1 Backtrack: the raw facts Income gaps are huge And they are not narrowing: Though some regions breaking through Others are falling further behind

2 Acemoglu, 2008

3 Africa gets left behind Sala-i-Martin, 2006

4 What have we learnt from the models of economic growth? Capital accumulation’s impact on growth will peter out. (Solow diagram) Accumulation of capital (including human capital) is not enough to explain growth of the advanced economies: the “Solow residual” accounts for most of leading-edge growth. Capital intensity differences between rich and poor not big enough to explain the differences (see calculation in next slide)

5 High income countries have output per head at least 10 times that of Low income countries But with common technology and diminishing returns to capital –Specifically with But capital per head in high income countries is only about 25 times poorest countries (see graph)

6

7 Weil (2007)

8 Or look at marginal product of capital: High income countries have output per head at least 10 times that of Low income countries Again with –A similar calculation gives But if return to capital in poor countries is 100 times that in rich countries, where’s the rush of capital from rich to poor countries to take advantage of such returns ?

9 Weil, 2007

10 What have we learnt from the models of economic growth? (2) Technology is key to sustained growth for the world as a whole Low income countries can grow by transferring technology…but they haven’t done so Why? Plausible reason: Social infrastructure—specifically the institutions and policies that align private and social returns to activities

11

12

13 Expropriation risk (as estimated by the consulting firm Political Risk Services) and GDP per cap. (Source: Acemoglu, 2008)

14 Interlude: Social infrastructure issues: it’s not just corruption and rent-seeking

15 Social infrastructure, rent-seeking, predation E.g. risk of predation discourages producers from modern sector or innovative activity –i.e. There is a reluctance to invest because much of the return to investment and production activity risks being captured by rent-seekers. What is rent-seeking?

16 Definitions of rent-seeking Cutting yourself a bigger slice of the cake rather than making the cake bigger. Trying to make more money without producing more for customers. Some examples of rent-seeking: a protection racket, in which the gang takes a cut from the shopkeeper’s profit; a cartel of firms agreeing to raise prices; lobbying the government for tax, spending or regulatory policies that benefit the lobbyists at the expense of taxpayers or consumers or some other rivals. Cf. The Economist: “Economics A-Z”

17 Rent-seeking and economic development – a simple model Career choice: producer or predator; Technology choice: modern or subsistence –(subsistence production less easy to grab – cf. African agriculture: Bates) Predator can grab a certain amount: the more predators, the less the producers have left over; too many predators  producers tend to retreat into subsistence Murphy, Shleifer, Vishny; Am Econ Rev 93.

18 Case 1: Predation not profitable: good equilibrium Equilibrium Subsistence level Cash crop

19 Case 2: Predation is so profitable that equilibrium is at subsistence Equilibrium

20 Case 3 – Multiple equilibria, one good, one bad Equilibrium Equilibrium (unstable) Equilibrium

21 Rent-seeking (3) And it is the more innovative producers that are likely to be the most vulnerable to predation – especially from officials who control issue of permits, etc. –They are often outsiders not part of the elite (who don’t need to innovate –They are credit-constrained –Their projects are long-run, plenty of time to milk them –Innovative projects are risky: predator takes when things work out Murphy, Shleifer, Vishny; Am Econ Rev 93.

22 Social infrastructure is correlated with investment AND productivity This time measuring social infrastructure using a combination of subjective measures from ICRG (collected by Knack and Keefer, 1995) and the country’s openness to international trade since 1950 (Sachs and Warner 1995) Positive correlations are found with country’s investment rate, schooling and (total factor) productivity (see next slides)

23 Fig. 7.1

24 Fig. 7.2

25 Fig. 7.3

26 But are the institutions cause or effect of poverty? Some evidence Colonial institutions of the past cannot be the effect of poverty today –Differential institutional development depending on suitability for settlers (Mortality; Population density) (Acemoglu, Johnson and Robinson) –AJR emphasize expropriation protection; others (Engerman and Sokoloff) emphasize slavery and inequality

27 Settler mortality then and protection against expropriation now (Source: Acemoglu, 2008)

28 Settler mortality then and GDP per capita now (Source: Acemoglu, 2008)