Institutions as a Fundamental Cause of Long-Run

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Department of Economics, MIT, 50 Memorial Drive E52-3806, Cambridge, MA 02142 e-mail:

Sloan School o f h f a ~ g e m e n t , MIT, 50 Memorial Drive, Cambridge, MA 02142 e-mail:

Deparhnent of Government, WCFIA, Harvard University, 1033 Massachusetts Avenue, Cambridge, MA 02138 e-mail:

Abstract Keywords 1. Introduction
1.1. The question 1.2. The argument 1.3. Outline

2. Fundamental causes of income differences
2.1. Three fundamental causes 2.1.1. Economic institutions 2.1.2. Geography 2.1.3. Culture

3. Institutions matter
3.1. The Korean experiment 3.2. The colonial experiment

4. The Reversal of Fortune


4.1. 4.2. 4.3. 4.4.

The reversal among the former colonies Timing of the reversal Interpreting the reversal Economic institutions and the reversal

Handbook ofEconomic Gmwth, Volume IA. Edited by Philippe Aghion and Steven N. Durlauf O 2005 Elsevier B.V All rights reserved 0 0 1 : lO.l016/Sl574-W84(05)OloW-3

D. Acemoglu er al.
4.5. Understanding the colonial experience 4.6. Settlements, mortality and development

5. Why do institutions differ?
5.1. 5.2. 5.3. 5.4. 6.1. 6.2. 6.3. 6.4. 6.5. 6.6. 6.7. 7.1. 7.2. 7.3. 7.4. The efficient institutions view - the Political Coase Theorem The ideology view The incidental institutions view The social conflict view Hold-up Political losers Economic losers The inseparability of efficiency and distribution Comparative statics The colonial experiencein light of the comparative statics Reassessment of the social conflict view Labor markets Financial markets Regulation of prices Political power and economic institutions

6. Sources of inefficiencies

7. The social conflict view in action


8. A theory of institutions
8.1. Sources of political power 8.2. Political power and political institutions 8.3. A theo~y political institutions of

9. The theory in action
9.1. 9.2. 9.3. 9.4.
Rise of constitutionalmonarchy and economic growth in early modem Europe Summary Rise of electoral democracy in Britain Summary

10. Future avenues Acknowledgements References

This paper develops the empirical and theoretical case that differences in economic institutions are the fundamental cause of differences in economic development. We first document the empirical importance of institutions by focusing on two "quasi-natural experiments" in history, the division of Korea into two parts with very different economic institutions and the colonization of much of the world by European powers starting in the fifteenth century. We then develop the basic outline of a framework for thinking about why economic institutions differ across countries. Economic institutions determine the incentives of and the constraints on economic actors, and shape economic .,

Ch. 6: Institutions us u Fundamental Cause of Long-Run Growth


outcomes. As such, they are social decisions, chosen for their consequences. Because different groups and individuals typically benefit from different economic institutions, there is generally a conflict over these social choices, ultimately resolved in favor of groups with greater political power. The distribution of political power in society is in turn determined by political institutions and the distribution of resources. Political institutions allocate de jure political power, while groups with greater economic might typically possess greater de facto political power. We therefore view the appropriate theoretical framework as a dynamic one with political institutions and the distribution of resources as the state variables. These variables themselves change over time because prevailing economic institutions affect the distribution of resources, and because groups with de facto political power today strive to change political institutions in...
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