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Economic Development and Growth:
The most basic challenge for economics is to understand the
nature and causes of economic progress. But what exactly is to be
explained? What are the facts? One very striking fact is historical—
the rapid acceleration in the rate of economic progress since the
early 1800s. Another is geographical—the huge differences in levels
of economic progress in different parts of the world today. The ques-
tions virtually ask themselves. Why did economic progress acceler-
ate? Why is it not universal? On the whole, these two questions have
been addressed by two different specialized fields within economics.
Economic history has addressed the question of change over time,
and development economics has addressed the question of contem-
porary differences across countries.
The theory that until recently guided work in both fields—the
Ricardian theory—measures economic progress in terms of the
quantity of output produced by the economy. It sees the economy as
a kind of machine that transforms inputs (labor, natural resources,
capital) into output: the amount of inputs and the technology of the
machine determine the quantity of output. If output increases more
rapidly, it is either because of larger amounts of inputs or because of
better technology. If output is low in some countries, it is because
inputs or technology are lacking. Since Solow (1957) showed that
increases in physical inputs explain only a small part of observed
Cato Journal, Vol. 29, No. 2 (Spring/Summer 2009). Copyright © Cato Institute. All
Meir Kohn is Professor of Economics at Dartmouth College.
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changes or differences in output, Ricardian theory has focused pri-
marily on the nonphysical in explaining growth—on technological
change and on increases in human capital in the form of skills and
knowledge ( Lucas 2002, Galor 2005).
The Deficiencies of the Ricardian Theory
The Ricardian theory of growth has been found wanting both by
economic historians and by development economists. The problem
for economic historians is that the Ricardian theory offers no expla-
nation for why the accumulation of human capital and technological
progress accelerated in the West in the early 1820s. There have been
attempts at purely Ricardian explanations: Pomeranz (2000) has sug-
gested that it was the discovery of new resources in the Americas and
in England’s coalfields that did the trick; Clark (2007a), that human
evolution in England came to favor human capital accumulation and
technological progress. However, both of these explanations have
been challenged on the facts, and neither has achieved wide accept-
ance (Broadberry 2007, Broadberry and Gupta 2006).
The problem for development economics, a more practical field,
is that the Ricardian theory has proven itself to be a treacherous
guide to policy. For decades after World War II, development econ-
omists advocated a series of dirigiste policies for the less developed
countries (LDCs) aimed at making up perceived deficiencies in
resources and technology: physical capital, technology, and human
capital all had their day. The results, to put it mildly, were disappoint-
ing: Lal (2000) and Easterly (2001, 2006) have documented the sorry
The failings of the Ricardian theory have caused economists to
look further afield for explanations of growth and development. In
particular, many have come to challenge a fundamental assumption
of the Ricardian theory—that an economy’s potential, defined by its
resources and technology, is fully realized. To development econo-
mists in particular this assumption has seemed increasingly far-
fetched: surely, the problem of the LDC economies is not a lack of
potential but an inability to achieve that potential (see de Soto 2000,
Parente and Prescott 2000, and Guest 2004). The obstacle to their
development is not a lack of resources or technology, but a failure to
exploit the resources and technology available. In development eco-
nomics and in economic history, attention has therefore shifted to
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Economic Development and Growth
how and to what degree economies succeed in realizing their poten-
tial. Grantham (1999) has labeled this approach—more in the spirit
of Adam Smith than of David Ricardo—Smithian.
A Role for Institutions
With this shift of perspective and understanding has come a
change in focus from the process of production to the economic
environment in which that process takes place. Rather than looking
only at resources and technology, economists have started to take an
interest in institutions—in the social and political structures that
facilitate, or impede, productive economic activity. In particular, eco-
nomic development and political development are increasingly seen
as being closely related. This revival of interest in institutions was
pioneered by economic historians—particularly North and Thomas
(1970) and Jones (1988). But many others have made important con-
tributions—economists such as Buchanan and Tullock (1965) and
Olson (1982), and historians such as McNeill (1982) and Macfarlane
(2002). Development economists, too, have begun to take an intense
interest in economic and political institutions (see Shirley 2005).
In the study of institutions and their role in economic progress
there are two fundamental questions: How do different institutional
arrangements affect economic development and growth? And how
and why do “good” institutions arise? In addressing these questions,
economists have largely relied on the two principal methods of mod-
ern economics—econometrics (statistical analysis) and mathematical
The Macro-Econometric Approach to Institutions
Development economics has largely taken the econometric route.
Work in this area has analyzed country-level data on GDP and vari-
ous measures of legal, financial, and political institutions in an
attempt to uncover which institutions are associated with more rapid
economic growth. Some important contributors to this literature
include Levine, Shleifer, Glaeser, and Acemoglu and their various
collaborators (for two surveys of this literature see Levine 1997 and
Shleifer et al. 2003). This work has been suggestive and has offered
some valuable insights, but it does suffer from some serious limita-
tions. As with all statistical work, a fundamental problem is establish-
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ing causality. While it is easy to show that certain institutions are asso-
ciated with economic growth, it is not at all easy to show that growth
is a result of good institutions rather than vice versa (Glaeser, et al.
(2004)). In addition, the quality of the data limits what can be
learned: there is only so much information in aggregate data at the
level of entire countries. Moreover, institutions do not lend them-
selves to quantification, so that the numerical measures used are
There is, however, a deeper problem with this literature: it does
not, and indeed cannot, shed any light on how different institutions
affect economic growth (as opposed to whether they do) or, con-
versely, on how growth might affect the evolution of institutions. The
work is essentially atheoretical: it is not based on any theory of how
institutions and economies function or of how they interact with one
another. Indeed, such a theoretical understanding would be point-
less, since data at this level of aggregation cannot get at the underly-
ing processes: these are micro issues and they cannot be addressed
with macro data.
The Micro-Theoretical Approach to Institutions
While development economics has taken a macro and economet-
ric approach to institutions, economic history has largely taken a
micro and theoretical one. In this it is part of a wider movement,
known as the new institutional economics (NIE) that has grown out
of the rediscovery of institutions (see Ménard and Shirley 2005). The
modifier “new” distinguishes this movement from the school of insti-
tutional economics that predated the mathematical and statistical
revolutions in economics (see Samuels 1987). While the old institu-
tional economics largely abjured and even rejected formal theoreti-
cal analysis, the new institutional economics embraces it.
Practitioners of NIE, therefore, attempt to explain the existence and
function of economic and political institutions in terms of rational
behavior, sometimes with the aid of mathematical models. Two
recent and very fruitful applications of this approach to economic his-
tory are of particular interest.
A recent book by Greif (2006) brings together much of his semi-
nal work on medieval institutions. Greif calls his approach the “ana-
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Economic Development and Growth
It involves a detailed study of a particular historical
institution—informal order among Maghribi traders in medieval
Egypt, for example, or the political arrangements of the Genoese
republic—together with a game-theoretical analysis of the case in
question. Greif’s work provides valuable insight into the microeco-
nomics of the institutions he examines and, by extension, of institu-
tions in general. The method of the analytical narrative does not,
however, permit him to address directly our two fundamental ques-
tions—how institutions affect economic outcomes and how good
Another recent book, by North, Wallis, and Weingast (2009)
(NWW), does address these questions. It is broader in its scope and
more ambitious in its aims—offering no less than an institutional
explanation of the entire evolution of human history. Its analysis is
“macro” rather than micro, and it does not employ explicit mathe-
matical modeling. The authors argue that economic and political
organization are not only interdependent but, more than this, they
are two parts of an organic organizational whole that addresses a sin-
gle fundamental problem—how to coordinate the activity of large
numbers of people. The incentive for achieving such coordination is
that it delivers far greater productivity. The role of political organiza-
tion is to provide the conditions under which economic organization
is possible. More specifically, the role of political organization is to
prevent or to contain violence—the primary obstacle to productive
economic organization. The principal vehicle of political organization
is the state, and the evolution of the state is therefore at the center of
economic and political development. This work represents a major
step forward in our understanding of institutional development.
However, it falls short of its very ambitious goal, because of two fun-
damental weaknesses that it shares with much of the NIE program.
The model of human behavior on which NIE rests is the model of
the atomistic rational individual. In a recent critique, Field (2007)
reviews evidence from psychology, anthropology, and behavioral eco-
nomics that refutes this model (see also Baumeister 2005). He argues
that humans have evolved as social and cultural beings with an innate
tendency to cooperate with one another—for example, to demon-
For other examples of this approach, see Bates et al. (1998).
See the review of Greif’s book by Clark (2007b).
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strate reciprocity and to exhibit moral outrage at “cheaters.” This
more realistic model of human nature undermines NWW’s rather
Hobbesian understanding of the essential role of the state in restrain-
ing a violent and selfish human nature. Humans, having evolved to
be naturally cooperative, are often able to create a viable social order
without a coercive state having to impose it on them.
also casts doubt on the usefulness of the “analytical” part of the
method of analytical narrative as a way of understanding institutions
(it does not, however, detract from the value of the narrative part).
More generally, the “rational” model of human behavior is a gross
simplification that provides a workable foundation for the Ricardian
theory of production. However, it is not an adequate foundation for
a study of economic and political institutions.
A second weakness of NWW, again characteristic of NIE in gen-
eral, is its treatment of the economy. In fact, the book has very little
to say about the economy as such. But we cannot really understand
how institutions affect the economy—or how the economy affects
institutions—without a detailed understanding of how the economy
actually works. NWW, and NIE, implicitly assume a Ricardian theo-
ry of production—a theory of resources and technology. They simply
add to this a “social technology” of institutions.
One danger of merely tacking on institutions to a Ricardian theo-
ry of the economy is that it practically invites yet another dirigiste fad
in development economics—aimed this time at making up deficien-
cies in institutions.
So where does this leave our quest to understand the nature and
causes of economic progress? We began by recognizing the failures
of the Ricardian approach both in economic history and in develop-
ment economics. We saw that there has consequently been a move-
ment in a Smithian direction—expressed particularly in recognizing
the importance of institutions. This has found expression in develop-
ment economics in a program of econometric analysis of cross-coun-
try data aimed at unraveling the connection between institutions and
growth. This work has been suggestive, but its contribution to our
See Dixit (2008) for a valuable sumarry of how they do so.
See, for example, Rodrik (2007). For a critique, see Lal (2007) and Dixit (2007).
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Economic Development and Growth
understanding has been constrained by the limitations of the data
and by a lack of theoretical foundations. It is not clear that much
more can be expected from this line of research.
Economic history has taken a more micro and theoretical
approach. The resulting work has shed considerable light on the
functioning of institutions, on which institutions matter, and to some
extent on why. However, it has paid insufficient attention to the
nature of the overall economic process within which institutions are
embedded. What is needed, therefore, is a more Smithian under-
standing of the economy—one that sees it not as a machine but as an
evolving organism (a biological rather than a mechanical analogy).
this can be done, a theory founded on the lessons of economic history
offers the greatest promise of answering the basic questions of eco-
nomic development and growth.
Bates, R. H.; Greif, A.; Levi, M.; Rosenthal, J.-L.; and Weingast, B.
R. (eds.)(1998) Analytical Narratives. Princeton, N.J.: Princeton
Baumeister, R. F. (2005) The Cultural Animal: Human Nature,
Meaning, and Social Life. New York: Oxford University Press.
Broadberry, S. (2007) “Recent Developments in the Theory of Very
Long Run Growth: A Historical Appraisal.” Department of
Economics, University of Warwick. Available at http://econpa-
Broadberry, S., and Gupta, B. (2006) “The Early Modern Great
Divergence: Wages, Prices and Economic Development in
Europe and Asia 1500–1800.” Economic History Review 59: 2–31.
Buchanan, J. M., and Tullock, G. (1965) The Calculus of Consent:
Logical Foundations of Constitutional Democracy. Ann Arbor:
University of Michigan Press.
See Kohn (2004) for a discussion of these two very different views of the economy
and for references to work that takes the second view. In the terminology of that arti-
cle, the NIE generally takes a “hybrid” approach to theory—an unhappy compro-
mise between the two views. A Smithian understanding of the economy has very
different implications—much less rosy ones—for the likely outcome of interven-
tions aimed at changing institutions.
I am currently attempting to develop just such a theory: manuscript chapters of my
book-in-progress may be downloaded from www.dartmouth.edu/~mkohn/how.html.
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Clark, G. (2007a) A Farewell to Alms: A Brief Economic History of
the World. Princeton, N.J.: Princeton University Press.
________ (2007b) “A Review of Avner Greif’s Institutions and the
Path to the Modern Economy: Lessons from Medieval Trade.”
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