. that…people can come here to invest… But all was not well. In classic Dutch Disease fully protected by the laws of the land…” fashion, growth in the bauxite sector drove up (Manley 1962, 306). the relative price of nontradeables, reducing the competitiveness of Jamaica’s agricultural Barbados, which attained full independence sector and precipitating an exodus of workers four years after Jamaica, adopted a constitu- from the countryside to the cities (Carl Stone tion with an effectively identical coverage of and Stanislaw Wellisz 1993). Because of strong private property. Both constitutions assert that unions, wages in other sectors did not adjust property cannot be compulsorily acquired downward to absorb the excess labor released except under written law that describes a pro- from agriculture (Caribbean Policy Research cedure for determining and providing compen- Institute 2005). Consequently, during its first sation and grants claimants the right of appeal decade of independence Jamaica experienced to a court (Chapter 3, Section 16, of Barbadian the odd combination of strong growth coupled Constitution; Chapter 3, Section 18, of Jamaican with an unemployment rate that rose from 13 Constitution). The constitutions also delineate percent in 1962 to 23.2 percent in 1972. similar sets of exceptions to this clause, such as Rising unemployment, income inequality, cases where property is acquired in satisfaction and the attendant societal tensions proved too of a tax, property is in a condition dangerous to much for the JLP at the ballot box. In 1972 the the health of others, or property is acquired to People’s National Party (PNP) rose to power pay debt of the insolvent. under the leadership of Prime Minister Michael Third, Barbados and Jamaica adopted legal Manley (son of Norman) and the promise of systems based on English common law (Rose- “democratic socialism.” The two cornerstones of Marie Antoine 1999). Describing the essence of democratic socialism and the PNP’s economic this adoption to the Philadelphia Bar Association policies were “self-reliance” and “social jus- in 1967, Manley says: “As to the law, we took over tice.” Self-reliance translated as extensive state the English common law holus bolus. But what intervention in the economy. The PNP nation- was more important we took over the structure alized companies, erected import barriers, and and machinery which England built up for the imposed strict exchange controls (R. DeLisle administration of justice” (Manley 1967, 340). Worrell 1987). Social justice meant income VOL. 99 NO. 2 Institutions Versus Policies: A Tale of Two Islands 265

Table 2—Economic Policy and Performance in Barbados and Jamaica Diverge after 1973

Barbados Jamaica 1966–1972 1973–1980 1962–1972 1973–1980 Growth rate of GDP per capita 6.0 2.7 4.2 4.3 − Fiscal deficit, percentage of GDP 2.7 5.3 2.3 15.5 Inflation 6.0 14.8 4.4 23.0

redistribution through job creation programs, was down to 2.9 percent. Since much of defi- housing development schemes, and subsidies on cit financing comes from the central bank, by basic food items. extension, Barbados also ran a tighter monetary Whatever merits the PNP’s economic program ship than Jamaica. Table 2 summarizes the may have had, it was expensive. Government net result of the difference in macroeconomic spending rose from 23 percent of GDP in 1972 policy in Barbados and Jamaica over the two to 45 percent in 1978. Revenue did not keep pace periods. with the rise in expenditure. From 1962 through 1972 Jamaica’s average fiscal deficit was 2.3 IV. Exchange Rate Policies percent of GDP (see Table 2). In contrast, from 1973 to 1980 the average fiscal deficit was 15.5 In 1975 Barbados pegged its currency to the percent of GDP! The PNP financed much of US dollar at a parity of B$2: US$1. The parity the deficit by borrowing directly from the Bank came under threat when Barbados suffered a of Jamaica. Predictably, inflation rose. From deep recession in the early 1990s and real GDP 1962 to 1972 inflation averaged 4.4 percent per per capita contracted by 5.1 percent per year year. By 1980 inflation was 27 percent per year, from 1989 to 1992. In the midst of the crisis investment had collapsed (to 14 percent of GDP in 1991, Barbados entered formal negotiations down from 26 percent in 1972), and the PNP with the International Monetary Fund (IMF) was voted out of power. to request financial assistance. Among other Because Jamaica’s reversal of fortune coin- things, the IMF recommended devaluation to cided with the oil price shock of 1973 and the stimulate production and return the economy to onset of worldwide stagflation, it is tempting full employment. Deeply attached to the stabil- to blame the country’s downward spiral on ity of their currency, the Barbadians resisted the external events. While many have done so (see recommendation. Instead of devaluing, the gov- Manley 1987), even a cursory comparison with ernment began a set of negotiations with employ- Barbados makes it difficult for an objective ers, unions, and workers that culminated with a observer to embrace that conclusion. tripartite protocol on wages and prices in 1993. The inflation rate in Barbados also spiked Under the 1993 Wage and Price Protocol, in the early 1970s, hitting a peak of 39 percent workers and unions assented to a one-time cut in in 1975, but Barbados’s policy response to the real wages of about 9 percent and agreed to keep external shocks that precipitated the spike could their demands for future pay raises in line with not have been more different from Jamaica’s. increases in productivity. Firms promised to First of all, Barbados avoided nationalization, moderate their price increases, the government kept state ownership to a minimum, and adopted maintained the parity of the currency, and all an outward-looking growth strategy (Courtney parties agreed to the creation of a national pro- Blackman 2006, 390). Second, instead of tak- ductivity board to provide better data on which ing an accommodative stance that delayed the to base future negotiations. inevitable retrenchment needed to adjust to To be sure, the protocol involved costly higher energy prices, policymakers in Barbados bargaining. When negotiations began, public kept government spending under control. While demonstrations broke out and the government’s the fiscal deficit in Barbados did climb to 7.7 wage-cut proposal was challenged in court, all percent of GDP in 1973, by 1978 that number the way up to the Privy Council (Alvin Wint 266 AEA PAPERS AND PROCEEDINGS MAY 2009

2004, ch. 3). Nevertheless, the center held. in the global economy. On the contrary, we The fall in real wages helped restore exter- think that important general lessons lie at the nal competitiveness and profitability, thereby heart of this Caribbean parable. Recent work achieving the same result as a devaluation but focuses on the very long-run effects of insti- without the risk of triggering an inflationary tutions to the point of exclusion of almost all spiral. The economy recovered quickly. From other factors. But the macroeconomic deci- 1993 to 2000 GDP per capita grew by 2.7 per- sions of governments can exert just as much cent per year. influence on the trajectory of the economy Unlike Barbados, Jamaica devalued its cur- as the institutional framework within which rency several times between 1975 and 2002. those decisions take place. Countries have no From this fact, many observers draw the spe- control over their geographic location, colo- cious conclusion that the difference in exchange nial heritage, or legal origin, but they do have rate policy accounts for Barbados’s superior agency over the policies that they implement. economic performance1. But Barbados’s fixed Of particular importance for small open econ- exchange rate did not cause its economy to omies (i.e., most countries in the world) is the outperform Jamaica’s. Rather, the proximate response of policy to macroeconomic shocks source of Barbados’ superior performance was such as a fall in the terms of trade. Pedestrian a set of growth-facilitating policies—monetary as it may seem, changes in policy, even those restraint, fiscal discipline, openness to trade, that do not have a permanent effect on growth and ultimately wage cuts to restore competi- rates of GDP per capita, can have a significant tive unit labor costs—that had the side effect impact on a country’s standard of living within of enabling the monetary authority to maintain a single generation. the exchange-rate parity without losing external competitiveness. In contrast, Jamaica’s policies were never consistent with maintaining commit- REFERENCES ment to any parity the government might have wanted to adopt. Acemoglu, Daron, Simon Johnson, and James The differences in exchange rate policy do, A. Robinson. 2001. “The Colonial Origins however, raise an important issue. Faced with a of Comparative Development: An Empirical scenario like that of Barbados in 1991, would Investigation.” American Economic Review, Jamaica be able to achieve the social consen- 91(5): 1369–1401. sus needed to adopt the measures required to Antoine, Rose-Marie. 1999. Commonwealth avoid a competitive devaluation? As stated in Caribbean Law and Legal Systems. London: the previous paragraph, we think the Jamaican Cavendish Publishers. record speaks for itself. Answering the deeper Blackman, Courtney. 2006. The Practice of Eco- question—why do some democratic societies nomic Management: A Caribbean Perspec- (of which Barbados is just one example) manage tive. Kingston: Ian Randle Publishers. to reach constructive policy compromises while Caribbean Policy Research Institute. 2005. Taking others (such as Jamaica) do not?—remains an Responsibility: The Jamaican Economy Since important research challenge.2 Independence. http://www.takingresponsibil- ity.org/. V. Conclusion La Porta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer. 2008. “The Economic Conse- It may be tempting for readers to regard this quences of Legal Origins.” Journal of Eco- paper as a quaint tale of two exotic islands nomic Literature, 46(2): 285–332. better known for their beaches, music, and Lewis, W. Arthur. 1955. The Theory of Economic Olympic sprinters than their significance Growth. Homewood, Illinois: Unwyn Hyman. Manley, Michael. 1987. Up the Down Escalator: Development and the International Economy: A 1 Hon. Edward Seaga, “The Caribbean Single Market: Jamaican Case Study. London: Andre Deutsch. Beneficial Path or Wayward Journey,” Jamaica Observer, February 10, 2006. Manley, Norman Washington. 1962. “The Inde- 2 See Donald Robotham (1998) for clues about answers pendence Constitution.” In Norman Washington to this question for Barbados and Jamaica. Manley and the New Jamaica: Selected VOL. 99 NO. 2 Institutions Versus Policies: A Tale of Two Islands 267

Speeches and Writings 1938–68, ed. Rex Net- the Western World, Encyclopedia Brittanica. tleford, 1971. London: Longman Caribbean. Stone, Carl, and Stanislaw Wellisz. 1993. Munroe, Trevor. 1972. The Politics of Decoloni- “Jamaica.” In The Political Economy of Pov- zation: Jamaica, 1944–1962. Jamaica: Univer- erty, Equity, and Growth: Five Small Open sity of the West Indies Institute of Social and Economies, ed. Ronald Findlay and Stanislaw Economic Research. Wellisz, 140–218. New York: Oxford Univer- North, Douglass C. 1990. Institutions, Institu- sity Press. tional Change, and Economic Performance. Williams, Eric. 1970. From Columbus to Cas- Cambridge: Cambridge University Press. tor: The History of the Caribbean 1492–1969. Payne, Anthony. 1993. “Westminster Adapted: New York: Random House. The Political Order of the Commonwealth Wint, Alvin. 2003. Competitiveness in Small Caribbean.” In Democracy in the Caribbean: Developing Economies: Insights from the Political Economic, and Social Perspectives, Caribbean. Kingston: University of the West ed. Jorgé I. Dominguez, Robert A. Pastor, and Indies Press. R. DeLisle Worrell. Baltimore: Johns Hopkins Wood, Hon. E. F. L., M.P. 1921. Report of a Visit University Press. to Certain West Indian Colonies and to Brit- Robotham, Donald. 1998. “Transnationalism in ish Guiana, as cited in Anthony Payne (op. cit.) the Caribbean: Formal and Informal.” Ameri- 1993, 58–59. can Ethnologist, 25(2): 307–21. Worrell, R. DeLisle. 1987. Small Island Econo- Smith, Adam. 1776. An Inquiry into the Nature mies: Structure and Performance in the Eng- and Causes of the Wealth of Nations. In lish Speaking Caribbean Since 1970. New Mortimer Adler (ed.), 2005, Great Books of York: Praeger.