Week 8 - Institutions

Question 1

How is korea an example of how different institutions can lead to differing income per capita?

Answer 1

Before the divide, they were very similar in geographical endowment, people, cultures etc. 50 Years after the war, it is estimated that south is 10 times richer than the north.

Question 1

How is the North different institutionally to the south?

Answer 1

No freedom of press, no democracy. A communist, authoritarian state. no room for private initiative.

Question 2

Define institutions

Answer 2

Institutions are rules of the game in a society or, more formally, are humanly devised constraints that shape human interaction

Question 3

What are 3 important features in this definition?

Answer 3

1. ‘Humanly devised’ - we decide which institutions rule.
2. ‘rules of the game’ setting ‘constraints’ or human behaviour
3. major effect will be through incentives

Question 4

What are the two types of institutions we can distinguish?

Answer 4

Economic - help determine the economic rules of the game e.g. property rights
Political - determine the rules of the political game e.g. rules to set the limits of political power and how it can change such as electoral rules

Question 5

What is another distinction we can make between institutions?

Answer 5

Formal - everything you can consult/written down e.g. a constitution
informal - how a given set of formal rules actually work in practise. Not written down e.g. loads of countries have similar presidential systems but in practise they often work very differently e.g. america and russia

Question 6

What are extractive/bad institutions?

Answer 6

set up an extractive income and wealth from one part of the population to benefit a different part (the elite)

Question 7

What are good/inclusive institutions?

Answer 7

Broad participation in economic activities, free choice, people choose the best way to deploy their talents and skills. Unbiased rule of law which provides a level playing field, not just for the elite but for a broad cross-section of the population

Question 8

How will a poor economic institution affect development, using the example of a farmer without secure property rights?

Answer 8

If there are poorly defined rights, the return on your investment for things such as fertiliser, plows, tractors (which will expand income per capita) become very uncertain since theres a risk you get expropriated by the government. There is no incentive for investment. You also have to to use your income for anti-diversion such as fences and security.

Question 9

When institutions are extractive, what is the biggest risk to people?

Answer 9

Expropriation from the government.

Question 10

What is a key issue in an extractive institution?

Answer 10

Lack of checks and balances on government power, so no limit to what people in power can do.

Question 11

What is another problem for the farmer in an extractive institution, regarding borrowing

Answer 11

Farmer will find it difficult to borrow because of these insecure property rights - collateral has less value.

Question 12

What are other reasons the farmer may not get a loan?

Answer 12

Weak courts and bankruptcy laws make it difficult for bank to recover money when repayments are not coming in, so won’t lend in the first place.
Political instead of economic motives for loans; bank under pressure to lend to politicians.

Question 13

In bad institutions when even simple buying and selling goods and services are more difficult?

Answer 13

1. Acts of buying/selling can be separated in time e.g. direct debits, buying online. Risky if courts don’t work and police are corrupt.

Question 14

What is an effect of having bad institutions in terms of policies and public services?

Answer 14

Elite enrich itself without regards to the population as a whole. This leads to bad policies: price controls, high export taxes, unsustainable public sector deficits leading to hyperinflation.these lead to bad public services: corruption, jobs allocated to political supporters. These are very detrimental top income per capita

Question 15

In a nutshell, what are characteristics of bad institutions?

Answer 15

1. Insecure property rights
2. No checks and balances on governemnt
3. risk of expropriation
4. unable to borrow

Question 16

What does Acemoglu, johnson and robinson (2001) do?

Answer 16

isolates a more plausible source of exogenous variation in institutions to estimate causal effect on economic outcomes.

Question 17

What is the general story in AJR?

Answer 17

When european countries were colonising the world, there would be a difference in expedition mortality rates depending on where they would go. When the mortality rates are lower, people would be more likely to settle there for longer so would create better institutions. Where mortality rates were higher, they were less likely to put good institutions in place since they weren’t going to settle there.

Question 18

So what are AJR linking the quality of institutions with?

Answer 18

Settler mortality rates

Question 19

Why might institutions persist?

Answer 19

1.Improving institutions might be costly: restrictions on government power, enforcing property rights etc. The Elite might prefer not to bear the cost and instead exploit extractive institutions for their own benefit. The key is that the elite is small which increases the incentive to being extractive instead of inclusion
2. If people make irreversible investments which are complementary to the institutions that are in place e.g. if you invest in physical and human capital you will be more in favour of property rights being enforced. But if you’ve invested in a sector that is only profitable because of favours lobbied from government then you’ll be in favour of keeping this extractive institution in place.

Question 20

Briefly explain the OLS regression in AJR?

Answer 20

data from 64 ex colonies. y variable = log of 1995 gdp per capita. x = quality of institutions. This is measured by an index of protection against expropriation.

Question 21

How do you work out the predicted difference in the log of GDP per capita?

Answer 21

The difference in the quality of institutions between 2 countries, multiplied by the coefficient that you’ve estimated for the effect of the quality of institutions on GDP per capita

Question 22

How do you then get the difference in GDP per capita between countries?

Answer 22

Log x - Log y = z
log(x/y) = z
x/y = e^z …
x is e^z times bigger than y
*This is normally lower than reality

Question 23

Is it plausible to interpret this relationship as causal?

Answer 23

No. Omitted variables, reverse causality (rich countries can afford and/or demand better institutions). Institutions measured ex-post, so measure may be influenced by income per capita

Question 24

Why might these measures not really be good measures of the quality of institutions?

Answer 24

They actually measure transitional policies - which are easier to change rather than the deep roots of the institutional setup. e.g. Lee Kuan Yew was pretty much a dictator for singapore, but made good decisions so gets high values on institutional measures. But it was still a dictatorship - the underlying institution was one of autocracy

Question 25

What is another problem of measuring institutions?

Answer 25

Measurement error, leading to attenuation bias. This is when we’re underestimating the true effect. Because we think institutions will have a positive effect on income per capita, we will underestimate because of measurement error how good these institutions are

Question 26

How do I fix these problems?

Answer 26

Include an instrumental variable

Question 27

What does AJR use an an instrumental variable in this case?

Answer 27

Log of settler mortality

Question 28

What is a concern with including this in this regression?

Answer 28

Settler mortality correlated with current disease environment of geography, which have a direct effect on income