Tuesday, May 26, 2009

Tropics, Germs and Crops: How Endowments Influence Economic Dvelopment by Easterly and Levine

Tropics, Germs and Crops: How Endowments Influence Economic Development
by Easterly and Levine (2002)



Main question: What explains cross countries differences in economic development?

“ How much of Canadians 107-fol income advantage over Burundians is due to more favorable geographic endowments? How is due to better instituitions? How much is due to better policies? Do geographic advantages of Canada over Burundi directly affect income or do they work through institutions or policies?
The purpose of this research is to test different theories of how geography, institutions and policies influence economic development” (p.2-3)


The geography/endowment hypothesis says that environment affects the quality of land, labor and production technology. Thus, tropical countries have poor yields, more disease and endowments that cannot use of the technologies developed in more temperate zones. Implied in this idea is that if a country is landlocked then it will affect its ability to access a larger economic market and decrease its production efficiency.

The institution view holds that environment’s main impact on development is through institutions. Environments where crops are most effectively produced in large plantations will quickly develop institutions to protect the few landowners from peasants.

During the settlement of the new world, Europeans chose to settle in the colonies with good climate and few germs. In these places the institutional environment created by the colonialist endured even after the end of colonialism.

The policy view questions the relevance of tropics, germs and crops in shaping economic development. The idea is that either the knowledge about which policies and institutions are best for development or changes in the political incentives produce rapid changes in institutions and economic policies. Authors say that in this view history does not play a large role because any adverse historical legacy can be quickly reversed.

In this aspect, I disagree with the authors mainly because what they are saying in the whole paper is that endowments are indeed a piece of fate. Therefore, due to the ‘endowment/fate’ theory, any poor country tend to be always poor. Nothing on earth, (or even beyond the earth) will improve economic development of poor countries to reduce the disparities in income. Institutions do evolve, change and improve through the use of economic policies and the right incentives. Therefore, it is too simplistic of an idea to say that endowments explain through institutions economic development. In other words, the different sets of endowments led to efficient or inefficient institutions. The good set of endowment led to efficient institutions which in turn, led to high rates of economic development. The fate hypothesis is left for the poor countries.


Lit Review

A. Geography/Endowment hypothesis (the ‘Tropics’ )

Main exponent: Sachs (1995, 1997, 1998, 2001).
Argument: Tropical location leads to underdevelopment through the low fertility of the soil, high rates of crop pests, high evaporation and unstable water supply, lack of a dry season for temperate grain crops, lots of tropical disease, lack of coal deposits and high transportation costs. (this is the “tropics’ idea)

Diamond (1997) stress that native from tropical countries develop some resistance against some diseases. However, the diseases are spread out to European settlers that arrived in the region because the did not develop the same resistance.

B. Institutions Hypothesis (the ‘germs and crops’)

The ‘germs’ part is due to Acemoglu, Johnson and Robinson (2001) (hereforth AJR). The institutional quality explained by the germs is the main determinant of economic development. Based on 3premisses:
1) Europeans used different types of colonization strategies. In one end, Europeans created institutions to support private property and check the power of the state (Ex: US, Australia and New Zeland). At the other end, Europeans did not aim to settle and instead sought to extract as much from the colony as possible. In these ‘extractive states’ Europeans did not create institutions to support property rights, rather they create institutions to support the elite to extract rent.
2) AJR stress that the choice of colonization strategy was dependent upon the degree of ‘germs ‘ (as a proxi for mortality). In areas with little germs (low mortality) Europeans tend to form settler colonies. In areas where germs created high mortality among settlers, Europeans created extractive colonies. Thus according to the endowment theory, the disease shaped colonization strategy and the types of institutions established by European settlers.
3) Institutions created by the settlers lasted even after independence. While settler colonies led to more democratic government devoted to protecting private properties, the extractive colonies preserved the pre-colonial institutions even after independence. Hence, the democracy was low as well as private property rights. In brief, differences in endowments created initial institutions whose effects on property rights remained unchanged after independence.

In the (2002) AJR stress that it is institutions and not tropics that matters. They explained that the countries with higher urbanization and population density in 1500 have worse institutions today. Assuming that urbanization and population as proxies for income, they suggest a reversal in income ranking between 1500 and today. Given that latitude does not change, the tropics hypothesis would predict persistence in income ranking. AJR argues that it is the introduction of extractive institutions in high urbanized places contrasted with the introduction of settler institutions in low urbanized places, explaining the reversal of incomes.

AJR say 2 things that are not reported in this paper. First, according to them:
” We document empirically that (potential) settler mortality were a major determinant of settlements; that settlements were a major determinant of early institutions (in practice, institutions in 1900); that there is a strong correlation between early institutions and institutions today; and finally that current institutions have a first order effect on current performance.” (AJR, 2000, p. 3).

“ it is useful to point out that our findings do not imply that institutions today are predetermined by colonial policies and cannot be changed. We emphasize colonial experience as one of the many factors affecting institutions. Since mortality rates faced by settlers are arguably exogenous, they are useful as an instrument to isolate the effect of institutions on performance. In fact, our reading is that these results suggest substantitial income gains from improving institutions in poor countries”.

The Crops Hypothesis

Due to Engerman & Sockoloff (1997, 2000, hereafter ES). ES argue that land endowments in south America led to the production of commodities that had economies of scale when produced in large tracts of land. In turn, the power over land was concentrated in the hands of the elite, the landowners. The concentration of power in the hands of a few, led to the creation of institutions to preserve the hegemony (like low access to schooling, weak property rights, narrow franchising for voting. The Latin American laws reflects the power of the elite regulating corporation, banks.
“ The work of ES follows a long history literature that postulates domination by the lite owners of encomiendas (ladn grants for plantations and mines from the crown, ccompanied by feudal rights over the indigineous population) as the ‘ original sin’ of Latin American underdevelopment.” (p.10).

ES suggest that the elite in Latin America opposed democracy and other institutions to promote equality because they were afraid the poor took the power.
It is the nature of the crop (for instance coffee in large tracts of land) endowments that led to the creation of a privileged elite, who in turn, created institutions to restrict opportunities to the society.

C. Policy Hypothesis

While tropics, germs and crops may influence production technologies and institutions, the adoption o policies that foster low inflation, openness to trade, and unchecked international financial flows will promote economic development.


3. Data and Summary
The authors will test how tropics, germs and crops influence economic development. In this section they define the variables used as endowments and the indicators of possible institutions via which endowments influence output.

A.Endowments
A1. Settler mortality
They use settler mortality (log of annualized deaths per thousands European soldiers) during the 19th century for 72 colonies located in US, Africa, Caribean (1817-1848).
There is a negative relationship b/w settler mortality and log of GDP in 1995 (see table 1). Higher levels of settler mortality are associated with lower levels of economic development. Settler mortality provides information on whether initial endowments tended to favor the creation of extractive or settler colonies (testing the AJR).

Latitude is the distance of the country from the Equator. For Sachs, countries closer to the equator have a tropical climate which in turn, hinder production or is a source of diseases for colonialists that may foster extractive institutions.

In table 1 and fig 2, we see a positive correlation b/w latitude and economic development. Countries with higher absolute latitude tend to have higher levels of real per capita GDP. Latitude is the measure of “ Tropics”.

A2. Crops/Minerals
Their measure of crops are dummies for whether a country produced any set of leading commodities in 1998-99.
They use the crops/minerals dummies to assess the ES idea. ES argue that some commodities lent themselves the use of economies of scale and slave labor. These commodities produced long lasting extractive institutions that protect the elite and hinder economic development. Other commodities lent to the production by middle class family farmers, which in turn induce the creation of growth enhancing institutions.
Their set of crops dummies are: bananas, coffee, copper, maize, millet, oil, rice, rubber, silver, sugarcane and wheat.

A3.Landlocked

Is a dummy that takes the value of 0 if the country has coastal territory on the ocean and 1 otherwise. There are 40 landlocked countries in the world and in their sample of 72 countries 10 are landlocked.

B. Institutions


According to AJR and ES, endowments influence economic development through their impact on instituitional development. The authors are going to present the institutional measures.
The authors use INSTITUTIONS INDEX build by Kaufman, Kraay and Zoid-Lobaton (1999). This index is the average of 6 measure of institutional development ( voice and accountability, political stability and lack of violence, government effectiveness, light regulatory burden, rule of law, freedom from graft).
The Institution Index (II) is positively associated with economic development and better endowments. Table 1, figure 3 shows the strong positive relationship b/w the log GDP and the II. The II (in table 1, figures 4and 5) shows that II is positively correlated with latitude and negatively correlated with settler mortality.

C.Macroeconomic Policies


To see the influence of macro policy in cross country development the authors use 3 measures: degree of OPENESS, REAL EXCHANGE RATE OVERVALUATION AND INFLATION. These measures are used for the last 4 decades and not for the past to see if macro policies could affect growth.

D. Other Explanatory Variables (Control variables)

Ethnolinguistic Diversity. The more ethnolinguistic diverse is a country the weaker are its institutions. When a group takes the power they tend to expropriate as many resources as possible from the ethnic losers. Thus ethnolinguistic diversity may hinder economic development.

RELIGION. Catholic and muslim religion tend to develop xenophobic cultures and powerful church/state bonds to maintain control, which hinders economic development.
FRENCH LEGAL ORIGIN equals one if the country has a French civil law and zero if country has a british common law. Countries with French legal origins tend to have lower levels of property rights than countries with britsh legal origins.


E. SAMPLE

The authors examine whether these endowments (given by tropics, germs and crops) directly influences economic development or if these endownments shaped the formation of critical, long lasting institutions that formed the foundations of economic development. In other words, authors will regress current GDP (dependent variable) against setller mortality, crops, landlocked, among other endowments. They are testing if current level of GDP is explained by previous institutions (or endowments).

4. Regression Results

Do endowments explain cross country variations in economic development? Yes
Do endowments explain cross country variations in institutional development? Yes
Do endowments explain cross-country variations in economic development beyond their ability to explain cross country variations in institution? (in other words: do endowments explain more than economic development ?) If no, then this provides evidence for the institutions hypothesis and against the geography hypothesis. If yes, then this provides support for the geography hypothesis.
After accounting for the impact that endowments have on growth through institutions, do macro policies pursued by countries over the last 4 decades help explain the current levels of economic development?

A. Do Endowment explain Economic Development?
Yes, see table 2. Indeed results do not change when control variables are included.
Settler mortality explains in one of the forms almost 50% of the log of gdp and the latitude and landlocked variables are not significant.
“ Lower settler mortality, higher latitude, and not being landlocked are akk associated with higher levels of development” However, latitude and landlocked are not significant.”
EXPLAIN THE TANZANIA EXAMPLE.
Tanzania rates of settler mortality = 5.6 (280 deaths per thousand, where 280=exp (5.6)).
Per capital GDP Tanzania: $182,log(182)=5.21.

The regression coefficient from the second regression in table 2 says that if Tanzania had a disease environment that produced settler mortality rates closer to India of 3.9 (49 deaths per thousands), then Tanzania would enjoy income levels of more than double its current level and even greater than that enjoyed in India now, about $415.
∆(logGDPpercapita) = -(0.62)* ∆(settler mortality)
given: Tanzania settler mortality = 5.6 and India’s settler mortality=3.9
∆(logGDPpercapita) = -(0.62)* ∆(-1.7) = 1.05
GDP per capita Tanzania = 5.21, its new GDP level per capita would be 6.27 or (ln 6.27 = $528).
B. Do Endowment Explain Institutional Development?
Table 3. Dependent variable: Aggregate institutional index.
Yes. Settle mortality and natural resources (germs and crops) are more significant than tropical latitude aor landlocked.

Example: Chile settler mortality rate is 4.23 while Singapore is 2.87. If Chile had Singapore’s settler mortality the results suggest that this would close the gap between Chile’s level of institutional development (0.87) and Singapore’s (1.44).
∆(institution index) = (-0.25)* ∆(settler mortality)
Chile’s settler mortality = 4.23 and Singapore’s = 2.87
∆(settler mortality) = 2.87-4.23
∆(institution index) = -(-0.25)* ∆ (-1.36) =0.34
Chile’s institutions index -=0.87
Chile’s new level of institution index = 0.87 +0.34 =1.21
Singapore’s institution index=1.44

Consistent with AJR (2001) and ES (1997), endowments shape institutional development.




C. Do Endowments explain Development beyond Institutions?
Endowment influence economic development (table 2) and institutional development (table 3). These finding are consistent with both the geography and the institutional hypothesis.

Distinguishing between the Geography and Institution Hypothesis.
2SOLS
Institutions index = δ (endowments) +γX + u ------------------First stage
Log GDPper capita = α (insititution index) +βX +v------------ second Stage

X e’um conjunto de variaveis exogenas incluidas apenas nos Segundo estagio (legal origin, religion ethinic).

When there are no X variables then the regression asks: Does the component of the Institutions Index explained by exogenous endowments explain cross country differences in the log of GDP? If α is significant then this suggests that endowments influence economic development through institutions which is consistent with the institution hypothesis.


Conclusao: como y is significant it suggests the influence of economic development through institutions which is consistent with the institutions hypothesis

They test when there are no variable X the overidentifying restriction (OIR): do endowments explain development beyond the ability of endowments to explain institutional development?
See table 4.

In all regressions from table 4 the institutions index is significant and the instrumental variables are correlated with the index..For instance, the regression coefficients indicate that if Mexico exogenously improved its level of institutional development from the sample mean to the level of US, this would eliminate the huge GDP gap between the two countries. From the second regression in table 4:
∆(logGDPpercapita) = -(2.1)* ∆(institution index)
Mexico institution index = -0.07
US institution index= 1.29
∆(institution index) = 1.36
Then:
∆(logGDPpercapita) = -(2.1)*1.36= 2.86
Mexico log of GDP per capita = 8.13
New level of Mexico GDP per capita = 8.13+2.86=10.99
US level of GDP per capita is 10.28

The table 4 results indicate that endowments do not explain development beyond the ability of endowments to explain institutional development. When considering the regressions that include only the endowment indicators – settler mortality, latitude, land lacked and crops – as instr. Variables the data never reject the hypothesis that endowments only explain institutional development. (The OIR is never reject at standard confidence intrerval)

Table 4: strong support for the institutional hypothesis and no evidence for the geography hypothesis.

Endowments explain institutions which in turn explains economic development.

D. Do Macro Policies Matter After Accounting for Endowments?
No, see table 5.

5. Conclusions

Tropics, germs and crops do explain cross country difference in development through their impact in institutions. In the beginning of the paper authors ask what are the factors that explains the 107 fold different in the log of per capita GDP between Burundi and Canada.
If Burundi’s endowment had been like those of Canada, it would have increased Burundi’s income per capital through institutions by a factor of 38. Given the 107-fol difference b/w Canada and Burundi’s income,we say that the paper explains 38 times which variabtion by a factor of 2.8 (107/38) is unexplained. (in log terms, 78% of the log income difference b/w the 2 countries is explained).
Endowment explains through institutions (but not through georgraphy) economic development.

Macro policy do not explain differences in GDP per capital once one controls for the impact of endowments on institutions and on development. Why? They say that ‘ bad policies’ are proxing for poor institutions,not included in the growth regression. The policy implication of this explanation is that bad policies are only symptoms of longer run institutional factors and correcting the policies without correcting the institutions will bring little long run benefits.

Endowments and policies have no independent effect once they control for institutions, contrary to a number of stories and that institutional quality seems to be a sufficient statistic for accounting for economic development.

The main message of the paper is that the differences in income among countries are explained by endowments (which, in turn, is a proxi for past institutions). Easterly and Levine do not distinguish between AJR and ES theories, including both as ‘ endowments’ that are going to explain development through institutions. For AJR it is the high mortality of the settlers that led them establish a ‘ colonia de exploracao’ whereas places with low mortality are the ‘settlers colonies’. In the former, weaker institutions prevailed while in the latter strong ones were the rules. For ES, the story is different. It is because of the type of crops developed in South America (coffee) that were planted in latifundio types of properties that created a rent seeking elite that always excluded the society and created weak institutions. While it is true that in both cases, current institutions are locked in their past, the more plausible idea is the one from AJR. Why? Because ES idea can be easily rejected when we show that in different countries in south America coffee was grown in different sizes of properties according to the nature of the elite (more urban oriented or more rural oriented determined the size of the tracts).

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