Institutions, what institutions?

There are many explanations for why some nations are rich while others are poor. The dominant view, in mainstream (neoclassical) economic circles is that institutions are the central cause of the divide between developed (center) and underdeveloped (periphery). I discussed before (here and here) the role of institutions vis-à-vis geography and culture. I have also noted how the New Institutionalist argument concentrates on the institutions (fundamentally property rights) that act on the supply side of the economy. That is growth arises because property rights provide incentives for productive investment. I also noted (here) that the historical evidence for patents, copyright and other forms of property protection for explaining growth is limited at best. Note that mainstream authors and heterodox authors, at least the majority, tend to agree that institutions rather than geography or culture are central for development.

Also, the table above suggests that cultural and geographical explanations tend to put an emphasis on the supply side, but that is not necessarily the case, and it would be difficult to speculate about what Jared Diamond, for example, thinks about the relative role of supply and demand. Also, it’s worth noticing that while in his early work economic historian David Landes favored a demand-led view (which I tentatively put in the institutional box) he clearly moved to a cultural supply-side interpretation in his later work.

So if you believe most heterodox economists institutions are relevant, but not primarily those associated to the supply side; the ones linked to the demand side, in Keynesian fashion are more important than the mainstream admits. Poor countries that arrive late to the process of capitalist development cannot expand demand without limits since the imports of intermediary and capital goods cause recurrent balance of payments crises. The institutions that allow for the expansion of demand, including those that allow for higher wages to expand consumption and to avoid the external constraints, are and have been central to growth and development. The role of the State in creating and promoting the expansion of domestic markets, in the funding of research and development, and in reducing the barriers to balance of payments constraints, both by guarantying access to external markets (sometimes militarily, like in the Opium Wars) and reducing foreign access to domestic ones was crucial in the process of capitalist development.

In this view, for example, what China did not have that England did, was not lack of secure property rights and the rule of law, but a rising bourgeoisie (capitalists) that had to compete to provide for a growing domestic market that had acquired a new taste (and hence explained expanding demand) for a set of new goods, like cotton goods from India, or china (porcelain) from… well China, as emphasized by economic historian Maxine Berg among others (for the role of consumption in the Industrial Revolution go here). Or simply put, China did not have a capitalist mode of production (for the concept of mode of production and capitalism go here). Again, I argued that Robert Allen’s view according to which high wages and cheap energy forced British producers to innovate to save labor, leading to technological innovation and growth, and the absence of those conditions in China led to stagnation is limited since it presupposes that firms adopt more productive technologies even without growing demand.

The same is true of Latin American economies, which several authors like Engerman Sokoloff suggest fell behind as a result of absence of secure property rights. Latin American economies entered the world economy to produce silver (mining-economy/Amerindian population), sugar (plantation-economy/African-American population) and other commodities, for external markets. They were exploitation colonies, less reliant on the development of domestic markets, typical of settlement colonies in the Northeast United States or of the central countries in Western Europe.

The economies that depend on the production of commodities for world markets and import everything else are more vulnerable to the fluctuations of the price of commodities. Booms in commodity prices lead to growth, albeit very concentrated in the hands of the owners of capital, but they leave very little in terms of infrastructure for future growth. Further, since the economy must import everything to satisfy domestic demand, the economy is dependent on external sources of production, and when the export of commodities does not allow for enough imports, then either demand must be curtailed or the economy must become indebted to be able to continue to consume. A thriving domestic market is central for economic development, and the ability to diversify production to provide for the market is the key to catching up.

Finally, since the economy was based on the mono-production of commodities (and the size of the domestic markets is relatively limited) there were little if any incentives for technological innovation and higher productivity. Note also, that once a country falls behind, and almost all countries were essentially at the same level of income per capita around 1800 (or at least differences were considerably smaller than now), it is very hard to catch up, since the distance to the technological frontier is increasingly steep. It is not the same to copy a textile mill that uses a steam engine than to emulate the development of the Silicon Valley. In this sense, the institutions associated to the colonization period are central, rather than property rights, to explain underdevelopment in Latin America. Capitalism and its institutions both caused growth in the center, and stagnation in the periphery.*

* I discussed here how the industrialization of Britain meant the deindustrialization of India and China.

Kirsten Ford, a young Old Institutionalist

Kirsten Ford (1976-2014)

I first met Kirsten in the mathematics leveling class for the incoming PhD students. I think it was in 2007, but it might have been the year before. She felt she needed to take more math courses, and did so at Westminster College, where she had obtained her Bachelor's degree. She had come to economics out of a concern with social justice, and her early views were shaped in Dick Chapman's classes on Keynes' General Theory and Chace Stiehl's discussion of classical political economy authors, both PhDs from Utah's graduate program, which influenced her choice for her graduate studies.

At that time I taught two regular courses in the graduate program, the second required macro class, which basically reviewed heterodox approaches and growth theory (both conventional and heterodox views), and the second history of economic thought course, which went from the Marginalist Revolution to the post-capital debates developments (the change in the notion of equilibrium, and what I referred to as the return of vulgar economics; the first part of the course on classical political economy and Marx was taught by E.K. Hunt). She and her classmates, which were among the best cohorts of students in the PhD program I can remember, took also two other elective courses with me. A seminar on Sraffian topics, and a course in international economic history.

That course was not chronologically organized. The topics covered emphasized unresolved controversial issues in international economic history, e.g. whether there was an Industrial Revolution, the critique of Eurocentric interpretations of History, and the revival of cultural and geographical explanations for relative backwarderness. One of the most fun courses I ever taught, not just because I basically taught what I wanted, but more importantly because I never learnt as much from my students as I did in that opportunity.

Kirsten's interests were broad, but she had a particular concern with the institutional aspects of economic development, approached from a historical perspective, and that would include the history of ideas. That was very much in line with the institutional/Marxist traditions that already existed in Utah's economics department, and fit with my own work in what might be called the Classical-Keynesian tradition (classical meaning the old classical political economists, including Marx, as interpreted by Sraffa, while Keynesian puts an emphasis on the radical followers of Keynes and Kalecki).

She published early on a paper (in a Brazilian journal called Versus, which I suggested as a venue; accessible version here) that was based on a previous one done in a development course with Nilüfer Çağatay. It was a critique of the New Institutionalism of Douglas North, and a discussion of the Veblenian, or Old Institutionalist roots in the radical development economics of Ha-Joon Chang. She also published, with Bill McColloch, one of her colleagues in the graduate program, a paper on the Journal of Economic Issues on the methodological compatibility between Marx and Veblen (working paper version available here), influenced by Hunt's views on the topic, to some extent.

Kirsten also collaborated with me, and Nathaniel Cline, another graduate student at the U, on a paper on the persistence of mainstream policy advice, even after the crisis of the marginalist paradigm in the 1970s, in which we hinted that a real world economic crisis, like the Global Recession of 2008, was an unlikely cause for significant changes in the direction of research, which was published in the Journal of Philosophical Economics (see here). Kirsten was particularly interested in the role of the IMF as a the institutional instrument by which conservative policies were maintained in developing countries. Further research on the lack of change in the IMF policy positions that she conducted will be published later this year in Development and Change.

She was also interested in the role of institutionalist authors during the New Deal, and helped me to do research on Marriner Eccles papers at Marriott Library. We had a project of publishing some of Eccles speeches as the chairperson of the Fed.

Kirsten was extremely generous in her intellectual exchanges, unwilling to take her contributions as exclusively her own, and sharing them as part of the knowledge of the group. Surprisingly that's not common among the heterodox tribe, in which pride and the desire for prominence often lead to fratricidal disputes. She was also generous with her time, dedicating immense amounts of it to organize the Heterodox Economics Student Association (HESA), and making the economics department better for other graduate students, and to her classes and her students. Economics as a profession is a little bit better because of her work.

On Argentina's secular decline: why The Economist is wrong

The Economist had a few weeks ago an issue on Argentina (here; subscription required), which I wanted to address, but had no time before today. The argument implies that the current Argentine woes (discussed here before) are part of a pattern which is associated to the long decline in income per capita from the late 19th century and early 20th century until now.

The Economist suggests that:

"In 1914 Argentina stood out as the country of the future. Its economy had grown faster than America’s over the previous four decades. Its GDP per head was higher than Germany’s, France’s or Italy’s. It boasted wonderfully fertile agricultural land, a sunny climate, a new democracy (universal male suffrage was introduced in 1912), an educated population and the world’s most erotic dance. Immigrants tangoed in from everywhere. For the young and ambitious, the choice between Argentina and California was a hard one."

In a sense that's true. According to Maddison's data in 1913 Argentina per capita GDP (in 1990s dollars) was 3,797 while France and Germany had respectively 3,485 and 3,648 (data available here). However, the reasons for the decline in the 20th century are based on simplistic notions, typical of the so-called New Institutionalism of North and more recently Acemoglu and Robinson (for a critique go here). In their words:

"Building institutions is a dull, slow business. Argentine leaders prefer the quick fix—of charismatic leaders, miracle tariffs and currency pegs, rather than, say, a thorough reform of the country’s schools."

They blame corruption and populism (mind you currency pegs were actually typical of liberal governments, both the ones that adopted the Gold Standard, an international institution, back when the economy was fine according to The Economist, and during the 1990s during the Neoliberal experiment, that The Economist fully supported; but I'm glad that now they admit that currency pegs might be sometimes dangerous. The Economist is not for the Gold Standard anymore, it seems. Any day now they will abandon their beliefs on free trade).

On a different note they also suggest that commodity production might be a problematic path to development (yes, The Economist again has a positive take on Prebisch-Singer; see before here). They say:

"Commodities, Argentina’s great strength in 1914, became a curse. A century ago the country was an early adopter of new technology—refrigeration of meat exports was the killer app of its day—but it never tried to add value to its food (even today, its cooking is based on taking the world’s best meat and burning it). The Peróns built a closed economy that protected its inefficient industries; Chile’s generals opened up in the 1970s and pulled ahead. Argentina’s protectionism has undermined Mercosur, the local trade pact. Ms Fernández’s government does not just impose tariffs on imports; it taxes farm exports."

In other words, Pinochet was great (Chile is developed it seems; again according to Maddison's data the Chilean GDP per capita in 1990 dollars in 2008 was 13,185 while the Argentine was 10,995. Not much of a difference; back in 1913 Chile's was 2,968 and like Argentina's high for Latin America's standards. In other words, while France and Germany had in 2008 22,223 and 20,801 respectively in 2008, both Chile and Argentina had fallen behind), and redistribution towards the poor (read Perón and the Kirchners) is bad. That's why the lesson is "that good government matters."

Don't get me wrong, the State matters, and a developmental state matters a lot. However, when and how you connect with global markets also matters. While France and Germany might have had a slightly smaller GDP per capita in 1913 than Argentina, they were quite ahead in the second Industrial Revolution, with firms that were leaders in steel production, in the chemical and pharmaceutical sectors, and with a developed network of firms and universities producing first rate scientists and technological innovations. Meanwhile, Argentina (but also Chile) produced mostly commodities (and only adopted imported technology) and the vast majority of their exports were concentrated in one or two commodities exported to a limited number of countries. Hence, only someone with the limited understanding of The Economist would have thought that Argentina and Chile were in 1913 as developed as France and Germany.

The lesson is more complex than The Economist's 'the state matters' (interestingly enough if markets did matter, which is their traditional motto, specialization in commodities due to comparative advantage should pose no problems). The state matters, but so does your colonial past (being an exploitation colony rather than a settlement one is a problem), what you export matters, and the access to international capital markets also matters (France and Germany got a Marshall Plan to reconstruct, since the US was afraid of Uncle Joe, but in Argentina we weren't that lucky). The parable of Argentina is a rich one, from which many should learn, but The Economist still has no clue.

PS: Don't get me wrong, building schools is nice, and Argentina actually produced three Nobel prizes in sciences (the last one in the 1980s), but schools alone do NOT produce development.

PS': Also, why is Messi a symbol of Argentina's secular decline?

Peter Temin on the strange death of economic history

Peter Temin recounts in this paper the vanishing (apparently complete by 2010) of economic history from the MIT curriculum. History of thought has probably vanished even before, if it was taught at all. He says that:

"Economic history at MIT reached its peak in the 1970s with three teachers* of the subject to graduates and undergraduates alike. It declined until economic history vanished both from the faculty and the graduate program around 2010."

He notes that the most famous economic historian graduated from MIT was Christina Romer, which, it must be emphasized, in her famous paper on the Great Depression claims that fiscal policy (and to a great extent the New Deal) was not responsible for the recovery. For her it was the non-sterilized inflows of gold that increased the money supply [yep, the most important historian graduated at MIT is more of a Monetarist than a Keynesian; New Keynesians are peculiar that way; for more go here].

Ideologically this is the result of the same forces that led to Fukuyama's hubristic announcement of the death of history after the fall of real communism in Eastern Europe. And the New Economic History, that received two of the Sveriges Riksbank Prize in Economics (aka the Nobel, but not really) given to North and Fogel, is part of the problem, as Temin notes. He says:

"In terms of the class struggle ... the coalition of theory and econometrics left economic history out of power in the counsels of economics. Proponents of the New Economic History were using more and more econometrics in their work, but they were no match for theorists."

That is why Temin does not consider the work of Acemoglu, including his recent Why Nations Fail to be good economic history. In his words the book:

"is an example of Whig history in which good policies make for progress and bad policies preclude it. Only transitions from bad to good are considered in this colorful but still monotonic story. The clear implication is that if countries can copy the policies of English-speaking countries, they will prosper."

For my critique of the book go here. At any rate, economic history, as well as history of economic thought, should be at the center of the teaching of economics.

* Temin who was hired to replace W.W. Rostow, Evsey Domar and C. P. Kindleberger.

Property rights and the Industrial Revolution

I have discussed here a few times (here, here and here, for example; last one by Cesaratto) the role of institutions in the process of economic development. Within the mainstream the dominant view is that property rights are the essential institution for promoting growth. I only now came across the excellent paper by Julian Hoppit.* He says:

"Such views of the interrelated importance of property and the rule of law have led to major interpretations of the interplay of Britain’s economic, social and political histories, including that secure property rights were a vital foundation for the first industrial revolution. Yet property was often heavily taxed, frequently expropriated and, exceptionally, eradicated through redefinition. Such vulnerabilities did not diminish after the Glorious Revolution, they increased—mainly because parliament now met annually, had greater sovereign power than earlier monarchs and legislated prolifically regarding property. After 1688, Britain’s economic precocity rested less on the enhanced ‘security’ of property in any general sense of the word, much more on respect for parliament’s authority and its willingness to allow property to be alienated, most usually by particular interests claiming to act for the public or wider good. At times this required the reversal of commitments made only a generation earlier, raising doubts about central government’s credibility. Taken together, these uncertainties over property rights were sufficient for some to question whether property had a sound theoretical basis at all.
...
The scale of that expropriation was such, and the consequences so profound, as to undermine an important thesis that property rights became more secure after the Glorious Revolution, developed in a notable essay by Douglass North and Barry Weingast and now conventional amongst some ‘new institutional economists’."

Hoppit looks at the extensive expropriations in financial markets, after the South Sea Bubble, in heritable jurisdictions (offices granted by the Crown), and in the property of slaves. Very little is left of the new institutional argument.

* Julian Hoppit in "Compulsion, Compensation and Property Rights in Britain, 1688-1833," Past and Present, No. 210, Feb. 2011 (here; subscription required).

Reversal of fortune and settlement colonies

Acemoglu and others have discussed the concept of reversal of fortune, the idea that the areas with high income per capita around the 1500s (basically the areas colonized by Europeans in the Americas and Asia) became relatively poor, and vice versa. The idea is that there is a negative relationship between economic prosperity in 1500 and income per capita today. They suggest that the type of settlement and the institutions built by colonizers explain the apparent paradox.

The idea is that in settlement colonies, were more equalitarian societies were built, institutions protected property rights and led to higher investment and growth (à la North). They use the mortality rates associated to a particular region as an instrument for the type of settlement and institutions built by European colonizers. High mortality rates imply low European population density, more indigenous or African slaves, and more unequal institutions, with less protection of property rights.

It is a clever argument, no doubt (put forward by Engerman and Sokoloff, in fact), and more importantly a creative use of the notion of settlement colonies.* I have several problems with it, nonetheless. It is far from clear that equality is really connected to growth, and that causality runs from Western type property rights to growth, rather than vice-versa. I tend to spend quite a bit of time on this in my Latin American History classes. There are also significant problems with Engerman and Sokoloff's notion that institutions responded to factor endowments [fundamentally the idea that in capital-abundant/labor-scarce societies, wages were high leading to technological development; yes the capital debates again, but I'll leave this for another time].

Recently I found the graph below in Angus Maddison's Contours of the World Economy 1-2030 AD: Essays in Macro-Economic History.

The graph shows that Southern Europe, North Africa, and the Eastern Mediterranean were the high income regions, while Northern Europe was relatively poor. In this case, in fact, disease is not a good guide for the type of institutions built in the different regions. Other than the Italian Peninsula, it is the Nile Valley, i.e. Egypt, that had the highest income per capita during the Roman Empire. The Reversal of Fortune is also evident in this case, with France having a significantly higher income per capita than Egypt, for example. It is hard, however, to think that mortality rates associated to tropical diseases (with Southern Europe and North Africa closer to the Tropics) would have something to do with this particular reversal of fortune.

It was the region of older agricultural settlement, more urbanized, more directly connected with Eastern trade, the Eastern Mediterranean part of the of the Empire that was more developed, and that survived for a longer period (until the Turkish conquest of Constantinople in 1453). The reasons for the reversal of fortune in this case, are connected to the rise of the Atlantic economy, related to the Great Discoveries, and the expansion of the African route to Asia. If you ask me, more relevant than the incentives provided by property rights in explaining the Portuguese (and then Dutch and British) search for the alternative routes to Asia, is the rising and changing patterns of demand in Western Europe (and success is based on the naval-military advantage, Guns and Sails, Cipolla would say). But for our purposes here it is only relevant to note that mortality rates no longer seem a relevant instrument for the types of institutions.

* Moses Finley suggests that the idea of settlement versus exploitation colonies (note that Acemoglu et al., avoid the use of the term colonies of exploitation referring only to the settlement ones) was originally developed by Wilhelm Roscher of the German Historical School and later by Paul Leroy-Beaulieu, a liberal (in the European sense of the word) French economist.

Why economists fail

The new book (and the accompanying blog) by Daron Acemoglu and James Robinson Why Nations Fails is a popular version of their academic papers (several with Simon Johnson, the ex IMF chief economist) on the topic [brief summary here]. The main idea is that institutions and not geography or culture are the key to economic development. That is for the most part true.

They use South and North Korea (and Nogales, México and Arizona) as an example of countries that share the same culture and geography, but have very different institutions, and, as a result, a huge disparity in income per capita. Jared Diamond is correct to point out that, in part, technology is geographically determined. No plants and animals to domesticate, and provide for a large surplus (Diamond uses the old classical notion of surplus), and higher population density (with the diseases and immunities associated to those Germs) and no advantages associated to a more developed division of labor (Diamond is also Smithian in that sense), with the consequent development of technology (Guns and Steel). But the problem is that this won’t help you understand why England and not China industrialized (the opposite extremes of the Eurasian continent).

Read the rest here.