Economic history from below the tropics.

Croatia vs Denmark, Round of 16, 1 July

July 1, 2018 by Tom Westland

What kind of rich people do poor countries need? 1 The wrong kind of rich person, after all, can be incredibly bad for growth. Money buys power, and power is, if not exactly zero-sum, at least usually highly restricted in supply. If elites spend most of their wealth in preventing other people from gaining power at their expense, then they can seriously hold back broad-based economic growth. For example, they might discourage the poor from getting an education, as Jörg Baten has demonstrated with a series of coauthors. Or they might use their political power to impose taxes on the poor that prevent them from accumulating wealth.

Galor, Moav and Vollrath argue that the difference is in what the rich own. Industrialists want a reasonably educated workforce, because educated labor is complementary to capital. Since there is no such complementarity with land, people who own a lot of land have no such incentive to encourage education; indeed, they have a strong incentive to discourage it, since education increases the marginal product in industry and not in agriculture, and so raises the industrial wage relative to the agricultural wage, and hence farmworkes to migrate to the city in search of a better wage. Of course, it’s always possible that the landholding elite might diversify into industry, as Warren Dean argues was the case for the São Paulo coffee barons; and indeed, Austin has suggested—in an argument reminiscent of those traditionally if not universally about France—that the relatively egalitarian distribution of land among African farmers precluded the rise of an industrialist class from successful agricultural entrepreneurs.

Of course, the assumption—which is not necessarily a good one—is that industrialisation is the only way to get rich. Denmark offers a partial example of a growing economy in which the leading sector was not textiles or other light manufactures, but rather milk and butter. Lampe and Sharp, the two most industrious historians of the Danish dairy sector, have documented from incredibly rich 2 microdata the sources of the increase in productivity in Danish milk and butter production, focusing primarily on changes in the use of cows (a capital good par excellence, I know Emi would agree) across the yearly cycle as well as the adoption of new techniques by well-educated and open minded farmers. It is usually remarked of this economic process that it was characterised by the widespread existence of cooperatives, which financed the establishment of creameries to make butter. The creameries would have been uneconomical if limited to just one herd (herd sizes being relatively small in 19th century Denmark). Any one entrepreneur setting up a creamery on her own would also find herself at the mercy of her milk suppliers: there was, in other words, a potential hold-up problem. Setting up cooperatives to help farmers collectively finance creameries was one way of obviating this problem.

However, as Lamp and Sharp and two coauthors have recently documented, the establishment of cooperatives was not a simple matter of institutions emerging endogenously when they become necessary. Instead, they show that cooperatives were more likely to form in areas of Denmark that had been exposed to a new kind of productive system in the eighteenth and early nineteenth century, the ‘Holstein’ system, which combined much more extensive crop rotation than the traditional three-field system, and with larger herds of cattle. This system was adopted mostly by large landholders. The authors of the paper argue that these landholders were ‘knowledge elites’, open to new ideas and techniques. These ideas trickled down over a century to smallholders, who would adopt them with the requisite institutional modifications. Here, then, we have the example of a benevolent elite that, possessing superior resources with which to innovate, could act as a vector of knowledge diffusion, but which didn’t have the power or incentive to prevent peasant farmers from adopting new techniques.

Croatia is about half as rich as Denmark (per capita GDP around $25,000 PPP-adjusted). But Croatia, or at least one very small part of it, used to be much richer: what is now Dubrovnik, and what was then (usually) called Ragusa, was once a little Mediterranean Singapore. In contrast to Denmark, Ragusa was a small trading port and a city-state, and its elite was a trading elite. What kind of elite would one want in a trading port? In an age where long-distance trade was dangerous and uncertain, anyone who controlled a vital route could extract rents. And since long-distance trade in those days required paying substantial fixed costs to establish trading networks, to gain information about foreign markets and so on. In the spirit of Rodrik and Hausmann’s arguments about the market failure of entrepreneurship in developing countries, if the kind of information generated by first-entrants was non-excludable, then you could suppose that some kind of limited competition-restricting regulations in a trading centre might be welfare-improving.

However, barriers to entry in merchant activities have not traditionally been seen as welfare-improving. In Venice, the Serrata del Maggior Consiglio of 1297 closed off membership in the Venetian Grand Council to even the most enterprising members of the lower order. Not only did this mean that the latter were excluded from political power; it allowed the Venetian nobles to pass laws that excluded poorer residents of the city from engaging in highly profitable international trade, an act which Trefler and Puga argue was part of “Venice’s fundamental shift after 1297 from a society characterized by political, economic, and social mobility and toward one of political immobility, economic polarization, and social stratification”. In contrast, in Ragusa, which also had its version of the Serrata, political closure was not accompanied by commercial closure, and the possibility of participating in long-distance trade was kept open to the lower orders. The kind of econometric work done by Trefler and Puga in the case of Venice has yet to be performed for Ragusa. However, as Havrylyshyn and Srzentić argue in their new book on the economy of Ragusa, the Serrata-led institutional decline story for Venice is hard to swallow, given the centuries-long gap between the closing of the political system and decline of the Venetian trading supremacy. It also doesn’t explain why Ragusa’s golden centuries ended more or less at the same time as Venice’s did. Havrylyshyn and Srzentić argue that the missing variable is the discovery of the sea route to the East Indies round the Cape of Good Hope. The value of Ragusa’s endowment—its location—was considerably diminished, and without any obvious options for economic diversification, the city declined.

What this suggests to me is that the value of institutions over endowments has been somewhat overplayed in the recent economic literature. To be sure, ‘institutions’ (in this instance, the characteristics of political elite) can be more or less appropriate to a particular endowment of the factors of production (broadly conceived), and to the historical circumstances. If Britain had not specialised in manufactures in the nineteenth century—and hence begun to import butter from Denmark—then the demand for a butter export industry may not have been sufficient for Denmark’s excellent institutions to matter all that much, nor Ragusa’s if it had happened to have been founded in the middle of the Kalahari rather than on the crossroads of medieval trade with the East. This is why I’m a sceptic that Rwanda’s attempt to become the Singapore of Africa will go very far (even if Rwanda develops, it will not look all that much like Singapore); and, speaking of elites, Paul Kagame’s increasingly creepy imitation of Lee Kuan Yew may simply turn out to be a cargo cult development strategy. And of course, one can doubt the fealty to the model: one wonders if Lee, or for that matter the apparently fiscally prudent nobles of Ragusa, would have blown £30 million on an Arsenal sponsorship.

  1. I confess that I’m someone who doesn’t much like rich people, purely from an aesthetic point of view. It certainly has nothing to do with the fact that I’ve just begun a period of severely depressed income to complete a PhD, a fact which has provoked absolutely no fits of jealousy. [return]
  2. Though presumably not creamy. [return]

Tom Westland and Emiliano Travieso are PhD students in economic history at the University of Cambridge.