Chapter Four

Historic Growth and Contemporary Development

Lessons and Controversies

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 4.1.1 Traditional Approach (Economic Factors) to
Development
a) Natural Resource
b) Capital Accumulation and Technological Progress
c) Entrepreneurship, Organization and Innovation
d) Division of Labor and Scale of Production

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4.1.2 Institutional Approach to Development

a) Types of Government

b) Institutions

c) Social Structure of Population

d) Social Capital and Cultural Traits

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Liberal economists have developed a framework of good governance as;
• Market-enhancing governance

• Reduce transaction costs

• Enable markets to work more efficiently

Heterodox economists have stressed the role of growth-enhancing

governance is the one who,

 Overcome entrenched market failures in allocating assets

 Acquiring productivity-enhancing technologies

 Maintaining political stability in contexts of rapid social

transformation.
 The two are not necessarily mutually exclusive
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• All Economists agree that governance is one of the critical factors
explaining the divergence in performance across developing
countries.
But, they disagree with,
• Which the types of state capacities necessary for the acceleration
of development?
• What is the importance of governance relative to other factors at
early stages of development?

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The economists in favor of good governance argue that the critical state
capacities are those
 That maintain efficient markets

 Restrict the activities of states to the provision of necessary public goods

to minimize rent seeking and government failure.

The relative failure of many developing country states are explained by the
attempts of their states to do too much, resulting in the unleashing of
unproductive rent-seeking activities and the crowding out of productive
market ones.
 Countries with better governance defied in these terms performed
better.

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• In contrast, heterodox institutional economists States that did
best in terms of achieving convergence with advanced countries
had the capacity to achieve and sustain high rates of investment
and to implement policies that encouraged the acquisition and
learning of new technologies rapidly.
• The institutions and strategies that achieved these varied from
country to country, depending on their initial conditions and
political constraints, but all successful states had governance
capacities that could achieve these functions.

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 Market-Enhancing versus Growth-Enhancing Governance

Market-enhancing governance focuses on the role of governance in

reducing transaction costs to make markets more efficient.
The key governance goals are:
– Achieving and Maintaining Stable Property Rights
– Maintaining a Good Rule of Law and Effective Contract
Enforcement
– Minimizing Expropriation Risk
– Minimizing Rent Seeking and Corruption
– Achieving the Transparent and Accountable Provision of Public
Goods in line with Democratically Expressed Preferences. 8
Growth-enhancing governance focuses on the role of governance in
enabling catching up by developing countries in a context of high-
transaction cost developing country markets.
In particular, it focuses on the effectiveness of institutions for;
 Accelerating the transfer of assets and resources to more productive
sectors
 Accelerating the absorption and learning of potentially high-productivity
technologies
 Achieving Market and Non-Market Transfers of Assets and Resources to
More Productive Sectors

• Managing Incentives and Compulsions for achieving Rapid Technology

Acquisition and Productivity Enhancement 9

•
 Social structure
• To what extent do deteriorated social
structures and poor social environments
create barriers to economic growth or
influence distribution of income?

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 Institution
• Differences in European mortality rates to estimate the effect of
institutions on economic performance.
• Europeans adopted very different colonization policies in different
colonies, with different associated institutions.
• In places where Europeans faced high mortality rates, they could not
settle and were more likely to set up extractive institutions.
• These institutions persisted to the present.

• Exploiting differences in European mortality rates as an instrument for

current institutions, to estimate large effects of institutions on income
per capita.

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 Questions concerning institutions role
 The role of the institutions in the economy;
 Existence of different institutions;
 The contribution of institutions on the productivity;
 The existence of inefficient institutions;
 The mechanisms of the institutional change

Things we should have a look at

• Religion (religiousness)?
• Cultural issues?
• Freedom?
• Anything else…

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 Questions
• People say “institutions matter.” Great!
• But, if institutions are nothing more than codified laws,
organizations and other such explicit, intentional devices, why
can’t badly-performing economies design (emulate) “good”
institutions and implement them?
• because they do not change so easily ...and they are informal…

How do institutions change?

“history matters” for development.

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 Institutions: a difficult definition
• Institution is an organization, establishment, foundation, society, or
the like, devoted to the promotion of a particular cause or program,
especially one of a public, educational, or charitable character
• The same definition of economic institutions is often contrasting and
it varies according to the various schools of economic thoughts and
the various theoretical approaches.
• Aarrangements that coordinate the behavior of individuals in society.

• Institutions are sets of regulatory norms.

• An institution is a stable, valued, recurring pattern of behavior.

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 Old Institutional Economy
1. The Old Institutional Economy (OIE) rejects the concept of a
rational individual (methodological individualism) who maximises
his own benefit and emphasises the role of the habits, behavioural
rules and social rules as the basis of the human action.
 The OIE develops an alternative concept of economic behaviour that
finds its own origins in the institutions.
 The institutions are the rules according to which enterprises and
consumers “satisfy” and not “maximise” respectively their own
return and utility.
 For this institutional approach of economics “institutions matter.”

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• The institutions are not necessarily created to be socially and
economically efficient; conversely they are created to serve and
to preserve the interests of some social clusters and to create
new rules.
• Institutions, therefore, can be said to be efficient as long as
they are committed to their original aims.

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 2. New Institutional Economics
 “The new institutional economics retains its general attachment to

neoclassical economics with its emphasis on individual maximization and

marginal analysis, but with attention to transaction costs, information

problems, and bounded rationality” Libecap (1998).

 According to North “the institutions represent the way through which

economies face the Market failures.”

 Nevertheless, North rejects the assumption of efficient institution and he

highlights the vital role of power clusters and lobbies upon the institutional

agreements.
 The most important role of Institutions is that of reducing the uncertainty in order to

determine a steady framework of social relations.

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 The neoclassical theory

3. In the pure paradigm of the neoclassical theory there is no

allocation mechanism different than the market.
• The only institution admitted is the market where the price is
determined.
• This allocation does not involves equity, norms or behaviour, cultural
differences and the institutions are exogenously given,
• i.e. they are not involved in the economic analysis.

• In the neoclassical theory with perfect information the allocation is

price-guided, the transaction cost is zero.
• Hence, the institutions (apart from the market) are not useful, instead
they inhibit the economic performance.
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 Formal institutions

 Formal institutions are generally defined as the law sphere, with

constitutions, regulations and organisations.
 There is a direct connection between formal rules and a political
economyy framework such as governance, property rights, and
judiciary system.
 Thus, reinforcing of the formal institutions is guaranteed by the
legal system.

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 Informal institutions
They are a set of social norms, conventions, moral values, religious
beliefs, traditions and other behavioural norms that have passed the
test of the historical time and that determine the individual behaviour.
The informal institutions can be called the Old Ethos or the Carriers of
History.
These informal rules are part of the dynamic evolution of a community
and heritage of its culture.
In addition these rules or institutions are self-reinforcing in course of time
trough mechanisms such as imitations, traditions and other forms of
teaching.

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 4.2 Kuznets’s six characteristics of Modern Economic Growth

• Simon Kuznets (1973) viewed economic growth as “a long-term rise

in capacity to supply increasingly diverse economic goods to its
population
• This growing capacity based on advancing technology and the
institutional and ideological adjustments that it demands.
• Kuznets was a leading figure in developing national income
accounting in the United States.
• He also investigated economic development and growth using
quantitative data to supplement the traditional qualitative analysis.
• Kuznets identified six characteristics of modern economic growth.
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(1) There is rapid growth in income per capita and population.
(2) There is rapid growth in productivity.
(3) There is structural change such as
 The shift from agriculture to manufacturing to services,

 The shift of production from individuals to companies and

 The shift of labor from self-employed to employee.

4) The structure of society changes as a result of education,

secularization and urbanization.
(5) The world becomes more interdependent.
(6) Economic growth has been limited to a minority of the world’s
population.
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• The fact that only some countries have achieved growth shows that
growth is not automatic.
• Kuznets argued that conditions necessary to
allow growth include a flexible social and political framework, and
incomes above some floor level.
• The central feature of growth, once it starts, is productivity growth. In
turn, productivity growth results from innovation.
• Kuznets places the driving force behind innovation in science (see
Kuznets’ (1973)):

• “some new major growth source, some new epochal innovation,

must have generated these radically different patterns.
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• And one may argue that this source is the emergence of modern
science as the basis of advancing technology – a breakthrough in
the evolution of science that produced a potential for technology
far greater than existed previously.”
• This is a self-sustaining process:
“Mass application of technological innovations, which constitutes
much of the distinctive substance of modern economic growth, is
closely connected with the further progress of science, in its turn
the basis for additional advance in technology. . . “
• Kuznets also was concerned with income distribution.

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Economic growth brings about;
A decline in the relative position of some groups such as,
 farmers,
 small scale producers
 landowners

And an increase in the position of other groups such as

o owners of produced capital,

o managers and

o entrepreneurs.

• Kuznets looked at the evolution of income distribution and postulated what has
become known as the Kuznets curve
• – as growth proceeds the inequality of income distribution at first increases and
then, as average incomes continue to increase, begins to decrease.

• Kuznets attributed economic growth to continuing technological advance. 25

• In turn, technological advance was based on science.
• Scientific knowledge is available to all so presumably the answer
to the question of why only some countries move into economic
growth is that the social structure, personal skills and attitudes
in some countries are permissive of growth whereas in others
they work to prevent growth.
• However, Kuznets did not link his arguments into a consistent
theory of growth. It was too easy just to attribute growth to
science.
• What gives rise to scientific advance?
• Is scientific advance the cause of growth or the result of growth?
• What causes scientific advance to be translated in to
technological advance?
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• Why do people behave in a way that generates growth?
• What are the practical mechanisms of growth?
• Kuznets did not create a practical view of the growth process.
But, Kuznets greatly advanced the measurement of growth, and
clarified the social characteristics and social effects of economic
growth.

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 4.3 The Limited Value of the Historical Growth Experience:
Differing Initial Conditions
• Physical and Human Resource Endowments
• Relative Levels of per Capita Income and GNP
• Climatic Differences
• Population Size, Distribution, and Growth
• The Historical Role of International Migration
• The Growth Stimulus of International Trade
• Stability and Flexibility of Political and Social
Institutions

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THANK YOU!

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