Economic development and growth Advanced Political Economics Fall 2011 Riccardo Puglisi

Why countries differ so widely in their economic development? Main Questions Why countries differ so widely in their economic development? Do institutions matter for development?

Reverse Causality: What drives what? Key fact Large evidence showing a positive correlation between “good” institutions and growth EXAMPLE: Property rights PROBLEM: Reverse Causality: What drives what?

FIND AN INSTRUMENT FOR THE RELEVANT EXPLANATORY VARIABLE Solution How to solve reverse causality problem? FIND AN INSTRUMENT FOR THE RELEVANT EXPLANATORY VARIABLE How to do this? Mauro (1995) analyzes corruption, instrumented by ethnolinguistic fragmentation

More difficult to control Solution His argument is: Higher fractionalization More difficult to control More corruption

Solution Lower growth Higher corruption Through this IV technique, Mauro found that: Lower growth Higher corruption Critics: Ethnolinguistic fragmentation may affect growth through other channels, such as political instability

Acemoglu, Johnson and Robinson (2001) They used MORTALITY OF THE SETTLERS as an instrument for good institutions LOW MORTALITY Settlers may decide to stay and re-create home GOOD INSTITUTIONS

Acemoglu, Johnson and Robinson (2001) HIGH MORTALITY Settlers may decide to extract rents and leave BAD INSTITUTIONS EARLY INSTITUTIONS CURRENT INSTITUTIONS GROWTH CURRENT INSTITUTIONS

Problem Which institutions matter? Acemoglu, Johnson and Robinson use security of property right but problem of high correlation with several other aspects ( democracy, independence of judiciary system,...) How do they matter? How do they promote or block development?

ACEMOGLU-ROBINSON (2000): “POLITICAL LOSERS AS A BARRIER TO ECONOMIC DEVELOPMENT Why do past societies fail to adopt the best technology or good economic policies? Who blocks economic progress (such as the introduction of new technology)? And why?

The economic losers HP Strong interest groups block the introduction of new technology to protect their economic rents LIT: Mokyr (1990), Parente-Prescott (1997) BUT…. To block new technologies, they need POLITICAL POWER If they have political power, why not using it to appropriate the gains from the introduction of new technologies?

The political losers HP IDEA: Groups whose political power is eroded will block the economic innovation Economic losers w/o political power cannot block it Non-political loosers have no incentive to block

The model Static environment 3 groups Consumers (with mass of 1) A Monopolist A potential entrant 2 goods corn, x, produced competitevely and with unitary price manufacturing good, y, produced by the monopolist or the rival at a price p Citizens have a large endowment of corn, m

The model Citizens have utility Budget constraint F.O.C. This is the demand function of good y

The model Monopolist/Rival Technology where 0 denotes the incumbent and 1 the rival There is a tax on manufacturing good, τ Profit function

The model

Timing Initially the Monopolist controls the political system and can block the rival’s entrance at a cost c There is a shock to the political system with the Monopolist who may lose his power If he remains in power, he may set A tax rate τ on the manufacturing good y A lump-sum tax on citizens

Timing If the new technology is not introduced, Monopolist remains in power with probability q introduced, the Monopolist remains in power with probability s Notice that s≤q

Behavior of the Monopolist Utilities: Blocks & remains in power: Block & loses power (assumption: no tax from next government) No block & no power

Behavior of the Monopolist No Block & power IDEA: In case you let the new firm enter the market, and then use your power to tax the rival. Hence, you maximize tax revenues

Behavior of the Monopolist Hence,

Behavior of the Monopolist Now we have to examine the expected returns in the different scenarios: In case the Monopolist blocks In case the Monopolist doesn’t block

Behavior of the Monopolist This implies that the Monopolist would block IFF INTUITIONS If new technology is so good that and so if q=s=1 ( no loss of political power) then the Monopolist would not block, and therefore would get T+R Blocking comes from the fact that s<1 and s<q: the threat of losing power decreases the appetibility of technological change

INCREASE THE INCENTIVE TO BLOCK Theoretical Implications INCREASE THE INCENTIVE TO BLOCK

Historical perspective: Different resistance to economic development (Gerschenkron argument): Landed Aristocracy in Britain or Germany Elites in Russia and Austria-Hungary