To its founders, the subject of political economy was the wealth of
nations and people.
In the fourteenth century, Ibn Battuta, one of the leading geographers
and explorers of his age, traveled widely in Asia, Africa, the Middle
East, Russia, and Spain. In 1347, he visited the land we now call Bangladesh.
“This is a country . . . abounding in rice,” he wrote. He described
traveling along its waterways, passing “between villages and orchards,
just as if we were going through a bazaar.”1 Six centuries later, a
third of the people of Bangladesh are undernourished and the country is
among the world’s poorest.
At the time of Ibn Battuta’s visit to Bangladesh, Europe was reeling
under the impact of the bubonic plague, which took the lives of a quarter
or more in many cities. Manual workers in London, probably
among the better off anywhere on the continent, consumed fewer than
2000 calories per day.2 The shortage of labor following the plague
somewhat boosted real wages through the middle of the next century,
but over the next four centuries, real wages of laborers did not rise in
any European city for which records exist; in most, wages fell by substantial
amounts—in Northern Italy to half their earlier level. Over the
past two centuries, however, real wages rose dramatically, first in England,
where they increased ten-fold, and somewhat later but by even
greater amounts in other European cities.
What accounts for these dramatic reversals of fortune? The most
plausible answer, very briefly, runs as follows. The emergence and diffusion
of a novel set of institutions that came to be called capitalism
brought about a vast expansion in the productivity of human labor.
This led to higher wages when workers’ bargaining power was eventually
augmented by the expansion of workers’ political rights and by the
drying up of the pool of new recruits from agriculture, household production,
and other parts of the economy that were not organized according
to these new institutions. This happened in Europe and not in
Bangladesh.
What did happen in Bangladesh, as in much of the Mughal Empire
and what became British India, was a growing entrenchment of the
power and property rights of powerful landlords. Their influence was
already substantial before the British, but during the Bengal Presidency
it was greatly strengthened by the Permanent Settlement of 1793. This
act of the colonial rulers conferred de facto governmental powers on the
landlords by giving them the right to collect taxes (and to keep a substantial
fraction for themselves). The fact that British taxation and land
tenure policy was not uniform throughout the Raj provides a natural
experiment to test the importance of these institutions for subsequent
patterns of backwardness or development. Banerjee and Iyer (2002)
compared the post-Independence economic performance and social indicators
of districts of modern-day India in which landlords had been
empowered by the colonial land tenure and taxation systems with other
districts in which the landlords had been bypassed in favor of the village
community or direct taxation of the individual cultivator. They found
that the landlord-controlled districts had significantly lower rates of agricultural
productivity growth stemming from lower rates of investment
and lesser use of modern inputs. The landlord-controlled districts also
lagged significantly in educational and health improvements These
findings suggest a remarkable persistence of the effects of an institutional
innovation that occurred a century or more earlier.
The effects of institutions on economic performance is further affirmed
by a dramatic turn in land tenure in the Indian state of West
Bengal.4 Following its election in 1977, the Left Front government of
the state implemented a reform under which sharecroppers who registered
with the Department of Land Revenue were guaranteed permanent
and inheritable tenure in the plots they cultivated as long as they
paid the landlord a quarter of the crop. Prior to the reform, the modal
landlord’s crop share had been one half, and landlord’s had routinely
used the threat of eviction to enhance their bargaining power with the
sharecroppers. The cultivators’ increased crop-share significantly increased
the incentives to work the land productively. The security of
tenure had two possibly offsetting effects: it enhanced the cultivators’
incentive to invest in the land, while restricting the ability of the landlord
to elicit high levels of output by threat of eviction. A further indirect
effect may have also been at work. The increased economic security
of the sharecroppers led to their more active participation in local politics;
partly as a result, the local councils—the panchayats—became
more effective advocates of the interests of the less well-off in the acquisition
of agricultural inputs, credit, and schooling.
The effects of the reform have been estimated from a comparison of
agricultural productivity between West Bengal and neighboring Bangladesh
(a similar region in which no such reforms were implemented)
and by exploiting the fact that the implementation of the reform (measured
by the fraction of sharecroppers registering for its benefits) varied
considerably within West Bengal. The resulting estimates are imprecise,
and it remains difficult to determine which causal mechanisms were at
work, but the effects of the reform appear to have been very substantial:
rice yields per hectare on sharecropped land were increased by about
fifty percent. Having lagged behind most Indian states prior to the reform,
agricultural productivity growth in West Bengal has been among
the most rapid since the reform.
The enduring importance of institutions is likewise suggested by the
work of Sokoloff and Engerman (2000) concerning an analogous New
World reversal of fortune. They estimate that in 1700 Mexico’s per capita
income was about that of the British colonies that were to become
the United States, while Cuba and Barbados were at least half again
richer. At the close of the eighteenth century Cuba had slightly higher
per capita incomes than the United States, and Haiti was probably the
richest society in the world. At the opening of the twenty-first century,
however, the per capita income of Mexico was less than a third of the
United States’, and Haiti’s was lower yet. In a series of papers, Sokoloff
and Engerman provide the following explanation.5 In the parts of the
New World in which sugar and other plantation crops could be grown
(Cuba and Haiti) or in which minerals and indigenous labor were abundant
(Mexico), economic elites relied on bonded labor or slaves, and
consolidated their power and material privileges by means of highly
exclusive institutions. These restricted access by the less well-off to
schooling, public lands, patent protection, entrepreneurial opportunities,
and political participation. As a result, over the ensuing centuries,
even after the demise of slavery and other forms of coerced labor, opportunities
for saving, innovation, and investment were monopolized
by the well-to-do. Literacy remained low, and land holding highly concentrated.
As the source of wealth shifted from natural resource extraction
of manufacturing and services, these highly unequal economies
stagnated while the far more inclusive economies of the United States
and Canada grew rapidly. The ways their less exclusive institutions contributed
to the success of these North American economies remains
somewhat unclear, but a plausible hypothesis is that broader access to
land, entrepreneurial opportunities, and human capital stimulated
growth.
The source of the institutional divergence among the colonies of the
New World appears to be their initial factor endowments, more than
the distinct cultures or colonial policies of the European states that conquered
them. British Belize and Guyana went the way of Spanish Honduras
and Colombia; Barbados and Jamaica went the way of Cuba and
Haiti. The Puritans who settled Providence Island off the coast of Nicaragua
forsook their political ideals and became slave owners. Slaves on
the island outnumbered the Puritans when it was overrun by the Spanish
in 1641. According to its leading historian, “[T]he puritan settlement
. . . with its economy fueled by privateering and slavery looked
much like any other West Indian colony” (Kupperman 1993, p. 2). At
the time of its demise, Providence Island was attracting migrants from
the more famous Puritan colony far to the north; two boatloads of hapless
Pilgrims arrived from Massachusetts just after the Spanish takeover.
While the success of China’s gradual reforms has been the subject of
extensive study, the differences among the countries undertaking a rapid
transition are poorly understood. A possible explanation is that, starting
from quite similar institutions, small differences in the content or
timing of reform packages or chance events resulted in large and cumulative
differences in performance, because some countries (e.g., Hungary
and Poland) were able to capture the synergistic effects of institutional
complementarities while others were not (Hoff and Stiglitz 2002).
Other explanations stress the substantial institutional differences among
the countries or their differing levels of trust or other social norms.
What is not controversial is that divergences in performance of this
magnitude, emerging in less than a decade, suggest both the importance
of economic institutions and the pervasive influence of positive feedback
effects, whereby both success and failure are cumulative.
I have deliberately chosen cases that dramatize the central role of
institutions. Other comparisons would suggest different, or at least less
clear-cut conclusions. Over the period 1950–1990, for example, countries
with democratic and authoritarian regimes appear to have differed
surprisingly little in their overall economic performance (controlling for other influences) with major differences appearing only in their demographic record, with slower population growth in democracies (Przeworski, Alvarez, Cheibub, and Limongi 2000). Nonetheless, the examples above—the divergence of living standards in Europe from many parts of the world, the reversal in New World fortunes, and the heterogeneous consequences of economic liberalization in the once-Communist nations—are of immense importance in their own right and, as subsequent examples show, are hardly atypical. What can modern economics say about the wealth and poverty of nations and people? No less important, what can it do? Contrary to its conservative reputation, economics has always been about changing the way the world works. The earliest economists—the Mercantilists and the Physiocrats—were advisors to the absolute rulers of early modern Europe; today’s macroeconomic managers, economic development advisors, and architects of the transition from Communism to market-based societies, continue this tradition of real world engagement. Economists have never been strangers to policy making and constitution building. The hope that economics might assist in alleviating poverty and securing the conditions under which free people
might flourish is at once its most inspiring calling and its greatest challenge.
