George Brighten

GV 478 lecture week 19

Acemoglu, D. et al. Institutions as a Fundamental Cause of Long-Run Growth

Handbook of Economic Growth (2005): 385-472. Print.
In Institutions as a Fundamental Cause of Long-Run Growth, Acemoglu et al.
tackle the question of: What causes long-run economic growth? The authors hold that
earlier theories that emphasise factor accumulation and endogenous technical change are
inadequate explanations of cross-country divergence in growth, and instead they focus on
the role of economic institutions. Assuming that (economic) institutions are endogenous,
they seek to answer a more specific set of questions: Why do economic institutions differ
by country and what implications do these different sets of institutions have for long-run
growth?
First, the authors establish the strong association between institutions and
economic growth. In theory, economic institutions such as the nature of property rights
and the existence and perfection of markets should be important for economic growth
because they condition the incentives faced by the main economic actors in society with
respect to investment (in physical and human capital and technology) and the
organization of production. The responses of these actors to these incentives determine
economic performance (the size of the aggregate pie) and the incidence of its benefits
(how the pie is divided within society). The authors find that there is solid empirical
evidence to support these hypotheses.

To examine the strong, positive correlation

between the strength of property rights and GDP per capita, the authors use the natural
experiment provided by the colonization activity of the Europeans that began in the early
fifteenth century. During this period, the Europeans introduced a variety of sets of
institutions across their Empire and the authors (in an earlier article) find that these
institutions were responsible for the Reversal of Fortune in economic prosperity seen
within former European colonies. Indeed, they find that the driver of the negative
correlation between urbanization and population density in 1500 and GDP per capita in
1995 is the economic institutions that these conditions yielded. The Europeans introduced
extractive economic institutions i.e. weak (poorly enforced) property rights and
imperfect markets in relatively rich areas (places where they would benefit the most
from such extraction), which tended to be those that were the most urbanized and densely
populated. If these institutions are important and if weak economic institutions depress

George Brighten

GV 478 lecture week 19

economic performance, then after 1500 the authors expect to see these countries become
poorer over time and this is what they observe.
If institutions affect growth, why do they differ across countries? Moreover, if bad
institutions produce poor economic growth, why dont the host countries change them?
The authors spend the remainder of the chapter developing their theory of economic
institutions, which makes the key assumption that institutions are endogenous and
specifically determined by the distribution of political power. The authors discuss a
number of theories of the relationship between political power and economic institutions,
but they argue that the social conflict view is most promising. In this view, the
incumbent chooses economic institutions that maximize their welfare at the expense of
efficiency. Individuals prefer different sets of economic institutions because of the
different resource allocations that they entail. The tradeoff between efficiency and
distribution arises because of the commitment problems in the use and the allocation of
power that are inherent in politics. For example, an autocratic government cannot
credibly commit to respect the property rights of producers if they make productive
investments because the government has both the interest and the ability to contravene
property rights and keep the rents for themselves. One important consequence of this
theory is economic institutions that cause underdevelopment may persist. Another
important consequence is that the distribution of political power (and its change over
time) determines the structure of economic institutions, and a theory on this point is the
final task of the chapter.
Political power, the authors argue, has two components: de jure political power
from political institutions and de facto political power which arises in individuals or
groups that can solve the collective action problem and organize efficiently. Usually,
those with de jure political power are able to reinforce the institutions that give them
power and this creates persistence in political power, political institutions, economic
institutions and, ultimately economic growth. However, on occasion the distribution of
resources changes, and the group that it favours will be able to organize more efficiently
and achieve greater de facto power. These groups, the authors argue, will be compelled to
reinforce this power with de jure power by changing the political institutions. This is
because de facto power is intrinsically transitory and the only way to lock-in

George Brighten

GV 478 lecture week 19

temporary gains in political power is to formalize them in political institutions. One key
element of the authors model of economic growth is that it is dynamic. Current political
power influences future political institutions and economic institutions, which in turn
affect economic performance and the distribution of resources. However, a change in the
distribution of resources may change the balance of de facto political power, which, if
translated into changes in de jure political power, will change future economic and
political institutions. To illustrate their institutional theory of growth, the authors use the
example of the establishment of constitutional rule in early modern Europe and the use by
commercial interests of newly acquired de facto power to reform political institutions and
acquire the de jure power necessary to change economic institutions and, finally,
influence economic outcomes.
While the authors empirical and theoretical justification is strong, there are a
number of concerns that can be raised with their argument. First, the authors dont
address the possibility that innovation in an economy might be exogenous. Innovations
diffuse across borders and though an economy may not have the economic institutions
necessary to incentivize domestic innovation, they might have institutions required to
accommodate foreign innovations. China is a good example of an authoritative regime
with relatively weak economic institutions (and a relatively high expropriation risk) but
that has accelerated the diffusion of western innovations to its economy in order to drive
economic development. Second, it can be seen that the authors do not accord enough
importance to the physical environment of an economy. Hypothetically, an economy may
have the highly robust economic institutions but have limited growth potential due to a
lack of natural resource wealth (which is determined by geography).