Exploiting differences in mortality rates in the European colonies, Acemoglu et al. (2001) create an innovative instrument to estimate institutional differences and their impact on economic performance. When faced with higher mortality rates, Europeans were unable to settle and thus implemented more “extractive” institutions, aimed solely at extracting the surpluses of the local population. Subsequent analysis strengthens the claim that past institutions are relevant for today’s institutions and thus for contemporary income per capita.
Source: The Boar
In Institutions we trust
Two natural historical experiments of the 20th century underscore the importance of Institutions: The South and North Korean, as well as the Eastern and Western German states followed different institutional paths, with one part of the (previously whole) countries stagnating under central planning while the other prospered with private property. In other words, in both cases, the world witnessed a unique institutional divergence with significant ramifications. Countries boasting a better institutional structure tend to support more secure property rights and increased investments in physical and human capital, which they subsequently employ more efficiently, achieving greater income.
But how exactly did this come to be and how can we safely exclude the possibility that other, obscure factors, function through institutions and are the ones that matter in achieving prosperity? To isolate the effect of institutions on economic performance, the authors innovate in using the reported settler mortality European settlers faced in the colonization process as an indicator of the institutional landscape that prevailed in the early settlements. The quality of these past institutions is a strong indicator, due to path dependence (i.e past institutions tend to, at least partly, shape current and future ones), of the contemporary institutional quality. Finally, as argued above, today’s institutions are vital for today’s economic outcomes. The whole mechanism is depicted in Figure 1 below.
Figure 1: Settler mortality as a determinant of future institutions
Source: Bonsai Economics, Acemoglu et al. (2001)
The Ghosts of Institutions Past
The numbers are there: the authors managed to present a cogent case for their theory. But the validity of their claims rested on three premises:
1) There were different types of colonization policies enacted by the settlers, which resulted in different sets of institutions. Indeed, in places like Congo or Brazil, European powers set up “extractive” institutions which did not adequately protect property rights nor provide checks and balances against government expropriation. On the other hand, in places like the US or New Zealand, the European migrants created “Neo-Europes”, with a strong emphasis on private property and checks against central authority.
2) The colonization strategy employed was influenced by the feasibility of settlements. In fact, when attempting to colonize places presenting high mortality rates, the Europeans were less likely to settle. The cards stacked against the creation of “Neo-Europes”, the only remaining way for the Europeans to become rich out of their colonies was heavy extraction of resources out of the indigenous population, hence the term extractive institutions.
3) The states that emerged and their institutions persisted after their independence.
Although described as “new states”, the now independent polities were actually successors to the colonial regime “inheriting its structures, its quotidian routines and practices, and its more hidden normative theories of governance”. Colonists living under inclusive institutions would not give them up easily. On the contrary, the extractive elites would fight to retain their privileges while placing restrictions on their power, and enforcing property rights was costly. This is why their institutional clusters persisted after these states’ independence.
Implications
The authors have presented us with a strong case for the role of institutions in economic outcomes and how this role came to be through history. Convincing though they may be, these arguments should not be perceived in a deterministic way. Institutions can indeed be improved in different ways: take for example the Meiji Restoration in Japan or South Korea in the '60s. However, institutions and the paths that lead to good ones are a good place to start when looking to improve economic performance, as was highlighted by the discussed paper.
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