Political Economy of Development

Key Facts About Wealth of Nations and Economic Growth

GDP per capita varies significantly across nations.
- In 2019, approximately 760 million people lived in countries with a GDP per capita less than $4,000.00$ .
- About 70% of the world's population lives in countries with a GDP per capita equal to or less than $14,000.00$ , around the level of China.
- 76% of the world's population lives in countries with a GDP per capita less than the average.
Historically, most of the world was poor.
- GDP per capita in year 1 is estimated to be around $700.00 - 1,000.00$ in 2015 dollars across major regions.
- There was no long-run growth in real per capita GDP for most of recorded human history.
- Today, GDP per capita in the richest countries is 50 times larger than in the poorest.
Economic growth is measured as the growth rate of real GDP per capita:
- Formula: $g<em>t = \frac{y</em>t - y<em>{t-1}}{y</em>{t-1}} \times 100$
  - Where:
    - $g_t$ = growth rate of real GDP per capita
    - $y_t$ = real GDP per capita in time period t
- Example:
  - Year 2008: real GDP per capita = $15,000.00$
  - Year 2009: real GDP per capita = $15,500.00$
  - Growth rate: $g_{2009} = \frac{15,500 - 15,000}{15,000} \times 100 = 3.33\%$
Rule of 70: Approximates the doubling time of a growing variable.
- Formula: Doubling\ time = \frac{70}{Growth\ rate\ in\ %}
- Example: If real GDP per capita grows at $3.5\%$ , it will double in $\frac{70}{3.5} = 20$ years.
Growth Miracles:
- The US grew slowly but consistently for over 200 years.
- Japan grew at $8.5\%$ per year from 1950 to 1970 and became one of the richest countries.
- South Korea had a similar GDP per capita to Nigeria in 1950 but grew at $7.2\%$ from 1970 to 1990, becoming comparable to many European economies.
Growth Disasters:
- Nigeria has barely grown since 1950 and was poorer in 2005 than in 1974.
- Argentina was one of the richest countries in 1900, but its GDP per capita fell to less than one-third of the US by 2000.
Poverty:
- More than 1 billion people live on incomes less than $3.00$ per day, reducing their prospects for health, happiness, and peace.
Economic growth has significantly raised the standard of living in developed nations.

The Political Economy of Development

Factors of Production:
- Physical capital: machines, structures, and equipment.
- Human capital: knowledge and skills acquired by workers.
- Technological knowledge: knowledge about how the world works used to produce goods and services.
Institutions:
- "Rules of the game" that structure economic incentives, including laws, regulations, customs, practices, organizations, and social norms.
- Institutions that promote growth align self-interest with social interest.
- Institutions of economic growth include:
  - Property rights.
  - Honest government.
  - Political stability.
  - A dependable legal system.
  - Competitive and open markets.
Property Rights:
- Encourage investment in physical and human capital.
- Under communal property, effort is divorced from payment, leading to free-riding.
- Individuals won't save or invest without the expectation of returns.
- Companies won't invest in R&D without expecting to profit.
Honest Government:
- Corruption is like a tax that drains resources from productive entrepreneurs.
- Resources invested in bribing cannot be invested in machinery and equipment.
- Corruption makes it more profitable to be a corrupt politician or bureaucrat.
- Few people want to be entrepreneurs if their wealth will be stolen.
Political Stability:
- Fosters predictable and consistent policymaking, encouraging long-term investment and business planning.
- Reduces the risk of violent conflict and social unrest, which can destroy capital and deter economic activity.
Dependable Legal System:
- Protects property rights and enforces contracts, encouraging investment, entrepreneurship, and long-term economic planning.
- Reduces uncertainty and disputes, lowering transaction costs and building trust among economic actors.
- Supports credit markets and formal economic participation by ensuring predictable and fair outcomes.
Competitive and Open Markets:
- Differences in physical and human capital explain about half the differences in per capita income across countries.
- The other half is due to the failure to use capital efficiently.
- Competitive markets encourage firms to compete on price and quality, driving productivity gains and technological advancement.
- Ensure that capital and labor flow to their most productive uses, enhancing overall economic output.
Countries with high GDP per capita have significant physical and human capital per worker and institutions that encourage investment and efficient resource organization.

Case Study: Colonialism and Institutional Persistence

Acemoglu, Johnson, and Robinson (2001) demonstrated the importance of societal institutions for a country's prosperity.
Societies with poor rule of law and institutions that exploit the population do not generate growth.
Research Question: What is the impact of institutions on economic performance?
Identification Strategy:
- Use an instrumental variable (IV) approach.
- A good instrument is correlated with the endogenous variable (relevance) and uncorrelated with the error term in the explanatory equation (exogeneity).
Instrumental Variable: Mortality rates expected by the first European settlers in the colonies.
Colonialism and Institutional Persistence:
- Different types of colonization policies created different sets of institutions:
  - Replicas of European institutions with an emphasis on private property and checks on the government.
  - Extractive institutions whose main purpose was to transfer the resources of the colony to the colonizers.
- The colonization strategy depended on the feasibility of settlements.
  - Colonies with many European settlers became "Neo-Europes" (e.g., US, Canada, Australia, and New Zealand).
  - European colonizers plundered colonies they did not settle (e.g., Belgian Congo).
- Colonial institutions persisted after independence.
- Feasibility of settlements is measured by potential settler mortality.
Data:
- European settler mortality: mortality rates of soldiers, laborers, and bishops, mostly prior to the twentieth century.
- European settlement: fraction of the population of European descent in 1900.
- Past institutions: constraints on the executive in 1900, index of democracy in 1900.
- Current institutions: index of protection against expropriation, averaged over 1985-1995.
- Economic performance: log GDP per capita (PPP) in 1995; log output per worker in 1988.
Main Findings:
- Europeans were more likely to settle in places where they had a lower risk of dying from disease.
- Colonies where Europeans settled developed institutions that protected property better than colonies where Europeans did not settle.
- There are close associations between early institutions and institutions today.
The paper argues that long-term economic development is primarily driven by the quality of institutions, particularly those that protect property rights and constrain elites.
Contributions:
- AJR fundamentally reshaped the understanding of why some countries are rich and others are poor by showing that inclusive institutions are the key drivers of prosperity.
- AJR introduced identification strategies to overcome endogeneity problems, allowing for credible causal inference in cross-country institutional research.
- Their contribution bridges economics with political science and history.
Other factors also important to economic growth:
- Natural resources may help explain why a country is able to accumulate physical and human capital
- Transport is cheaper over water than over land, so countries with access to water are more open to trade
- Landlocked countries have lower per capita GDP than countries with access to a coast

Culture

Culture Definition: Internalized values and beliefs (often about what is right and wrong). We can call these preferences and norms of behavior.
Why study Culture in Economics?
- Do such beliefs really affect our decision making?
- Why would we rely on such values/beliefs rather than simply acting rationally?
To understand the primary benefits of culture, we must recognize that as human beings we have cognitive limits:
- 1 We don’t know everything
- 2 Processing information is difficult and costly
In face of these limits, we have developed heuristics, short-cuts, or “rules-of-thumb” that help us make decisions
Two Important Aspects of Culture:
- 1 Culture is efficient
- 2 Cultural knowledge is cumulative
Cultural Traits:
- Generalized trust.
- Individualism/collectivism.
- Family ties.
- Generalized/limited morality.
- Attitudes towards work.

The Origins of Trust

Nunn and Wantchekon (2011) studied the relationship between the slave trade and mistrust in Africa.
Basic finding: individuals that belong to an ethnic group from which more slaves were taken exhibit lower levels of trust today
Establishing causality:
- Instrument for slave exports using the historical distance of an individual’s ancestors from the coast
- Undertake a number of falsification tests to determine the validity of the instruments
Distinguish between channels of causality:
- Internalized norms, culture
- External environment, institutions
During the slave trade, the environment of insecurity caused individuals to turn on others
Data:
- Afrobarometer: individual-level survey data from 17 sub-Saharan countries in 2005.
- Ethnicity-level slave export estimates from shipping records.
Estimating Equation: trusti,e,d,c is the measure of trust and slaveexporte is a measure of the number of slaves taken from ethnic group e. Also, include the other controls
Channels of Influence
- slave trade might have deteriorated institutions
- Analyses suggest that much of the slave trade’s effect on trust arises from a change in the internal norms and beliefs of the descendants of those affected by the slave trade