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Article Summary | Tutorial 1 - Subgroup B
Reversal of Fortune:
Geography and Institutions in the Making of the Modern World Income Distribution
In this paper, the authors present two hypothesis that aim at explaining the current economic order. The first
hypothesis is the so-called geography hypothesis. It states that economic differences are due to geographic, climatic
or ecological differences across countries. However, authors argue that if this view would explain economic growth, a
persistent economic performance should be seen as geographic factors are stable over time. The alternate view which
is referred to as the institutions hypothesis states that differences in economic performance are due to the
organization of a society. Societies with good incentives and opportunities to invest should achieve the best economic
growth.
The paper’s goal is to distinguish these two broad hypothesis by using a “natural experiment”, the expansion
of European overseas empires starting at the end of the 15th century. European colonialism caused a major change in
the organization of societies and a “institutional reversal” took place in the countries they colonized. European
colonialism led to better institutional quality in previously poor areas and they introduce extractive institutions in
previously prosperous places.
This institutional reversal together with the hypothesis view suggest a possibility of a reversal among the
former European colonies. To quote the paper: “countries that were relatively rich in 1500 should be relatively poor
today.” This is because of the different institutions Europeans would set up in colonies depending on their prosperity.
The argument the authors use is the following: Europeans would set up institutions with the goal of exploiting the
natives rather than to attract European settlers, extractive institutions, in densely populated areas. Whereas they
would set up more inclusive institutions with strong protection of property rights in sparsely populated areas because
they wanted European settlers to come.
The finding of the paper is that indeed countries who were relatively rich 500 years ago are relatively poor
today. They state that there was a close association between urbanization rates and prosperity. In their data analysis
they used both population density and urbanization as proxies for economic prosperity and found a robust reversal in
relative incomes among former European colonies between 1500 and today. This reversal cannot be explained by the
simple geography hypothesis for the reason that if this view was right, there would be high of persistence in economic
output. Since the findings show exactly the opposite it can be concluded that this view comes short in explaining the
reversal.
The reversal can be explained by the institution hypothesis. The different type of institutions that were
implemented, extractive in rich areas and inclusive in sparsely populated areas, sort of laid the seeds for a reversal in
relative incomes. However, the industrial revolution really made the reversal happen because institutions with private
property were essential. These institutions would give people an incentive to invest whereas extractive institutions
did the opposite. Therefore, the institution hypothesis explains the “reversal of fortune” the best.
Article Summary | Tutorial 1 - Subgroup B
Group Members:
Irene Soriano, s3520749
Inês Cunha, s3169057
Iuliana Frunze, s2577089
Jan Ruben de Goede, s3215520
Hailun Zhou, s3188957
Jan Paul de Jong, s3165736
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