You could argue that the original question of economics is why some countries are rich, and others are poor. After all, it was the topic of Adam Smith's 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations. After 250 years of study, we must have a pretty good idea of the answer. And yet, as Dietrich Vollrath outlined in this article in Asterisk last month, we really don't. Vollrath (who blogs at growthecon.com) does a great job of summarising what we know and, importantly, what we don't know. The latter is, unfortunately, still a lot.
The causes of economic growth and development remain a bit of a mystery. Factors of production obviously matter, but why some countries have rapidly increased their factors of production and others have not is unclear. Institutions also seem to matter. I recommend that you read the whole article, as it gives a very clear sense of the state of knowledge. In terms of institutions though, this bit on democracy seems the most important in terms of what we know with some certainty:
A good example is from Acemoglu and Robinson along with coauthors Suresh Naidu and Pascual Restrepo... They show that the transition to democracy leads to higher economic growth in the future, finding GDP per capita is around 20% higher in a democracy compared to an otherwise identical nondemocracy. What they see is that countries that democratize invest significantly more in public health and education, consistent with the initial work that Mankiw, Romer and Weil and Alwyn Young did on economic growth.
They explicitly take on all of the empirical issues I complained about above. They do not try to quantify “democracy” along some arbitrary scale (e.g., North Korea is a one, the U.S. is a seven, etc.). They instead focus on a simple comparison of places that clearly democratized versus those that did not. They use several methods to try to assure themselves, and us, that their results are coming from the causal effect of democracy on growth, and not the other way around. This includes a sort of natural experiment where democratization is more likely to occur when more neighboring countries are democracies.
Some counterexamples may immediately come to mind. South Korea, whose economy took off in the ’60s, did not democratize until 1988, and China has undergone impressive economic growth without democratizing at all. But once Acemoglu, Naidu, Restrepo and Robinson make the comparison across all countries, it turns out that their experiences are something of an outlier, not the norm.
The research by Acemoglu et al. that Vollrath refers to is here (with ungated earlier version here). Development economics was where I started my journey as an economist. There has been a large-scale shift from 'macro' development towards 'micro' development in recent years. That may help to explain why we don't have answers to the macro questions of development (and is related to critiques that Lant Pritchett has made of randomised control trials in development - for example, see here). Perhaps economics needs to go back to its roots, and study the question that occupied Adam Smith nearly 250 years ago.
[HT: Ranil Dissanayake]
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