Institutions as the Fundamental Cause of Long-Run Growth - Assignment Example

Comparative Development There is notable difference in countries’ development rates across the world. For instance, the average income per capita in OECD countries was way above 20 times higher than that of sub-Sahara Africa countries in the 2000 and elsewhere, and sub-Saharan countries are not only lagging behind the developed nations, they have fallen way beyond in the previous years (Hulten & Isaksson 2007: 2). Similarly, different gross fixed capital formation rates, ranging from 6% to 77% of production have been recorded across the globe in the past 30 years, from 1980 till 2010 with developing countries, typified by diverse political-economic institutions and structures recording much of the variability (Jerome 2013: 2). These observations have not helped in addressing the one of the hotly-debated issues in development economic- explanation of the huge gaps in average incomes between the world’s poorest and richest countries (Rodrik & Subramanian 2003: 31). On the one hand of the debate lies a group of scholars who assert that such differential economic development can be explained by geographical variables such as latitudes Hall and Jones (cited in McArthur & Sachs 2001); infectious diseases Acemoglu, Johnson and Robinson (cited in McArthur & Sachs 2001); tropical climate Gallup, Sachs and Mellinger and Masters & McMillan (cited in McArthur 2001). On the other hand of the debate lies a group of people who assert that the differences are as a result of economic institutions and the role they play in the society. This paper explores the debate of geography versus institutions as roots of economic development. The economists’ debate about the role of institutions and physical geography can be pigeonholed under three distinct themes. One theme considers the consequences governance (institutions) and physical geography as co-existent factors that enhance the development of the society. Another theme examines the roles of institutions (governance) and physical geography as competing forces that influence the development of the society. The third and final theme is a bit more complex than the previous two themes in that it holds that human conditions are influenced by physical geography not directly but indirectly through institutions (governance). Distinction has been clearly established between the effects from institutions and physical geography. For instance, Acemoglu, Johnson and Robinson (2004: 1) hold that geography comprises “forces of nature” whereas institutions (governance) are all about “man-made” factors. Despite minority of people associating human conditions entirely to either institutions (governance) or geography, contemporarily and historically, there exist divided opinion as to which factors- institutional or geographical- play a prime role in determining development of a society, a nation in this case. “Geographers” argue that geographical factors play a significant role more than institutional factors whereas “institutionalists” argue that institutional factors have a superior role in shaping development of nations across the globe. The tenets for each side are discussed in the following paragraphs under the themes identified above. I) Geographical arguments Geographers had a considerable stake in developing the early environmentalism determinism version courtesy of respectable individuals such as Frankel and Romer, Bloom and Sachs, Diamond and Gallup et al. (Auer 2012: 2). They hold that geographical factors such as climate, location, topography directly influence labour productivity, disease prevalence and society prosperity hence the stand that social development result from the physical environment. It argues that countries locate in cool environment (northern latitudes) are comparatively more developed than countries in hot environment (around the tropics). After the 1930s, this view lost its credibility and appeal because of ignoring contrary evidence, reliance on anecdotal evidence and loose correlations and ethnocentric grading of the environment. However, it was later revived. In the final years of the 20th century, some development economists, in attempts to explain the divergent global patterns of economic growth, economic development differences among countries were again linked to geographical conditions. For example, Sachs and Bloom and Sachs (cited in Easterly & Levine 2002: 5) stipulate that the tropical location of Africa largely hinders its development through eight mechanisms namely unstable supply of water and high evaporation rates; lower photosynthesis rates and excessive respiration of plants; absence of coal deposits; low soil fertility; high prevalence of crop parasites and pests; short summer days; and high transport costs. Sachs and Warner (cited in Easterly and Levine 2002: 5) assert that commodity dependence, landlocked location and tropical location hamper growth and/or development; access to the sea opens the country to the global market whereas landlocked nature of countries obstruct access to economies of scale and the global market that results into reduced efficiency that in turn results into reduced development and growth. Landes (cited in Easterly & Levine 2002: 6) stipulates that high temperatures around tropics deter people’s willingness to work; he quotes one diplomat who claimed to be mentally or physically affected in countries such as India, Ghana and Nigeria and not in countries such as Germany and France because of the temperate climate. Easterly and Levine (2002: 24) emphasize that natural resources such as ecological conditions support growth of cash crops that generate income thus countries having poor ecological conditions are less developed compared to countries having favourable ecological conditions. However, the most far-reaching argument under physical environment’s dominance in shaping development over institutions is presented by Diamond who acknowledges proximate causes such as modern technologies, germs and guns utilised by westerners to colonise other countries. In his attempts, diamond zero in country differences, continents’ orientation and existence of large mammals and plants wild ancestors as the causes of comparative development. He points out that the abundant fertile wild ancestors grew as annuals making it easy to produce big seeds, and domestication were easy; the domesticated pulses and cereals accounts to a half of the 12 major crops across the contemporary world. The favourable flora as well as other natural factors such as animals, environment and climate sustained the advantages in countries having them over those countries not having them. Thus, these natural factors help in explaining the earlier rise and supremacy of the west over other countries such as those located in sub-Sahara Africa. II) Institutional arguments Institutionalists hold a contrary view to the geographers; they classify institutions as the firs-order determinant of countries’ economic growth and development- termed as primacy of institutions by Rodrik and Subramanian (2003). Institutions’ quality exceeds everything else in explaining the huge differences witnessed between poorest and richest nations (p. 31). By institutions, economists refer to the game’s rules within the society that is the constraints devised by human beings to control human interactions; they structure incentives in human economic, social and/or political exchanges North (cited in Acemoglu, Johnson & Robinson 2004: 1). They encompass cultural characteristics as well as governance mechanisms. For instance, Easterly and Levine (2002) develops an index to evaluate institutions’ role in economic development: accountability and voice (democracy, independent press, civil liberties and political rights); government effectiveness (civil servants and public service delivery); regulatory burden (market controls, international trade and banking system); political stability; corruption; and rule of law (contract enforcement and people and property protection). Institutional view traces its roots in the works completed by John Stuart, Adam Smith, North and John Locke (Acemoglu, Johnson & Robinson 2004: 2). For instance, Locke emphasised the significance of property rights administered by institutions in comparative development. Easterly and Levine (2002) are in favour institutions’ primacy (governance) over geography in determining economic growth and development. Also, Coviello (2003) document evidence supporting institutionalist view rather than the geographical/endowment view. Such evidence, combined together with the assertion that institutions high quality institutions override every other factor lead to institutionalist proponents’ declaration that institutions and roles of institutions explain comparative economic development better than geography. Economic institutions are critical for economic growth since they influence the incentives to the society’s key economic actors, specifically, they influence organisation of production and investment in technology and human as well as physical capital. Acemoglu, Johnson and Robinson (2004: 3) acknowledge the impact of geographical and cultural factors on economic performance but maintain that cross-country differences in economic prosperity and growth majorly stem from economic institutions. They point out that the influence of economic institutions is not only limited to the economy’s aggregate growth but also extends to a number of economic outcomes including future resources’- human and physical capital- distribution in the society. Economic institutions not only affect the “aggregate pie’s size but also the divisions among individuals and society” (Acemoglu, Johnson & Robinson 2004: 3). Thus, economic institutions are responsible for resources’ distribution and economic performance and not geography as explained by the endowment hypothesis. Second, economic institutions are endogenous that is they are established and shaped by societies’ collective choice rather than an individual’s choice. Because no prerequisite exists for groups of people choosing similar economic institutions, the adoption of different economic institutions explains dissimilar distribution of resources hence divergent economic performance and growth. III) Geography through institutions arguments It is reasonable that harsh physical conditions lead to delayed development or under-development in some instances. However, there exists a paradox to it because underdeveloped countries do exist in regions away from the tropics- regions where natural environment conditions are favourable for economic development. This paradox is referred to as “resource curse” (Engeman & Sokoloff 2005). At the centre of “resource curse” paradox exists the consideration of the role of geography via institutions. This consideration manifests in several studies about comparative development (Easterly & Levine 2002; Acemoglu, Johnson & Robinson 2004; Rodrik & Subramanian 2003). Such studies acknowledge the influence of geography on institutions as well as the influence of institutions on geography. Acemoglu, Johnson and Robinson (2004: 21) discuss the “Institutional Reversal” effect that generates “reversal of Fortune” whereby the initially underdeveloped areas turned out to be developed places whereas initially developed areas turned out to be underdeveloped areas. They point out that the institutions established by the colonialists in response geographical forces continued to function on cessation of colonialism. This point has led to most institutionalists’ stipulation that geography impacts economic development indirectly through institutions, for instance, Easterly and Levine (2002) investigate the role of environment and geography on economic development via institutions. Similarly, Rodrik and Subramanian (2003), in their article “The Primacy of Institutions,” examine geography as an exogenous factor and institutions as partly endogenous factors. Such considerations prove acknowledgement of the roles of both factors in economic development. Conclusion The differences in economic development among countries across the globe are evident; there is a huge gap between the poorest and the riches countries. Competing schools of thought have attempted to explain the root cause of such comparative development; geographical school of thought argues that comparative development results from geographical factors such as landlockedness, infectious diseases and availability of natural resources whereas institutionalist school of thought argue that comparative development stems from economic institutions. Both sides have strong arguments and impact of either set of factors cannot be entirely refuted. However, the institutionalist school of thought turns out more germane than the geographical school of thought because countries situated in regions with similar geographical factors are not equally developed whereas institutions are shaped by society’s forces which are never similar. Therefore, institutionalist view is superior to geographical view. References Acemoglu, D, Johnson, S & Robinson 2004, ‘Institutions as the fundamental cause of long-run growth. NBER working paper 10481, Pp 1-92. Auer, R 2012, ‘Geography, institutions, and the making of comparative development. CESIFO working paper No. 3874, pp. 1-41 Easterly, W & Levine, R 2002, ‘Tropics, germs, and crops: How endowments influence economic development. National Bureau of Economic Research, working paper 9106, pp. 1-40. McArthur, JW & Sachs, JD 2001, Institutions and Geography: Comment on Acemoglu, Johnson and Robinson (2000). NBER Working Paper 8114, pp. 1-22. Rodrik, D & Subramanian, A 2003, ‘The Primacy of Institutions’, Finance and Development, pp. 31-34. Read More