Growth and Development Notes 15-18

In these lectures we will look at institutions being the fundamental

cause of growth.
We will look at why good economic institutions are needed for growth
and how good political institutions are needed for good economic
institutions.
We will then look at why, according to the institutional argument,
and continued to grow rapidly after
Britain was first to achieve A > A
that. In particular, how Britain had the right conditions when the Black
Death hit and when the Atlantic Trade opened, giving Britain good
political institutions and paving the way for industrial revolution and
the emergence of sustained economic growth.
We will then look at how the French Revolution allowed good political
institutions to be spread amongst some European countries, allowing
these places to then grow and converge to Britain.
We will then look at how European colonialism meant that some nonEuropean countries began to grow very early and others did not.
Finally, we have looked at how institutionalists explain the very
different development path of China and Japan.
Good and bad economic institutions
Economic institutions are the rules and polices that govern the
economic interactions of individuals in a society. A society with good
economic institutions (also known as inclusive economic institutions) is
one where its rules and polices encourage citizens to innovate and to
invest in new physical and human capital.
On the other hand, we say that a society has bad economic institutions
(also known as extractive economic institutions) if its rules and polices
discourage citizens from innovating and investing in new physical and
human capital.
So from this we can see that countries with good economic institutions,
the proximate causes of growth are more likely to come into play, as
there is greater chance of technological progress and capital
accumulation. Whereas, in countries where they have bad economic
institutions there is less likely to be growth as proximate causes of
growth will be blocked.

Types of Good economic institutions

A key good economic institution is secure property rights. This
means that it is well defined who owns what, and property is protected
by the law. If this wasnt the case the innovators could be expropriated
of their intellectual property rights to their invention, and this would
reduce the incentives for innovators to invent in the first place.
Similarly, an entrepreneur could be expropriated from their profits, and
this would reduce their incentives to invest into physical capital that
produced those profits. Thus we can see how secure property rights
and thus good economic institutions are needed for proximate causes
of growth to come into play.
Another key good economic institutions is a fair and efficient
judiciary. This is because both innovators and investors are likely to
face many legal disputes over their careers. If there was judiciary that
was corrupt or took forever to settle cases and in other words was not
fair and efficient, then there is a possibility that an innovators invention
could be lost and a entrepreneurs profits could be taken away. This
would again reduce the incentives for them to invest and innovate in
the first place and would therefore block proximate causes of growth.
And thus we see why a fair and efficient judiciary is needed for
innovation and investment to take place and thus allow proximate
causes of growth to come into play.
Another important good economic institution is an efficient and
transparent bureaucracy. In the USA it only takes a few days to set
up a new company, whereas in other countries it can take many
months. Vast amounts of profits made come from innovation and
investment from new companies and so having a corrupt and
inefficient bureaucracy is blocking proximate causes of growth.
Another good economic institution is having contestable markets.
This means that new companies can enter the market easily. This is
important as it means companies have an incentive to invest and
innovate to stay ahead of new competitors that enter the market. This
will allow technological progress to occur and allow accumulation of
capital and thus allow proximate causes of growth to come into play.
The final important good economic institution is a developed and
transparent financial sector and widespread access to
education. Without widespread access to education we are preventing
people that may possibly have a lot of talent from getting education

and thus hindering the human capital within a society and this can
limit capital accumulation. Moreover, if there is a corrupt financial
sector then this could mean that if a poor person was to have a good
idea for an invention that they could not possibly make it because the
financial sector would not be willing to lend money to the poor but only
to a select few of elites. This would prevent physical capital
accumulation and thus prevent proximate causes of growth from
coming into play.
Good and bad political institutions
Political institutions are the set of rules that determines who governs a
country and what power the government has. By good political
institutions (also known as inclusive political institutions) we mean
political institutions where:
The government is contestable, anyone in principal can stand for
office and win
The government is accountable to a wide range of interests in
the society
The government is constrained by the law, and by a series of
checks and balances
To see why good political institutions are needed for good economic
institutions, we must look at what would happen if a country was to
have bad political institutions. Bad institutions (also known as
extractive political institutions) are ones where:
They will not promote secure property rights, since the ones in
power are the ones who are able to expropriate and thus by
having secure property rights they lose the power to expropriate
They will not allow for a fair judiciary to emerge. This is because a
fair judiciary could rule against them and thus decrease their own
power
They will promote inefficient and corrupt bureaucracy
They will not promote contestable markets. Because it is the few
elites that are in charge of the monopolies and thus by protecting
them and not allowing entry in the market the elites benefit
They will not promote a fair financial sector
Finally, they will not allow for widespread access to education,
because this means people will become more knowledgeable and
powerful and potentially challenge their leadership in the future.

From this we can see why countries need good political institutions for
growth, as this will lead to good economic institutions and thus allow
proximate causes of growth to come into play.
But why, then, dont all countries adopt good political institutions?
After all, all countries should prefer to be able to grow, and become
rich. Well this is because, bad political institutions benefit the few elites
in the society, and they will greatly resist the dismissal of bad political
institutions. So the transition from bad to good political institutions will
typically require a traumatic political event (such as a revolution),
where an incumbent elite is forced to accept more inclusive political
institutions.
Difference between institution argument and luck argument
In the luck argument, they also agreed that good economic
institutions such as secure property rights and schooling system
was needed for growth but bad leaders were picked because of
bad luck the country faced
In the institutional argument bad leaders are picked because of
the political institutions are currently in place and the country will
continue to pick bad leaders as long as bad political institutions
are in place. Even if the leader is not bad, and is smart and knows
what is needed for growth to take place, they will enrich
themselves and entrench themselves in power due to the bad
political institutions that are in the country. And because of this,
they will not implement the right polices needed for good
economic institutions.
Why the Industrial Revolution was British: The Legacy of the
Black Death
In the 14th century, feudalism had been the political system for all of
Europe. This meant that all power rested with a small elite of landed
aristocracy. These extracted high taxes (both in cash and in kind,
particularly forced labor) from the majority of peasants. These bad
political institutions made sure that economic institutions were bad as
well. For example, the property rights of the vast majority were highly
insecure, given arbitrary taxation by the elite. The judiciary was tightly
controlled by the elite. And economic initiative was not only not
encouraged, but was strongly discouraged, since most people did not

have the right to leave the land where they were born, or to do
anything other than farming.
The Black Death changed all of this. The Black Death killed around a
third of the European population and thus reduced the labour force
heavily. This had two very opposing effects on political institutions.
The first effect was that some labour become much more valuable,
elites had increased incentives to strengthen the existing bad political
institutions, so that it could continue to impose forced labour onto
peasants.
On the other hand, because labour became more valuable, each
individual acknowledged this and became more conscious of their own
worth and thus were more willing to fight to obtain more good political
institutions.
Depending on which of these effects prevailed, the Black Death had
different effects in different countries.
In Western Europe, due to historical circumstances the feudal elite
were already less powerful than elsewhere and thus the second effect
prevailed. Peasant workers became more demanding and fought for
better political institutions and this marked the end of the feudal
system. Two years after the Black Death, the king of England decided
to pass the Statute of Laborers, which meant that wages could not rise
to what they were before the plague and workers could not move
without the permission of their landlord. This was to increase the
strength of their bad political institutions. However, after a full scale
rebellion, the Statute of Laborers was not enforced and instead a good
labour market was created in England and wages rose.
Whereas, in Eastern Europe the feudal elites were very powerful and
thus the first effect prevailed. The elites expanded their holdings and
strengthen the bad political institutions.
We have seen in earlier lectures that the industrial revolution happens
when the level of technology reaches A, peasants begin to move to the
cities to work in the nascent modern sector, capital begin being
accumulated, etc. Now its clear why the industrial revolution could
happen in Western Europe, but not in Eastern Europe: quite simply, in
Western Europe the peasants were free to innovate and to move to the
modern sector, in Eastern Europe they were not.

But why, according to the institutional view, was the industrial

revolution British, and not French, Spanish? Or Italian? To see this, we
need to look at the impact that the opening of Atlantic Trade had on
these countries.
Atlantic Trade and the rise of Britain
By the end of 1500s, countries like England, France, Spain and Portugal
had moved out of feudalism. However, power still remained mainly in
the hands of absolutists monarchs. All of these countries had
parliaments which represented a wide range of interests, but England
had a more powerful parliament which was capable of blocking the
introduce to new revenue collecting measures by the monarch. And
this small difference had huge implications.
The Atlantic Trade brought huge profits through established mines and
plantations of highly sought and cheap to produce commodities.
According to the institutional view, Monarchs in Portugal, Spain and
France were able to pass new revenue collecting measures which
introduced large number of monopolies. And only these monopolies
were able to carry out colonial trade. Monarchs and aristocracy were
either key stakeholders in these monopolies or they granted
themselves the right to tax a large share of their profits. This meant
that those in power benefited the most from the Atlantic trade and
others could not become rich and eventually challenge the positions of
the absolutists.
Thus the overall effect of the Atlantic Trade in Portugal, Spain and
France was that it strengthens the existing bad political institutions.
And therefore under these bad political institutions, good economic
institutions could not rise and therefore growth could not occur.
In England the effects of Atlantic trade were very different, because the
people who benefited from Atlantic Trade were very different. In
England, due to the parliament having the power to block new revenue
collecting measures, the monarch was not able to introduce
monopolies that were able to only take part in colonial trade. Instead in
England, the market was contestable and was open to competition.
This meant that the Atlantic trade benefited the merchants in England
and allowed them to become rich.
Overtime, these outsiders (people outside the few elites in charge)
became very wealthy and gained political power. This allowed them to

challenge the existing political institutions. After many political events

between the Parliament and Monarchy, the parliament won thanks to
the support of the Atlantic trade merchants.
Following the Glorious Revolution (1688), political power in England
was re-allocated from the narrow aristocratic interests represented by
the Monarchy to the pluralistic interests represented by Parliament.
Under these new, good political institutions, England introduced in the
18th century most of those good economic institutions that, according
to the institutional view, are needed to spur growth.
Thus, the long-run effect of Atlantic Trade on England was to help
transform existing bad political institutions into good political
institutions. Under good political institutions, good economic
institutions were introduced in the course of the 18th century - a time
when no other country had them. Ultimately, this institutional
advantage is what explains the fact that the industrial revolution - and
the emergence of sustained economic growth - happened in Britain
and not elsewhere.
The French Revolution and the spread of good institutions
The French Revolution explains why good institutions spread to some
European countries and not to others.
By the end of the 18th century, Western Europe with the exception of
Britain was still in the grip of bad political institutions. Eastern Europe
still had serfdom (labour which is bound by feudalism). In Portugal,
Spain and France, absolutism has been reinforced by the expansion of
Atlantic Trade. In Germany and Italy, absolutism was also very strong.

Then, the French Revolution (1789) came along, followed by Frances

invasion of Europe (1794-1815). The French Revolution (1789) marked
the end of absolutism in France, ultimately (1870) giving this country a
parliamentary system similar to that of Britain.
This implied that good political institutions were introduced in France:
for example, the elimination of remaining feudal regulations,
sanctioning the equality of all citizens in front of the law; a government
accountable to a wide range of interests; and a government
constrained by the rule of law, and by checks and balances.

Good economic institutions followed: property rights were increasingly

upheld, creating a stable business environment for innovators and
investors. Old privileges such as monopolies and guilds were abolished,
so that markets became accessible to innovators and investors. The
financial system was developed, allowing people from all backgrounds
to finance their innovations and investments. A large primary schooling
system was set in place, allowing people from all background to learn
the basic skill needed to innovate and invest (particularly in human
capital).
And guess what happened? That in the mid 1800s, France began to
converge to Britain!
The positive effects of the French Revolution were not limited to
France, however. In the 20 or so years in which France ruled over parts
of Western Europe, it exported its new, improved political and
economic institutions to the territories it directly ruled over.
How good institutions spread to the rest of the world
To see how good institutions spread to the rest of the world, we have to
examine a phenomenon known as Reversal of Fortunes. According to
data, European colonies that were highly developed in 1500 (high
urbanization rate) were relatively poor in 1995, and the European
colonies that were poor in 1500 and not that developed were on
average rich in 1995.
The institutional arguments says that he Europeans tended to create
bad institutions in colonies that were rich, and good institutions in
colonies that were poor. Because of this, it was the latter places that
experienced sustained economic growth in the 19th and 20th century,
explaining the fact that they are now much richer.
The Europeans created bad institutions in rich colonies and good
institutions in poor colonies for two reasons: the profitability of bad
institutions and European settlers.
The profitability of bad institutions
Europe conquered other countries to make economic gains. And so put
into place institutions that best suited their needs. Colonies are
valuable if they are able to export primary commodities such as silver,
sugar, tobacco etc. And these commodities could be produced in large

plantations with the help of large quantities of labour. So the ideal

colonies (from a European point of view) were those that were rich in
these commodities, and were densely populated, at the time of
conquest.
In rich and densely populated territories, the Europeans created bad
political institutions, whereby a small elite of Europeans (or of
European descent) controlled all political power, and used it to force
the local population to work in the mines and plantations. In doing this,
the Europeans were also advantaged by the fact that densely
populated territories typically had centralised political systems already
in place - so the Europeans could simply substitute the rulers, and use
existing taxation systems to reach their goals. For example, this is
what the Spanish did in Peru and Mexico, and the English did in India.
These bad political institutions persisted over time, even after
decolonisation: this may explain why sustained economic grow did not
emerge in these places.
Of course, the relation between high population density and bad
political institutions was not perfect. In fact, thanks to the African slave
trade, the Europeans were able to implant bad political institutions
even in places with a low population density. Thats because some
places had the right climates to grow highly sought out commodities
like sugar.
European settlers
The other crucial determinant of the type of institutions implanted by
the Europeans was the facility with which the conquered territories
could be settled. Whereas in some conquered territories the Europeans
sent large amount of settlers, in others they did not. Again, initial
population density had a crucial role in determining this.
This was both for a direct and indirect effect. The direct effect was
simple: a higher population density implied that there was less space
for European settlers. The indirect effect was that more densely
populated regions tend to have a more disease-rich environment, and
in turn the more resistant the population are to these diseases. The
argument there was that, coming from more densely populated
societies, the Europeans were better at exporting diseases, and this
helped them subjugate the rest of the world. But of course, the
conquered places also had some disease that could be lethal to

Europeans, and the more densely populated those places where the
more disease were going to be present. In particular, some places
tended to have a lot of malaria and yellow fever, two diseases to which
the Europeans lacked immunity. Since settlers didnt want to go to
places where malaria and yellow fever were endemic, this was a
second reason why densely populated places where settled much less
by the Europeans.
European settlers made up large percentage of the colonial population,
and to implant bad political institutions would have meant for these
settlers to essentially enslave themselves. Clearly, that was
something that these people were not prepared to do. The second
reason was that, in many cases, settlers came from European countries
where good political institutions had already been established. They
were then unwilling to accept anything less than what they were
accustomed to, and so they forcefully rejected any attempt by the
mother country to establish bad political institutions to exploit them.
As they landed in the New World, these people were determined to
build political institutions at least as good as those of their mother
country. In fact, in some cases the political institutions they built were
even better than in the mother country (think of the USA being the
oldest surviving democracy in the world).
So the logic of the argument is as follows: in places that were
developed and densely populated, the Europeans had a strong
incentive to implant bad political institutions. In places that were less
developed/scarcely populated, on the contrary, they had an incentive
to implant good political institutions - that was also because European
settlers mostly went to these places. Thus, places that were initially
developed got the wrong kind of institutions: this prevented them from
growing in the 19th and 20th century, explaining the fact that they are
now poor. In the institutional view, this can explain why places like the
USA, Canada, South Africa, Australia, New Zealand began to catch up
with Britain in the 19th century, and are now rich. It can also explain
why Singapore and Hong Kong began to catch up to the West in 1950,
and are now rich. Finally, it can explain why Latin America, most of
Africa, and the other Asian colonies were held up, and are now
relatively poor.

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Countries that were not colonized: China versus Japan

We will now study the role (possibly) played by institutions in countries
that were not colonised by Europe, and we will summarise the debate
on the fundamental explanations for growth. We begin by comparing
the historical experiences of China versus Japan. We then summarise
the debate on the fundamental explanations for growth.
According to the institutional view, the main factor hindering Chinas
growth in the 19th and 20th century was absolutism, first of the
emperors and then of the Communist leaders. As we saw briefly in
lecture 1, China was very technologically advanced until the Middle
Ages; this was thanks to government planning that favoured innovation
during the Song dynasty (960-1279 AD). Under the Ming (1369-1644)
and Qing (1644-1912) dynasties, however, innovation slowed down.
That is why China appeared extremely developed to Marco Polo (late
1200s), not so much so to 18th century European observers.
A good example of this is the fate of long-distance trade in China.
China emerged from the Middle Ages with a much better sailing
technology than Europe, and was active in attempting to
circumnavigate Africa as early as the Portuguese (early 1400s).
Differently than in Europe, however, attempts to establish longdistance trade links were suddenly interrupted in China, by imperial
decree. No more expeditions were launched after 1450, and
international trade was severely restricted throughout the 15th-19h
century
Why did the Chinese emperor prohibit foreign trade? Well, we have
seen what the opening up of long-distance trade did in Britain - it took
power away from the Monarch, creating the basis for more pluralistic
political institutions. According to Acemoglu and Robinson, the Chinese Emperor saw this coming and, being strong enough to do so,
reacted by restricting trade altogether. You may wonder why the
emperor did not opt for allowing long-distance trade, while capturing
its benefit for himself by setting up trade monopolies - what the
Spanish king did.
According to Ferguson (2011), however, the emperor did not have an
incentive to chose this option, since he was super-rich anyway, and,
perhaps more importantly, he didnt need to raise money to survive
wars against neighbouring kingdoms. In fact, differently from Europe that was fragmented in a large number of countries often in war with

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each other - China did not have any powerful and aggressive
neighbour.
This is just one example of how, in the institutionalist view, bad
(absolutist) political insti- tutions hampered growth in China. Had
international trade been free, there would have been much more
incentives for people to innovate (increase A), bringing the country
closer to the point of transition to a modern economy (A). Why?
Because trade makes vast foreign markets accessible, thus increasing
the profit that one can make by improving the way in which things are
produced. Once reached the point of transition, people would have had
much more incentive to continue to innovate, and to invest in physical
and human capital. Again, openness to trade would have reinforced
that process, since access to vast market makes investment inherently
more profitable.
A limited amount of trade was allowed in China in the 19th century, but
that was mainly on the force of unequal treaties imposed by the West
on China. Such treaties forced China to partially open up to trade with
the West, but at conditions that were more favourable to the West than
would have otherwise been the case.
Japan was also an absolutist state in the 14th-18th century, and in fact
it remained closed to international trade throughout most of this
period. Differently from China, however, in Japan the power of the
central government was matched by the power of the regional lords.
So the arrival of the West (1853) had a very different and positive
effect on Japan - not because the West had better intentions towards
Japan than towards China, but because its arrival triggered a rebellion
of the lords against the central government (1868), following to which
good political institutions were introduced. In particular, the lords
understood that the only way to resist the West was to allow the
country to grow. Crucially, they had the power to overthrow the
absolutist political institutions that prevented grow from emerging. Of
course in China people understood this too - but in the mid 19th
century, the emperor was too strong for the opposition to be able to
overthrow him.
So in Japan feudalism was abolished in 1869, and a written
constitutions adopted in 1890 (the first in Asia). This created an
institutional monarchy with an elected parliament, and an independent
judiciary. Following to this, individual property rights were introduced,
people were allowed to enter and practice any trade, the state built up

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an efficient bureaucracy, etc. As a result, people began to innovate and

invest, and Japan was the first country in Asia to experience the
industrial revolution.
Of course In China a revolution also took place, but much later, and it
only completely ended in 1949. And unfortunately (at least from the
point of view of economic growth in China), that revolution installed a
communist government that did not believe in the importance of good
economic institutions for growth. Thus, property rights were abolished,
the movement of people across space and markets restricted, etc.
According to the institutional view, then, absolutism first, communism
then, were the reason why the Chinese people did not have good
incentives to innovate and accumulate physical and human capital in
the modern era. Of course, things changed dramatically in the early
1980s, and we are going to consider in the next chapter.

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