Do Institutions and Culture Matter for Long - term Development?

Why are some countries so rich while other countries are so poor?

Standard economic answers highlight the role of capital accumulation and innovativeness in shaping economic fortunes. However, these standard answers fail to explain why some countries accumulate more capital and are more innovative.

It could be that differences in institutional environment are responsible for observed differences in capital accumulation and innovativeness. Examples of such institutions include: property rights protection - which give incentive to accumulate capital minimizing risk of expropriation or patents laws which affect innovativeness.

In other worlds maybe institutions i.e. 'rules of the game' in some societies are more conducive to economic development?

While is seems evident that good institutions are conducive to growth it is also possible that richer countries can afford better institutions. How to cut this feedback loop and identify empirically the causal effect of institutions in development? The answer in the literature is to study critical junctures of history that involved exogenous shocks to institutions. 

The shock that attracted most attention in the literature was European colonization of lands in Americas, Africa, Asia and Australia. The Europeans set up incentive systems in the colonies and these institutions persisted until present and continue to shape economic fortunes. But how to establish the causal link between history and development today? The best would be to observe two parallel worlds: one in which Europeans colonized countries and an alternative in which they did not, like in a laboratory experiment. Then compare the outcomes of such experiments.

In 1815 Poland was divided between three neighboring empires: Prussia, Russia and Austro – Hungary. At the eve of the partitions Poland was a feudal society with 80% of the population being peasants. During the partition period the seeds of a new economic and social order were planted, namely the serfs were freed and peasants were granted property rights over the land. In Prussian partition the decision was dictated economically and hence bigger and more effective farms emerged freeing the rest of the rural population to move to the newly emerging industrial sector in the towns and cities. In the Russian and Austrian partitions more farmers were granted property rights and hence smaller and ineffective farms emerged preventing a larger exodus to the cities. 

There were other differences between the occupied parts: more rule of law in the Prussian partition and better educational system and administration. After the end of the experiment in 1918 when the three partitions were united, the reborn Polish state had 4 different legal systems, 3 currencies, a railways system not connecting major cities in different parts. The differences in development were also apparent as the Prussian lands stand out in the productivity of agriculture, number of telegraphs, electrification, density of the railway network etc. In 1931, the illiteracy rates in all counties were below 5% in the Prussian partition while in the Austrian up to 20% and in the Russian up to 80%. The Prussian and Austrian partitions also enjoyed better administration.

There can be many reasons why Western and Eastern parts of Poland differ in development today. In fact, regional differences were present already between 1815. However, not around the borders of interest. The Prussian - Russian partition border divided relatively homogeneous region of Greater Poland. According to census of 1808 and 1810 the urban population is comparable within 50km around the border subsequently introduced in 1815. This suggest no pre-existing differences in economic development. This is important for attributing the present differences to the 1815 - 1914 division. 

Hence, to isolate the role of the 19th century partitions I look at municipalities within 50km of the historic borders between partitions. Gross domestic product - the typical measure of development is not available at the municipal level, so I adopt other proxy of development , namely own revenues of municipality. The two major components are Personal Income Taxes (PIT) and Real Estate Taxes which together constitute around 80% of own revenues. Note that each municipality keeps a constant share (around 40%) of PIT and the rules of the real estate taxes are also set nationally.

Using data on own revenues per capita from 2002-2013 I find that crossing the border from the Russian to Prussian partition the revenues rise between 10-20% (depending on the model specification). The differences in Personal Income Taxes per capita are even larger and amount to an increase of 28%. I do not find any robust differences in prosperity on the Austrian - Russian border. Hence, the difference in economic development between former Prussian and Russian partitions today is both economically and statistically significant. What is the underlying factor of development that persisted for a century until present and continues to shape economic fortunes between regions in Poland?

There were frequent shifts in institutional environments in Poland after the end of experiment in 1914. First, the rebuilding of state in interwar period (1918-1939), then the introduction of communism after the world war II breaking introducing new economic and political institutions of central planning and totalitarianism. After 1989 the Poland reintroduced institutions of market economy and democracy. Given all these abrupt changes it is highly unlikely that 19th century institutions survived until present. Therefore cultural norms and attitudes seem to be a possible explanation of observed differences in economic development.

 In fact, the differences in electoral choices between the three partitions visible in elections on the Civic Platform (PO) and Law and Justice (PiS) could be evidence of differences in culture. The division of society on liberal- conservative axes can be very persistent and viewed as dictated by attitudes and outlook (hence culture) rather than interests driven (institutions). In fact, the division of the Polish political scene between Civic Platform (PO) and Law and Justice (PiS) can be placed on this axis. The 19th century division possibly affected the attitudes on the liberal - conservative axes which persisted until the present. Hence, the Russian and Austrian partitions vote conservative and the Prussian more liberal. The mechanism of persistence could be inter-generational transmission of values and attitudes within family.

Against the odds, one of the formal institutions has persisted until the present - namely the farm size. In the 19th century Polish Lands went through the initial phase of transformation from feudal to a capitalistic organization of the economy. However, in all three partitions those reforms were conducted with different twists. 

In the Prussian partition larger and effective farms emerged while in the Austrian and Russian partitions the aim was to give land to more people, a political decision to prevent peasants from rebelling against the rule of the Russian empire. Hence, smaller farms emerged, where economic motives to increase productivity were less pronounced. Despite major agrarian reforms in the period post - 1918, which affected many larger farms, the initial difference in sizes of the farms was preserved and persisted until today. In addition, the agriculture was not collectivized in Poland during communism, with few exceptions. Crossing the border from the Russian to the Prussian partition, the average size of the farms increases by 6 hectares, i.e. 66%. It is important to notice that during communism agriculture in Poland was not collectivized, with few exceptions, which helped to preserve the structure. 

However, rather than looking at the direct effect on development of the size of the farm, it is worth looking at the indirect effect. Namely, crossing the border from the Russian to the Prussian partition the share of households involved in agricultural activities drops from 39% to 23% within 50km from the historic border. These are very large shares given that only 5% of GDP comes from agriculture. In the Russian and Austrian partitions there seem to be incentives to stay in unproductive activities and not enough push factors to exit and urbanize. The EU transfers to rural areas might be further preventing the outflow to non-agricultural activities.

To shed more light on a possible channel of persistence I exploit the forced migration movements after World War II, where people whose ancestors lived during 19th century in Russian partition moved to lands formerly belonging to Prussia (these are dark green parts in West and North of Poland - number 2). This experiment keeps the structure of the farm land constant (keeps institutions constant) and adds variation to culture. So there is a chance to observe how within the same incentive scheme different cultures behave.

The results within 50km of the border suggest the newly inhabited municipalities are as prosperous as the ones in the rest of the Prussian partition. The new comers also adapted in terms of their political choices and favor candidates from Civic Platform. The only difference is in voter's turnouts. The new comers preserved their lower engagement in civic life and are less likely to vote then their incumbent neighbors.   

19th century partitions continue to affect economic fortunes of regions in Poland even after 100 years from the unification. The effects for incomes are large as crossing from the former Russian to Prussian partition today, the incomes rise by up to 28%. 

The channel through which history persists is related to incentives provided by agrarian reforms initiated during the 19th century. The smaller farms which emerged in the Russian and Austrian partitions provided negative incentives for urbanization and escape from agriculture to more productive activities. 

As for the cultural channel, even though culture was affected during the 19th century (as evidenced by voter turnout in national referenda) the lessons from the Stalin's forced migration experiment suggest that does not matter for economic development, at least not on its own.