Institutional Economics: Geography Hypothesis

• The presentation is about Institutional Economics, and was presented by Dr. Siyun Jiang in January 2025.

Public Speaking Session Rules

• Each student gives a 90-second speech.
• Answer 2 audience questions.
• The audience, not the speakers, votes for each speech.
• In the event of a tie, there will be a second voting round.
• To earn the full 5 points, participate twice with each participation earning 3 points
• Sign-ups are first-come, first-served.
• Participation is not mandatory.
• Focus on improving your speech rather than competing.

Why are some Countries Rich and some Poor?

• Industrialization in the 19th century caused city lights to emerge.

Geography Hypothesis

• A country's location determines its economic prosperity.
• Tropical climates face numerous disadvantages that impede development like tropical diseases and poor soil.
• Factors lead to low returns on investment, discouraging economic activity and creating the poverty trap.

Geography Hypothesis Problems

• Historically, tropical zones have not always been poorer than temperate zones.
• Civilizations like the Aztec and Inca empires were wealthy 500 years ago.
• The hypothesis does not explain prosperity differences between regions within the same continent.
• The hypothesis doesn't explain why Nogales, Arizona, is richer than Nogales, Sonora, despite similar climates.
• Disease and agricultural productivity are significantly influenced by institutional context.
• Disease is a consequence of poverty and governments that cannot take public health measures.
• Agricultural productivity is determined less by soil and more by land structure and incentives.

Culture Hypothesis

• A society's prosperity links to its ideas, customs, and social behaviors.
• Religious views are linked to ideas, customs, and social behaviors.
• Max Weber argued that the Protestant Reformation and "Protestant work ethic" were key to the rise of modern industrial society in Western Europe.
• Interpersonal trust levels affect cooperation and economic activity.
• Work ethic, values, and ethics drive productivity and innovation.
• Some cultures are more conducive to development.

Culture Hypothesis Problems

• The economies of East Asian nations developed regardless of Christian influence.
• Argentina and Uruguay, despite a European population proportion, have not matched the US or Canada's performance.
• Cultural traits are not independent causes but the result of political and economic entities.
• Cultural differences between North and South Korea are the result of institutional differences.
• The hypothesis struggles with rapid economic shifts like the rise of China, or with broad cultural category differences.
• Cultural factors don't explain, within Latin America, why Argentina and Chile are more prosperous than Bolivia and Peru.

Ignorance Hypothesis

• The hypothesis posits that some countries' leaders and policymakers do not know how to make their countries rich.
• Poor countries are poor because they design 'bad' economic policy, and if they designed 'good' economic policy, they would develop, naturally adopting policies fostering economic growth if better informed.
• This was the dominant perspective in economics and the development field during the 1980s and 1990s.
• Macro-economic policy includes monetary policy, exchange rates, and fiscal policy.
• Government spending involves determining how to allocate the total budget across various activities.
• The hypothesis culminated in the Washington Consensus, policy recommendations aimed at promoting economic growth through macroeconomic stability and market liberalization.

Ignorance Hypothesis Problems

• The hypothesis states that international institutions try to engineer economic growth by telling poor countries to adopt better policies, but those attempts are unsuccessful.
• It cannot explain countries continuing to implement bad policies.
• Leaders being simply unaware would eventually adopt better policies however advice is not often adopted in practise.
• It ignores that bad policies are often chosen for political reasons.
• African leaders hold insecure property rights to enrich themselves and keep themselves in power
• The hypothesis ignores that a society's political entities determine what policies are adopted, and that small market failures can stem from extractive entities.

Institutions and Economic Performance

• Institutions determine long-run economic performance.
• Successful economies have institutional innovations lowering transaction costs, enabling them to capture more of the gains from trade and expand their markets.
• Innovations have not created conditions necessary for efficient markets.
• Political market characteristics are essential for understanding why markets are imperfect.
• The ideal institutional structure most approximates a zero-transaction cost for efficient economic exchange in modern democratic society with universal suffrage.
• Checks and balances minimize political transaction charges by giving decision access to a large percentage of the population.
• Political competition and opposition can help alleviate agency problems.
• Rational voter ignorance and agency problems can stop democratic systems achieving an efficient outcome.

Explaining Change in Economic History

• Some exchange forms are stable while others lead to more complex and productive exchange forms.
• Local exchange means rudimentary specialization and self-sufficient households.
• Regional trade entails an increased number of partners, geography, occupational specialization, marketplace growth, and hierarchical producing organizations.
• Long-distance trade includes substantial trading specialization, center development, geography & occupational specialization, and large scale organization in manufacturing & agriculture.

North's Dynamic Theory of Long-Run Economic Change

• Regional Trade involves informal standards that provide standards of conduct for their players.
• Includes low transaction costs attributable to intimate understanding and the threat of violence
• There are no incentives to modify institutions.
• Higher transaction costs mean resources must be devoted to measurement and enforcement.
• Long-distance trade involves agency, contract fulfillment, enforcement and innovations to lower transaction costs

Stable Patterns of Limited Cooperation

• Exchange in tribal society relies on informal constraints.
• Deviance and innovation are seen as a threat to group survival.
• Suq: High measurement costs, continuous clientization effort, bargainining, incompletely standardized weights, lack of market information and legal entities.
• Caravan Trades are long distance across regions and cultures with protection of goods and services being necessary.
• Skills needed for success did not result in internal modifications of the basic institutional framework.

Long-Distance Trade in Early Modern Europe

• Agency Problems: It was costly to ensure agents acted in the principal’s best interest.
• Institutional innovations existed to lower transaction costs with standardized weights, measures, units, mediums and exchange rates.
• The rise of notaries, consuls, merchant law courts, and capital markets allowed easier investing and risk management.
• Organizations pursuing trading opportunities drove institutional evolution.

Innovations Lowering Transaction Costs

• Techniques evolved to circumvent usury laws.
• Negotiability and discounting further enhanced mobility of capital
• Account and audit aided in debt collection and behavior monitoring.
• The printing of prices and information reduced costs.
• Insurance evolved from individual contracts to specialized firms.
• The emergence of portfolio diversification and stock companies.

Fundamental Forces Driving Innovation Evolution

• Long-distance trade raised returns to devising mechanisms for enforcing contracts.
• Improving mechanisms to lower contracting costs made trade more profitable.
• Continuous interplay between the state and merchants fostered a fiscal need, credibility, and citizen involvement.
• The Netherlands and England were the primary institutional change carriers.

Why Nations Fail

• Acemoglu and Robinson argue that institutions are the drivers of economic institutions and that this is the cause of economic growth
• Political entities and distribution are state variables.
• Economic entities shape incentives for investment and participation.
• Dejure/De Facto

Towards a Theory of Institutions

• Acemoglu and Robinson focus on differing institutions and their impacts, while North focuses on transaction charges and the development of property rights.
• Extractive institutions involve a lack of laws or secure property rights, creating a bad playing field, designed for the benefit of elites.
• Inclusive entities involve secured rights/laws, market regulation for competition (free entry with opportunity)

Political Institutions

• Extractive Entities: Concentrating power hands of few, sans legal checks/balances
• Inclusive Entities are split into two:
  • Broad distribution of power (Pluralism), with checks, and the rule of law
  • Monopoly of legitimate violence for law regulating and public goods, per Weber (Political Centralization)

Growth Under Inclusive Institutions

• Growth is more likely under inclusive institutions.
• Inclusive Entities Create:
  • Investment from enforced rights.
  • Power of markets with easier finances
  • Broad participation with a free entry
• A Key aspect:
  • Investment in new technology with creative construction

Growth Under Extractive Institutions

• Economic or high-productivity elites allocate resources to high activities.
• Secured elites allow for development of economic entities.
• Typically lacks creations
• Elites dislike creative construction, with innovation and no development.
• The absence of innovation limits growth.

Logic of Extractive Institutions

• The economically and politically privileged
• Can be altered during junctures.
• Require revolution.
• Most democracies/institutions in the West are not very different.

Emergence of Inclusive Institutions in Britain

• Before 17th century: England was developing features such as a centralized state with a Parliament that could constrain monarchs
• Incrementally, there was a drift in power towards the citizens exemplified by Revolt of 1381
• The 17th century presented a juncture to fiscal crisis of the Stuart monarchs
• England’s trade was decentralized compared to France and Spain.
• The Glorious revolution led to revolution with parliamentary power, over finance, and more independence.
• Led to industrial success.

England and Spain

• Both faced pressures for revenue due to technological costs with common relative prices.
• England had representative governments and secure rights.
• Developed impartial judicial systems, secure finance, economic growth, and innovative institutions to lower transactions.
• However, Spain featured bureaucratic monarchies, limited financial freedom, and rents for bureaucracy.

Emergence of World Inequality

• The Industrial Revolution was a critical juncture affecting countries.
• These nations were Western Europe, and European Settler Colonies(Australia and US).
• In East Europe and China, long with Africa, those nations had extractive institutions and political upheaval
• Some were colonized.
• Nations were heavily influenced 250 years ago for persistence of extractive entities.

Presentation on Institutional Economics by Dr. Siyun Jiang in January 2025. Examines the geography hypothesis, proposing that a country's location impacts its economic prosperity. Tropical climates may face disadvantages that impede development.