1. Inequality, Institutions and Long-Term Growth in Colombia Michael Clemens William Easterly Carlos Esteban Posada Banco de la República, Bogotá, Nov. 19, 2002

2. Part I: Inequality and Economic Development

3. Outline zMotivation zLiterature review zEmpirics

4. Motivation : predicting inequality with factor endowments zEngerman and Sokoloff 1997, 2000 link tropical commodity factor endowments in Latin American countries to high inequality and powerful elites, who in turn suppressed democracy and did not invest in mass human capital. The elite feared giving increased political voice to the majority (political voice increases with human capital), because they did not want to lose their power and the rents that came from that power. zThe non-tropical land in North America lent itself to family farms, which implied greater equality, more democracy, and greater investment in mass human capital. zBourguignon and Verdier 1999 have similar theory story.

5. Aristotle 306 BC “Thus it is manifest that the best political community is formed by citizens of the middle class... where the middle class is large, there are least likely to be factions and dissension.”

6. Literature review: Inequality and growth zHigh inequality linked to poor growth outcomes (Alesina and Rodrik 1994, Persson and Tabellini 1994, Clarke 1995, Perotti 1996, Deininger and Squire 1998) zThis literature was challenged by Barro 2000 and Forbes 2000 with high frequency data, but they in turn were challenged by Deininger and Olinto 2000. zBut: problems of data frequency, robustness, data quality, and endogeneity remain.

7. Literature review: growth and ethnic fractionalization zEasterly and Levine QJE 1997 on association between high ethnic fractionalization, rent-seeking policies, low human capital and low growth in cross-country sample. Mechanism could be similar to inequality story: ethnic coalitions in power don’t want to invest in human capital of ethnic groups excluded from power for fear of increasing their political voice zExample of prohibition of educating slaves and “separate but equal” schooling in the American South zAlesina, Baqir, and Easterly QJE 1999 find association between high ethnic fractionalization and low education spending in US cities

8. Predictions zWeaker incentive for the government to invest in human capital or public goods when it goes to excluded poor majority Elite will want to suppress democracy under high inequality and high ethnic fractionalization. zPrediction: Societies with smaller middle class will invest less in human capital and public goods, and thus will have lower growth and income, and will have less democracy

9. From predictions to empirics zWe have good instruments to use for commodity exporting (crop production dummies) in a GMM system with one equation predicting inequality (as a function of crop production dummies) and a second set of equations predicting institutions, policy, and schooling, and a third equation predicting development outcome as function of institutions, policy, and schooling. zInstrumenting for inequality addresses both the endogeneity and errors in variables problem

11. Engerman and Sokoloff point to specific commodities as fueling inequality zES: Sugar, rice, and silver were the bad guys in Latin America zES: Wheat and maize were the good guys in North America zI find some evidence for all but wheat zOil is a suprise (decreases inequality). Millet is another grain that decreases inequality. zA lot of collinearity between commodity dummies -- very hard to estimate separate effects on inequality of particular commodities, but fairly high explanatory power of commodity endowments for middle class share in the aggregate.

12. Running a horse race for alternatives to middle class hypothesis to explain level of development zHall-Jones Institutions + Openness instrumented with latitude and European language zAcemoglu et al. Institutions and Settler Mortality zLa Porta et al./Glaeser and Shleifer Institutions and Legal Origins zSachs-Warner natural resource curse zSachs tropics curse zGalor and Zeira inequality and schooling zFrankel-Romer openness instrumented with gravity model

18. Robustness checks zWorks with land inequality as well as with income inequality. zShare of agriculture + mining in GDP works as well as commodity exporting dummy. zFind no evidence that tropics or crop production has a direct effect in the income or growth equations (nor landlocked dummy) -- provisionally solves the tropics mystery zPrediction also works with US counties -- higher inequality predicts lower income.

19. Research along these lines may give insights into some empirical puzzles zWhy do natural resource producers do badly? (because certain natural resources are associated with high inequality) zWhy is there such a strong correlation between latitude and per capita income? (because tropical commodities like coffee and sugar are associated with high inequality)

20. Fail to reject overidentifying restrictions for instruments for each equation separately For equations for Institutions, Openness, Log(schooling), log(GDP90) all fail to reject at 5% level (Openness does reject at 10% level)

21. Conclusions to Part I zTheory and previous literature suggest that inequality is bad for human capital accumulation, democracy, and overall economic development zA middle class consensus (high middle class share) parsimoniously explains high growth, high income, more democracy, and more schooling