A negative side of inclusive institutions

Long-term economic growth has many determinants such as geography, culture, diversity or institutions. The last one, institutions, is probably the most important direct determinant of long-term growth. Institutions influence variables that are highly important for basic stability such as the rule of law, things that are important for sustaining growth levels in the mid-run such as smart investments in infrastructure, and even things that set highly successful countries apart from moderately successful ones such as efficiency of bureaucracies or promoting an entreprenurial/innovative spirit.

The importance of institutions has long been established, but what is still quite an interesting question is how good (inclusive) and bad (extractive) institutions arise. Generally speaking, one must look at the specific history of each country/region to answer this question precisely. For those interested, Acemoglu and Robinson do just that in their book “Why Nations Fail?“. This post, however, is about how a formerly desirable institution can become a rather undesirable institution as the environment changes.

Specifically, consider the Midwest in the second half of the 19th century. Initially there were very few people living there, but then as railroads became more widespread (see figure below) the population rose sharply from 5 million in 1850 to 20 million 1900. Most newcomers were immigrants from Europe, primarily of German, Irish, and English descent.

Economic development, 19th century Midwest

The immigrant groups formed ethnic clusters both from a geographical and occupational point of view. This meant that most jobs were given via contacts. During this time, it was mostly the manufacturing sector that grew in the Midwest. And it was badly in need of workers. Workers were numerous because of the influx of immigrants, but opportunities in other parts of the country made many people leave the Midwest. To counter this, the region developed very community-centered, inclusive institutions, which enhanced the attachment of the people to the local labor market.

This happened especially in more resource-rich counties (i.e. counties with more employment opportunities), becuase that was where all the new immigrants went, and that was where all the new industry went. These inclusive institutions succeeded in making people want to stay. This basically helped avoid a potential labor shortage.

These institutions and their values persist to this day to a certain extent. They are basically responsible for the local-orientedness and the reluctance of people in the Midwest to leave despite a lack of jobs. So in more modern times, these institutions that were once very much desirable became a barrier to labor mobility, which curbed economic growth in the region.

This is the theory put forward by Galor, Munshi and Wilson (2013). Let me emphasize again that the main idea is that these inclusive institutions arose in resource-rich counties, whereas resource-poor counties are not expected to have developed them. The institutions in general are centered around local churches, and related institutions such as parochial schools.

The first question is whether inclusive institutions indeed arose more in resource-rich counties. The authors measure resource wealth by one minus a Herfindahl Index indicating ethnic diversity. The idea is that it was resource-rich counties that received the most immigrants.

Resource wealth, Midwest, 1860

Indeed the authors find that inclusive institutions popped up more often in resource-rich counties. Specifically, church participation and parochial school attendance are consistently higher in resource-rich counties starting from 1860, all the way until today (see figure below). The effect is much stronger for and is driven by Catholics and Lutherans, who represented the bulk of the immigrants in the 19th century.

Church attendance, 1860-2000, Midwest

The second question is whether labor mobility is indeed lower in formerly resource-rich counties. The idea is that resource wealth is not persistent in the case of the Midwest. I.e. more resources in the 19th century generally meant proximity to railroads and canals, which were both of huge importance then. Today, however, these factors do not provide a big competitive edge to a county. Indeed, 1860 resource wealth is correlated with economic development then, but it is uncorrelated with economic development today. Thus, variation in resource wealth mostly ceased to exist. Therefore, labor mobility should be similar across counties if the theory was false.

The authors find that indeed people born in formerly resource-rich counties have much lower migration rates, and are much more likely to select into less mobile occupations (which are generally less intellectually demanding). As noted above, this is not because their counties are more economically developed (not anymore), neither is it due to superior government-provided public goods or due to lower individual abilities (as measured by standardized test scores).

Finally, note that it is not the historically resource-rich counties’ economies that impose these less mobile and less intellectually demanding jobs on their residents. People employed in these counties are in just as mobile and intellectually demanding occupations as people in historically resource-poor counties. It is people who were born in these counties that are in the less mobile occupations. Thus it appears institutions and the values they instilled in subsequent generations really do influence labor mobility.

The main lesson here, in my opinion, is that as it has been previously proven institutions can do wonders to development. However, different situations and context might require different institutions. What is beneficial today may not be beneficial tomorrow. This is not really good news because (1) it is hard to predict what’ll be beneficial tomorrow, and (2) once institutions are established it is hard to get rid of them, and even if you get rid of them the values they once instilled in people will persist for some time. Of course, this all applies at the local level. It is questionable whether similar things can happen on a national level.

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2 thoughts on “A negative side of inclusive institutions

  1. Pingback: ZeeConomics | Islam, trade and development

  2. Pingback: ZeeConomics | How far can cultural differences be traced back?

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