This leads to a different way of asking the big questions, one that is not grounded
in any presumption of convergence. The starting point is that two economies with
the same fundamentals can move apart along very different paths. Some of the bestknown
economists writing on development in the first half of the twentieth century were
instinctively drawn to this view: Young (1928), Nurkse (1953), Leibenstein (1957) and
Myrdal (1957) among them.
Historical legacies need not be limited to a nation’s inheritance of capital stock or GDP
from its ancestors. Factors as diverse as the distribution of economic or political power,
legal structure, traditions, group reputations, colonial heritage and specific institutional
settings may serve as initial conditions — with a long reach. Even the accumulated
baggage of unfulfilled aspirations or depressed expectations may echo into the future.
Factors that have received special attention in the literature include historical inequalities,
the nature of colonial settlement, the character of early industry and agriculture,
and early political institutions.
- I. Expectations and Development
Consider the role of expectations. Rosenstein-Rodan (1943) and Hirschman (1958) (and
several others following them) argued that economic development could be thought of as
a massive coordination failure, in which several investments do not occur simply because
other complementary investments are similarly depressed in the same bootstrapped way.
Thus one might conceive of two (or more) equilibria under the very same fundamental
conditions, “ranked” by different levels of investment.
Such “ranked equilibria” reply on the presence of a complementarity: a particular form
of externality in which the taking of an action by an agent increases the marginal benefit
to other agents from taking the a similar action. In the argument above, sector-specific
investments lie at the heart of the complementarity: more investment in one sector raises the return to investment in some related sector.
Once complementarities — and their implications for equilibrium multiplicity — enter
our way of thinking, they seem to pop up everywhere. Complementarities play a role
in explaining how technological inefficiencies persist (David (1985), Arthur (1994)), why
financial depth is low (and growth volatile) in developing countries (Acemoglu and Zilibotti (1997)), how investments in physical and human capital may be depressed (Romer (1986), Lucas (1988)), why corruption may be self-sustaining (Kingston (2005), Emerson (2006)), the growth of cities (Henderson (1988), Krugman (1991)), the suddenness of currency crises (Obstfeld (1994)), or the fertility transition (Munshi and Myaux (2006));
I could easily go on. Even the traditional Rosenstein-Rodan view of demand complementarities has been formally resurrected (Murphy, Shleifer and Vishny (1989)).
An important problem with theories of multiple equilibrium is that they carry an unclear
burden of history. Suppose, for instance, that an economy has been in a low-level
investment trap for decades. Nothing in the theory prevents that very same economy
from abruptly shooting into the high-level equilibrium today. There is a literature that
studies how the past might weigh on the present when a multiple equilibrium model
is embedded in real time (see, e.g., Adser`a and Ray (1998) and Frankel and Pauzner
(2000)). When we have a better knowledge of such models we will be able to make more sense of some classical issues, such as the debate on balanced versus unbalanced growth.
Rosenstein-Rodan argued that a “big push” — a large, balanced infusion of funds —
is ideal for catapulting an economy away from a low-level equilibrium trap. Hirschman
argued, in contrast, that certain “leading sectors” should be given all the attention, the
resulting imbalance in the economy provoking salubrious cycles of private investment in
the complementary sectors. To my knowledge, we still lack good theories to examine
such debates in a satisfactory way.
- II. Aspirations, Mindsets and Development
The aspirations of a society are conditioned by its circumstances and history, but they
also determine its future. There is scope, then, for a self-sustaining failure of aspirations
and economic outcomes, just as there is for ever-progressive growth in them (Appadurai (2004), Ray (2006)).
Typically, the aspirations of an individual are generated and conditioned by the experiences of others in her “cognitive neighborhood”. There may be several reasons for this: the use of role models, the importance of relative income, the transmission of information, or peer-determined setting of internal standards and goals. Such conditioning will affect numerous important socio-economic outcomes: the rate of savings, the decision to migrate, fertility choices, technology adoption, the adherence to norms, the choice of ethnic or religious identity, the work ethic, or the strength of mutual insurance motives.
As an illustration, consider the notion of an aspirations gap. In a relatively narrow
economic context (though there is no need to restrict oneself to this) such a gap is
simply the difference between the standard of living that’s aspired to and the standard
of living that one already has. The former isn’t exogenous; it will depend on the ambient
standards of living among peers or near-peers, or perhaps other communities.
The aspirations gap may be filled — or neglected — by deliberate action. Investments
in education, health, or income-generating activities are obvious examples. Does history, via the creation of aspirations gaps, harden existing inequalities and generate poverty traps? Or does the existence of a gap spur individuals on ever harder to narrow the distance? As I have argued in Ray (1998) and Ray (2006), the effect could go either way. A small gap may encourage investments, a large gap stifle it.
This leads not only to history-dependence, but also a potential theory of the connections
between income inequality and the rate of growth.
These remarks are related to Duflo’s (2006) more general (but less structured) hypothesis that “being poor almost certainly affects the way people think and decide”. This “mindset effect” can manifest itself in many ways (an aspirations gap being just one of them), and can lead to poverty traps. For instance, Duflo and Udry (2004) find that certain within-family insurance opportunities seem to be inexplicably foregone. In broadly similar vein, Udry (1996) finds that men and women in the same household farm land in a way that is not Pareto-efficient (gains in efficiency are to be had by simply realocating inputs to the women’s plots). These observations suggest a theory of the poor household in which different sources of income are treated differently by members of the household, perhaps in the fear that this will affect threat points in some intrahousehold bargaining game. This in itself is perhaps not unusual, but the evidence suggests that poverty itself heightens the salience of such a framework.
- III. Markets and History-Dependence
I now move on to other pathways for history-dependence, beginning with the central role of inequality. According to this view, historic inequalities persist (or widen) because each individual entity — dynasty, region, country — is swept along in a self-perpetuating path of occupational choice, income, consumption, and accumulation. The relatively poor may be limited in their ability to invest productively, both in themselves and in their children.
Such investments might include both physical projects such as starting a business, or
“human projects” such as nutrition, health and education. Or the poor may have ideas
that they cannot profitably implement, because implementation requires startup funds
that they do not have. Yet, faced with a different level of initial inequality, or jolted
by a one-time redistribution, the very same economy may perform very differently. Now
investment opportunities are available widely through the population, and a new outcome emerges with not just lower inequality, but higher aggregate income. These are different steady states, and they could well be driven by distant histories (see, e.g., Dasgupta and Ray (1986), Banerjee and Newman (1993), Galor and Zeira (1993), Ljungqvist (1993), Ray and Streufert (1993), Piketty (1997) or Matsuyama (2000)).
The intelligent layperson would be unimpressed by the originality of this argument. That
the past systematically preys on the present is hardly rocket science. Yet theories based on convergence would rule such obvious arguments out. Under convergence, the very fact that the poor have limited capital relative to labor allows them to grow faster and (ultimately) to catch up. Economists are so used to the convergence mechanism that they sometimes do not appreciate just how unintuitive it is.
That said, it is time now to cross-examine our intelligent layperson. For instance, if all
individuals have access to a well-functioning capital market, they should be able to makean efficient economic choice with no heed to their starting position, and the shadows cast by past inequalities must disappear (or at least dramatically shrink). For past wealth to alter current investments, imperfections in capital or insurance markets must play a central role.
At the same time, such imperfections aren’t sufficient: the concavity of investment returns would still guarantee convergence. A first response is that such “production functions” are simply not concave. A variety of investment activities have substantial fixed costs: business startups, nutritional or health investments, educational choices, migration decisions, crop adoptions. Indeed, it is hard to see how the presence of such nonconvexities could not be salient for the ultrapoor. Coupled with missing capital markets, it is easy to see that steady state traps, in which poverty breeds poverty, are a natural outcome (se, e.g., Majumdar and Mitra (1982), Galor and Zeira (1993)). Surveys of the econonomic conditions of the poor (Banerjee and Duflo (2007), Fields (1980)) are
eminently consistent with this point of view.
A related source of nonconvexity arises from limited liability. A highly indebted economic
agent may have little incentive to invest. Similarly, poor agents may enter into contracts
with explicit or implicit lower bounds on liability. These bounds can create poverty traps
(Mookherjee and Ray (2002a)).
Investment activities that go past these minimal thresholds are potentially open to “convexification”. There are various stopping points for human capital acquisition, and a
household can hold financial assets which are, in the end, scaled-down claims on other
businesses. Under this point of view, dynasties that make it past the ultrapoor thresholds will exhibit ergodic behavior (as in Loury (1981) and Becker and Tomes (1986)) and so the prediction is roughly that of a two-class society: the ultrapoor caught in a poverty trap and the remainder enjoying the benefits of convergence. History would matter in determining the steady-state proportions of the ultrapoor.
But this sort of analysis ignores the endogenous nonconvexities brought about by the
price system. For instance, even if there are many different education levels, the wage
payoff to such level will generally be determined by the market. There is good reason
to argue (see, e.g., Ljungqvist (1993), Freeman (1996) and Mookherjee and Ray (2002b, 2003)) that the price system will sort individuals into different occupational choices, and that there will be persistent inequality across dynasties located at each of these occupational slots. Thus an augmented theory of history dependence might predict a particular proportion of the ultrapoor trapped by physical nonconvexities (low nutrition, ill-health, debt, lack of access to primary education), as well as a persistently unequal dispersion of dynasties across different occupational choices, induced by the pecuniary externalities of relative prices.
Note that it is precisely the high-inequality, high-poverty steady states that are correlated with low average incomes for society as a whole, and it is certainly possible to build a view of underdevelopment from this basic premise. The argument can be bolstered by consideration of economy-wide externalities; for instance, in physical and human capital (Romer (1986), Lucas (1988), Azariadis and Drazen (1990)).
IV. History, Aggregates and the Interactive World
Theories such as these might yield a useful model for the interactive world economy.
Take, for instance, the notion of aspirations. Just as domestic aspirations drive the
dynamics of accumulation within countries, there is a role, too, for national aspirations,
driven by inter-country disparities in consumption and wealth, and its effect on the
international distribution of income. Even the simplest growth framework that exhibits
the usual features of convexity in its technology and budget constraints could give rise
in the end to a world distribution that is bipolar. Countries in the middle of that
distribution would tend to accumulate faster, be more dynamic and take more risks as
they see the possibility of full catch-up within a generation or less. One might expect
the greatest degree of “country mobility” in this range. In contrast, societies that are
far away from the economic frontier may see economic growth as too limited and too
long-term an instrument, leading to a failure, as it were, of “international aspirations”.
Groups within these societies may well resort to other methods of potential economic
8gain, such as rent-seeking or conflict. (The aggregate impact of such activities would
reinforce the slide, of course.)
Of course, an entirely mechanical transplantation of the aspirations model to an international context isn’t a good idea. Countries are not individual units: a more complete theory must take into account the aspirations of various groups in the different countries, and the domestic and international components that drive such aspirations.
Next, consider the role of markets. Once again, tentatively view each country as a single economic agent in the framework of Section III. Now the nonconvexities to be considered are at the level of the country as a whole — Young’s increasing returns on a grand scale, or economy-wide externalites as in Lucas-Azariadis-Drazen. This reinterpretation is fairly standard, but less obviously, the occupational choice story bears reinterpretation as well. To see this, note that the pattern of production and trade in the world economy will be driven by patterns of comparative advantage across countries. But in a dynamic framework, barring nonreproducible reources such as land or mineral endowments, every endowment is potentially accumulable, so that comparative advantage becomes endogenous.
Thus we may view countries as settling into subsets of occupational slots (broadly
conceived), producing an incomplete range of goods and services relative to the world
list, and engaging in trade.
For instance, suppose that country-level infrastructure is suitable for either high-tech
or low-tech production, but not both. If both high-tech and low-tech are important in
world production and consumption, then some country has to focus on low-tech and
another on high-tech. Initial history will constrain such choices, if for no reason than the
fact that existing infrastructure (and national wealth) determines the selection of future
infrastructure. This is not to say that no country can break free of those shackles. For
instance, as the whole world climbs up the income scale, natural nonhomotheticities in
demand will push composition more and more in favor of high-quality goods. As this
happens, more and more countries will be able to make the transition. But on the whole,
if national infrastructure is more or less conducive to some (but not the full) range of
goods, the nonconvergence model that we discussed for the domestic economy must apply to the world economy as well.
This raises an obvious question. What is so specific about “national infrastructure”?
Why is it not possible for the world to ultimately rearrange itself so that every country
produces the same or similar mix of goods, thus guaranteeing convergence? Do current
national advantages somehow manifest themselves in future advantages as well, thus
ensuring that the world economy settles into a permanent state of global inequality?
Might economic underdevelopment across countries, at least in this relative sense, always stay with us?
To properly address such questions we have to drop the tentative assumption that each
country can be viewed as an individual unit. In a more general setting, there are individuals within countries, and then there is cross-country interaction. The former are
subject to the forces of occupational structure (and possible fixed costs), as discussed in Section III. The latter are subject to the specificities, if any, of “national infrastructure”,
determining whether countries as a whole have to specialize, at least to some degree. The relative importance of within-country versus cross-country inequalities will rest, in large part, on considerations such as these.
I haven’t brought in international political economy so far (though see below). Yet, as
frameworks go, this is not a bad one to start thinking about the effects of globalization.
It is certainly preferable to a view of the world as a set of disconnected, autarkic growth
V. Institutions and History
In many developing countries, the early institutions of colonial rule were directly set up
for the purposes of surplus extraction. There would be variation, of course, depending
on whether the areas were sparsely or densely populated to begin with, or whether
there was large-scale availability of mineral deposits. Resource deposits certainly favored large-scale extractive industry (as in parts of South America), while soil and weather conditions might encourage plantation agriculture, often with the use of slave labor (as in the Caribbean). On the other hand, a high preexisting population density would favor extraction of a different hue: the setting-up of institutional systems to acquire rents (the British colonial approach in large parts of India).
It has been argued, perhaps most eloquently by Sokoloff and Engerman (2000), that initial institutional modes of production and extraction in distant history had far-reaching
effects on subsequent development. In their words, scholars “have begun to explore the
possibility that initial conditions, or factor endowments broadly conceived, could have
had profound and enduring impacts on long-run paths of institutional and economic development
. . . ”. Such inequalities may then be inimical to development in a variety of
ways (such as the market based pathways discussed earlier). In contrast, where initial
settlements did not go hand in hand with systems of tribute, land grants, or large-scale
extractive industries (as in several regions of North America), one might expect comparative equality and a subsequent path of development that is more broad-based.
This is consistent with the market-based processes considered earlier. But a principal
strand of the Sokoloff-Engerman argument, as also the lines of reasoning pursued in
Robinson (1998), Acemoglu, Johnson and Robinson (2001, 2002) and Acemoglu (2006), emphasizes political economy. In the words of Sokoloff and Engerman (2000), “initial conditions had lingering effects . . . because government policies and other institutions tended to reproduce them. Specifically, in those societies that began with extreme inequality, elites were better able to establish a legal framework that insured them disproportionate shares of political power, and to use that greater influence to establish rules, laws, and other government policies that advantaged members of the elite relative to nonmembers contributing to persistence over time of the high degree of inequality
. . . In societies that began with greater equality or homogeneity among the population,
however, efforts by elites to institutionalize an unequal distribution of political power
were relatively unsuccessful . . . ”
The elite —erswhile collectors of tribute, land-grant recipients, plantation owners and
the like — may survive long after the initial institutions that spawned them are gone.
Such survival may nevertheless be quite compatible with the maximization of aggregate
surplus provided that the elite are the most efficient of the economic citizenry in the
generations to come. But of course, there is absolutely no reason why this should be the case. A new generation of enterpreneurs, economic and political, may be waiting to take over in the wings. It is an open question as to what will happen next, but often, the elite may well engage in policy that has its goal not economic efficiency but the crippling of political opposition. Some evidence of this reluctance to let go may be seen in literature that argues that more unequal societies redistribute less (see Perotti (1994, 1996), and the survey by B´enabou (1996)).
There are other routes. The elite may be unable to avoid an oppositional showdown.
A theory of bad policy may then have to be replaced by model of social unrest and
conflict generated by initial inequality. While this mechanism is clearly different, the end
result is the same. The channeling of resources to ongoing conflict will surely inhibit the
accumulation of productive resources (Benhabib and Rustichini (1996), Gonz´alez (2007)).
There may also be effects running through legal systems (see, e.g., La Porta, Lopez-de-
Silanes, Shleifer and Vishny, (1997, 1998)) or the varying nature of different colonial
systems (see, e.g., Bertocchi and Canova (2002)). There may be effects running through the insecurity of property rights of fear of elite expropriation (see, e.g., Binswanger, Deininger and Feder (1995)).
We do not yet have a systematic exploration of these mechanisms, nor an accounting
of their relative importance. But there is some reduced-form evidence that historical
institutions do affect growth in the manner described by Sokoloff and Engerman. The
problem in establishing an empirical assertion of this sort is fairly obvious: good institutions and good economic outcomes may simply be correlated via variables we fail to observe or measure, or any observed causality may simply run from outcomes to institutions.
Acemoglu, Johnson, and Robinson (2001) propose a novel instrument for (bad)
institutions: the mortality rate among European settlers (bishops, sailors and soldiers to
be exact). This is a clever idea that exploits the following theory: only areas that could
be settled by the Europeans developed egalitarian, broadbased institutions. In the other
areas, the same Europeans settled for slavery, dictatorship, highly unequal land grants
and unbridled extraction instead. (The implied instrument is more convincing when the
analysis is combined with controls for the general disease environment, which could have a direct effect on performance)
The Acemoglu-Johnson-Robinson results, which show that early institutions have an
effect on current performance, are provocative and interesting. It bears reiteration,
though, that IV estimates are suggestive of an institutional impact on development, but
one just cannot be sure of what the mechanism is. By relinquishing more immediate
institutional effects on the grounds of, say, endogeneity, it becomes that much harder to
figure out the structural pathways of influence. This appears to be an endemic problem
with large, sweeping cross-country studies that attempt to detect an institutional effect.
Good instruments are hard to find, and when they exist, their effect could be the echo
of one or more of a diversity of underlying mechanisms.
Iyer (2004) and Banerjee and Iyer (2005) consider a somewhat different channel of influence. Both these paper study the differential impact of colonial rule within a single
country, India. Iyer studies British annexations of parts of India, and the effect today
on public goods provision across annexed and non-annexed parts. There is obvious endogeneity in the areas chosen for annexation (a similar observation applies, in passing, to countries “selected” for colonization). Iyer instruments annexation by exploiting the so-called Doctrine of Lapse, under which the British annexed states in which a native ruler died without a biological heir. Banerjee and Iyer study the effect of variations in the land revenue systems set up by the British, starting from the latter half of the eighteenth century. In particular, they distinguish between landlord-based institutions, in which large landlords were used to siphon surplus to the British, and other areas based on rent payments, either directly from the cultivator or via village bodies. While these institutions of extraction no longer exist (India has no agricultural income tax), the authors argue that divided, unequal areas in the past cannot come together for collective action. Dispossessed groups are more worried about insecurity of tenure and fear of expropriation than about the absence of public goods, investment (public or private) or development expenditure.
VI. Institutions and the Interactive World
In Section IV , we applied market-based theories of occupational choice and persistent
inequality to the interactive world economy, (tentatively) treating each country as an
economic agent. Recall the main assumption for such an interpretation to be sensible:
that countries must face infrastructural constraints that limit full diversification. With
these constraints in place, there will be persistent inequality in the world income distribution, with countries in “occupational niches” that correspond to their infrastructural choices.
Bring to this story the role of institutional origins. Then a particular institutional history
may be more suited to particular subsets of occupations, driving the country in question
into a determinate slot in the world economy. From that point on, the persistent
cross-country inequalities generated by the market-based theory will continue to link
past institutions to subsequent growth. In short, initial institutional differences may be
correlated with subsequent performance, but the the magnitude of that under- or overperformance is not to be entirely traced to initial history. Distant history could simply
have served as a marker for some countries to supply a particular range of occupations,
goods and services. Today’s inequality may well be driven, not by that far-away history
but simply by the world equilibrium path that follows on those initial conditions. If all
goods are needed, there must be banana producers, sugar manufactureres, coffee growers, and high-tech enclaves, but there cannot be too little or too many of any of them.
The “inefficient political power” argument used in Section V can also be transplanted
to international interactions. It may well be that a large part of such interactions —
protection of international property rights, restrictions on technology transfer, or barriers
to trade — is used to deter the entry of developing countries onto a level playing field in
which they can successfully compete with their compatriots in developed countries. It
would certainly be naive to disregard this point of view altogether.
Looked at this way this way, our view of history fits in well with the entire debate on
globalization. One might view one side of this debate as emphasizing the convergence
attributes of globalization: outsourcing, the establishment of international production
standards, technology transfer, political accountability, responsible macroeconomic policies may all be invoked as footsoldiers in the service of convergence.
On the other side of the battlelines are equally formidable opponents. A skewed playing
field can only keep tipping, so goes the argument. The protection of intellectual property
is just a way of maintaining or widening existing gaps in knowledge. Technology transfers are inappropriate because the input mix isn’t right. Nonconvexities and increasing returns are endemic.
My goal here isn’t to take sides on this debate (though like everyone, I do have an opinion) but to clarify it from a “nonconvergence perspective” that has so far received more attention within the closed economy. There is a strong parallel between globalization (and those contented or discontented with it, to borrow a phrase from Joseph Stiglitz (2002)) and the questions of convergence and divergence in closed economies.