ECON 240: COMPARATIVE

ECON DEVELOPMENT –
GROWTH DETERMINANTS
Sheikh Arsalan-ul-Haque
How do we classify National Economic
Development
• Gross Domestic Product (GDP) and Gross National
Income (GNI)
• Does not measure relative domestic purchasing power of different
currencies.
• Purchasing Power Parity (PPP): How much foreign currency buys
the same goods as $1 in the US?
Other Common Country Classifications
• G7 and G20: Common countries of geopolitical
significance.
• Least Developed Countries
• Landlocked and Small Island Countries
• Heavily Indebted Poor Countries
• Newly Industrializing Countries
• Emerging Market
• Human Development Level
Human Development Index
• Most widely used measure of the comparative status of
socioeconomic development by UNDP.
• Ranks each country on a scale of 1 to 10 based on 3
goals:
• 1) Life Expectancy at Birth
• 2) Average schooling attained by adults and expected years of
schooling for school-age children
• 3) GNI adjusted for PPP
Computation
!"#$%& (%&$)*+,-,.$. (%&$)
• Dimension Index =
+%/,.$. (%&$) *+,-,.$. (%&$)
• “Goal posts” 85 and 20. Actual: 79.93 – Life expectancy
• Similarly for education and GNI.
! ! !
(")
• Then take the geometric mean of all 3: !"# = ! % #
" "
Comparing characteristics among developing
countries
• These ten features of similarities and differences are:
1.Levels of income and productivity
2.Human capital attainments
3.Inequality and absolute poverty
4.Population growth and age structure
5.Rural population and rural-to-urban migration
6.Social fractionalisation
7.Level of industrialisation and manufactured exports
8.Geography and natural resource endowments
9.Extent of financial and other markets
10.Quality of institutions and external dependence
 4. Population growth and age structure
• Fertility rate
Population growth and age structure
• High birth rates in low-income countries
• Issue: the active labour force has to support proportionally
almost twice as many children as it does in richer
countries.
• By contrast, the proportion of people over the age of 65 is
much greater in the developed nations.
• Both older people and children are often referred to as an
economic dependency burden in the sense that they
are supported financially by the country’s labour force
(typically defined as citizens between the ages of 15 and
64).
• Middle-income countries (both LMCs and UMCs: Birth
rates have fallen dramatically.
• As large numbers of children become adults and join the
workforce, children are a smaller fraction of the
population.
• And before these large generations retire, the fraction of
the population older than working age remains small.
• This is called a “demographic dividend,”
• crucial opportunity for a country to grow rapidly and become a high-
income country.
5. Rural Economy and Rural-to-Urban
Migration
• In most low- and many middle-income countries, a
relatively high share of the population lives in rural areas,
and correspondingly fewer in urban areas

• A massive population shift is well under way as hundreds

of millions of people are moving from rural to urban areas
• But rapid urbanization has also challenges
• slums
6. Social Fractionalisation
• Several low and middle income countries have ethnic,
linguistic, religious, and other forms of social divisions
• This diversity can result in internal strife and political
instability
• Particularly if inequality falls along these identity group lines.
• Conflict is one of the most important reasons why the
development progress of many LICs has been held back
• i.e Afghanistan, Congo, Liberia, Somalia, South Sudan, and
Yemen.
• Conflict sent Syria back from being a middle-income to a
low-income country.
7. Level of Industrialization and Manufactured
Exports
Level of Industrialisation and Manufactured
Exports
• Developing countries have a far higher share of employment
and output in agriculture than developed countries.
• In some LIC, more than 2/3 of the population works in
agriculture.
• Vs in Canada, the United States and United Kingdom, agriculture
accounts for between 1% to 2% of both employment and income
• Madagascar: while about 82% of both men and women worked
in agriculture, it represented only a quarter of total output.
• Indonesia, 41% of both men and women worked in agriculture,
but it represented just 14% of output.
• LICs remain highly dependent on a relatively small number
of agricultural and mineral exports.
• vulnerable to negative commodity price shocks and price
volatility.
Level of Industrialisation and Manufactured
Exports
8. Geography and Natural Resource
Endowments
• Landlocked economies, common in Africa, often have
lower incomes than coastal economies.
• Developing countries are primarily tropical or subtropical,
• suffer more from tropical pests and parasites, endemic diseases
such as malaria, water resource constraints, and extremes of heat
• endowments of natural resources such as minerals.
• Favourable case: oil-rich Persian Gulf states
• Contrast: DRC tin and gold. Help fund conflict

• But geography is not a destiny: Singapore directly on the

equator
9. Extent of Financial and Other Market
Development
• Developing countries: prevalence of Imperfect markets and
incomplete information
• Some aspects of market underdevelopment are that they often
lack:
• a legal system that enforces contracts and validates property rightse
• a stable and trustworthy currency
• an infrastructure of roads and utilities that results in low transport and
communication costs so as to facilitate interregional trade
• a well-developed and efficiently regulated system of banking and
insurance
• substantial market information for consumers and producers about
prices, quantities, and qualities of products and resources as well as
the creditworthiness of potential borrowers
• social norms that facilitate successful long-term business relationships
10. Quality of Institutions and External
Dependence
• During colonization, European powers established institutions
(legal systems, labor rules, governance structures). In many
cases, these were designed to extract wealth (e.g., taxes,
forced labor) rather than promote development.
• These extractive systems often persisted even after
independence, creating long-lasting damage.
• Extractive institutions: Built to take resources from colonies
with little concern for citizens’ well-being or long-term
development (e.g., coercive labor, monopolies, weak property
rights).
• Productive institutions: Support innovation, education, law,
and investment. These are often missing in places with
extractive legacies.
 18

BOX 2.2 FINDINGS: The Persistent Effects of Colonial Forced Labor on Poverty
and Development
• Mita, a forced labor system instituted by the Spanish government in Peru and Bolivia
was established in 1573 and only formally abolished in 1812
• A sharp Mita boundary: on one side, all communities had to send the same percent of
population to work; on the other side, all communities were exempt
• This discrete change at the border suggests a special statistical approach for
evaluating the long-term effects of the Mita: The Regression discontinuity design (RD)
approach
• Uses fact that the Mita boundary forms a discontinuity in longitude–latitude space
• Key Findings: Impact: Lowered household consumption by approx. 25%; and
• Increases the prevalence of stunted growth in children by around 6 percentage points
• Mechanisms: What forces led to these impacts? Long-run mechanism is not obvious:
• Negative impacts of Mita persisted through impacts on land tenure and public goods;
• Mita districts historically had fewer large landowners and lower educational attainment
• Today, these districts are less integrated into road networks and their residents are
substantially more likely to be subsistence farmers
• *From Melissa Dell. “The Persistent Effects of Peru’s Mining Mita.” Econometrica 78 (2010): 1863–1903
Long-run causes of comparative
development
• What explains the extreme variations in development
achievement to date among developing and developed
countries?
• Long-run determinants of economic development
• Two main contenders to explain the fundamental causes
of cross-country differences in prosperity:
• Geography
• Institutions
 Geography versus institutions
• Sachs is in the geography or “nature influence”
camp
– Institutions matter, but not for everything
– The role of geography and resource endowments
should not be underestimated
– Disadvantage of geography: physical isolation,
endemic disease, or other local problems (such
as poor soil fertility)
– Increase in transaction costs
 Geography versus institutions
• Acemoglu is in the institutions or “human
influence” camp
– The most important determinant is whether you have
good institutions
– A lot of the differences in countries’ incomes can be
explained by the type of institutions they have
 Geography is correlated with
income
• The countries in the geographical tropics are
nearly all poor.
• Almost all high-income countries are in the mid-
and high latitudes.
• Coastal economies are generally higher income
than landlocked economies
– There is not a single landlocked, high-income country
outside Europe even though there are 29 non-
European landlocked countries in the world!
 Geography is correlated with
income
• The countries in the geographical tropics are
nearly all poor.
• Almost all high-income countries are in the mid-
and high latitudes.
• Coastal economies are generally higher income
than landlocked economies
– There is not a single landlocked, high-income country
outside Europe even though there are 29 non-
European landlocked countries in the world!
• But correlation is not causation!
 Why might geography matter (in theory)?
• Topography, climate and ecology

• Affect factor productivity

– Different agricultural productivity due to climate
– Different diseases endemic in different areas

• Transport cost
– Distance
– Physical access (distance from coast and navigability of
rivers)
– High transport costs are a barrier to trade
• Suggested channels :
• Comin et al. (2012) Geography influences the speed
and depth of technological diffusion.

• Climate affects the depreciation rate of physical

capital and the feasibility and cost of investment in
physical capital and infrastructure.

• Climate affects morbidity and shorter life spans

reduce the incentive to invest in human capital.
Coastal versus landlocked
countries
• Landlocked countries are particularly
disadvantaged even when the distance from one
is the same as that of an interior part of a coastal
economy
– 1) cross-border migration of labor is much more
difficult than internal migration,
– 2) infrastructure development possibilities larger
within a country and harder across national borders,
– 3) neighboring coastal economies might have
economic incentives or military considerations for
limiting access of landlocked countries to their ports.
 Landlocked countries in Europe
• Most landlocked countries in the world are
poor except for a handful of Western and
Central European countries…

• How have they overcome their disadvantage?

 Landlocked countries in Europe
• Landlocked countries in Europe are not
terribly distant from the coast.
• They are deeply integrated into the regional
European market and connected by low-cost
trade.
Why is China investing in
Pakistan?
• China and Pakistan are building the China-
Pakistan Economic Corridor (CPEC) with a $60
billion investment including highways,
railways, pipelines, ports, and energy
infrastructure
CPEC route versus current sea
route
 Trade enables growth
• Incomes are higher with trade (lesson from
introductory economics)
• Without trade, regions are condemned to
small internal markets, an inefficient division
of labor and continued poverty
Morbidity – endemic diseases
• Climate affects morbidity

• and shorter life spans reduce the incentive to invest in

human capital.
Impact of malaria?
How might malaria/disease affect
incomes?
• The last map shows correlation
– We cant be sure it’s a causal effect of malaria but its
possible. Why?
• High disease burden è low productivity
• This leads to low production and low investment
– Low investment in human capital: children are sick
and absent from school
– Low investment from foreign sources as foreigners
don’t want to travel to these regions
• Also low tourism
 Does geography matter (Sachs)
• “Economies in tropical ecozones are nearly everywhere
poor, while those in temperate ecozones are generally rich”
• “Certain parts of the world are geographically favored.
Geographical advantages might include access to key
natural resources, access to the coastline and sea,
advantageous conditions for agriculture, advantageous
conditions for human health.”
• “The burden of infectious disease is higher in the tropics
than in the temperate zones”
• But Correlation IS NOT causation

• Omitted factors driving the

associations

• Institutions?
Next class
• Institutions
What do we mean by institutions
• Institutions are the rules of the game in a society...the
humanly devised constraints that shape human
interaction" (North 1990)

• Institutions are the way we organize society

• Equality of access to economic resources and protection

under a transparent legal system?

• In empirical studies, institutions are often proxied by

measures of protection from expropriation, rule of law,
constraints on executive, and surveys of corruption
 What are good institutions?
• Some societies have good institutions that
encourage investment in machinery, human
capital and technologies, which lead to
prosperity.
• 1) Enforcement of property rights
• 2) Constraints on the actions of elites,
politicians, and other powerful groups
• 3) Equal opportunity or mobility
Institutions hypothesis (Acemoglu et al
• Some societies are organized in a way that defend the
rule of law, encourages investment of all kinds, facilitates
broad-based participation by citizens, and supports
market transactions.
• 3 elements of good institutions:
• enforcement of property rights
• Incentives to invest
• constraints on the actions of elites, politicians, and other powerful
groups
• Some degree of equal opportunity
• Man-made influences
• Acemoglu: The two explanations could be complementary
• Role of geography is limited
 Acemoglu arguments
• Acemoglu has two pieces of supportive
evidence he uses to argue that institutions are
more important than geography
• 1) Reversal of fortunes
• 2) Natural experiment using experiences
across places colonized by Europeans
– Says institutions can explain 3/4th of the income
per capita differences across former colonies
Acemoglu, Johnson, Robinson (AJR):
Reversal of Fortune
• “Economic institutions, not culture or geography, are the
fundamental cause of differences in growth.“

• “The structure of property rights, presence and perfection

of markets are the key forces that shape incentives and
influence input accumulation and technological change.
They drive economic performance and the distribution of
resources."
 Reversal of fortunes
• Societies like the Mughals (India), Aztecs and Incas (Americas) were
among the richest in 1500 and are among poorer societies today

• Whereas less developed areas of North America, New Zealand,

Australia are now much richer

• This is the reversal of fortunes…

• If the most important determinant of incomes is geography,

Acemoglu argues that we should see persistence in fortunes
– i.e. societies that were richer in the past should still be among the
richer ones today
– because geography has not changed
BUT Effect of geography
• Even though geography doesn’t change, its effect
• can
– Disadvantage of being in North Dakota and Mongolia is
smaller today because of roads, air travel, internet
– Drip irrigation developed in Israel
• Micro-irrigation technique
• Instead of flooding land
– Vaccine/cure for disease

• Reversal of fortunes can happen and still be consistent

with geography being/having been very important
Correlation DOES NOT imply causation
• Suppose we want to measure the effect of institutions
Why can't just compare countries?

• Countries have different institutions for many reasons

• It may be that rich countries can afford good institutions

(courts are expensive)

• Then it is not good institutions that cause growth, but

growth that causes good institutions
• Reverse causality
From correlation to causation
• Correlation does not imply causation if there is:
• Reverse Causation: What if faster economic growth caused better
institutions?
• Omitted Variable: What if some other variable, say better
geography, cause faster growth AND better institutions?
• Strategies for identifying causality:
• Instrumental Variable: Show that a variable that cannot directly
cause faster growth but causes institutional quality is correlated
with economic performance. The correlation must work through
institutions.
• Natural Experiment: Find an institutional change that could not be
caused by growth and show that it led to differential economic
performance.
Problem of the missing counterfactual
• We can not see at the same time a country (i) with a set of
institutions and without them
• Also, we cannot assign one country one set of institutions,
and another country a different set, and see what
happens.
• So we need to be smart and creative in finding places that
look very similar to country i.
• Look at the accidents of history to create a natural experiment
• Two countries, alike in almost every other way, except for
differences in institutions
• The more alike they are, except for different institutions, the more
sure we can be that institutions are the reason for the differences
 Natural experiment
• “We need to find a source of exogenous variation in
institutions - in other words a natural experiment
where institutions change for reasons unrelated to
potential omitted factors” – Acemoglu
– Societies that were colonized by Europeans provide us a
natural experiment/case study of how countries developed
after the introduction of different types of institutions
– The colonization experience transformed the institutions
in many lands conquered or controlled by Europeans but,
by and large, had no fefect on their geographies
– Colonizer settlements è good early institutions è good
current institutions è high incomes today
 Colonization and institutions
• Societies that were colonized by Europeans
provide us a case study of how countries
developed after the introduction of different
types of institutions
– There is an extremely strong relationship between
institutions put in place by colonizers and incomes
today
• Two main types of settlements – extractive
and settler societies
 Two types of settlement
1. Extractive settlements:

– Colonizers did not settle there themselves e.g. Belgian

colonization of Congo (King Leopold – ivory and rubber), slave
plantations in Caribbean, and forced labor systems in mines of
Central America

– No property rights or checks against government

– The main purpose of the state was to transfer as many

resources from the state to the colonizer with minimum
investment possible
– Europeans did not settled
Two types of settlement
• Settler societies:
– Where colonizers settled themselves e.g. U.S., Australia, Canada,
NZ

– They replicated and often improved institutions protecting

private property

– The settlers in these societies also managed to place

significant constraints on elites and politicians
 Choice of institutions
• European colonizers had a choice for the types of institutions to
introduce in their colonies
– They chose good institutions when they would live in the colony and
benefit from it

– They chose extractive institutions when they were not going to live in
the colony and were only interested in plundering it

– When the land had resources that colonizers could benefit from
and/or large populations that could be used as cheap labor and slaves,
they set up extractive institutions

– When the land was empty, resources scarce and disease burden low,
colonizers often settled in large numbers and set up good institutions

• Colonizer settlements è good early institutions è good current

institutions è high incomes today
• AJR hypothesis:
• Different population densities and settlers' disease
burdens led European colonizers to introduce different
economic institutions.
• These institutional differences led to different economic
performance.
Thus an institutional reversal:
• Previously richer societies ended up with worse institutions
• Europeans introduced relatively good institutions in sparsely-
settled and poor places, and introduced or maintained
previously-existing bad institutions in densely-settled and rich
places.
• E.g.; slavery in the Caribbean, forced labor in South America, tribute
systems in Asia, Africa and South America.
• Two kinds of colonial institutional setups:
• Extractive (e.g. Bolivia) No protection of private property. No checks
and balances against government. Confiscatory taxation
• Settler (e.g. New Zealand) Protection of private property. Law and order
• What determined which colony got which? Extent to which
settlers died.
• Exploit variation generated by local disease environment, proxied by
Europeans' mortality rates
• Political and economic institutions tend to be persistent.
Empirical evidence of institutions
• They use early settlers mortality rates and other variables
– not directly correlated with current income - to predict
the current level of protection from expropriation.
• They find a strong correlation between the so predicted
level of protection from expropriation and the current level
of income.
• They find that differences in institutions explain 75% of
differences in income per capita.
• They also find that geography has no direct influence on
income per capita (but only through differences in
institutions.)
Summary
• Colonialism radically changed institutions around the
world.
• Led to good and bad institutions that have persistent
effects today.
• Different types of colonialism caused differential inflows of
people, capital, and adoption of innovations
 Sachs’ critique of colonization
story

• Acemoglu compared colonies where colonizers settled

and brought good institutions with colonies where they
did not settle and put in extractive institutions

• What influenced this choice of whether the colonizers

settled in a colony?
Sachs’ critique of colonization
story
• What influenced this choice of whether the colonizers
settled in a colony?
– Whether there was plentiful (and, therefore, cheap) labor,
whether there were resources to earn from (e.g. soil for
sugar), whether the climate was favorable, and whether
there was a lot of tropical disease (malaria etc) that they
had no immunity to
• Most of these factors are geographical factors
– This actually supports the role of geography (and malaria)
in affecting long term development!
– Geography (disease/resources) è Colonizer settlements
è good early institutions è good current institutions è
high incomes today
The allure of the institutions
argument
• A single factor explanation is simple,
uncomplicated and therefore tempting
• It also jives with the Western message of
freedom, property rights and markets
• If institutions account for 3/4th of income
differences, rich countries have little financial
responsibility because poverty is not due to a
lack of resources
Effect of geography not
deterministic
• Sachs argues that the role of geography is very
important
• But he says it is not deterministic
– Bad geography doesn’t mean you’re doomed
• We can see this clearly since we just discussed how the
effect of geography can change over time
– It does mean that poor countries with bad
geography need special investments
The role of geography and foreign
aid
• An important role of geography in development
means that foreign aid and investments are
crucial
• Need more efforts to fight malaria, AIDS, TB, to
address depletion of soil nutrients, provide drip
irrigation + fertilizer, build roads to connect
remote populations to markets and ports
• Disease, geographic isolation, low productivity
can together lead to a poverty trap