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Reversal of Fortune - Geography vs. Institutions

Ever wondered why some once-wealthy regions are now among the poorest? Discover how colonial policies and institutions reshaped global wealth distribution. Explore the link between history, industrialization, and modern economies in this eye-opening study!

Frequently Asked Questions (FAQ)

  1. What is the central argument of the paper “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution”? The paper argues that institutions, not geography, are the primary determinant of long-run economic development. It challenges the geography hypothesis, which suggests that geographical factors like climate and resources drive income differences. The authors show that prosperous areas in 1500 (proxied by urbanization and population density) are now relatively poorer, while less developed areas then are relatively wealthier. They attribute this “reversal” to the types of institutions established during colonization: extractive institutions in initially prosperous areas hindered long-term growth, while more inclusive institutions conducive to investment and innovation were established in initially less developed areas, facilitating subsequent economic progress, particularly during the era of industrialization.

  2. How do the authors define and measure “institutions”? The authors focus on institutions that protect private property rights and constrain the power of elites and the executive. They primarily use quantitative indices like the “protection against expropriation risk” index (averaged over 1985-1995 from Political Risk Services) as their main measure of current institutional quality relevant for securing investment and fostering growth. They argue these indices capture the cluster of institutions essential for economic development.

  3. What evidence supports the institutions hypothesis and the “reversal of fortune”? The core evidence includes:

    • The Reversal: A statistically significant negative relationship between proxies for prosperity in 1500 (urbanization rates, population density) and current GDP per capita. Regions that were more urbanized/densely populated in 1500 are poorer today.
    • Institutions as the Driver: Using settler mortality rates as an instrument for institutional quality, they show that current institutions (measured by protection against expropriation) have a strong positive effect on current GDP per capita. Furthermore, controlling for current institutions eliminates the negative relationship between prosperity in 1500 and current income, suggesting institutions are the key intermediate variable explaining the reversal.
    • Robustness: The findings hold after controlling for various geographical factors (latitude, climate, disease environment, resources), continental effects, and legal origin.

  4. How do the authors address the potential endogeneity between institutions and income? The authors use an instrumental variables (IV) approach. They employ historical European settler mortality rates as an instrument for the institutions established during colonization. The logic is:

    • High mortality rates discouraged Europeans from settling permanently, leading them to establish “extractive” institutions focused on resource extraction with minimal protection for property rights.
    • Low mortality rates encouraged settlement, leading Europeans to establish “neo-Europes” with institutions that protected their own property rights and constrained power, similar to those in their home countries.
    • These historically determined institutions persisted and influenced current institutional quality.
    • Settler mortality is argued to affect current income only through its effect on these historical and current institutions, not directly (after controlling for current disease environment etc.), thus satisfying the requirements for a valid instrument.

  5. What role does geography play in the authors’ framework? Geography plays an indirect role, primarily by influencing the type of institutions established during colonization.

    • Initially prosperous areas (often with favorable geography for agriculture or dense populations) were more attractive for extractive strategies, leading to the imposition of extractive institutions.
    • Initially poorer, sparsely populated areas (often in temperate zones) were less suitable for extraction but more suitable for European settlement, leading to the establishment of inclusive institutions.
    • The paper argues geography does not have a strong direct effect on current income levels once the impact of institutions is accounted for. Geography matters mostly because it influenced the historical path of institutional development.

  6. What is the “geography hypothesis,” and how is it challenged in this study? The geography hypothesis posits that geographical factors (like climate, latitude, soil quality, disease burden, resource availability) are the primary direct determinants of cross-country economic development and income differences. This study challenges this hypothesis by:

    • Showing the “reversal of fortune,” which contradicts simple versions of the geography hypothesis (if geography is key, prosperous areas should remain prosperous).
    • Demonstrating that the effect of geographical variables on current income becomes insignificant once institutional quality is controlled for.
    • Arguing that geography’s main impact was indirect, influencing the choice of institutions established during colonization.

  7. How do the authors measure urbanization and population density in 1500?

    • Urbanization: Measured as the percentage of the total population living in towns with 5,000 or more inhabitants, primarily using data from Bairoch (1988), Eggimann (1999), and Chandler (1987), cross-checked with McEvedy and Jones (1978).
    • Population Density: Calculated as total population divided by arable land area. Population estimates are mainly from McEvedy and Jones (1978). The authors acknowledge data limitations for these historical periods and conduct robustness checks.

  8. What are some of the data limitations and potential criticisms of the study?

    • Data Quality: Historical data on population, urbanization, and even settler mortality are estimates and subject to measurement error. The authors perform robustness checks to mitigate this concern.
    • Instrument Validity: The key criticism often revolves around the settler mortality instrument. Critics question whether settler mortality only affects current income through institutions (the exclusion restriction). It might be correlated with other persistent factors (like the current disease environment, aspects of geography not fully captured, or cultural traits) that directly affect income. The authors attempt to control for many such factors.
    • Homogeneity of Institutions: Treating “institutions” as a single index might oversimplify complex institutional realities.
    • Mechanism: While showing correlation and using IV, precisely pinning down the exact mechanisms through which institutions affected the reversal (e.g., specific policies, investment channels) is complex.

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