Institutions as the ultimate causes of growth
# 7
11 October 2016
The institutions hypothesis
The institutions are the “rule of the game”
they are determined by individuals (groups) as members of a society
they place constraints on behaviour
they shape behaviour by determining incentives
Institutions are humanly-devised, man-made
factors, vs geography (out of control) and culture (a very slowly changing variable)
They do not come out of the blue but are a complex product of choices and conditions
Efficient and inefficient institutions
Societies may chose different economic institutions. The efficient ones:
protection and enforcement of property rights partial or impartial judicial systems
financial arrangements (how much efficient is borrowing money for businesses?)
business and labour regulation (how much open and free is entering into a new line of business or occupations?)
education and training opportunities
Extractive vs inclusive institutions
Inclusive economic institutions are those
institutions that encourage the participation of the great/vast majority of the population in economic activities by best allocating talents and skills
Extractive economic institutions are those institutions shaped by those who control
political power to extract resources from the rest of the society
typically, a dictatorship, an absolute monarchy
A natural experiment of history:
North and South Korea
South Korea has a legal system in which private contracts are recognised (property rights) and enforced, a market economy allocating K and H, whilst North Korea has a dictatorship, the opposite of the rule of law
A second experiment:
Austria and her neighbours
A more reliable experiment?
“The West” and “the Rest”
A long-term growth process with diverging areas depending on sets of different
institutions is represented by how “the West” expanded after 1500
A larger number of observations
(countries), a longer term process (i.e., a larger sample over a longer time period) This experiment is a good test for the
institutions hypothesis
The reversal of fortune
When considering
“the Rest” a
reversal of fortune between differently colonised zones emerges
The poorer areas in 1500, proxied by urbanisation rates, are today the
richest areas across the world Why?
Understanding
the reversal of fortune 1/2
The geography hypothesis could argue that
poorer countries today are so because of less productive semitropical soils in comparison to temperate soils (North America)
But the opposite is true: in 1500 North America was poorer and other areas such India and North Africa were comparatively more
prosperous!
Europeans established more extractive
institutions in places that were more populated to funnel gold and agricultural surplus
Understanding
the reversal of fortune 2/2
On the contrary, Europeans set up more
inclusive institutions in areas that were less populated and developed
Such a simple strategy was conceived in order to extract wealth and income by controlling former empires (Aztec and Inca in America, Mogul in India): labour, riches, income flows whilst setting up inclusive institutions where
Europeans themselves were settlers, like in North America or in Australia and New
Zealand, i.e. scarcely populated areas
Urbanisation rate in 1500 and institutions in 1995
Population density in 1500 and institutions in 1995
Efficient institutions and settlers’ mortality
Inclusive institutions
as a key factor for growth
An environment where market participants are not harassed by excessive
regulations, or corruption, or paralysed by uncertainty about the future
will provide a better place in which actors
will work harder and invest more being
more able to innovate with a higher risk
taking and experimentation propensity
The great divergence
# 8
12 October 2016
The great divergence
Differences in prosperity (GDP per capita) in 1500 were relatively small
After 1500 some countries became richer while others lagged behind with low per capita
income
But when they became rich and inequality began to take place?
Between 1500 and 1800 the rich countries forged a small lead
Between 1820 and the present the income gap expanded with few exceptions
The great (and the little) divergence:
GDP per capita levels in 1990 international dollars
According to Broadberry
[2015] Britain and the Netherlands forged ahead of Italy and Spain in the 17th and 18th centuries, while Asian GDP per capita was lower even before the early modern period
England/
GB
Holland/
NL
Italy Spain Japan China India
725 551
900 476
980 1,247
1020 1,518
1050 1,458
1086 754 1,204
1120 1,063
1150 508
1280 679 957 552
1300 755 1,482 957
1348 777 876 1,376 1,030
1400 1,090 1,245 1,601 885 960
1450 1,055 1,432 1,668 889 552 983
1500 1,114 1,483 1,403 889 1,127
1570 1,143 1,783 1,337 990 968
1600 1,123 2,372 1,244 944 605 977 682
1650 1,110 2,171 1,271 820 619 638
1700 1,563 2,403 1,350 880 597 841 622
1750 1,710 2,440 1,403 910 622 685 573
1800 2,080 1,752 1,244 962 703 597 569
1850 2,997 2,397 1,350 1,144 777 594 556
GDP per capita around the world, 1820-2008 (US1990$)
In 1820 Europe (+
Western offshoots) was the richest
continent but there are
differences in
Europe as well (NL and UK)!
The richest countries in 1820 have grown the most
The divergence equation
Since 1820 the inequality has increased as the richest have grown constantly richer, whilst the poorest achieved modest income gains
Some exceptions in
Asia (and China may follow this pattern today)
A periodization of growth
The Mercantilist Era, 1500-1800 ca
from an integrated global economy to the Industrial Revolution
The Westerners Catch-up Era, 1800-1900
catch-up policies in Europe and USA madeindustrialisation a priority
The Big-Push Era, 1900-present
closing the gap with the West by using planning and investment coordination
Models and growth strategies
1500-1800: a global economy
The “Atlantic trade”: Europe, Africa and Asia
European countries sought to increase trade and manufactures by colonies, tariffs and wars – de- industrialising colonies
1800-1900: catch-up strategies (a first variant)
creating a unified national market (tariffs &
transportation infrastructures)
protectionism (“levelling the playing field” vs UK)
modernising financial systems to stabilise currency and finance industrialisation (K)
mass education to upgrade the labour force (H)
Models and growth strategies
1900-present: the Big Push (a second variant)
The effective policies that had worked in Western Europe and USA proved to be less effective in backward countries
Most technology is created in rich countries to foster the productivity of expensive labour (N) by using more capital (K)
Such technologies are not always cost-effective in low-wage countries albeit that is what they need to catch up with the West
The Big Push: planning and investment coordination to jump ahead
How can we explain the great divergence?
Industrialisation and de-industrialisation have been major causes of the
divergence in world income
In 1750 most of the world’s manufacturing took place in China (33%) and the Indian subcontinent (25%)
In 1913 the world had been changed: the
UK, the USA and Europe accounted for
three-quarters of the total
The distribution of world’s manufacturing, 1750-2006
The Western World increased its manufacturing share up to the early 1970s reducing it after the East Asian miracle after WWII and recently because of the China’s industrialisation
If China and East Asia caught up with the West the world would come full circle to the starting point!
Why did China and India
de-industrialise in the XIX cent.?
The Asian decline as the workshop of the world in the XIX century was a decline in productivity
from exporting manufactures to exporting commodities (raw materials + primary goods) → a vicious circle, a poverty trap
The spread in labour productivity
deepened while Britain was
industrialising (and even more so after
industrialisation spread in the West)
The productivity differential
The great divergence is related to the differential in productivity, in turn
depending on technological trajectories
how much capital intensive and laboursaving?
Technological dynamics depend on the
incentives to use capital instead of labour
→ the relative prices (K and N) explain the
variance in technological capabilities
The real wages
To assess the incentive to use machinery (K) instead of labour (N), that is K/N, a
different measure than GDP per capita is adopted (hard to compute and misleading)
the real wages can solve this problem by calculating the living standard that can be bought with one’s earnings
the labourers’ living standard is obtained by comparing their wages to the averaged
prices of consumer goods (consumer price index)
The subsistance ratio for labourers
The consumer price index (CPI) is calculated as the cost of maintaining a man “at bare bones subsistence”
The graph shows the ratio of full-time earnings to the
family’s cost of subsistence (an exercise in comparing
“the breadwinner”)
A great divergence in real wages occurred within
Europe and between Europe and Asia
The subsistence ratio in London and Beijing in the very long run
The divergence in the
subsistence ratio between London (4 times) and
Beijing became
astonishingly clear-cut after 1850-70, up to fifty times Today the vast majority of
workers live at bare bones subsistence levels, with a 15% of the world population below the poverty line ($1 per day at 1990 values)
High wages
and economic growth
The real wages approach allows to assess living standard as the overall wellbeing:
longevity, health, height, education
high wages foster economic progress by sustaining good health and education
High wages are a good incentive to invent and adopt machinery to raise
productivity
Whilst the opposite is a sort of poverty trap
The industrial revolution
as a response to high wages
According to Allen the industrial revolution in England is not the cause of high
wages, but it was a creative response to high wages
The model is centred on relative prices:
high wages were a good incentive to save expensive labour, whereas low wages encourage the use of this factor as main input with cumulative and incremental effects over time: so the gap deepens…
The rise of the West
# 9
13 October 2016
The “Smithian growth”
Institutions, technological change and
economic policies matter, but they are to be put in the right context
The “Smithian growth” [Smith, 1776]:
institutions promoted peace, order and good government
as a result, trade flourished and regional specialisation increased, cities expanded income increased as a consequence of a
rise in productivity
The Smith’s model in a flow diagram
The first globalisation
The first globalisation began as soon as technological changes occurred in ship- building techniques
The newly invented full-rigged ship in the late XV cent. allowed to sail the high seas
(Columbus, Magellan, etc.)
The use of such vessels was conducive to the integration of international markets in
Europe first, across the world afterwards The grain market and the “new draperies” (a
shift from Italy to Flanders and England) The Voyages of Discovery by the Portuguese
in search of all-water routes to outcompete the Venetians (Vasco da Gama, 1498)
The quest for… pepper
The efficiency gains from all-sea routes may be measured by the price of pepper
The Portuguese benefited from the cut in transport costs keeping the price high and pocketing the
savings as profits
The arrival of English and Dutch East Indies Companies broke the Portuguese monopoly
The European consumers reaped most of the efficiency gains
A sea change in the sea routes
The Voyages of Discovery promoted a string of colonial empires
Spanish and Portuguese empires in the 16th century (the Americas; Brazil, Indian Ocean, Indonesia): but pursuing different strategies English and Dutch empires since the early 17th
century mingling imperialism with private enterprise (East Indies Companies, 1600, and VOC, 1602)
The Mediterranean routes lost weight and
the Oceans became the key trade axis
The Atlantic trade system
The Atlantic
trade system developed from the mid- 17th century and entailed a regional division and specialisation of labour
The European consequences
The growth of colonies in America and Asia boosted the European export-led
manufacturing, as well as cities (services) Dutch and English trade with their colonies
drove their economies forward as a higher level of the aggregate demand
provided room for specialisation of labour changed the occupational structure
accordingly
Changing economies
and the divergence within Europe
The occupational
structure shows the impact of colonial trade and empires on the European economies
The Mediterranean regions stagnated after 1500, thus a divergence took place in Europe
Globalisation and growth
The first globalisation transformed some countries (UK + NL) by fostering
urbanisation and export-led manufacturing which pushed up real wages
while a higher demand for primary goods stimulated an agricultural revolution (high farming)
and an energy revolution (coal in England) but high wages encouraged education as
well
The energy revolution
The emerging energy paradigm (coal) had a side effect on
technologies as it promoted related technological
progress in the 18th century, rather
consistent with labour saving incentives
and England has the largest coal mining industry in the world!
The human capital:
literacy as a very rough measure
The high-wage economy generated a high level literacy, numeracy and skill formation
Adult literacy in Europe rose everywhere, but the most in northwestern Europe The expansion of commerce
and manufacturing made education economically valuable
