What Causes Economic Growth? Institutions or Human Capital?
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Published: Tue, 19 Jun 2018
Sybren Dijkstra, Catello Alvino
Growth, Institutions and Business
An increasing amount of empirical research has been focused on measuring and approximating the effects of historical variables on the economies of today. There seems to be a chicken or the egg story in the literature: Do
political institutions cause economic growth or does economic growth, through human capital, lead to better institutions? There seems to be a gap in the literature around the colonization period concerning human capital and institutions. before the colonization period: Could it be possible that the human capital people brought to the colonies was gained due institutions in their native countries In this essay we will bring across a simple message: you first need institutions to create human capital, in order to foster growth. ? First we will lay the foundation of our theory by discussing empirical works that cover the period before the age of imperialism. Then we shall discuss the empirical proof that institutions do cause growth, after which we will analyze the human capital side . Finally, we will sum up our findings and provide suggestions for further research.
Reversal of fortune and the importance of institutions
Acemoglu et al. (2003) deliver a detailed analysis on different outcomes of today’s post-colonial countries. It was found that the divergence in economic development that is observable among former colonies is caused by the way the settlers established institutions in the area. Indeed, it is easily seen that regions like North America have shown to perform much better than countries located in Central and Southern America and in other parts of Africa colonized by roughly the same populations. Essentially, in the areas where resources were relatively scarce and population density was low, the pioneers established institutions pretty similar to the ones they had in their homeland, implementing systems of property rights protection that stimulated investments. In areas where resources and indigenous inhabitants were abundant, the settlers created “extracting institutions”, where their goal was not a long lasting development, but just a depletion of resources. These institutions were based on property rights restricted to an enclosed elite that consisted of the European settlers,
in which the indigenous population was not included. The y much worse than countries where institutions were accessible to all the inhabitants. Therefore what these findings really show is that human capital is not the ultimate cause of e conomic de velopment, but that instead it is the proximate cause , the of institutions being the ultimate cause .
on this favor thesis is given by Acemoglu et al. (2014), who gathered data about the literacy of the different settlers. They show ed that the conquistadores that colonized South and Central America w here much more educated ( at least speaking about literacy) than the English settlers colonizing North America. Nevertheless, the latter turned out to be better developed in the future. Acemoglu et al. find s again the reason of this difference into the kind of institutions that were in place. Beside s this explanation, there is another key variable missing; the education these settlers received in their homeland. Institutions and human capital did not come out of the blue, but most of the papers written supporting t argument For example, a person educated as an engineer does not lose his engineering knowledge, once s/he arrives in the colony, like the human capital argument suggest. Furthermore, Acemoglu et al. (2014) show that there is no significant support for the human capital argument that differences in the human capital endowments of colonists have been a crucial factor in the institutional development of these institutions. The way institutions were established by the colonists was deeply influenced by the institutions in their home countries. Especially before those colonies became independent they were legally dependent on their homeland, with roughly the same institutions, the difference being that these institutions were reshaped in order to comply with territorial needs. The new communities established would base their institutions on the ones they were used to in their native country. Of course with time some switched to different systems, but the so-called seed that let the tree grow was coming from somewhere else. And this “somewhere else” is indeed their country of origin its .
Considerations on the human capital theory
In this section we are going to better explain why we consider the claim that
human capital is the prime cause of economic development is wrong . In a prominent human capital argument article by Glaeser et al. (2004) the relation between human capital and growth is the point of discussion. The authors claim that countries possessing more human capital in the past performed better than others, independently by which institutions were established before the introduction of human capital. They affirm that human capital is not caused by institutions but that instead it causes them . Granted, Glaeser et al. (2004) has the same requirement as we propose for growth; property rights. However, We strongly disagree with that view. A population can have as much human capital as they can accumulate, but if it is not pushed to its real potential, it fails to improve a society ’s economic situation. w If that society does not protect property rights or does not give to all its components roughly equal rights, growth will be slower, if not completely absent. Think about a generic example: if a society does not protect anyone’s property but just the property of a closed elite, outsiders who might have groundbreaking ideas, will probably not get to develop their ideas , given that in this way they might not have the means to do so or they might just not be given the incentive to fulfill their potential. This is exactly what we think has happened in the extracting societies: even if the conquistadores (according to the literacy measurements made by Acemoglu et al.) were pretty educated on average, the indigenous population w as not allowed to participate in the society improvement process or to hold property; instead they were forced to work in conditions of slavery. The opposite happened in North America and we can see how it turned out: most of the population was composed by emigrants from the Old Continent to whom were given the same rights, and even if there were some minorities like the African American who were granted less rights, there were still more people enjoying the benefits of the institutions than in the countries where extracting institutions persisted.
Further evidence in support of our
on this topic is given by Weil (2013): when comparing a country’s wealth with its amount of human capital seen as education, he shows that there is no direct correlation. The difference in wealth is not entirely explained by education. If this was the case, for example, Mozambique would have had 43% of the U.S. GDP (Gross Domestic Product) per worker, but in reality it produces only 1.9% of it. Weil explains this discrepancy using the quality of education, which changes the effect of education on wealth drastically. These differences in quality of schooling are directly related to the institutions present; the students of richer countries learn faster and more effectively, because they are provided better educational facilities and means of learning.
As we have shown in this brief essay, in order to foster growth potential in the first place, one needs institutions that create and protect property rights. have shown, using empirical research, in the first place
human capital at a later stage, the relation is far more elegant and complex than that, wanted to show were native As a final remark, strongly urge institutions and human capitaland how they compare to their native country e literature.
Acemoglu, D., Johnson, S. and Robinson, J. (2002). ‘Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution’. The Quarterly Journal of Economics, 117(4), pp.1231-1294. Acemoglu, D., Gallego, F., and Robinson, J. A. (2014). ‘Institutions, human capital and development’. Unpublished working paper. University of Harvard, Cambridge.
Glaeser, E., La Porta, R., Lopez-de-Silanes, F. and Shleifer, A. (2004). ‘Do Institutions Cause Growth?’. Journal of Economic Growth, 9(3), pp.271-303. Weil, D. (2013). Economic growth. Boston: Pearson, pp.170-197.
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