We estimate the respective contributions of institutions, geography, and trade in determining income levels around the world, using recently developed instrumental variables for institutions and trade. Our results indicate that the quality of institutions “trumps” everything else. Once institutions are controlled for, conventional measures of geography have at best weak direct effects on incomes, although they have a strong indirect effect by influencing the quality of institutions. Similarly, once institutions are controlled for, trade is almost always insignificant, and often enters the income equation with the “wrong” (i.e., negative) sign. We relate our results to recent literature, and where differences exist, trace their origins to choices on samples, specification, and instrumentation.

This paper develops the empirical and theoretical case that differences in economic institutions are the fundamental cause of differences in economic development. We first document the empirical importance of institutions by focusing on two “quasi-natural experiments” in history, the division of Korea into two parts with very different economic institutions and the colonization of much of the world by European powers starting in the fifteenth century. We then develop the basic outline of a framework for thinking about why economic institutions differ across countries. Economic institutions determine the incentives of and the constraints on economic actors, and shape economic outcomes. As such, they are social decisions, chosen for their consequences. Because different groups and individuals typically benefit from different economic institutions, there is generally aconflict over these social choices, ultimately resolved in favor of groups with greater political power. The distribution of political power in society is in turn determined by political institutions and the distribution of resources. Political institutions allocate de

Abstract: Does economic development depend on geographic endowments like temperate instead of tropical location, the ecological conditions shaping diseases, or an environment good for grains or certain cash crops? Or do these endowments of tropics, germs, and crops affect economic development only through institutions or policies? We test the endowment, institution, and policy views against each other using cross country evidence. We find evidence that tropics, germs, and crops affect development through institutions. We find no evidence that endowments affect country incomes directly other than through institutions, nor do we find any effect of policies on development once we control for institutions.

National economic policies ’ effects on growth were over-emphasized in the early literature on endogenous economic growth. Most of the early theoretical models of the new growth literature (and even their new neoclassical counterparts) predicted large policy effects, which was followed by empirical work showing large effects. A re-appraisal finds that the alleged association between growth and policies does not explain many stylized facts of the postwar era, depends on the extreme policy observations, that the association is not robust to different estimation methods (pooled vs. fixed effects vs. cross-section), does not show up as expected in event studies of trade openings and inflation stabilizations, and is driven out by institutional variables in levels regressions

Carnegie-Rochester conference, NYU and MIT for their suggestions. Countries that have pursued distortionary macroeconomic policies, including high inflation, large budget deficits and misaligned exchange rates, appear to have suffered more macroeconomic volatility and also grown more slowly during the postwar period. Does this reflect the causal effect of these macroeconomic policies on economic outcomes? One reason to suspect that the answer may be no is that countries pursuing poor macroeconomic policies also have weak “institutions, ” including political institutions that do not constrain politicians and political elites, ineffective enforcement of property rights for investors, widespread corruption, and a high degree of political instability. This paper documents that countries that inherited more “extractive ” institutions from their colonial past were more likely to experience high volatility and economic crises during the postwar period. More specifically, societies where European colonists faced high mortality rates more than 100 years ago are much more volatile and prone to crises. Based on our previous work, we interpret this relationship as due to the causal

Do historical institutions have a persistent impact on economic performance? We answer this question by analyzing a specific set of institutions – the Colonial land revenue systems set up by the British in India – and show that differences in historical property rights institutions lead to sustained differences in economic outcomes. Areas in which proprietary rights in land were historically given to landlords have lower agricultural investments and lower productivity in the post-Independence period than areas in which these rights were given to the cultivators. The results are robust even when we restrict ourselves to analyzing only neighboring areas with differing land institutions, and when we use an instrumental variables strategy. We find that these differences arise mainly in the 1960’s, when landlord areas lagged behind in adopting new agricultural technologies. Further, we find significant differences in health and educational infrastructure and outcomes between the two types of areas, indicating a lower level of investment in human capital as well. We thank participants at the the MIT-Harvard Development Seminar, the North-Eastern Universities Development Conference and the MIT Development Economics and Organizational Economics Lunch for helpful comments, Nabeela Alam and Theresa Chengfor research assistance and Michael Kremer for help in accessinghistorical land tenure data.

This paper analyzes how property rights affect the allocation of firms' available resources among different types of assets. In particular, we investigate emp irically for a large number of countries whether firms in environments with more secure property rights allocate available resources more towards intangible assets and consequentially grow faster. We find that improved asset allocation due to better property rights has an effect on growth in sectoral value added equal to improved access to financing arising from greater financial development. The results are robust using various samples and specifications, including controlling for growth opportunities.

Abstract Most independent nations today were part of empires in 1945. Using bilateral trade data from 1948 to 2006, we examine the effect of independence on post-colonial trade. While there is little short-run effect on trade, after three decades trade with the metropole (colonizer) shrinks by more than 60%. Hostile separations lead to large, immediate reductions in trade. We also find that trade between former colonies of the same empire erodes as much as trade with the metropole, whereas trade with third countries decreases about 20%. The gradual trade deterioration following independence suggests the depreciation of some form of trading capital. JEL classification: F15

Institutions — quality of contract enforcement, property rights, shareholder protec-tion, and the like — have received a great deal of attention in recent years. Yet trade theory has not considered the implications of institutional differences, beyond treating them simply as different technologies or taxes. The purpose of this paper is twofold. First, we propose a simple model of international trade in which institutional differ-ences are modeled within the framework of incomplete contracts. We show that doing so reverses many of the conclusions obtained by equating institutions with productiv-ity. Institutional differences as a source of comparative advantage imply, among other things, that the less developed country may not gain from trade, and factor prices may actually diverge as a result of trade. Second, we test empirically whether institutions act as a source of trade, using data on US imports disaggregated by country and industry. The empirical results provide evidence of “institutional content of trade: ” institutional differences are an important determinant of trade flows.

Abstract: New research suggests that cross-country differences in legal origin help explain differences in financial development. This paper empirically assesses two theories of why legal origin influences financial development. First, the “political ” channel stresses that (i) legal traditions differ in the priority they give to the rights of individual investors vis-à-vis the state and (ii) this has repercussions for the development of property rights and financial markets. Second, the “adaptability ” channel holds that (i) legal traditions differ in their ability to adjust to changing commercial circumstances and (ii) legal systems that adapt quickly to minimize the gap between the contracting needs of the economy and the legal system’s capabilities will foster financial development more effectively than would more rigid legal traditions. We use historical comparisons and cross-country regressions to assess the validity of these two channels. We find that legal origin matters for financial development because legal traditions differ in their ability to adapt efficiently to evolving economic conditions.