A Theory of Institutions

Question 1

Why Nations Fail: According to Acemoglu, Johnson

Answer 1

-Extractive Economic institutions

Question 2

What do Inclusive Economic Institutions entail?

Answer 2

-Unbiased system of law
-secure property rights
-provisions of public services that level playing field (education, roads, electricity)
-permit entry of new businesses–> allow ppl to choose their careers
-this leads to those who have good ideas to start businesses
-workers will tend to go to activities where their productivity is greater
-less efficient fims can be replaced by more efficient ones (creative destruction)
-incentives to innovate with new tech
-invest in education

Question 3

What is Creative Destruction?

Answer 3

-Strong centralized state (a weak state does not have the resources or tax provision to implement them)
-Pluralistic state

Question 4

Pluralistic State

Answer 4

-a broad cross-section of society in power

Question 5

Absolutist State

Answer 5

-State with only elites at the top controlling everything

Question 6

What does pluralism entail?

Answer 6

-broad cross-section of society in power
-broad distribution of power
-must have checks and balances on power by judiciary, parliamentary system, media, civil society
-pluralism is diff from democracy–> one can have voting without all these checks and balances (voting isn’t an effective power check)

Question 7

Why does pluralism entail inclusive institutions?

Answer 7

When you have pluralism, a broad cross-section of society in power will demand inclusive economic institutions ie. secure property rights, justice and public goods for all.

Question 8

Who decided political institutions?

Answer 8

-Those with political power
-if elites–> extractive institutions
-if cross-section of society–> inclusive institutions

Question 9

Why do elites prefer extractive institutions?

Answer 9

Because of:
1. Fear of creative destruction
2. Limited commitment issue

Question 10

what determines the distribution of economic resources?

Answer 10

Economic institutions at time t-1 ie. in the past

economic institution at t-1–> political power–> political institutions–> economic institutions

Question 11

Negative Feedback Loop

Answer 11

economic institutions at (t-1) favor elite–> extractive political institutions–> extractive economic institutions

Question 12

Positive Feedback Loop

Answer 12

economic institution at (t-1) enable the gains to be widely distributed–> political power to a broad cross-section–> inclusive political institutions–>inclusive economic institutions

Question 13

What is “First Great Divergence”

Answer 13

The Atlantic Divergence:
-the major profit opportunity in 1500 was Atlantic trade
-Opening of sea routes to the New World, Africa, Asia; Colonization; Slavery
-Atlantic traders: Britain, France, Netherlands, Portugal, Spain
-phenomenon of trade driven by the Atlantic port
-western european cities without atlantic ports were equivalent to eastern european cities in terms of city size
-proof that atlantic trade is driving the first great divergence

Question 14

Iberia vs England

Answer 14

-in iberia, there were no positive spillovers to cities not ports
-in england, there were positive spillovers to cities not ports

Question 15

England vs Spain 1600

Answer 15

No problem for spain monarchy–> wealth form colonies since 1492 meant that the monarchy did not have to depend on the masses for taxation, because they already had enough wealth
-bigger problem for Elizabeth I bc england did not have this power–> in exchange for tax revenue, there was no monopoly on Atlantic trade in England–> the queen of England was poor compared to the king of spain therefore she needed tax revenue and the permission of parliament–> she was unable to hold onto a royal monopoly

Question 16

England and the Atlantic trade

Answer 16

-they had no monopoly on Atlantic trade
-massively enriched a broad cross-section of merchants

Question 17

English Civil War 1640

Answer 17

-Between king and parliament
-merchants financed war with their wealth from the trade and won
-outcome: king cannot rule without parliaments consent (beginning of pluralism and inclusive institutions)

Question 18

Rise of Europe Summary- England

Answer 18

-no royal monopoly on Atlantic trade enriched merchants, who demanded political power
-led to inclusive political institutions (parliament)
-culminated in glorious revolution in 1688: constitutional monarchy (restricted kinds power substantially)
-built inclusive economic institutions to favor these merchants

Question 19

Exceptions to Institutions theory

Answer 19

-Extractive political and inclusive economic: China
-Extractive economy and inclusive political: Athens
-Nazi Germany
-Japan in WWII

Question 20

Venice (breaking of positive virtuous cycle)

Answer 20

The cycle can be broken: A positive feedback loop refers to a cycle where a process reinforces itself, leading to amplification or growth. However, this virtuous circle can be disrupted. In Venice, inclusive economic institutions like the commenda facilitated upward social mobility and demanded more political power for new trading families. Yet, existing elites threatened by this change implemented the “serrata” in 1297, closing access to political institutions and banning commenda contracts. This led to Venice’s decline from 110,000 people in 1330 to 100,000 in 1500. Similarly, in Nazi Germany and authoritarian Japan during WWII, such positive feedback loops favored by those in power eventually led to catastrophic consequences.

Question 21

Extractive political and inclusive economic reasoning

Answer 21

The concept of implementing both extractive political and inclusive economic strategies might appear advantageous to the elite. Rather than solely focusing on extracting a large share of a small economic pie, this approach involves implementing institutions that expand the size of the pie and subsequently taxing it, resulting in a small share of a larger economic pie. This strategy aims to benefit both the elite, who still retain control over political power and taxation, and the broader population through economic growth. (if it happens it’s only a transitional phase)

→ Problems:

1. Commitment issue: After creating a large economic pie through inclusive strategies, there’s a temptation for unchecked dictators to seize the entire pie.
2. Fear of expropriation: Without constraints, dictators may be inclined to expropriate wealth for themselves.
3. Fear of creative destruction: Extractive political elites may resist inclusive economic policies, fearing loss of economic and political power. (Resistance to reforms: Despite potential societal benefits, existing power structures may resist changes that threaten their status quo).

Question 22

Extractive Political and Inclusive economic in practice

Answer 22

Extractive political (elite) cannot have (or do not want) inclusive economic institutions
- If it happens, which is has (South Korea, China, Singapore) it is only a transitional phase
-Extractive political will revert back to extractive economic institutions
-Inclusive economic institutions benefit a broad cross-section who will then ask for or demand inclusive political institutions

Question 23

Extractive Growth is possible?

Answer 23

-Growth is still possible under extractive political and economic institution
-Example: forced labor (slavery)–> ancient greece, egypt, rome, several islamic and asian empires, pre-columbian civilizations, plantation economies in latin america and US, European agriculture until the 19th century under feudalism
-allocated resources to high productivity activities controlled by the elites

Question 24

The downfall of extractive growth.

Answer 24

No innovation
-No incentives to work hard, invest, think creatively
-no creative destruction
-therefore its probably short-run, only “catch-up” growth
-not sustainable

Question 25

France (institutions)

Answer 25

• An intermediate case between inclusive England and absolutist Spain
• Royal monopoly on Atlantic trade: 1600 one merchant group benefited from Atlantic activity and the protestant Huguenots in Atlantic port LaRochelle, which was the second biggest city. This new group instituted a fear of creative destruction and Louis XIII sieged de LaRochelle and Louis XIV outlawed protestantism = Royal monopoly on Atlantic trade, because extractuve institutions were implemented as a consequence ie. absolutism. King Louis XV’s Seven years’ war was poor finances and convened the Estates-general (equivalent to the Parliament) to increase taxes.

French Revolution

• Abolition of feudalism: serfdom (A Lord in charged of forcing people to work for free ie. extractive) and extortionary taxes by landed nobility = insecure property rights, because the land was owned by the Lords.
• Aboliton of guilds (association of artisans): Limited entry into profession ie. difficult to become an artisan, because people weren’t free to choose their career = extractive, blocked innovation ie. fear of creative destruction and extractive institutions.
• Consequently, they updated the legal system, implementing a new civil code ie. code Napoleon = inclusive economic institutions, which paved the way for the industrial revolution.\→ The Natural experiment:
  • Revolutionary France attacked by neighbours, because of fear of creative destruction ie. fear of revolutionary France motivating other countries.
  • French revolutionary armies invaded neighbouring countries: imposition of inclusive economic institutions (some places implemnted them others didn’t, but what occured to countries that were forced to implement them, did it lead to more development?)→ The treatment group vs. control group (they didn’t have french presence and got everything much later compared to the treatment group, because the urbanization rate follows the same outcome as the reform index

Question 26

“The Consequences of Radical Reform: The French Revolution” Acemoglu, Cantoni, Johnson, Robinson

Answer 26

-Revolutionary france was attacked by its neighbors
-so then the revolutionary french armies invaded neighboring countries in response, bringing with them the inclusive institutions
-did it lead to more development in these places?

Question 27

Ottoman Empire (institutions)

Answer 27

• An absolutist state = politically and economically extractive
  
  • High tax rates: they lacked the ability to collect taxes, because of lack of admin so they sold rights to tax farmers
  • No private property land
  • Lawlessness, banditry, insecure poperty rights
  • Commerce regulated by state ie. limited entry into a profession
  • Fear of creative destruction ie. ban of printing press that could have spread ideas threatening to the status quo and control by elites
• Consequences of the absolutist regime:
  
  • only 2-3% of citizens were literate compared to the 60 percent male and 40% female in England
  • they missed the industrial revolution
  • negative feedback loop: Europeans colonizers and elites had to incentives to change instituions

Question 28

Russia (institutions)

Answer 28

-XIXth century Russia led by the Tsar–> absolutist rulers supported by a nobility (1% of total population)
-no parliament or political representation of other groups in russian society
-economic institutions organized to make the tsar and nobility as wealth as possible–> mass system of labor coercion and control (ex: serf system: The Russian serf system was a form of forced labor that bound peasants, called serfs, to the land and to their noble landlords. Lasting from the 16th to the mid-19th century, serfs were obliged to work the land, pay taxes, and provide services to their lords. Although not slaves in the traditional sense, serfs had limited rights and freedoms and faced harsh conditions. The system hindered economic progress and contributed to social unrest. It was gradually abolished starting in 1861 under Emperor Alexander II’s reforms, aiming to modernize Russia.)
-replaced by soviet union and planned economy

Question 29

China (Institutions)

Answer 29

• 13th-14th century: wealthiest country with various technological innovations. (Song dynasty (960-1279): clocks, compass, gunpowder, paper and paper money, porcelain, and blast furnaces to make cast iron, spinning wheels, waterpower and in 1500: China richer than Europe)→ These inventions were not spurred by market incentives but by the government
  • Political institutions had a centralized state but were absolutist.
• Ming and Qing dynasties that followed opposed change, sought stability, and feared creative destruction.
  • Banned all commercial ocean shipping!
  • Complete control of government, stagnation for 19th 20th century = missed industrial revolution

Question 30

Communist China Mao Zedong (Institutions)

Answer 30

Mao Zedong: extractive political institutions, extractive economic institutions (sole person in power)

• No property, no incentives, state firms, 5-year plans

→ Great leap forward (=industrialization): forced farmers to produce steel with “backyard furnaces”, low-quality steel, to respect quotas, people used metal from agricultural tools as input, reduced agricultural output, famine, 20-40 million deaths (there was a specific weight required so peope would use cheaper material to achieve that quota)

• Cultural revolution: send intellectuals, students, professors, scientists to the countryside to experience working life (fear of creative destruction) ie. sending intellects away prevented that

Question 31

Marxism and Institutions

Answer 31

-Marxism lived during industrial revolution in Britain in 19th century–> bc emerging industries, real wages falling, difficult conditions, class struggle (capitalist/worker)
-marxism doesnt account for the role of inclusive institutions in possible capitalist society (i.e England and parliament)

Question 32

Communist China Deng Xiaoping (Institutions)

Answer 32

1976: Mao’s death + Deng Xiaoping: inclusive institutions (supposedly this was created by famers anf Xiapoing just slapped a name onit)

• Household responsibility system: all profits kept by farmers (the beginning of secure property rights, which gave farmers the ability to invest).
• More autonomy to state-owned firms
• Township Village entreprises: new firms free to start up
• 14 “open cities” could attract foreign investment

= Dramatic growth: enrichment of a broad cross section of society, but inclusive institutions can only be sustained if there’s inclusive political institutions.

Question 33

Institutions and Dependency Theory

Answer 33

-dependency theory is small elite blocks reforms that would benefit the general population
-this elite is dependent from center (the developed countries, multinational corporations, world bank, IMF) for import of manufactured goods, or debt
-similar to institutions–> small elite blocks reform
-Different to institutions–> not serving the center, serving themselves

Question 34

Dependency Theory: Why is there Debt?

Answer 34

-Extractive political institutions
-Trade: extractive economic institutions do not allow local firms to start up and compete on an international level
-Debt: Profligate spending by politicians to buy votes, maintain their interests, and reward themselves and their followers

Question 35

Problems with Institutions Theory

Answer 35

-Very difficult to prove (Ottoman empire, Russia, China)
-Few empirical tests on the impact of institutions are subject to criticisms–> reversal of fortunes: a correlation but not a causality–> mortality rate of settles: data controversy

Question 36

Data Controversy: Mortality Rate (Reversal of Fortunes)

Answer 36

-Mortality rate comes from soldier not settlers
-big diff between mortality rate of soldiers in peace (in barracks) or in war (campaign)

Question 37

The role of geography reexamined

Answer 37

-The reason why settlers set up inclusive/extractive economic institutions in latin and north america was no mortality rate of settlers or initial population density
-but, the climate and soil suitability to sugar vs grain

Question 38

Sugar (Sugar vs Grain)

Answer 38

Caribbean, Brazil, southern US:
- Good climate and soil for sugar, coffee, tobacco, rice, cotton
- These crops are much more efficient on large-scale plantation (with slave labour)
- High degree of land inequality

Question 39

Grain (Sugar vs Grain)

Answer 39

• Northern colonies of North America
• Better for grain and livestock
• Low capital requirements, no economies of scale
• Most people can operate as small scale farmers
• Low land inequality
  -Small initial difference (sutability of soil to sugar) led to divergent institutional paths
  -geography matters but via institutions

Question 40

US South vs North (institutions)

Answer 40

• The US South is on pare with the North, though it shouldn’t be according to the Institutions theory, because of it’s extractive institutions.
  
  • The soil was suitable for sugar = slavery
  • Civil War = North abolished slavery→ Despite victory it persisted and not much changed ie. it’s hard to exit a negative feedback loop:
    • A law exempted one slaveholder from military service for every twenty slaves owned.
    • Despite abolition, the same planter elite retained power.
    • Promises such as “40 acres and a mule” for freed slaves were broken.
    • The elite preserved an economic system reliant on cheap labor, with laws like the Black Code of Alabama restricting labor mobility.
    • Methods like taxes and literacy tests were used to disenfranchise Black voters.
    • “Jim Crow” laws enforced segregation, including separate schools.
    • Violence, exemplified by groups like the KKK, perpetuated an essentially apartheid system.
  • Dramatic economic consequeces: no innovation, low levels of education
  • 1950s-1960s: The Civil rights movement destroyed the political basis for this regime and they have sustained economic growth thereafter
  = Illustrates how difficult it is to exit negative feedback loop

Question 41

Restriction of Franchise (voting), education, property shaped the institutional development of the United States and Latin American countries, particularly Brazil.

Answer 41

Restriction of Franchise:

• In the US, the franchise was initially restricted based on property ownership, gradually expanding over time to include more people, reaching 38% by 1940.
• In Brazil, franchise restrictions were severe, with only 2.4% eligible to vote in 1914, expanding to 5.7% by 1930, but still with additional barriers like wealth and literacy requirements and no secret ballot.

Restriction of Education:

• In the US, literacy rates were relatively high by 1870 at 80%.
• In Brazil, literacy rates were much lower and increased slowly over time, from 15.8% in 1872 to 57% by 1939.

Restriction of Property Rights:

• In the US, property rights were more accessible, allowing for easy acquisition of land by small holders.
• In Latin America, including Brazil, vast tracts of land were controlled by a small elite, creating significant land inequality.

Conclusion:

• Small initial differences, such as soil suitability for sugar, led to divergent institutional paths between the US and Latin American countries.
• Geography matters in shaping institutional development, but its impact is mediated through the lens of institutions, such as franchise, education, and property rights.