1. Economic development and growth
Advanced Political Economics
Fall 2011
Riccardo Puglisi

2. 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?

3. 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?

4. 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

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

6. 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

7. 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

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

14. 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?

15. 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?

16. 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?

17. 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

18. 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

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

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

21. The model

22. 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

23. 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

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

25. 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

26. Behavior of the Monopolist
Hence,

27. 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

28. 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

29. INCREASE THE INCENTIVE TO BLOCK
Theoretical Implications
INCREASE THE INCENTIVE TO BLOCK

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