The Skeptics Guide to Institutions – Part 3

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

This is the third in a series of posts regarding the institutions literature. The first two posts dealt with original cross-country work on institutions and the attempt to identify the effects using settler mortality.

The third generation of institutions work is, in large part, a response to the empirical problems of the first 2 generations. These new papers avoid vague measurement of “institutions” by drilling down to one very specific institution, and do their best to avoid identification problems by looking for natural experiments that give them good reason to believe they are looking at exogenous variation in the institution.

The following are some good examples of this third generation. There are others that I haven’t listed, but these are ones I talk specifically about in class:

  • Dell (2010). Household consumption and child health are lower in areas in Peru and Bolivia subject to the Spanish mita – forced labor in mines – than in areas just outside the mita.
  • Nunn (2008). The number of slaves taken from an African country is negatively related to income per capita today.
  • Banerjee and Iyer (2005). Agricultural output and investments in education and health are currently lower in areas of India where the British invested property rights in landlords as opposed to cultivators.
  • Iyer (2010). Areas of India subject to direct British colonial rule have lower investments in schooling and health today than areas ruled indirectly through Indian governors.
  • Michalopoulos and Papaioannou (2013). Pre-colonial ethnic political centralization in Africa is related to current levels of development within Africa.

So, problem solved, right? We’ve got solid empirical evidence that institutions matter. Not necessarily.

What these papers demonstrate is that economic development is persistent. If you like, they are evidence that there are poverty traps. If something happens to knock you below some threshold level of development – slaving activity, the mita, arbitrary borders, bad landlords – then you can’t get yourself out of that trap. You are too poor to invest in public goods like human capital or infrastructure because you are spending all your money just trying to survive. So you stagnate. Pushing you into the trap was the result of an “institution”, if we call these historical experiences institutions, but it isn’t institutions that keep you poor, it’s the poverty itself that prevents development.

Take Dell’s paper. She does not have evidence that the mita reduced living standards while it existed, she has evidence that contemporary development in the area covered by the mita is lower, roughly two hundred years after the mita was abolished. Dell shows that education is lower and road networks are less dense in mita areas than in their close neighbors. So what explains the historical persistence? One possibility is that there was some other institutional structure left behind by the mita that limited development. But we have no evidence of any institutional difference between the mita areas and others. We simply know that the mita areas are poorer, and that could be evidence of a poverty trap rather than any specific institution.

The papers on India have a similar flavor. The British no longer are in charge in India, but there are some differences today related to how they did govern. With regards to the effects of direct British, we don’t actually know what the channel is leading to the poor outcomes. We just know that there is an effect. With regards to the effect of landlords or cultivator property rights, this isn’t about institutions, it’s about the distribution of wealth.

Think of the question this way. What specific policy change do any of these papers suggest would lead to economic development? “Don’t get colonized, exploited, or enslaved by Europeans” seems like it would be hard to implement retroactively.

Of the papers I listed, probably the strongest evidence that institutions actually matter is the Michalopoulos and Papaioannou work using African ethnicities. Geographic homelands of ethnicities cross national boundaries, and one can measure the economic development in one of these homelands by using satellite data on lights at night. What MP (I’m not spelling those again) find is that ethnicities that had stronger political centralization prior to being colonized – they had political systems beyond simple chief-led villages – are rich today relative to other ethnic groups within the same nation. But this still leaves unanswered what specifically about pre-colonial ethnic political centralization has been transmitted to current populations. The policy implication for development here is just “be descended from a more coherent political unit”.

Those same authors have another paper, by the way, that looks at the question from the other direction. They look within an ethnicity that spans a national border. Does the economic development level of the two parts depend on the national-level institutions? No. Measures of national-level institutions like those discussed in Part 1 have no explanatory power for development differences between the two parts of a partitioned ethnicity.

Understanding how a country/region/ethnicity got poor is not the same thing as understanding what will make them rich. “Institutions mattered” is different from “institutions matter”. I think the better conclusion from the 3rd generation of institutions research is that economies can fall into poverty traps from which escape is difficult if not impossible. Would better institutions allow these places to escape these traps? I don’t think we can say that with any confidence, partly because we have no idea what “better institutions” means.

I think the right null hypothesis regarding existing institutions is that they likely solving a particular issue for a particular group. Let’s call this the Elinor Ostrom hypothesis. I don’t think that the existing empirical institutions literature has provided sufficient evidence to reject the null at this point. Certainly not to the point that we can pinpoint the “right” institutions with any confidence.

Could I be wrong to be this skeptical? Absolutely. We may come up with concrete definitions of institutions that we can measure and use empirically. There may be research in the works right now that gives some definitive evidence that “institutions matter” for development, in the present, and that appropriately tweaking them will generate growth. If so, hallelujah. But until then, I remain skeptical.

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37 thoughts on “The Skeptics Guide to Institutions – Part 3

  1. Dietz, since you’re looking at effects across borders, you might be interested in my new working paper on this: http://bit.ly/14Xq060 We try to estimate the effect differences in institutional quality affect oil exploration location choices and the effect seems to be large once we account for geological difference. Would love to hear your thoughts, Jim

  2. Dietz,

    You, of course, know that authors emphasize “institutions mattered” because of identification problems. Today GDP and rule of law correlate as well (“institutions matter”?), but we have to use into history to establish the direction of causality.

    Secondly. Persistence, yes. But this persistence lasts after institutional changes: mines, colonial rule, slavery. The idea is, if you manage to change institutions for better, they have positive impact on development.

    And this: “Understanding how a country/region/ethnicity got poor is not the same thing as understanding what will make them rich.” We can argue about the details, but in most cases, getting poor = getting rich with the minus sign.

    Neverless, I fully agree that we may benefit from more modern recipes. Obviously, if labor is mostly free now, we can’t get much practical advice from the observation that slavery is detrimental.

  3. Suppose a miraculous political movement delivers a significant improvement to quality of political and economic institutions, broadly defined, in Nigeria. Are you really skeptical about the proposition that would be good for growth?

    • Luis – sure, that would be good for Nigeria. I’m not denying that institutions may be important, I’m saying that we don’t have any good empirical evidence of that.

      Your thought experiment is “If Nigeria wasn’t so screwed up, it wouldn’t be screwed up”. This is the inherent problem with the institutions literature – it’s true, sure. But you cannot define what it is that being un-screwed-up means.

      • no, I think you are being a bit too hasty.

        I think you could write down a set of improvements to the functioning of the judiciary, political process, bureaucracy etc. that would be as well defined as anything intangible in economics ever is, and these changes may or may not lead to economic growth, it is not a circular definition or a truism. It might be that some poor countries would remain poor even if enjoying high quality institutions.

      • Ok – then why hasn’t any one written them down. Is it better to have a US/UK style common law system, or a French-style civil law system? I don’t think it is actually easy to say what “good institutions” are. The UK has no written constitution, so how would you even know what good institutions consist of in the UK?

        I’m not trying to be overly snarky here. I think there are legitimate questions about whether one could actually *define* good institutions in a truly operational way. Like “pass these specific laws” and you’ll have good institutions. I think it is too slippery a topic.

  4. “I think the right null hypothesis regarding existing institutions is that they likely solving a particular issue for a particular group. ”

    I agree with this comment. But… the next question is what can we recommend for particular groups in terms of their institutions and their history and context.

    Let’s take Cuba or North Korea. I would agree that we cannot be absolutely sure what exact framework of institutions would be the best recipe for economic growth. I also agree that some institutional ideals may not be achievable based upon their history and current institutions. But I am pretty sure we could point out institutional successes and failures of similar countries with similar histories and give them useful advice assuming they desire economic growth and are willing to pay the costs.

    Again, I still think you are overstating our ignorance. Yes, we cannot perfectly quantify such things as an honest and efficient bureaucracy. But I am pretty sure we can agree that a dishonest and inefficient bureaucracy, all else equal , is not a great institutional ideal for economic growth. Can’t we?

    • Hypothetically yes, I think we could recommend certain reforms or policies for North Korea that would improve things economically. But specifying those in detail is not trivial. Not impossible, but not trivial. Is it a set of laws that NK could pass? Or is it a set of cultural norms about trust, fairness, etc.? And how would you install those to NK?

      • I am sorry to be so skeptical, but if this is the case, you should subtitle this series “the Crisis In Economics”. Mr Smith gave us some institutional observations relating to the Wealth of Nations almost 250 years ago. If after all this time we haven’t been able to build upon his institutional ideas (indeed you are suggesting we may have lost ground), then we do indeed need to reconsider the entire field.

        I certainly agree with the following:
        1). There are many ways to skin a cat. The important thing is that the cat get skinned when all is said and done.
        2). You can’t always get there from here. historical contingency matters. But it is important to know where “there” is.
        3). Informal norms and habits are essential and any institutions must build upon or complement these. In addition, norms and habits are extremely resistant to interference and change.
        4). There is probably a difference between lead growth and catch up growth and the institutions may well differ in how effective they are at one or the other.

        However what we do know is how wealth is created and what institutions look like broadly to support this. For example, we need to specify how to determine who decides how property is used, we need to solve alignments between effort and risk and reward, we need to minimize zero sum actions without positive externalities, we need to facilitate division of labor and exchange, optimize freedom within positive sum relations and provide mechanisms to handle negative externalities.

        Putting this all together, the issue isn’t which legal system is best, it is that each nation needs to create a legal system which meets the above (admittedly somewhat contradictory) conditions and does so in ways which complement its current institutions and norms and non economic mores. There are lots of wealthy countries with different norms and conditions, so it is not impossible to provide role models from other nations to adopt.

        At the most skeptical, if we really know so little, the solution seems to be to focus on discovery processes themselves. In other words, if we are that clueless, then it may be prudent to follow the lead of Romer and create ways to import and experiment with proven institutions (charter cities).

      • I think we actually agree on more than it seems. I think we do know what kind of “institutional issues” have to be resolved – we need to know the rules on how property is governed. The actual rules are probably less important than the fact that they are known and not arbitrarily or suddenly altered. Part of my skepticism of the current inst. lit. is that there is some presumption that there is a singular way to resolve the inst. issues at hand, and that need not be the case. So I’d agree that if we want to study inst (and we should!) we should focus on what you call the discovery mechanism.

  5. I don’t want to get ahead of things again, but will you have parts 4, 5…n ? Besides the “reversal of fortune” thing I mentioned in the comments section of part 2, two other topics I would love seeing you blog about : (1) the persistence of bad institutions, for which AJR appeals to various old and new multiple equilibria models. But how can we know whether there are, in fact, “development traps” if we can’t reliably measure changes in institutional quality over time or the variation between countries in cross-section ? When ever they do discuss specific country cases (at their blog or in their book) A&R are painfully ad hoc about any and all apparent changes in institutions. (2) human capital. Glaeser…Shleifer (can’t remember the other authors) from a decade ago argued that “institutions” are at least partially capturing human capital differences which result in institutional quality. (Institutions are created by people…who knew ?) And there’s now quite a bit of evidence for preindustrial human capital, well before modern institutions, e.g. Baten et al. using age-heaping and book-publishing data. Not to mention findings on the education side like Hanushek showing (for Latin America) that years of schooling don’t necessarily translate into achievement as captured by regional & international testing.

    • That is to say, even when countries manage institutions inclusive enough to enact universal state-funded education it apparently doesn’t guarantee educational productivity and/or academic achievements.

    • Plans for a part 4 to wrap things up. Vague plans to write something about the Reversal in the future.

      I like the Glaeser et al paper the more I look at it – we just talked about it in class a few weeks ago. Some very good points about how our measures of institutions are just capturing snapshots of current policy, not underlying constraints. But I need to think a lot harder about how HC influences institutions. As you say, institutions are created by people (surprise!) so HC must factor in at some point.

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  7. “they find is that ethnicities that had stronger political centralization prior to being colonized – they had political systems beyond simple chief-led villages – are rich today relative to other ethnic groups within the same nation.” Really, northern Nigeria is richer than the south today?!!! The Ibo have traditionally been identified as the most successful business class in Nigeria; they were among the least decentralized. None of the really applies to the Ivory Coast or plenty of other places. I am almost certain their study is a classic example of fallacy of composition!!!!

    • In Michalopoulos & Papaioannou “precolonial institution” is proxied by ordinal numbers based on a “jurisdictional hierarchy of index” constructed by the anthropologist George Murdoch (Avner Greif has used his data on family systems also). So maybe the same problem which afflicts indices like “constraint on the executive” that DV talked about in part 1 is also present here.

      • MP are a little more sophisticated, in that they actually use dummies for each of Murdock’s categories, avoiding a big part of my critique from part 1. The general finding is that there is a distinct advantage to being in Murdock’s group 4 (pre-colonial states) relative to being in any group below that (tribes, uber-tribes, loose chiefdoms).

    • Are these better or worse than the ones made up out of thin air by other people? Why? Which ones has Murdoch personally created? How do they fare empirically? Have they made predictions based on the indexes? Do they plan to?

      • All excellent questions, and the Murdock indexes are potentially just as arbitrary as any x-country index. My guess is that there are anthropologists out there that would violently oppose Murdock’s rankings. Put it this way, even *if* Murdock’s ranks are accurate, these papers still don’t tell us that institutions matter. So if the ranks are wrong, that makes it worse.

    • See my reply to Cardiff. Economists have taken Murdock as some kind of Gospel truth, but of course none of us ever dug back into the antro literature to confirm any of this.

  8. Also the nice thing about the Banerjee Iyer paper is that they actually point to a mechanism: differential adoption of green revolution technologies, and _not_ land inequality, as most states enacted some form of land reform after independence. They in fact argue that it is the smoldering social conflict that prevented villages from making complementary Green Revolution public investments that is the source of the persistent effect. The best kind of these papers show how the historical difference interacted with subsequent shocks to generate persistent effects.

    • Great point. One could certainly call that social conflict a “bad institution”, so in that sense the institutions view is right. But that also seems to define institutions really broadly. I’m going to talk about this in a new post, but the issue seems to be that once you’ve created some kind of elite (landlords in British India), that elite will work hard to prevent anything happening to that status.

  9. Probably the rise of the institution issue is connected to the rise of historical research in the study of economics with the aim of explaining economic development. This last sentence is taken from Easterly, The Tyranny of Experts, pp 137 with the amendment of qualification by myself.
    It seems that institutions cannot be discussed without the policy of the institution. An institution is not an unconnected thing without influence for good, bad or indifference. However in Professor Easterly’s book, pp 217, he lists many major economists as finding that national policies affect growth very little which seems a surprising finding not to say confusing. If good institutions are proved to be beneficial then their policies would be contributing to that. The list is Larry Summers, Michael Kremer and Lant Pritchett with Dani Rodrik quoted in the same section as having the same finding.
    I would think lots of things can be considered but one is institutions and innovation. The former will tend to impact the latter adversely. But, of course, I can’t prove that.
    Another is the current oil price fall. I was in East Africa this week and the pump price is already reflecting the decline in oil freeing up potential spend elsewhere in the economy. But here there is no change in the price. So it is an institutional policy issue impacting on growth or at least broader growth.

  10. Probably you can define a good institution as one that meets its own policy goals or stated ideals as it defines for it self irrespective of whether is its part of “US/UK style common law system, or a French-style civil law system”.

    And identifying the critical/dominant Institution/s of a particular country or region and comparing their performance with that particular region or country’s economic development might provide good information on successful policies.

    So are they any studies on these lines.

    • So how would you measure the critical/dominant institution? How would you decide which one was important, or what is really was? These are not measurable things, inherently.

  11. I think this discussion shows that maybe we (economists) have not been thinking deeply enough about these issues which other disciplines (anthropology and political science) have wrestled with for much longer time. Instead we find some “measure” of institutions and then just ran regressions as this was the only valid scientific method. Could it be that the methods used on other disciplines are better to use to answer questions about the institutions -development nexus? In other words, maybe we believe that democratization is an important step in the process from stagnancy to growth and, yet, it may be impossible to quantify the causal effect of democracy on growth.

    P.S. Look forward to your comments on the reversal paper which I also have very critical remarks about. (for example effects from regression to the mean )

  12. Firstly, a policy recommendation is not a requirement for confirming/rejecting the hypothesis that institutions matter. You don’t propose this requirement explicitly yet you do appear to try to use it as an argument against some hypotheses.

    Secondly, I don’t agree that the possibility of a poverty trap refutes such studies’ claims about the effects of institutions. If the poverty trap is caused by the quality of institutions, then that means institutions matter in determining incomes, albeit indirectly. In fact, the effect of institutions on economic outcomes is normally indirect – e.g. better institutions lead to more investment, or lower transaction costs, etc. which in turn affects overall income. If institutions do in fact impact the existence of a poverty trap, then I would definitely say that institutions matter.

    Put another way, I think you’re placing too many constraints on the way in which institutions must be shown to matter. You seem to require evidence of a contemporaneous effect between institutions and prosperity. I don’t agree – I think a paper that shows a measurable difference in development even 200 years after the exogenous institutional difference existed is pretty strong evidence that institutions matter in a very important way, even if we can’t pin down exactly how or when.

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  15. Overall, this was just an awesome set of posts. I came to them belatedly, but I’ll be coming back. If you had said nothing else, the distinction between what mattered in the past (obviously, something did) and what matters going forward (something will, but what?), is one that would have paid the rent. Thanks.

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