INTRODUCTION
Why some nations are poorer than others or why some poor states flourished while the richer states became poor important questions in economics and development.
The reason for this is due to differences in saving rates or total factor productivity.The theory regarding growth rate, as explained by Lucas(1988), stated that growth is exogenous of physical or
human capital accumulation while Grossman and Helpman had antagonistic view considering state growth as a process which is determined by individuals i.e endogenous.
In North and Thomas's view comparative growth is due to differences in institutions where institutions refer to constraints or rules regulating human actions.
According to this view economic institutions are of primary importance because they influence the structure of economic incentives and determine who gets profit or
revenue. All institutions are in general 'endogenous'. They are determined by the interaction of individuals and this is the point that explains that the condition of
countries depends on its instittuions.Many scholars like Adam Smith, John Mill etc too emphasized on the importance of economic institutions. So a framework has been
outlined regarding cross country growth differences and that framework states the importance of political institutions in determining good economic institutions.
FUNDAMENTAL CAUSES OF INCOME DIFFERENCES
Three fundamental causes have been explained that determine cross country economic differences. They are:
1)Economic Instituions
The idea that prosperity of societies depend on its economic institutions has been given by Adam Smith. By good economic institutions we mean that the society as a
whole gets property rights, incentives and opportunity to invest. Market is the key to the lock of good economy. Market imperfections and economic institutions play
a central role in development.The structure of markets is again 'endogenous' depending on property rights. Achieving a perfect market is impossible but having
opportunities to invest and good incentives assures a good market. Here however, it is important to mention that political mechanisms and outcomes also influence
growth rate[Ades and Verdier(1996)]. So this mean that difference in market is the outcome of differening systems of property rights and political institutions.
- Geography
This hypothesis has three explanations to 'how geography effects economy?'. They are:
(i) Climate;areas with moderate climate has a better opportunity to attract man and develop market.
(ii) Geography determine the technology available. Some areas are difficult to reach so they remain backward and underdeveloped.
(iii) Disease stricken areas has a poor market. For example the sub-Saharan African countries that are stricen by malaria, killing millions of children every year.
This reduce the annual growth rate of their economies.
- Culture
Different societies have different cultures and religions. It is viewed as a key determinant of values and beliefs of individuals and in this way determine
economic performance. Weber has given an example to explain this. He says that protestentism focused on hardwor, saving etc which lead to economic success.
Likewise,caste system in indian religion blocked capitalistic development[Weber(1958)]
THE KOREAN EXPERIMENT
The experiment regarding split of Korea is a natural experiment that tells that institutions are of primary importance and not the geography or culture because
both the North and South Korea had the same culture and same history yet the south is more prosperous. All this is due to difference in institutions. The south
utilized its incentives rightly, secured property rights and flourished while the North Korea had an extractive system,they negated private property which gave
devastating outcomes but it was not improved because the ruling party was at an advantage because of this.
REVERSAL OF FORTUNES
This refers to how the rich states became poor while the poor states rose to prosperity. This has been explained by the colonial experiment which uses all three
hypothesis's of causes of income differences to explain why reversal of fortune took place.
Colonialization-an outlook
The time of European colonization was from 1500-19th century. During this time reversal of fortunes took place. An example of Mughals, Incas and aztecs has been given
who were the richest in 1500 but the states encircling them were poor. While the less developed civilizations of North America, New Zeland and Austrailia are now
richer than they were at the time of mughals.
Initially the highly urbanized countries were prosperous until around 1800. But after that the low urbanized countries started to grow much rapidly and thus economic
gap occured.
Geographical Perspective
To explain its geographical aspect it is stated that geography matters but in a time varying way[ sophisticated geography hypothesis-Acemoglu,Jhonson and Robinson
(2002)]. This explains that the Europeans must have introduced specific technologies that functioned in some places(US,Austrailia) but not others (West Africa,Mexico).
The technology might have been industraial and not not suited agriculture in the tropics. So a difference occurs.
Cultural Hypothesis
Likewise, culture may be slow changing yet it is the key determinant of values which inturn effect human efficiency to work. The cultural hypothesis does not
provide a natural explanation for the reversal neither can it dertermine the time factor of reversal.
Institutional hypothesis
The most natural and valid explanation for the reversal comes from institutional hypothesis. It was documented that the relatively densly settled and urbanized
colonies ended up with the worst sort of institutions while the less developed rose to prosperity.
What the Europeans did was that the areas that had large population there they established their hold merely to extract their resources and explaoit the masses. This
has been explained by stating the example of mughal institutional setup that the Mughals had established a system through which the masses could be exploited to favour
few ruling elites. Whatsoever the systems were extractive and lead to mass exploitation. Thus the areas had worst institutions.
In the sparcely populated areas the Europeans settled to establish institutions protecting property rights. This helped them secure power and as a concequence of all
this the rich states gradually became poor(because they had worst economic institutions) while the poor states flourished as they had incentives to be rightfully
utilized.this clearly indicates that economic institutions are the major determinant of prosperity and economic growth and is a reason why some countires are rich
while others poor. But why is it so? Why dont they jut switch to good econimoc institution? Following are a few reasons to explain this setback:
1-EFFICIENT VIEW
This view focus on the efficiency of institutions.Societies will choose institutions that are socially efficient. These institutions are the outcome of bargains or
negotiations between different economic parties e.g a farmer suffering from the pollution of a factory might pay its owner to reduce pollution. To judge the efficiency
we observe the institutions and try to find what makes it efficient.
In efficient institutional view when we discuss political influence it must be remembered that structure of political institutions are irrelevent because it matters
in distribution of total surplus but will not matter or efficiency itself.
2- IDEOLOGICAL VIEW
The reason why different societies choose different institutions is that different societies have different beliefs about what is socially efficient and thus choose
different economic instituions. Acemoglu(2003a) also call it the Modified Political Coase Theorem. People or their leaders might disagree about what would be good
for the society and this would determine different set of institutions. For example Piketty(1995)says that some people might prefer a hight taxation rate because
effort is not being rewarded. But those who believe that effort is effort is being rewardedthen low taxation is preferred. There are power holders who look after
their own interests. These leaders also dteremine what sort of institutions should be set so that they could benefit from them.
3- INCIDENTAL VIEW
This states that the individuals calculate efficiency from social costs and benefits. They compare working of different institutions and decide which needs to prevail.
Theorists like Moore believed that historical incidents determine institutions, and it is ture, but they are still variable i.e changes can be made any time in these
institutions.
SOCIAL CONFLICT VIEW
This view states that it is not always the choice of whole society to determine institutes rather it is in the hands of those who hold political power. He would choose
economic institution that benefit him. For example an institute that enforce and protect property rights would never be chosen by a leader who aim at state predation
to increase his assets for future. If he does so he would lose his political hold as these assets are a means of influence. These institutions are only mean to serve
thier vested interests.
SOURCES OF INEFFICIENCIES
Following are a few reasons for the enefficiency of institutions:
(i) Hold-up
Hold-up reffers to the non fulfilment of commitments. It means that in bargains one party fails to to fulfill the terms of agreement. The situation in which the
commoners make investments but the commitments are not fulfilled, it would lead to inefficient institutions. The political power holders monopolize the situation
in their favour. In this case constitutional and institutional ex-post protections are needed in advance to overcome the problem.
(ii) Political losers
Another source of inefficient institutions are the political losers who consider their power as a source of prestige. They would never be in favour of institutions
that would benefit the masses putting their interests at stake. Therse elites fear that if their profits increase then they would compete with the existing power
holders. Due to these reasons they do not let the existing state of affairs( status quo) change.
(iii) Economic losers
Just like political losers economic power holders would never let change in status quo that would threaten their economic gains. Losing economic power would also
mean that they lose political power because both are interlinked. The solution to this could be agreement that their rents would be protected. But due to their
fears, economic power holders would never take the risk.
(iv) Colonial experiment
Colonial experiment in a way has an effect on the current working of institutions. They introduced good and bad both type of institutes. Present day institutions are
an extention of those.
POLITICAL POWER AND INSTITUTIONS
Throughout the discussion political power has been interlinked with good institutions. Actual political power is the combination of de jure and defacto powers.
De facto power(illegitmate power) and political institutions combine to form economic institutions and this could be proved from Habers example of Mexico and
United States of America.
THE FRAMEWORK OF INSTITUTIONS
From the whole discussion we sum up that the reason why there is a difference in economic system of countries is due to their differing frameworks of economic
institutions . These institutions are determined by the politically powerful group of people (having defacto and de jure power) who exploit the situation for
their interest. They would never opt for institutions that would compromise their power. In order to improve the situation constriants needs to be imposed
on the politically powerful people.
img credz: pixabay.com
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