Wednesday, May 6, 2009

When Do Macroeconomic Policies Matter?

A nice natural experiment from the latest NBER bulletin:
Economists have long believed that there is a correlation between institutions and economic performance. Rich countries, they argue, have laws that provide incentives to engage in productive economic activity. Investors rely on secure property rights, facilitating investment in human and physical capital. Government power is balanced and restricted by an independent judiciary. Contracts are enforced effectively, supporting private economic transactions. Yet these institutional factors are not the only determinants of economic growth, even over horizons of several decades.

Barbados and Jamaica provide a striking counter-example to the institution-focused long-run view of income determination. In Institutions vs. Policies: a Tale of Two Islands (NBER Working Paper No. 14604), authors Peter Blair Henry and Conrad Miller remind us that both countries inherited property rights and legal institutions from their English colonial masters, yet experienced starkly different growth trajectories in the aftermath of independence. From 1960 to 2002, Barbados' GDP per capita grew roughly three times as fast as Jamaica's. Consequently, the income gap between Barbados and Jamaica is now almost five times larger than at the time of independence. Since their property rights and legal systems are virtually identical, recent theories of development cannot explain the divergence between Barbados and Jamaica. The authors show that differences in macroeconomic policy choices, not differences in institutions, account for the differing growth experiences of these
two Caribbean nations.
Here is an ungated working paper.

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