Principal investigator: Eduarda Miller de Figueiredo
Article title: Reversal of Fortune: Geography and institutions in the making of the modern world income distribution
Authors: Daron Acemoglu, Simon Johnson, and James A. Robinson
Location of the Intervention: World
Sample Size:
Sector: Development
Primary Variable of Interest: Per capita income
Type of Intervention: Urbanization
Methodology: OLS
Summary
Among the areas colonized by European powers during the last 500 years, those that were relatively wealthy in 1500 are now relatively poor. To analyze the reversal of relative income among European-forming colonies, data from 1.500 and data from the study's base year were used. It was found that the reversal of relative incomes is a result of the different profitability of alternative colonization strategies in different environments. In densely populated, prosperous areas, Europeans introduced or maintained existing extractive institutions to force the local population to work harder in mines and plantations, taking over existing tax systems.
- Policy Problem
The article analyzed here deals with the reversal of relative income among European-based colonies. To illustrate this, the authors present Figure 1, which shows a negative correlation between the percentage of the population living in cities with more than five thousand inhabitants in 1.500 and per capita income in the year of the study.
Figure 1 – Log of GDP Per Capita in 1995 versus the Urbanization Rate in 1995
According to the authors, Figure 1 reveals an interesting pattern, providing an opportunity to distinguish between a series of competing theories on the determinants of long-term development. The "geography hypothesis," one of the most popular theories, explains most differences in economic prosperity through geographical, climatic, or ecological differences between countries. It predicts that nations and areas that were relatively wealthy in 1.500 should also be relatively prosperous today. However, the reversal of relative incomes is evidence that does not support the geography hypothesis.
According to the authors, the "institutional hypothesis," which links differences in economic performance to the organization of society, best explains the patterns they document. This hypothesis posits that societies that provide incentives and opportunities for investment will be wealthier than those that fail to provide such incentives.
Given this, the authors hypothesize that a group of institutions that guarantee secure property rights for a broad cross-section of society, which the authors refer to as private property institutions, are essential for investment incentives and successful economic performance. Conversely, extractive institutions, which concentrate power in the hands of a small elite, are likely to discourage investment and development.
- Implementation and Evaluation Context
Civilizations in Mesoamerica, the Andes, India, and Southeast Asia were wealthier than those located in North America, Australia, New Zealand, or the southern cone of Latin America. However, European intervention reversed this pattern. And this, according to the authors, is an important fact for understanding economic and political development, as well as for evaluating various theories of long-term development.
Historical data and econometric evidence suggest that European colonialism caused an “institutional reversal,” meaning that European colonialism led to the development of private property institutions in previously poor areas, while introducing extractive institutions or maintaining existing extractive institutions in previously prosperous places. The main reason for the institutional reversal is that the relatively poor regions were sparsely populated, and this allowed Europeans to settle in large numbers and develop institutions that encouraged investment.
- Policy/Program Details
Bairoch (1988) points out that during pre-industrial periods, a large part of the agricultural surplus would likely be spent on transportation; therefore, both a relatively high agricultural surplus and a developed transportation system were necessary for large populations. The authors complement this argument by empirically investigating the relationship between urbanization and income.
- Assessment Method
For the 1.500 data, urbanization estimates from Bairoch (1988) were used, augmented by the work of Eggimann (1999). They performed a regression of Bairoch's estimates on Eggimann's estimates for all countries where they overlap in 1900.
The main measure of economic prosperity in 1500 was urbanization, as Bairoch (1988) and de Vries (1976) argued that only areas with high agricultural productivity and a transport network could support large urban populations. As a proxy for adding prosperity, the authors used population density.
The authors point out that the urbanization and population estimates for 1.500 likely contained errors, and therefore the negative coefficients found in the initial results may be underestimated. Furthermore, a serious problem would arise if errors in urbanization and population density estimates were not random, but rather systematically correlated with current income. To correct for this potential "error," the authors used a variety of different estimates for urbanization and population density.
- Main results
By regressing the log of per capita income in 1995 on urbanization rates in 1.500 for the sample of former colonies, the authors find that a 10 percentage point lower urbanization rate in 1.500 is associated with approximately double the GDP per capita in current times. They emphasize that this result is not simply a reversion to the mean (countries richer than the average returning to the mean), but rather an inversion.
As an example of this last statement, the authors present a comparison between Uruguay and Guatemala. The native population in Uruguay was not urbanized, while Guatemala showed an urbanization rate of 9,2%. The estimate for the relationship between income and urbanization implies that Guatemala, at the time, was approximately 42% richer than Uruguay. And, according to the estimates presented by the authors, Uruguay should have been 105% richer than Guatemala at the time of the study – which is the approximate difference in per capita income between the two countries in the most up-to-date data.
The authors become concerned that the relationship is being driven primarily by the "Neo-Europes": the United States, Canada, New Zealand, and Australia. These are countries that are colonies built on lands that were inhabited by relatively underdeveloped civilizations. Thus, when performing the regression, a weaker, but still negative, relationship is proven. Therefore, the results are very similar. In all cases, there is a negative relationship between urbanization in 1.500 and per capita income in 2000.
By using a variety of different estimates for urbanization and population density, to correct for a possible "error" described in the previous section, the authors find that the results are robust to a variety of modifications in the urbanization data.
Based on the results found, the authors conclude that the reversal in relative rents is inconsistent with the simple geography hypothesis. Instead, they find that the reversal of relative rents over the last 500 years appears to reflect the effect of institutions (and the reversal caused by European colonialism) on current income.
The authors argued that the reversal of relative rents is a result of the different profitability of alternative colonization strategies in different environments. In densely populated, prosperous areas, Europeans introduced or maintained existing extractive institutions to force the local population to work harder in mines and plantations, taking over existing tax systems. Furthermore, Europeans settled in large numbers and created private property institutions, providing secure property rights to a broad section of society, encouraging trade and industry.
- Lessons in Public Policy
Therefore, the authors conclude that the reversal in income is due to the emergence of the opportunity to industrialize during the 19th century. While societies with extractive institutions, or those with highly hierarchical structures, could effectively exploit agricultural technologies, the spread of industrial technology required the participation of a large segment of society. Therefore, the industrial age created a considerable advantage for societies with privately owned institutions. Thus, the authors argue that these societies took much better advantage of the opportunity to industrialize.
References
ACEMOGLU, Daron; JOHNSON, Simon; ROBINSON, James A. Reversal of fortune: Geography and institutions in the making of the modern world income distribution. The Quarterly journal of economics, v. 117, no. 4, p. 1231-1294, 2002.
