Diversity, Institutions, and Economic Development: Post-WWII Displacement in Poland Volha Charnysh∗ Abstract How does cultural diversity affect social organization? Do institutional differences between di- verse and homogeneous communities have implications for economic development? This paper argues that heterogeneity not only impedes informal mechanisms of cooperation, but also in- creases demand for formal institutions. Greater reliance on formal law and public authority, in turn, facilitates economic development by enabling arm’s length transactions and encouraging entrepreneurship. I test this argument using an original dataset on the size and composition of migrant groups settled in 1,217 municipalities transferred from Germany to Poland in 1945. I find that homogeneous migrant groups were more successful in reestablishing private-order in- stitutions that relied on informal enforcement mechanisms, such as volunteer fire brigades, while diverse migrant communities depended on the state for the provision of public goods and enforce- ment of cooperative behavior. Economically similar during state socialism, communities settled by diverse migrants in the 1940s registered higher incomes and greater entrepreneurship follow- ing the transition to a market economy. Their residents also express greater confidence in formal institutions, such as courts and the police. ∗Ph.D. Candidate, Department of Government, Harvard University, [email protected]. Fieldwork for this project was funded by the Social Science Research Council’s Mellon International Dissertation Research Fellowship (IDRF) and the Krupp Foundation’s Center for European Studies Graduate Dissertation Research Fellowship. 1 1 Introduction The impact of diversity on social organization and economic outcomes is a topic of great discussion. Some believe that diversity undermines the formation of informal private-order institutions – such as communities, business networks, guilds, and collective reprisal systems – that reduce transaction costs and facilitate economic exchange (Greif, 1989, 2006; North, 1981). This is why, the argument goes, diversity lowers public goods provision and weakens overall economic performance. What has been largely overlooked in this literature, however, is that while diversity weakens in- formal norms and networks, it also increases the incentives to adopt more formal and complex insti- tutional solutions and to rely on state enforcement. Long-run economic implications of diversity may thus be conditional on the effectiveness of formal legal institutions. Indeed, to the extent that diversity increases demand for formal rules, it may facilitate economic development by enabling arm’s length transactions and removing barriers to entry that often accompany more informal coordination and enforcement practices. I test this argument using an original micro-level dataset on the size and diversity of migrant pop- ulation settled in 1,217 communities transferred from Germany to Poland in the aftermath of World War II (WWII). In 1945, Poland ceded 46% of its prewar territory east of the Curzon line to the Soviet Union and gained an equivalent 26% of its prewar territory from Germany. The shift in borders trig- gered resettlement of nearly six million people, or one-fifth of Poland’s pre-war population, from the USSR, Central Poland, and Western and Southern Europe into the communities abandoned by ethnic Germans. Arbitrary resettlement procedures adopted by the Polish authorities produced varying de- grees of cultural heterogeneity at the local level. Some formerly German municipalities were settled by Polish migrants from the same region, while others were populated by migrant groups of different origins. Polish communities resettled earlier in the process were able to stay together upon migration while the communities resettled at later stages were dispersed across different areas. The resulting variation in the composition of migrant communities allows us to examine the importance of shared norms and networks for institutional development and long-run economic outcomes. This paper shows that homogeneous migrant groups were more likely to establish informal private- 2 order institutions, such as volunteer fire brigades, while diverse migrant groups faced greater coor- dination challenges and eventually came to rely on formal legal institutions and state organizations. I further show that although greater reliance on formal institutions in diverse communities produced no economic benefits during state socialism, it began to pay off after Poland transitioned to a market economy in 1989. In the 1990s and 2000s, communities settled by diverse migrant groups had higher per capita incomes and greater entrepreneurship levels than communities settled by migrants from the same region. Moreover, firm owners and managers operating in historically diverse communities were less likely to report encountering obstacles such as corruption, inadequate functioning of the judiciary, theft, and organized crime in the 2005 Business Environment and Enterprise Performance Survey (EBRD-World Bank). More recent survey data also indicates that historically diverse com- munities perceive formal institutions and related organizations more favorably: In the 2010 Life in Transition (LiTs) survey, trust in the government, the courts, and the police was higher in the localities populated by diverse migrant groups in the 1940s (EBRD). These results suggest that different levels of cultural diversity, at a critical historical juncture in Poland’s history, not only led to different patterns of social organization at the micro-level, but also resulted in divergent economic outcomes. Paradoxically, forced migration and an increase in cultural diversity produced a wealthier and more entrepreneurial society more than half a century later. The paper builds on the body of research that emphasizes the importance of formal institutions and third-party enforcement for economic development (Greif, 1993, 1994; Woolcock, 1998; Cook et al., 2004; Ogilvie and Carus, 2014). My findings confirm that markets function best when supported by formal rules that apply uniformly to all economic agents (Ogilvie and Carus, 2014). I advance on this work, however, by emphasizing variation in the reliance on formal institutions across different communities subject to the same laws and regulations (Hendley, 1999). The findings suggest that we need to pay attention not only to the effectiveness of formal institutions, but also to their use by economic actors, which may depend on the availability of informal institutional alternatives (Gans- Morse, 2016). Indeed, even when the formal institutional environment is conducive to economic exchange, informal enforcement and coordination mechanisms may continue to predominate. The observation that diverse communities are more economically successful than homogeneous 3 communities challenges the predominant view of diversity as harmful to economic development and suggests that in the long run, a society can minimize the costs and maximize the benefits of diversity by adopting appropriate institutional mechanisms. My findings also challenge the prevailing view of social capital – defined as norms and networks that facilitate collective action – as contributing to eco- nomic growth (Knack and Keefer, 1997; Woolcock, 1998) and weakening with cultural heterogeneity (Alesina and Ferrara, 2002, 2000; Costa and Kahn, 2003; Putnam, 2007). I find that in the Polish case, diversity undermined some indicators of social capital (volunteer fire brigades), reinforced others (in- stitutional trust), and failed to affect yet others (sport clubs, generalized trust). Overall, however, my analysis suggests that informal norms and networks may be a poor substitute to formal institutions in developed market economies such as Poland. The remainder of the paper is organized as follows. The next section presents the argument on the effects of cultural diversity on informal and formal institutions and economic outcomes in more detail. Then I provide a brief background on population transfers in Poland and apply my theory in the Polish context. Description of data, measurement strategies, and regression analyses follow. I conclude by discussing the contributions of this research and the generalizability of my findings. 2 Theoretical Argument I start with the insight that community-level characteristics, such as cultural homogeneity or diversity, shape how cooperation is enforced at the local level (Greif and Tabellini, 2015). Homogeneity - – in ethnicity, language, religion, or social status — confers a comparative advantage to informal enforcement mechanisms that rely on shared norms and networks (Bandiera et al., 2005; Habyarimana and Weinstein, 2009; Miguel and Gugerty, 2005) and reduces demand for more formal enforcement procedures. Culturally diverse societies, on the other hand, lack dense intergroup ties and shared norms and thus have more to gain from adopting formal legal institutions1 that are generally provided and enforced by the state. In the language of transaction cost economics, cultural differences and weak intergroup ties increase exchange hazards and thus the need for more complex and formal enforcement 1The paper uses Gans-Morse’s (2016) definition of formal legal institutions as “both the formal rules (e.g., laws and government decrees) that shape economic relations and also the state organizations charged with enforcing these rules.” 4 and coordination mechanisms (Williamson, 1985).