The Skeptics Guide to Institutions - Part 3

Posted by Dietrich Vollrath on November 23, 2014 · 7 mins read

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 rule, 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.