Do institutions matter?

Well, as titles go, this one is both provocative and stupid. Of course, they do matter. The subtext is whether they matter as much as we think they do. If they do, in what manner and over what time -frame do they affect economic outcomes? We do not have clear answers to these questions. It was a coincidence that Narayan Ramachandran wrote about the National Green Tribunal in his fortnightly ‘Visible hand’ column the day I had finished going through the paper I am discussing here. As one would expect, Narayan had cited the work Daron Acemoglu in his column. Pl. note that I am using Narayan’s column as a peg for this post. This post itself is not a criticism of his column.

The paper I read was by Professor Nicholas Ziebarth of Northwestern University (Year 2011). The paper is titled, ‘Are China and India backward? Evidence from the 19th Century of U.S. Census of Manufactures’.

Professor Ziebarth compares the present-day India and China to that of the United States of the 19th century since, on many counts, they share similar characteristics, including that of per capita income, etc. If anything, the US had a far better set of institutions:

We started with a completely dierent country in terms of policy but a similar level of development in the form of the 19th century U.S. and ended up with very similar levels of misallocation. This casts doubt on the relation between policies and the measures of distortions suggested by HK. Whereas the policy distortions in India and China are well known in terms of state owned enterprises and previously the License Raj in India, it is not so easy to what those explicit barriers are in the U.S. at this time.

As I argued above, economic institutions were rather conducive to allocating resources. Government spending was limited. There were few market restrictions. Bank decisions were not overseen directly by the government. And where the government did play a larger role in developing communication and transportation networks, its eect appears to have been salutary.

Simply put, there is no good policy reason why the U.S. at this time should have such a distorted capital allocation. The only thing that it shares with China and India of the late 20th century is a similar level of economic development as re ected in real GDP per capita. I interpret these results as suggesting that part of the natural process of development is capital reallocation. Policy surely does play some role here, but I think it is much less than we think while development itself is the main driver. What this means is that HK succeeded along the accounting dimension while overstating the case for the institutional one. Rather than a cause of low income per capita, capital misallocation seems to be an effect.

In fact, we can simply accept the superiority of the U.S. in the 19th century in relation to the present-day India and China for this reason, even if for no other reason. Yet, it had a similar level of distorted capital allocation as these two have now.

Professor Ziebarth cites Atack and Bateman (1999) here:

No single early economic data source surpasses the nineteenth-century U.S. federal census manuscripts in quality, in consistency, or in comprehensiveness; from mid-century onward, the census enumerations oer a unique historical record detailing the transformation of the United States from an agricultural to an industrial economy.

How one wishes for better quality data from China and India?! Both lack that but for different reasons, of course.

His concluding paragraph suggests that we do not know remotely enough about the process of development:

This paper contributes to both the historical literature on the development of the American economy and more broadly to economists’ thinking on development. The results suggest that a sizable fraction of subsequent manufacturing TFP growth in the 20th century can be tied to a better allocation of resources. For the latter, this paper shows that the mapping from economic policy to the allocation of capital is not straightforward. It appears instead that part of the process of development itself is a natural reallocation of capital towards more ecient ends, totally independent of policy decisions. And this is endogenous process is now what needs a theory. Future work should attempt to ll in the gap between the results presented here for 19th century America and those in HK for the 20th century. In the end, much remains to be learned about development through the lens of economic history.

That must make economists very humble. So, we should add the question of ‘what makes economies tick?’ to the question of (as yet unresolved questions) of ‘what makes companies tick ?’ and well, ‘what makes movies tick?’

[P.S: What Ziebarth refers to as ‘HK’ is the paper by Hsieh and Klenow published in 2009: ‘Misallocation and manufacturing TFP in China and India. Quarterly Journal of Economics 124, 1403-1448.]



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