Daron Acemoglu and Melissa Dell have a paper out entitled Productivity Differences Between and Within Countries.
We document substantial within-country (cross-municipality) differences in incomes for a large number of countries in the Americas. A significant fraction of the within-country differences cannot be explained by observed human capital. We conjecture that the sources of within-country and between-country differences are related. As a first step towards a united framework, we propose a simple model incorporating both differences in technological know-how across countries and differences in productive efficiency within countries.
They note that “among eleven Latin American countries for which we have municipality level data, the between-municipality differences in individual labor income are about twice the size between-country differences,” but that when the United States is included, the ratio reverses (1). But only half of the former differential fits differences in human capital (ibid). As a result, the authors try to figure out an explanation for their residual results. Their theory is that differing institutions lead to different levels of productivity, and that institutions explain most of the residual differences. Areas with poor local institutions—more corruption, more red tape, less protection of property—will under-achieve given a certain level of physical and human capital.
I had a few arguments in the margins of my copy of the paper, but won’t include them here because they weren’t too pertinent. I will say that there were a couple of points I disagreed with concerning migration options, at least in the case of the United States, but they lay out their framework pretty well, and make a good point that institutions and human capital are both important. Over the past few decades, we’ve seen two distinct schools grow up: developmental economics and new institutional economics. The development side focuses on human capital, and the new institutional school focuses on, well, institutions. The two tend not to meet very often, and this is a mistake—to get the full picture, you have to see both sides.
For a federalist, this is an important paper. We talk about the benefits of federalism: greater scope for competition, the possibility to come up with better solutions, reduction of tension between groups (because they can differentiate themselves geographically), and so forth. But at the same time, there are also costs: institutions are valued not simply from a “general” standpoint (though do note that I’m not fond of social welfare functions and I mean “general” only in a highly-theoretical sense that we could never measure and provides only educational context), but more importantly, from the standpoint of the individuals who determine the institutions. In areas with tight local control, local bosses have more influence over the creation of institutions than we would like to give them credit for having. This means that the institutions are going to be, to some extent, shaped in the image of those local bosses. As a result, unless you have perfect mobility—something that we are still rather far from having today—there may be enough barriers to exit to prevent institutions from being selected strictly on competitive grounds. If we did have perfect mobility, people could leave and go to the places with better institutions, leading to including institutions in geographical competition. But without it, we can still end up with inferior institutions taking and keeping hold, as we can see in Latin America.