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The guiding hand

Using New Institutional Economics to examine the economic growth experience of Spain and Portugal in the 15th-16th century in order to establish the importance of institutions

The guiding hand

I would like to continue from where I left off in the last article viz., use tools of New Institutional Economics (NIE) to explain why some nations succeed and why others fail. Before that a caveat. I am not an Economic Historian and have gathered my knowledge of economic history from undergraduate courses and from some well-known research work such as that of Douglas North, Niall Ferguson, Daron Acemoglu, Mancur Olson and others. In the following articles, we will look at some momentous events from the history of a few European countries to understand the importance of institutions in economic growth. In this article, we will first take a brief look at some of the research and then analyse the experience of Spain and Portugal in the 15th and 16th Century.

Importance of Institutions in Economic Growth and Development

In his path-breaking work published in 1990, Douglas North has argued that efficient institutions are a necessary condition for achieving economic growth. He looks at institutions as rules of the game which are established to reduce uncertainty and obstacles arising out of asymmetric information. These obstacles are also referred to as transaction costs which need to be overcome. In such a framework, property rights are protected, contracts are enforced and rules of the game are drawn up in such a manner that future political authorities cannot change them by whims or fancies. In other words, North modifies the basic principles of Neoclassical economics by incorporating institutions and dynamic change. We may recall that Ronald Coase had made a similar argument when he emphasised that market transaction could be understood only in conjunction with institutions.

Daron Acemoglu and James Robinson in a famous book, 'Why Nations Fail' have also underlined the importance of political and economic institutions in the economic performance of a country. Their work looks at historical evidence from the Roman Empire, the Soviet Union, Latin America, England, Europe etc., and concludes that institutions which reward innovation, protect property rights and provide equal and widespread economic opportunities to all are necessary for economic growth. For example, while South Korea has a developed economy with per capita income of almost $30,000, just across the border is North Korea which is amongst the poorest countries on the earth with a per capita income of $1200. Acemoglu and Robinson ascribed this difference to the institutions in South and North Korea. In another example, they give the example of the city of Nogales on the border of United States and Mexico. On one side of the border is Nogales in Santa Cruz Country, Arizona of the United States where the per capita income is $30,000 and good social-economic conditions prevail. On the other side of the border, is Nogales, Sonora which is a relatively prosperous part of Mexico but their per capita income is only $10,000. On the Mexico side, education levels are poorer, infant mortality rates are higher and public health outcomes are worse off.

A similar point has been made by Niall Ferguson in his book 'Empire: How Britain Made the Modern World', where he argues that it was the difference in institutions of the British Empire and the Spanish colonial masters, which explain the difference in the development experience of British colonies and Spanish colonies. Hence, British law and administration, the railways and protection of property rights were better guaranteed by the British as compared to the Spanish.

Mancur Olson in a 2001 article, 'Big Bills Left on the Sidewalk: Why Some Nations are Rich and Others Poor' has underlined the importance of institutions in explaining variations in economic development. He argues that since differences in endowments, technology and various factors of production (land, labour, capital) cannot explain the variation in economic development, it must be the quality of institutions and economic policies that are responsible. He cites the example of the different growth experience of China/Hong Kong, East/West Germany and North/South Korea.

Experience of Portugal and Spain

We know that since the 15th century, five European countries viz., Spain, Portugal, Netherlands, France and England were the main actors who established global empires at some point or the other. In the 15th and 16th century, Spain and Portugal were the leading colonial powers which were then followed by a power struggle between France, England and Dutch from the 17th century onwards.

The Portuguese Prince Henry, the Navigator and his father King John I, who founded the Avis Dynasty set the tone for the establishment of Portuguese as the dominant global power. In the 1400s, Portuguese mariners built an empire across the Atlantic Ocean by first colonising islands such as Canary, Cape Verde and the Azores off the coast of Africa and then moved on in two directions first to the eastern coast of South America viz., Brazil and the western coast of India viz., Masulipatnam. The Portuguese also captured the island of Madeira (currently owned by Cristiano Ronaldo, the famous footballer) and many countries of western Africa. It is no surprise, therefore, that some of the most daring and well-known navigators such as Vasco Da Gama (who discovered the route to India), Magellan (circumnavigated the world) and Bartholomew Diaz (sailed around Africa) were all Portuguese. The institutions that allowed Portugal to take an early lead and expand across the world through the 15th century were the following.

Taking an initial lead in the trade of African slaves, ivory and gold.

Establishing the foundations of maritime technology that would be the template for sea-farming nations for the next 200 years or so. These included:

The designing of new and bigger ships which could negotiate unknown and longer sea routes better (called 'caravel' and 'nau')

New navigation techniques.

Mapmaking Oceanography (including information on winds, currents)

Domination of spice trade with the East Indies.

Pro-active role in spreading Christianity with the backing of the Roman Catholic Churches.

However, Spain which was competing with Portugal around this time also developed a high level of navigation skills. The Monarchy sponsored a number of expeditions to explore new territories and trade partners. We know that it was the Spanish Monarch who sponsored Christopher Columbus, who set out to find lands in Asia but instead discovered the Americas. The Spanish also discovered Peru and Mexico which provided a vast and unending supply of silver and gold.

The Rise of Spain

The Treaty of Tordesillas in 1494, which was ratified by the Pope divided the new world between Portugal and Spain. As a result of this Treaty, Portugal came to control Brazil as well as their possessions in Africa and Asia, while Spain got the control of the North American continent and the rest of South America (apart from Brazil) and a number of possessions in Africa and Asia (most importantly Philippines).

It was, however, the race to reach India that was the 'big game' between Spain and Portugal at the time. In fact, Columbus was turned down by the Portuguese when he had taken his proposal of a voyage to find India. Only then did Spain sponsor Columbus who set sail to find India in 1492. When Columbus claimed he had found India in 1492, Spain was overjoyed. However, when it transpired that Columbus had failed to find India, Portugal sent Vasco Da Gama on another voyage. The finding of India put Portugal in the front and put pressure on Spain to find something valuable. It was only with the capture of the Aztec treasure in Mexico and the Incas gold of Peru that the tide turned for the Spanish.

The factors that led to the rise of Spain were largely the same ones that contributed to Portugal's success. The following institutions can be said to have contributed to Spain's rise-

Better and bigger ships and modern navigation techniques

Unending resources for their wars and sea voyages from the silver and gold of Mexico and Peru

The downfall of the House of Avis of Portugal in 1578 and the subsequent merger of Portugal with Spain under King Philip II of Spain in 1580. This lasted till 1640

The continued weakening of Portugal even after it became a separate kingdom in 1668. This happened by poaching of Portuguese territories by the Dutch in Africa, (Sao Tome, Angola), Asia (Ceylon, Malaysia, Indonesia), and South America. France and England also captured many of Portugal's territories across the world (including Bombay which was a forced dowry paid when the Portuguese Princess Catherine Braganza became Queen of England in 1665)

Larger army, navy and administrative capacity alongside better accounting and revenue collection techniques

Christian re-conquest of Spain after the capture of Granada in 1492 and the subsequent large scale conversion of Muslims to Christianity which raised the prestige of Spain.

After Spain

A combination of the above factors made Spain the greatest European power for almost 200 years and secured the position of the ruling Habsburg Dynasty as the leading dynastic house in Europe. However, the Protestant Reformation was well on its way and England, France and Holland were readying themselves to challenge the Spanish hegemony at the end of the 17th century. We will take this up in the next series of articles.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal. Views expressed are strictly personal

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