Making Sense of the Economics Nobel for 2024

“In spite of the vogue of ‘Quantitative Economic History’, economic historians are under less temptation to see their subject as purely quantitative.”

John Hicks (1969), ‘A Theory of Economic History’

     The 2024 Nobel Prize for Economics has been conferred jointly on Daron Acemoglu, Simon Johnson and Derek Robinson (henceforth AJR). They have co-authored several articles and books in various combinations that include one or the other among them, but have together written two well-known articles. The first is “The Colonial Origins of Comparative Development” in the ‘American Economic Review’ (2001) and the other one is “Institutions as the Fundamental Cause of Growth” in the prestigious ‘Handbook of Economic Growth’ (2005). My assessment of their contribution is based on these two studies.

     In AJR (2005), where the authors reflect on their earlier work together, they state their objective is to answer the question why some countries grow faster than others. While conventional growth theory focuses on the proximate determinants of growth – think Solow –  they themselves wish to go back a step and address the question ‘what causes growth?’ They consider earlier contributions as being concerned with the “mechanics of growth” – think Lucas here - while they themselves are unravelling something deeper. To convey more clearly what they attempt, they refer to Douglass North’s observation that capital formation, economies of scale, etc., are “already growth”. It may be said that they are aiming at a ‘meta narrative’ .

     Methodologically, theirs is a model-free investigation, attempting a parsimonious explanation of growth globally i.e., across all countries. Their starting point is to postulate that whether or not an economy grows depends upon how it is organised, i.e., on its economic institutions. Institutions themselves are the rules governing interaction in society. As they proceed, we find that AJR have in mind not only interaction among citizens but also between state and citizen. So, institutions are “the rules of the game”, as in Douglass North.  Their main contention is that “There is convincing empirical support for the hypothesis that differences in economic institutions, rather than geography or culture cause differences in incomes per capita.    (AJR 2005, p. 402; italics as in the original). They arrive at this conclusion by exploiting the institutional divergence between the countries colonised by Europeans in the ‘modern age’. Briefly, Europeans settled down in in the sparsely populated regions putting in place good institutions. In the densely populated ones they imposed “extractive” institutions. They state “We think of good economic institutions as those that provide security of property rights.” They do not define extractive institutions as precisely, though their econometric exercise conveys what they have in mind, which is the absence of “protection from expropriation”. Anyhow, for AJR these colonial institutions have remained till today, and explain the divergence in income today among the ex-colonies, those with the good institutions having achieved far higher growth than the rest.

     That secure property rights, assuring that the returns to investment will not be expropriated, is a necessary condition for an economy to achieve long-term growth is not something that any sensible economist would contest. However, note that AJR claim that secure property rights “cause” growth. Their claim is based on their implementation of an instrumental variables regression that instruments institutional  quality with European settler mortality at the time of colonisation. Without stating it in as many words, AJR view their empirical strategy as mimicking a randomised control trial (RCT) and their method approximating the standards of explanation in the natural sciences. In the rest of this article I shall first comment on their econometric results and then evaluate their representation of colonialism.

     The scientific community, in the sense of Thomas Kuhn, to which AJR belong view their choice of instrument as an inspired one. It satisfies the conditions of both ‘externality’ and ‘exogeneity’ (See Deaton, 2010). There can be no question of reverse causality here, as current national income cannot cause settler mortality rates of several centuries ago. Prima facie, the econometric estimate appears robust but is less so upon closer scrutiny. The first- stage regression, of institutional quality today on settler mortality, is only .26. AJR (2005) assert that there is a “…. very strong relationship between the historical mortality risk faced by Europeans and the current extent to which property rights are enforced. A bivariate regression has an R-squared of .26.” An R-squared of .26 does not come across as particularly strong even for a cross-section regression. Next, AJR scrupulously provide both the OLS and IV estimates, but somewhat disconcertingly the coefficient on institutional quality is consistently higher in the latter. (They experiment with more than one specification.) This is counter-intuitive, as reverse causality is ostensibly extinguished in an IV regression. Now, even if the econometric grounding of their study were much stronger, it may still be asked what causal mechanism links growth to property rights. In RCTs in medicine, and the biological sciences more generally, it may be that an outcome is viewed as having been caused by the treatment but this seems hardly sufficient in the social sciences. A causal mechanism needs to be specified. While claiming to explain comparative development, AJR have no model of development. It is interesting to find that they do not even feel the need to provide one. So prestigious is the methodology of ‘causal inference’ in the economics profession today.

     To bring up the issue of the causal mechanism in the AJR account is a matter of more than just academic interest. Their reducing colonialism to a matter of institutions serves to mask other possible causes. They speak of “understanding the colonial experiment” (AJR 2005), but it may be asked if they have one.  Arguably, the institutions were only incidental to the objective of the colonizer. Slavery would be a case in point. It’s existence in the United States even after the American republic is particularly problematic for the AJR thesis, for it is a case of secure property rights (of the slave-owner, that is) coexisting with extraction. Now their neat classification scheme distinguishing countries on the basis of good and extractive institutions breaks down. The case of slavery points to the possibility that institutions came second under colonialism. More importantly, institutions were not the only means by which the colonizers achieved their objective. In some important instances, colonialists achieved their objective by directing income flows. Institutions may have little to do with this aspect of colonialism, perhaps its most important one. An astute account of the role of income flows under colonialism is to be found in writings of Keynes: “…. I trace the beginnings of British foreign investment to the treasure which Drake stole from Spain in 1580. In that year he returned to England bringing with him the prodigious spoils of the Golden Hind. Queen Elizabeth was a considerable shareholder in the syndicate which had financed the expedition. Out of her share she paid off the whole of England’s foreign debt, balanced her Budget, and found herself with about £40,000 in hand. This she invested in the Levant Company, which prospered. Out of the profits of the Levant Company, the East India Company was founded; and the profits of this great enterprise were the foundation of England’s subsequent foreign investment.” (J.M. Keynes, ‘The Economic Possibilities for our Grandchildren’, 1930).

     A focus on institutions without taking income flows into account is to misunderstand what AJR refer to as “the colonial experiment”, and leaves one unable to make a quantitative assessment of what was at stake for the European colonisers. This can be illustrated by looking at the relationship between India and England. I do not see such an exercise as limiting. Unlike in AJR, the colonial experience was not uniform, and to reduce it to institutions is procrustean. It is this treatment of the European colonies as alike in all respects except their institutions that leaves AJR to suggest that the colonies of north America and Australia-New Zealand were successful in industrializing while Indian and Bangladesh were not. This is blind to the feature that for the most successful European colonizer, namely Britain, its black and white colonies were not at par. The latter were seen as extensions of the mother country to be nurtured while the latter were possessions acquired purely for exploitation. In this account, Britain industrialised at India’s expense by first extracting surplus from India and then using it as a defenceless market for its goods, ‘defenceless’ in that Britain itself had protected its markets from Indian manufactures at the nascent stage of its industrial development. Under colonialism, India could not have protected its industry. Dadabhai Naoroji and Romesh Chandra Dutt had figured this out over a century ago. More recently, Irfan Habib estimated that during a crucial phase of the Industrial Revolution outflows from India amounted to thirty percent of capital formation in Britain. This investible surplus was lost to India forever. Later, British textile exports to India are estimated to have amounted to two thirds of domestic consumption in India (see Habib 1977 for the source). AJR claim to explain the ‘colonial origins’ of comparative development but end up comparing development across the European colonies while ignoring the role of colonialism in the rise of Europe.

     Finally, the rise of India after 1947 has implications for the AJR thesis. It would be highly plausible to argue that India broke out of colonial stagnation due to state direction. The Nehru-Mahalanobis Strategy shifted the economy to a higher level of output from which resulted continuous and accelerating growth, making India the fastest growing major economy in the world today. A causal explanation of this is provided by Balakrishnan, Das and Parameswaran (2017). This quickening of India’s economy was achieved at a time when there was no major overhaul of its economic institutions. It has been pointed out that China’s rise with ambiguous property rights is a challenge to AJR, but actually a more direct challenge is posed by India’s after 1947. India was intrinsic to European colonisation in a way that China was not. To cut a long story short, Britain’s rise and India’s falling back in the colonial era have little to do with institutions. It has to do with colonialism understood as unrequited income transfers from the colony to the metropolis. Under colonialism India’s economy was pinned down by military power, not any institution.

Conclusion

     Shorn of the deft handling of the putative issue of endogeneity in their econometrics, there is little of interest to the wider economics profession in the work of Acemoglu, Johnson and Robinson. There is no economic analysis or historical narrative relevant to their field of investigation, namely, the colonial origins of comparative economic development. Above all, they provide no mechanism to back their claim that they have delivered a causal account of the role of institutions in economic growth. It would be reasonable to insist that any account of economic phenomena must commence with a theoretical model, not necessarily mathematical, with a clearly specified mechanism of change.

I thank, without implication, Rohit Joseph, M. Parameswaran and S. Sivakumar for discussion. An initial version of this note was presented at the Madras Institute of Development Studies, for which opportunity I thank its director, M. Suresh Babu.

References

Balakrishnan, P., M. Das and M. Parameswaran (2017), “The internal dynamic of Indian economic growth”, ‘Journal of      Asian Economics’, 50: 46-61.

Deaton, A. (2010) “Instruments, Randomization, and Learning about Development”, ‘Journal of Economic Literature’,       48: 424–455.

Habib, I. (1977) “The Colonialisation of the Indian Economy”, ‘Social Scientist’, 3: 23-53.