Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Political Economy of Development and Underdevelopment Daron Acemoglu Department of Economics Massachusetts Institute of Technology October 10, 2005 & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ The State of the World Economy ² Vast di®erences in prosperity across countries today. { Income per capita in sub-Saharan Africa on average 1=20th of U.S. income per capita { In Mali, Democratic Republic of Congo (Zaire), and Ethiopia, 1=35th of U.S. income per capita ² What explains the di®erent economic outcomes? ² How could we understand development and underdevelopment? & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Plan of the lectures ² This lecture; two parts. 1. Sources of prosperity: Institutions matter { Institutions vs geography vs culture 2. How do institutions emerge? { Four theories of institutions ² Future lectures: Understanding and modeling institutions. { Lecture 2: How institutions a®ect the allocation of resources and are chosen for distributional consequences. { Lecture 3: How institutions may be more e±cient (or less distortionary) in the short run than in the long run ¤ `Reversal of Fortune' among countries. { Lecture 4: How equilibrium institutions change or may be reformed. ¤ Democratization vs. Consolidation vs. Repression & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Part 1: Sources of Prosperity ² Outline { Proximate causes of prosperity { Fundamental causes of prosperity: Institutions vs culture vs geography { \Natural experiments" of history: ¤ European colonization ¤ South vs. North Korea ¤ Chinese experience & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Proximate Causes of Prosperity ² Physical capital di®erences; poor countries don't save enough. ² Human capital di®erences; poor countries don't invest enough in education and skills. ² \Technology" di®erences; poor countries don't invest in R & D and technology adoption, and don't organize their production e±ciently. ² Markets; markets don't function in poor countries. Question: Why don't poor countries save enough, invest enough, develop and use technologies and have functioning markets? & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Potential Fundamental Causes of Prosperity ² Institutions; humanly-devised rules shaping incentives. ² Geography; exogenous di®erences of environment. ² Culture; di®erences in beliefs, attitudes and preferences. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ What Are Institutions? ² Douglass North (1990, p.3): \Institutions are the rules of the game in a society or, more formally, the humanly devised constraints that shape human interaction." ² Economic institutions (e.g., property rights) { shape economic incentives, contracting possibilities, distribution ² Political institutions (e.g., form of government, constraints on politicians) { shape political incentives and distribution of political power. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Institutions? Key Distinctions (1) ² Formal vs. Informal Institutions { How rules are codi¯ed vs. how rules are applied ¤ e.g., Constitutions of U.S. and many Latin American countries are similar, but the practice of politics is di®erent. { Why? Because the distribution of political power is di®erent & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Institutions? Key Distinctions (2) ² De jure vs. de facto political power { De jure political power: power allocated by political institutions ¤ e.g., power allocated to a party by an election { De facto political power: determined by economic, military or extra-legal means ¤ e.g., power of rebel groups in a Civil War, or the threat of such groups in peace. ¤ de facto power typically relies on solving the \collective action problem" & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Institutional Variation ² Big di®erences in economic and political institutions across countries. { Enforcement of property rights. { Legal systems. { Corruption. { Entry barriers. { Democracy vs. dictatorship { Constraints on politicians and political elites. { Electoral rules in democracy. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Economic institutions and economic performance (1) . LUX USA SGP CHE HKG JPN BELCANDNKAUTFRANOR 10 AUSITA ISL NLD SWEFINGBR KWTARE ISR NZLIRL QATBHR ESP PRT MLT GRC KOR BHS CHL OMN SAU CZE ARG URYVEN ZAF MEX GABMYS PAN CRI COL BWA HUN TTOTHA BRA IRN TURPOL TUNECU BGR PER DOM DZA ROM RUS GTM JORPRYJAM PHL SYR MAR IDN SUR EGY 8 SLV BOLGUY CHN AGO HND ZWELKA NIC CMRGIN CIV COG SENGHA SDN PAK MNG IND VNM TGO GMB HTI KEN UGA ZAR MDGBFA BGD NGA ZMB Log GDP per capita, PPP, in 1995 in PPP, capita, per GDP Log NER YEM MLI MOZ MWI SLE TZA ETH 6 4 6 8 10 Avg. Protection Against Risk of Expropriation, 1985-95 & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Economic institutions and economic performance (2) . USA SGPCHE JPN HKG BEL FRA AUT NOR CANDNK 10 ITA AUSDEU NLD GBR SWEFIN ISR IRL NZL ESP PRT KOR GRC SVNCHL CZE ARG VEN URY MEX ZAF MYS COLPAN SVK HUN THA BRA LBNTUR POL ECU BGR TUN DOM RUS ROMHRV PER LTU KAZ LVA JAM JOR IDN PHL MAR EGY 8 BOL CHN UKR ARM ZWE LKA PAKGEO GHASEN VNMIND KEN UGA NGA ZMB MDGBFA Log GDP per capita, PPP, in 1995 capita,PPP,in per LogGDP MLI MOZ MWI TZA 6 0 .5 1 Control of Corruption & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Political institutions and economic performance . LUX USA SGP CHE JPN FRA NORDNKCANAUTBEL 10 DEUAUSNLDITAISL SWEGBRFIN NZLISRIRL ESP PRT KOR GRCCHL ARG VEN MUSURY MEXGAB MYSZAF COLBWAHUNPANCRI THA BRATTO POL TUR TUN ECU DZA PER DOM GTM FJI JOR PRY JAM SWZ PHL SYR IDN MAR EGY 8 CHN GUY SLV BOL AGO ZWE HNDLKA GIN CMR NIC CIV MRTSEN COG COM SDN GHA LSO PAK IND TGO GMB CAF HTI KEN BEN UGA NPL NGATCDZAR BFA ZMB MDG BGD Log Log GDP per PPP, in capita, 1995 NER YEM BDI MLI RWA MWI MOZ SLE TZA ETH 6 0 2 4 6 8 Constraint on Executive in 1990s & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ But Institutions Are Endogenous ² Institutions could vary because underlying factors di®er across countries. { Geography, ecology, climate { Culture { Perhaps other factors? (a®ecting exogenous component of productivity or technology) & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Geography Hypothesis: Montesquieu's Story ² Warm climate ) laziness ) poverty and despotism. \The heat of the climate can be so excessive that the body there will be absolutely without strength. So, prostration will pass even to the spirit; no curiosity, no noble enterprise, no generous sentiment; inclinations will all be passive there; laziness there will be happiness." Moreover, lazy people tend to be governed by despots, while vigorous people could be governed by democracies. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Geography Hypothesis: Modern Versions (1) ² Jared Diamond: \Guns, Germs and Steel". { Importance of geographic and ecological di®erences in agricultural technology and availability of crops and animals. { Particularly important are di®erences across continents. { But much variation within continents. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Geography Hypothesis: Modern Versions (2) ² Je® Sachs: { \Economies in tropical ecozones are nearly everywhere poor, while those in temperate ecozones are generally rich" because \Certain parts of the world are geographically favored. Geographical advantages might include access to key natural resources, access to the coastline and sea ..., advantageous conditions for agriculture, advantageous conditions for health." { \Tropical agriculture faces several problems that lead to reduced productivity of perennial crops in general and of staple food crops in particular" { \The burden of infectious disease is similarly higher in the tropics than in the temperate zones" & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Montesquieu’s story? . USA LUX CHE SGP HKG NOR QAT JPN FRAAUT BELNLD DNK CAN AUS DEU FINISL 10 ITA IRLGBR SWE ARE ISR GRCESPNZL KORPRT BRB BHSBHR KWT MLT ARG CZE SAU SVNHUN MUS CHL SVK EST MYS MEX URY TTO LBY ZAF POL OMN BLR FJI LTULVA RUS BRACRI THAKNA BWA IRNTUN TUR GAB VEN COL PAN DOM DZA BGRHRVROMKAZ PER GUY LCA PRY GEO PHL NAM SWZ GRDDMASLVGTM EGY UKR JAM JORMARCHN TKM IDNLKA BLZ SYR ECU VCT BTN AZE 8 NICHND ARM MDA PNG BOL LSO IRQ UZB ZWEIND YUG GHA VNM MRT PAK CMR CAFTGOCIV SEN HTI BIH KEN CPV BGD NPL GIN MMR UGASTP GMBSDN TJK COG LBR BEN BFATCDMOZ NGADJIGNBMWINER Log GDP per capita, PPP, in 1995 YEMZMBMLI RWA TZA COMAGO MDG AFG ZAR BDI ETH SLE SOM 6 0 .2 .4 .6 .8 Latitude & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Empirical Pitfalls of Correlations and Ordinary Least Squares Estimates ² Montesquieu's story an example of omitted variable bias and identi¯cation problem in empirical work { Other omitted factors, e.g., human nature, culture, geography, vary across countries and a®ect economic performance. { These are also correlated with or may have a causal e®ect on institutions. ² Reverse causality: { Income a®ects institutions ² Attenuation bias: { Measures of institutions very coarse, poorly correspond to conceptual measures, creating \errors in variables" problem. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Empirical Pitfalls for Geography ² The same concerns apply to the correlation between geographic characteristics and income per capita. ² Correlation does not make causation. & % Gaston Eyskens Lectures, Leuven 2005. Lecture 1 ' $ Need for Exogenous Variation ² Exploit \natural experiments" of history, where some societies