Geography, Institutions and Development

GDP OF ECONOMIES FOR A LONG PERIOD

 Geography, Institutions and the Poverty of Nations

• There are tremendous differences in incomes and standards of living between the rich and
the poor countries of the world today.

• Why the economic fortunes of countries have diverged so much?

• Poor countries often lack functioning markets, their populations are poorly educated, and
their machinery and technology are outdated or nonexistent. These are, however, only
proximate causes of poverty. (We are going to discuss proximate causes in more detail in
subsequent classes. You also studied some of them in growth models in your
macroeconomics class. Please revise them to understand better)

• There must be some fundamental causes of poverty, leading to these outcomes, and via
these channels, to dire poverty.
 Geography, Institutions and Poverty of Nations

• The two main popular candidates for the fundamental causes of cross-country
differences in prosperity
– Geography
– Institutions (the rules of the game in a society or, more formally, are the humanly devised
constraints that shape human interaction-In consequence they structure incentives in human
exchange, whether political, social, or economic (North 1990))

• Geography hypothesis: geography, climate, and ecology of a society’s location shape

both its technology and the incentives of its inhabitants.

• Institutions hypothesis: some societies are organized in a way that upholds the rule of
law, encourages investment in machinery, in human capital, and in better technologies,
facilitates broad-based participation in economic and political life by the citizens, and
supports market transactions.
Geography
 Geography
• Perhaps the deepest source of heterogeneity between countries is the natural
environment they happened to be endowed with.

• Jarred Diamond (in his 1999 Pulitzer-Prize-winning book Guns, Germs and Steel) described
geography as a plausible candidate for a determinant of broad development paths.

• Diamond suggests that one key reason Europe conquered America, and not the other way
around, was that Europe had an endowment of big animal species that were relatively easy
to domesticate, which in turn led to improved immunisation by humans exposed to animal-
borne diseases, and more technological advances.

• You can watch the you tube video by Marginal Revolution University on Diamons’s book.
https://www.youtube.com/watch?v=6GshzzmJBGM&t=78s
 Geography Hypothesis
• There are three main versions of the geography hypothesis.

i) Climate may be an important determinant of work

effort, incentives, or even productivity.

“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, and people are more vigorous in cold climates.
The inhabitants of warm countries are, like old men,
timorous; the people in cold countries are, like young men,
brave”
- Montesquieu ([1748], 1989)

“Vigour depends partly on race qualities:

but these, so far as they can be explained at all, seem to be
chiefly due to climate“
– Marshal (1890, p. 195)
 Geography Hypothesis
ii) Geography may determine the technology available to a society, especially in
agriculture.
"By the start of the era of modern economic growth, if not much earlier,
temperate-zone technologies were more productive than tropical-zone technologies..."
- Sachs, 2001

"serious study of the problems of underdevelopment... should take into account the climate
and its impacts on soil, vegetation, animals, humans and physical assets - in short, on living
conditions in economic development"
- Gunnar Myrdal, 1968

"...proximate factors behind Europe's conquest of the Americas were the

differences in all aspects of technology. These differences stemmed ultimately from
Eurasia's much longer history of densely populated...[societies dependent on food
production].," which was in turn determined by geographical differences between Europe
and the Americas
-Jared Diamond, 1997
 Geography Hypothesis
iii) The third variant of the geography hypothesis links poverty in many areas of the world to
their "disease burden“.
"The burden of infectious disease is similarly higher in the tropics
than in the temperate zones“
-Sachs, 2000

• Bloom and Sachs (1998) claim that the prevalence of malaria, a disease which kills millions of
people, particularly children, every year in sub-Saharan Africa, reduces the annual growth rate
of sub-Saharan African economies by more than 1.3 percent a year.

• This is an enormous effect, implying that with malaria eradicated in 1950, income per capita in
sub-Saharan Africa would have been double of what it is today.

• The basic idea is very simple: unhealthy people are less productive.
 Correlation between Geography and Development

Distance from the equator and income

• The scatter plot shows that

countries that are closer to the
equator are poorer on average.

• To what extent these

geographical differences underlie
the ultimate performance?

• This is not an easy empirical

question

Source: Acemoglu (2012)

 Correlation between Geography and Prosperity
• In the last slide, we have seen a very high degree of correlation between geography and
prosperity.

• Does this evidence establish that geography is a first-order influence on prosperity?

• It is true there is a correlation between geography and prosperity, i.e., a simple statistical
association.

• But statistical association does not prove causation. This is because there are often
omitted factors driving the associations we observe in the data.

• Example: History of malaria and omitted variable

• Similar to the case of Malaria, it is quite possible that an omitted factor, some
institutional feature, is the root cause of the poverty of many tropical countries, and the
statistical association between geography and poverty is a mere correlation and no more.
Institutions
 Institutions hypothesis

• While the geography hypothesis emphasizes "forces of nature" as a primary

factor in the poverty of nations, the institutions hypothesis is about "man-
made" influences.

• Three crucial elements of good institutions are:

– First, enforcement of property rights for a broad cross-section of society, so that a

variety of individuals have incentives to invest and take part in economic life;
– Second, constraints on the actions of elites, politicians and other powerful groups
so that these people cannot expropriate the incomes and investments of others in the
society or create a highly uneven playing field; and

– Finally, some degree of equal opportunity for broad segments of the society, so that
they can make investments, especially in human capital, and participate in productive
economic activities.
 Correlation between Institution and Prosperity

• As was the case with geography, this statistical association between institutions and development, also does not
prove causation.

• It could once again be omitted factors, or even reverse causality (the fact that richer countries can afford better
institutions, better protection against arbitrary behaviour and better constitutions), which account for the
associations depicted in these Figures.

• In order to understand the causation, we need to differentiate the impacts of geography and institutions.
 How to differentiate the impact of Geography and Institution?

• How can we make progress in distinguishing between the roles of geography and
institutions as fundamental causes of prosperity and poverty?

– Natural experiments
 Natural Experiments of History
• In the natural sciences, causal theories are tested by conducting controlled experiments.

• Controlled experiments are much harder to conduct in the social sciences (Fortunately).

• We cannot change a country’s institutions and watch what happens to the incomes and
welfare of its citizens

• Fortunately, history offers many natural experiments, where we can convincingly argue that
one factor changes while other potential determinants of the outcomes of interest remain
constant.

• In order to track the effects of institutions on economic prosperity, the most direct sort of
natural experiment would be one where a homogeneous country is divided into two, each
part with very different institutions.
 Natural Experiments of History: Korea

The history of Korea since World War II offers such a natural experiment (Yeon 1988)
While this natural experiment is very appealing, it is not sufficient for our purpose. Why?
 Natural Experiments of History
A case of intensive experiments
• The evidence of Korea is not sufficient for our purposes of establishing the importance of
institutions because -

– First, this is only one case, and in the better-controlled experiments in the natural sciences, a
relatively large sample is essential.

– Second, here we have an example of an extreme case, the difference between a market-
oriented economy and a communist one.

– Few social scientists today would deny that a lengthy period of totalitarian centrally planned
rule has significant economic costs. And yet, many might argue that differences in institutions
among capitalist economies or among democracies are not the major factor leading to
differences in their economic trajectories.

• To establish the major role of institutions in the prosperity and poverty of nations we
need to look at a larger scale "natural experiment" in institutional divergence.
History, Colonization, Institution and Development
 The Reversal of Fortune: Colonization
• The colonization of much of the globe by Europeans starting in the 15th century
provides such a natural experiment.

• The colonization experience transformed the institutions in many lands conquered or

controlled by Europeans, but, by and large, had no effect on their geographies.

• Therefore, if geography is the key factor determining the economic potential of an

area or a country, the places that were rich before the arrival of the Europeans should
continue to be rich after the colonization experience as well, in fact also today.

• If, on the other hand, it is institutions that are central, then those places where good
institutions were introduced or developed should get richer compared to those where
Europeans introduced or maintained extractive institutions.
 The Reversal of Fortune
• Historical evidence suggests that Europeans set up very different institutions in various
colonies.

• At one extreme, they set up extreme extractive institutions.

Ex: Belgian colonization of the Congo, slave plantations in the Caribbean or forced labour
systems in the mines of Central America.

• These institutions introduced neither protection for the property rights for citizens nor
constraints on the power of elites. So there were no equality of opportunity of individuals.

• At the other extreme, many Europeans went and settled in a number of colonies, creating
settler societies, replicating, and often improving, the European form of institutions
protecting private property. The settlers in these societies also managed to place significant
constraints on elites and politicians, even if they had to fight to achieve this objective.

Ex: Australia, New Zealand, Canada, and the United States.

The Reversal of Fortune
 The Reversal of Fortune
• So what happened to economic development after colonization?

• Did places that were rich before colonization remain rich, as suggested by
the geography hypothesis?

• Or was there a systematic change in economic fortunes associated with the

changes in institutions?
 The Reversal of Fortune

• The historical evidence shows no evidence of the persistence suggested by the

geography hypothesis.

• On the contrary, there is a remarkable Reversal of Fortune in economic prosperity.

• Societies like the Mughals in India, and the Aztecs and the Incas in America that
were among the richest civilizations in 1500 are among the poorer societies of
today.

• In contrast, countries occupying the territories of the less-developed civilizations in

North America, New Zealand and Australia are now much richer than those in the
lands of the Mughals, Aztecs and Incas.
The Reversal of Fortune: Evidence

• In 1500, when we don’t have a

good measure of GDP per
capita, prosperity can be
measured by urbanisation.

• Urbanization can be measured

by population size of a
particular place.

• The places those were less

urbanised in 1500, are rich
today. Provides support for
reversal of fortune
The Reversal of Fortune: Evidence

• The places were sparsely

populated in 1500, are rich
today.

• Provides support for reversal

of fortune
 Institutional Reversal

• Is the Reversal of Fortune consistent with the institutions hypothesis?

• Yes. Once we look at the variation in colonization strategies, we see that the Reversal of Fortune is
exactly what the institutions hypothesis predicts.

• European colonisation made Europeans the politically powerful group with the capability to influence
institutions more than any indigenous group was able to at the time.

• So, we expect Europeans to have done so not according to the interest of the society as a whole, but in
order to maximize their benefits.

• And this is exactly what the historical evidence suggests happened.

• In places where Europeans did not settle and thus did not care much about aggregate output or
welfare, in places where there was a large population to be coerced and employed for cheap in mines
or in agriculture, or simply taxed, in places where there was a lot to be extracted, Europeans pursued
the strategy of setting up extractive institutions.
 Institutional Reversal
• In those colonies, there were no constraints on the power of the elites, and no civil or
property rights for the majority of the population; in fact, many of them were forced labourers
or slaves.

• In contrast, in other colonies Europeans settled in large numbers and developed the laws and
institutions of the society to ensure that they themselves were protected, both in their
political and economic lives.

• In these settler colonies, the institutions were therefore much more conducive to investment
and economic growth.

• The relatively densely settled and highly urbanized colonies ended up with extractive
institutions, while sparsely-settled and non-urbanized areas received an influx of European
migrants and developed institutions protecting property rights and constraining elites.

• European colonialism therefore led to an institutional reversal, in the sense that the richer
places ended up with worse institutions.
 Institutional Reversal

• We find further support for the view that the Reversal of Fortune is related to the
institutional reversal and the effect of this institutional reversal on long-run growth

• In the fact that there appears to be no comparable reversal among countries not
colonized by Europeans between 1500 and today, and nothing of the sort in the
colonized or non-colonized samples between 1000 and 1500.

• Something special, most probably related to changes in institutions, took place in

these lands after colonization.
Evidence in support of Institutional Reversal

• The figure shows average

urbanization in colonies with
relatively low and high
urbanization in 1500.

• The initially high-urbanization

countries have higher levels
prosperity until around 1800.

• At that time the initially low-

urbanization countries start
to grow much more rapidly
and a prolonged period of
divergence begins.
Evidence in support of Institutional Reversal

• The figure shows industrial

production per capita in a number
of countries.

• There was more industry (per capita

and total) in India in 1750 than in
the U.S.

• By 1860, the U.S. and other colonies

with relatively good institutions,
such as Australia and New Zealand,
began to move ahead rapidly, and
by 1953, a huge gap had already
opened up.
 Alternative hypotheses like colonial
plunder and sophisticated geography
 Is reversal consistent with colonial plunder hypothesis?
Nature of colonial trade:

• This hypothesis would be an extension of the

Marxist analyses of colonialism- Colonies as
suppliers of raw materials and labour;
Destruction of indigenous production of
manufacturing goods in colonies

• But if plunder were the cause of the reversal,

we would expect the reversal to happen shortly
after colonization, which witnessed the most
intense plunder.

• Instead, it takes place mostly in the 19th

century, significantly later, at least for the
Americas.

• This indicates that the reversal is not the direct

consequence of colonization per se, but results
from the institutions that were put in place by
the colonial powers with the aim of extracting
resources.
 Can the Geography Hypothesis Be Salvaged?
Sophisticated Geography Hypotheses

• It is possible to develop more sophisticated geography hypotheses predicting time-varying effects of

climate, ecology or disease environments.

• Perhaps certain geographic characteristics that were not useful, or were even harmful, for successful
economic performance in 1500 turned out to be beneficial later on.

• The “temperate drift hypothesis," argues that areas in the tropics had an early advantage, but later
agricultural technologies, such as the heavy plow, crop rotation systems, domesticated animals, and high-
yield crops, have favoured countries in the temperate areas.

• However, the evidence is not consistent with the temperate drift hypothesis.

• According to the temperate drift hypothesis, the reversal should have occurred when European
agricultural technology spread to the colonies.

• Yet, while the introduction of European agricultural techniques, at least in North America, took place
earlier, the reversal occurred mostly during the 19th century and is closely related to industrialization.
 Question still remains.

Why the settlers decide to settle in

one place and decide to extract
others??
 Mortality of European Settlers
Another Source of Divergence in Institutions

Institutions today are much worse in places with higher settler mortality
Mortality of European Settlers
• The figure shows a
very strong
association between
these mortality rates
and economic
prosperity today,
again as measured by
income per capita.

• Countries that had

lower mortality rates
for European settlers
are now richer.
 Mortality of European Settlers:
What explain this pattern?
• The association works through the effect of these mortality rates on European
settlement and institutional development.

• In places where they faced high mortality rates, Europeans did not settle and
typically introduced extractive institutions.

• Extractive institutions have a lot of staying power; for example, groups who
benefit from using the power of the state to expropriate others will resist and
attempt to block any move towards better institutions.

• As a result, in many cases extractive institutions persisted from colonial times

to today and still adversely affect economic growth.
 Mortality of European Settlers
What explain this pattern?

• Overall, the evidence both from the Reversal of Fortune and from the
divergent patterns of institutional development driven by differences in
European settler mortality rates points to the same conclusion:
institutions have a large and quantitatively important effect on
economic prosperity today.

• What's more, once we recognize the importance of institutions on

economic performance, geography seems to play a relatively small role
in the large cross-country differences in prosperity today.
 Conclusion
• The evidence presented so far makes a fairly convincing case that it is
institutional differences, not geographic factors, which are at the root
of the very large differences in economic prosperity we observe today.

• Yes, countries near the tropics are poorer than those in temperate
areas. But this does not reflect the effect of climate or ecology on
economic outcomes, simply the fact that a key determinant of
prosperity, institutions, differs between these areas. Institutions differ,
in turn, because institutions in many parts of the world today are
shaped by the colonial history of these areas.

• Europeans were more likely to settle in the temperate areas and

develop institutions encouraging investment and economic progress,
and they were more likely to set up extractive institutions in tropical
areas and in areas that were at the time more prosperous and
densely settled, which were also typically the ones near the tropics.
• Does this all mean that geography is unimportant?
The answer is No.

• There is no evidence that geography plays a major direct role in the very large differences in
income per capita and growth potential of countries today.

• But this does not mean that geography is unimportant.

• It is important in at least four major ways.

• First, geography and diseases almost surely matter for economic outcomes. There can be
no agriculture at the poles, and it is a truism that healthy individuals will be more productive
and motivated in their work, in school and in their lives.

• The statement here is that the effects of geography and diseases are not a major factor in
explaining the tremendous cross-country differences in prosperity, not that geography and
diseases have no economic effects at all.
• Second, geography is not at the root of the tremendous differences in economic
prosperity today does not mean that it was unimportant in history.

• It is quite possible that geographic differences shaped why some areas were richer than
others more than 500 years ago.

• Third, geography could have an effect via institutions, especially during a particular
historical juncture. After all, the disease environment is a geographic characteristic of
many tropical areas. However, the major effect of disease environments was not direct,
but indirect: during the particular episode of European colonization, they determined
whether Europeans could settle and therefore, which types of institutions developed.

• Finally, even if geography has no effect on income per capita, it does have significant
effects on "social welfare", properly measured. Many parts of the world, especially
many parts in the tropics, suffer from poorer health and higher mortality and morbidity
than North America and Western Europe, partly because of their geographic
characteristics.
 References
• John Luke Gallup, Jeffry D. Sachs, and Andrew D. Mellinger. Geography and economic
development. NBER Working Paper No. w6849., December 1998.

• David E. Bloom, Jeffrey D. Sachs, Paul Collier, and Christopher Udry. Geography,
demography, and economic growth in africa. Brookings Papers on Economic Activity,
2:207–295, 1998.

• William Easterly and Ross Levine. Tropics, germs, and crops: the role of endowments in
economic development. Journal of Monetary Economics, 5:3 – 39, 2003.

• Daron Acemoglu, Simon Johnson, and James A. Robinson. The colonial origins of
comparative development:An empirical investigation. American Economic Review,
91(5):1369–1401, December 2001.

• Daron Acemoglu, Simon Johnson, and James A. Robinson. Reversal of fortune:

Geography and institutions in the making of the modern world income distribution.
Quarterly Journal of Economics, 117(4):1231–1294, November 2002.