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Colonialism in the Theory of Growth Graziella Bertocchi ¤ University of Modena and CEPR Current Draft: October 1998 1. Introduction Surprisingly, within the exploding recent literature on growth and underdevelopment 1 , virtually no attention has been paid to the economic impact of colonial rule on the countries that were subject to it. Still, there is no doubt that former colonies have had weaker growth performances than other countries. At the end of the modern colonial era, i.e., the period that roughly goes from 1880 to the early 1960's, they were among the poorest countries in the world, and most of them did not catch up in the next decades. Table 1 illustrates the relative economic performance of countries which were colonies and of countries which were metropolises over that decade, 1963-73, which marks the end of the colonial era. From the table we see that virtually all colonies in 1963 were concentrated in the four lowest classes in terms of per capita gross national product. Moreover, over the decade, colonies displayed lower growth rates if compared again with metropolises. One preliminary inference one can draw from this picture is that colonization - which in principle could be viewed as a process of international integration - did not induce convergence to a common level of income. While the performance of the metropolitan countries appears to be consistent with the convergence hypothesis and the standard neoclassical growth model, since they display a clear negative correlation between growth rates and initial conditions, the same cannot be claimed for colonies, pointing to the potential relevance of omitted variables. 1 See Romer (1986) and Lucas (1988). 1 This paper represents the ¯rst attempt to analyze the historical causes of underdevelopment by looking at the consequences of colonial domination. While the history of economic colonialism is a complex one, our model highlights those speci¯c elements which, more than others, seem crucial to understand the issue at hand. We examine the e®ects of colonization from the viewpoint of the colony, whose economy is described by a neoclassical growth model with capital accumulation. We identify two main features of colonial economic domination: a restricted in°ow of foreign direct investment, which is controlled by the metropolitan country, and direct exploitation activities. 2 TABLE 1 Gross national product per capita 1963 in 1972 dollar equivalents (gnp) and average annual growth rate 1963-73 (°). Colonies are in small case, metropolises are in capital letters. gnp <100 100-199 200-299 300-499 <1 burma india somalia u.volta chad cambodia sudan no.vietnam so.vietnam niger egypt ghana senegal zambia 1-1.99 mali burundi rwanda dahomey guinea sierra leone c.a.r. morocco congo 2-2.99 ceylon uganda philippines 3-3.99 indonesia laos tanzania cameroon kenya zaire togo nigeria ivory coast no.korea tunisia 4-4.99 pakistan mauritania 500-999 1,000- 1,999 2,000-2,999 >3,000 ° UK algeria malaysia US GERMANY ITALY 5-5.99 >6 kuwait BELGIUM FRANCE NL SPAIN so.korea taiwan gabon libya PORTUGAL JAPAN Source: The table is extrapolated from Portes (1976) and based on U.S. State Department 1975 data. Not included are the countries of the Soviet Block, the self-governing British dominions, and those countries that were neither colonies or colonizers in the period from 1880 to present. 3 Svedberg (1982) documents that indeed colonial domination coincided with the existence of restrictions on investment in the colony, which were imposed unilaterally by the metropolitan power and were enforced through discrimination against investment from third countries, monopolistic curtailment of own investment, or discouragement of domestic investment 2 . Direct exploitation activities in the colonies in the form, for example, of forced labor or taxes, are also well-documented by historians and economic historians 3 . While the economic profession has devoted little attention to the issue of colonialism, historians and political scientists have developed several theories to explain its causes and e®ects. The marxian theory of imperialism argued that the main economic motive for colonization of capital-poor countries was that the metropolises needed colonies to dampen their capital surplus. According to the closely-related dependence theory, underdevelopment is a result of colonial or post-colonial dependence. More generally, there exists a widespread belief that the \drain of wealth" 4 imposed by the metropolitan countries on the colonies has harmed their growth prospects in a decisive fashion. On the opposite side, others have emphasized that, despite the fact that certain forms of exploitation occurred, positive development impulses came from the metropolis. These attempts to legitimize colonial rule in economic terms usually stress the fact that integration into the world economic system pushed a modernization process which secured for the colonial peoples higher living standards and rosier growth prospects. In our model, we do build in a \modernization" e®ect 5 , by which we mean an addition to the capital stock due to the in°ow of foreign investment, which contributes to produc2 See also Kleiman (1976) for a companion analysis of the e®ects of colonization on the patterns of trade. This view is also present in Adam Smith (1776)'s and Dobb (1946)'s descriptions of mercantilism. 3 See Boahen (1990) for a history of Africa under colonial domination. 4 The \drain of wealth" thesis - which was developed for the case of India - states that most of the colonial surplus was withdrawn from the colonial economies in the form of interest payments on loans, repatriated pro¯ts, salaries and pensions (see von Albertini (1992)). 5 However, we do not focus on the distinction, which has frequently been stressed in development economics, between a \modern" manufacturing sector and a \traditional" agricultural one. By modernization, therefore, we simply mean an increase in the capital stock, which could a®ect the agricultural sector as well. See Matsuyama (1992) for an open economy model of sectoral adjustments. 4 tion (directly, or indirectly through the provision of infrastructure and general knowledge). In this setup, the \drain of wealth" induced by colonialism has three components: First, the remuneration of local capital is reduced by the presence of foreign investment, with a negative e®ect on accumulation. Next, the portion of total pro¯ts which represents remuneration of foreign capital is repatriated. Finally, we consider direct exploitation in the form of economic plundering and slavery. We study the net e®ect of modernization and drain on the colonial economy and show that, under realistic parameter values, it amounts to an increase in total capital and domestic product, which is however associated with a fall in the standards of living. We also examine the destiny of the same economy after colonization ends and foreign investment ceases, while the damages from past exploitation persist. The reaction of the former colony's economy depends on the timing of decolonization. For a long enough length of the colonial phase, the former colony can experience negative growth rates. Finally, we extend the model to consider the impact on growth of human capital, and we show how the rapid modernization process induced by foreign capital can negatively and permanently a®ect the development process by creating a chronic shortage of the human factor. The paper is organized as follows. In section 2 we present the basic model. In section 3 we identify the two main features of colonization, restricted foreign investment and direct exploitation, and study their impact on the colonial economy. Section 4 looks the e®ects of decolonization. In section 5 we consider the interaction between human and physical capital. Finally, in section 6 we sum up our results and indicate a few directions for future research. 2. The basic model We intend to study the e®ects of colonization from the viewpoint of the capital-poor country which becomes subject to it. The basic structure of the economy is as in Diamond (1965). We consider a simple model with one good and overlapping generations of individuals that live for two periods. Population is constant and individuals are identical within 5 each generation. Young agents are endowed with one unit of labor which they supply inelastically at the competitive wage rate. They maximize a time-separable utility function given by u(c1t ) + v(c2t ), subject to the constraints c1t · wt ¡ st and c2t · st rt+1 , where c1t and c2t are the levels of consumption of the agent born at t when young and old, respectively, wt is the wage rate at t, st is saving at t, and rt+1 is the interest rate at t + 1. The functions u(¢) and v(¢) are assumed to be strictly concave. To ensure interior solutions, the Inada condition at zero is also imposed on u(¢) and v(¢). c1 and c2 are normal goods and they are gross substitute. The technology is characterized by a constant-returns-to-scale production function involving local 6 capital and indigenous labor (in this simple speci¯cation, capital can include both physical and human components, as well as land and infrastructure). The technology in intensive form is described by yt = f (ht ), where yt is per capita output at t and ht is per capita local capital at t. The function f(¢) is strictly concave in h and satis¯es the Inada conditions for h. For simplicity, capital fully depreciates in one period. While we do not consider technological progress, it would be easy to expand the model to allow for it, and assume that the technology starts at a rudimentary level and becomes more sophisticated as time goes. Balanced growth paths, which are now ruled out, would then become possible, but would not add much to the point we want to make in this paper. The economy starts with a \low" level of capital, \low" if compared with a positive steady state level which we assume to be unique and stable. Our assumption of a positive level of local capital before colonization is consistent with the evidence 7 . The solution of the consumer's problem yields a saving function given by st = s(wt ; rt+1 ) which, under our assumptions is increasing in both arguments, i.e., the wage rate and the interest rate 8 . The solution of the ¯rm's problem under perfect competition implies the following expressions for factor prices at time t: rt = f 0 (ht ) ´ r(ht ) and wt = f (ht ) ¡ ht f 0 (ht ) ´ w(ht ). The market clearing 6 By local capital, we mean capital which is owned by the residents of the underdeveloped country. 7 Capital generally did exist in these countries. Africa, for example, was in an early stage of economic development, but had for centuries employed capital goods in the production of clothes, pottery, glass, and soap. 8 Fry (1995) reviews the empirical literature on the interest sensitivity of saving in developing countries and concludes that the evidence supports a small but positive elasticity, especially in the earlier the phase of the development process. 6 condition for capital in this economy is given by the equation ht+1 = s[w(ht ); r(ht+1 )] and implies the following di®erence equation in ht , which determines the equilibrium dynamics of capital: ht+1 = Á(ht ): (1) Under our assumptions, equilibrium is uniquely determined in this economy. We also assume that the sequence of capital stock levels converges to a unique stationary level hO starting from any initial condition h0 > 0 9 . The economy being underdeveloped, we have h0 < hO and the sequence of capital stock levels is increasing. 3. Modernization or a drain of wealth? In this section, we introduce the two main features that characterize economic colonization, restricted foreign investment and direct exploitation activities, and we study their impact on the colonial economy. 3.1. Restricted foreign investment Before colonization takes place, the economy is closed to the rest of the world. However, since the stock of capital is small, the return to capital is high enough to attract foreign investors. Of course under free capital mobility investment would instantaneously °ow into the capital-poor country such to equalize returns worldwide. However, what historically characterized international capital °ows under colonialism is precisely the fact that investment into an underdeveloped area was not subject to the rules of free competition, but was instead restricted by the metropolitan country which had been able to establish its ruling over it. Restrictions included monopolistic control on the amount of colonial investment allowed to residents of the metropolis, discrimination against domestic capital formation, and 9 If preferences are homothetic, existence and stability of a non trivial solution to Á is guaranteed by the Inada conditions on f, while uniqueness is not. See Galor and Ryder (1989). 7 prohibition to third countries to invest (which was often enforced by establishing sovereignty over the colony 10 ). Let k denote total capital in the colony, which is the sum of local capital h and foreign capital x, i.e., k ´ h + x, where time subscripts are suppressed for convenience. It is important to stress that the in°ow x should be viewed as something broader than mere physical capital: it can in fact represent infrastructure, human capital and, more generally, knowledge. Lucas (1990) and Grossman and Iyigun (1995) present models in which the size of foreign intervention is endogenously and optimally determined. The former introduces a monopoly model of an imperial power in an e®ort to explain distortions in international capital °ows. The latter paper studies the pro¯tability of colonialism by taking into account the threat of extralegal appropriation by the indigenous population. However, neither looks at the dynamic impact of colonialism on capital accumulation and development. Their analyses can be therefore viewed as complementary to ours. While an optimal value of x, which purely maximizes economic pro¯ts, could easily be derived within our model 11 , it should be noticed that economic interests were by no means the only relevant factor, and that a variety of di®erent considerations, for example, political, humanitarian, and religious ones, also played a role 12 . In other words, the economic pro¯tability of colonial investment cannot be taken as the only determinant of x. Therefore, to simplify, we treat x, the metropolis' action, as exogenous and time-invariant, to focus on the reaction of the economy of the colony. It is useful to introduce now a few basic de¯nitions and accounting identities which will 10 In the case of the Congo, for example, King Leopold's original aim was purely economic domination. It was only later, in order to preserve its monopoly against the pressure from the other European powers, that Belgium turned to territorial aims (see von Albertini (1982)). 11 Given a level ½ of the return to capital at home, the metropolitan government would set x to maximize rx ¡ ½x = f 0 (k)x ¡ ½x, i.e., repatriated pro¯ts less the opportunity cost of capital. The ¯rst-order condition for this problem is f 0 (k) = ½ ¡ xf"(k), which implies that the optimal level of x is low enough to keep the marginal product of capital in the colony higher than the home return. 12 Classic references are Gallagher and Robinson (1953, 1961). In addition, it is also generally accepted that colonization was not a relevant factor in explaining the growth performances of the metropolises. See, for example, Bairoch (1993). 8 help to keep track of the e®ects of colonization on the relevant economic variables, i.e., total capital, local capital, domestic product, and national product. With the introduction of foreign investment there is no longer an identity between location and ownership of the capital stock. Moreover, a distinction between gross national product and gross domestic product becomes relevant. Per capita gross (and net) domestic product for this economy is given by gdp = f (k), while per capita gross (and net) national product is de¯ned as gnp = f(k) ¡ rx. The in°ow of foreign capital is in fact associated with a return °ow of interest and dividend payments required to service outstanding debt and equity holdings. In the literature, the economic impact of colonization has been measured in di®erent ways. The \real resource transfer" 13 , for instance, is calculated by subtracting from foreign in- vestment the out°ow of capital income: It is therefore given by x ¡ rx = ¡b, where b is the per capita trade balance. Others have instead referred to the \drain of wealth", which according to a strict de¯nition is captured by the quantity rx. In this paper, however, we will refer to a broader de¯nition of \drain of wealth" which, besides repatriated pro¯ts, will also take into account the indirect impact of x on endogenous capital formation and exploitation activities. On the other hand, we will refer to the direct impact of x on total capital as a \modernization" e®ect. Our goal is to determine the net e®ect of modernization and the drain on the economy of the colony. Foreign capital is invested into a competitive domestic capital market. Foreign and local capital are perfect substitutes. We ¯rst analyze the e®ect of colonization on local capital formation. The impact of foreign capital on production decisions is easy to determine: Labor becomes scarcer and its marginal productivity increases; since total capital is now higher, its marginal product will decrease. The ¯rst e®ect tends to increase saving and local capital formation, while the second goes into the opposite direction. A trade-o® arises between the two channels and the e®ect of foreign investment on local capital formation will re°ect both. The decrease in the return to local capital induced by foreign investment can be viewed as an indirect restriction on indigenous investment, which we interpret as a component of the drain of wealth. The deformation of 13 See Fishlow (1985) for an application of the concept to the analysis on international capital markets during the 19th century and the interwar period. 9 saving behavior due to colonization can be described by a new market clearing condition given by ht+1 = s[w(ht + x); r(ht+1 + x)] and implies a new law of motion for local capital according to the following function Ã: ht+1 = Ã(ht ; x) (2) ¹ Under Ã, the sequence of capital stock levels converges to a long-run level hC = Ã(x). For a given level of foreign investment, x, the relationship between hO and hC will depend on ù0 (x). ù0 (x) will be positive, and hC > hO , if the condition sr < ksw is satis¯ed, where sw and sr are the partial derivatives of the saving function with respect to w and r, respectively. In other words, if the interest sensitivity of saving is su±ciently low, restricted foreign investment produces an increase of the growth rate of local capital formation and of its long-run level. It is only under implausibly high values of the sensitivity of saving to capital income that local capital is negatively a®ected. While keeping track of the evolution of local capital provides useful information about the stage of development of an economy, the growth performance of a country is usually evaluated by examining the evolution of its product. In our context, a distinction between domestic and national product is necessary. We will study ¯rst the e®ects on domestic product, f(k). For realistic values of the interest sensitivity of saving, local capital increases with x, so that gdp will also grow in the long run. In fact, for gdp to go up it would be su±cient that sr < ksw ¡ f1" , which is equivalent to ù0 (x) > ¡1, i.e., a less than one-to-one crowding-out e®ect. The e®ect we have just isolated is a consequence of what we refer to as \modernization", and could justify the positive view of colonial rule which has been shared by some. However, it is also necessary to study the impact of colonization on gnp which, in the presence of a substantial out°ow of interest income, can be taken as a more appropriate measure of a society's standards of living 14 . In our context, gnp is given by ¹ ¹ + x)x: f (k) ¡ rx = f (Ã(x) + x) ¡ f 0 (Ã(x) 14 (3) A a complete welfare analysis within an overlapping generations model should also take into account the potential dynamic ine±ciency problem. 10 The level of gnp in the long run is determined by the level of gdp and by the size of repatriated pro¯ts, which are functions of x. The e®ect of colonization on national product can be computed as follows. De¯ning as gnpx the partial derivative of gnp with respect of x, we have that gnpx = ù0 (x)f 0 (k) ¡ [1 + ù0 (x)]f 00 (k)x. It follows that gnpx is positive only when x < f 0 ù0 (x) f " 1+ù0 (x) . Notice that this condition is satis¯ed by a positive (and su±ciently restricted) x only for the range in which ¡1 < ù0 (x) < 0. In other words, for values of ù0 (x) outside this range the advent of colonization will never increase long-run gnp, even though, for ù0 (x) > 0, gdp will actually go up. In sum, our analysis implies that those realistic preference parameters values that yield a positive impact of colonial investment on local capital and gdp are associated with a fall of gnp. This result supports a negative view of colonization, in the sense that the economic growth it induced was not associated with an improvement in the living standards of the indigenous population. Our ¯ndings have interesting implications also with respect to the dynamics of repatriated pro¯ts, i.e., the sequence rt x: Since total capital increases over time after colonization 15 , the marginal product of capital will decrease, and so will foreign capital income. Colonial returns which are initially higher than returns in the metropolitan countries, are progressively eroded. In our model, there is no contradiction between these performances and the existence of monopolistic restrictions on investment. A crucial dispute about the pro¯tability of colonial investment is therefore resolved 16 . 3.2. Economic plundering In addition to the potential crowding-out of local capital and the subtraction through repatriated pro¯ts, we now include into the analysis a third component of drain, which captures the plundering activities which were associated, in di®erent degrees, to most colonization experiences. We are referring not only to the presence of taxes that the colonizers With the exception of the extreme case for which ù0 (x) < ¡1. Contrary to Svedberg (1982), Davis and Huttenback (1988, 1989) ¯nd that for the case of Britain colonial returns were substantially above domestic ones in the early years, but after 1880 they became lower. On this basis, they reject the view that colonial investment was regulated. 15 16 11 collected on various sources of income, and to the practice of forced labor, and in some cases enslavement, which were enforced on the indigenous population. More generally, we are also referring to a variety of distortions which produced colonial and post-colonial societies with dysfunctional institutions, rent-seeking elites and corrupt bureaucracies, and suppressed decisive growth factors such as entrepreneurship, energy for technical innovations, hope and trust in the future. We will introduce these considerations into the model in the simplest possible way, through a single exploitation parameter ± imposed on total product 17 . If we decompose output into its income components, wages and capital interests, we can interpret the ¯rst component of the plundering as the e®ect of forced labor, while the second can be interpreted as a tax or tari® imposed on local businesses. The e®ects of plundering on the dynamics of local capital are the following: There is a decrease in wage income, which depresses saving, and a further decrease in interest income, which goes in the same direction. The total e®ect on saving can therefore only be negative. Market clearing when exploitation is taken into account is given by ht+1 = s[(1 ¡ ±)w(ht + x); (1 ¡ ±)r(ht+1 + x)] and the dynamics of local capital are determined by ht+1 = »(ht ; x; ±) (4) with a corresponding stationary state hE . The presence of distortive exploitation activities therefore weakens the modernization e®ect of foreign investment. From the viewpoint of the metropolis, exploitation has two e®ects. There is a direct e®ect on the pro¯ts that can be extracted from the colony, and an indirect e®ect produced by the fact that plundering slows down local capital accumulation and keeps its marginal product high: The erosion of returns to colonial investment is therefore delayed. 4. Decolonization 17 Chari, Kehoe and McGrattan (1996) consider a similarly-interpreted distortion parameter in the e®ort to explain income disparities across countries, but without referring explicitly to colonial heritage. 12 We consider now what happens to the economy of the colonies once they gain independence. The economic reason why this event might occur is that, because of the progressive increase in the stock of local capital, the return to foreign colonial investment will eventually decrease enough to equalize the return to investment in the metropolis. Moreover, as we have already argued, it may in fact be the case that it is political and social reasons that trigger this event 18 . We identify economic decolonization with the end of the foreign investment °ow 19 . On the other hand, we assume that the economic and sociopolitical damage induced by exploitative imperial policies persists even in the post-colonial phase. Output is therefore permanently a®ected by the parameter ±. Under these assumptions, we will show that the growth performances of former colonies depends on the impact of foreign investment on local capital formation and the degree of exploitation, but also on the length of the colonial period and the timing of decolonization 20 . Consider an economy that under colonization has developed according to the function » towards a stationary value hE . Once foreign investment is removed, and the distortions associated with ± are still in place, accumulation slows down according to a new function  with a stationary value hD < hE . Depending on the timing of decolonization, di®erent patterns can prevail. Consider the following two cases: (i) If decolonization occurs before hD is reached, it implies a decrease of the growth rate and convergence to the long-run level of local capital. (ii) If, instead, the colonial period lasts long enough, such that ht at the time of decolonization is above hD , then foreign divestment has even more disastrous e®ects: It in fact provokes negative growth rates and a regression of the levels of local capital and gdp. Figure 1 illustrates this pattern: Colonization starts at time t0 and ends at time t¤ . From t0 to t¤ , the dynamics are governed by the function ». After that, the dynamics are 18 See Fieldhouse (1986) for an economic history of post-colonial Africa. Svedberg (1981) ¯nds that the unilateral enforcement of foreign investment did decrease once the colonies gained their political independence. 20 Since in this model we have assumed full depreciation of capital, we do not have to consider the lasting e®ects on the colonial economy of a gradually depreciating stock of foreign capital. 19 13 governed by to  and we observe a decreasing sequence of local capital stock levels. These results help to explain the di®erences in the performance of former colonies after the 1960's. 5. Human capital and permanent e®ects The goal of this section is to extend the basic model in order to recognize explicitly the crucial role that human capital can play in the process of development. While the link between growth and human capital has been studied in depth within the endogenous growth literature 21 , we are going to investigate how colonization may have speci¯cally a®ected this link. The stylized fact we have in mind is the particularly low level of human capital which has been empirically documented, for example, for post-colonial sub-Saharan Africa 22 . Moreover, the issue is central because convergence has generally been shown to hold conditionally with respect to this speci¯c factor, i.e., a country grows faster if it begins with lower real per-capita income relative to its initial level of human capital 23 . Within an augmented neoclassical growth model which contains a threshold externality, Azariadis and Drazen (1990) are able to model the notion that rapid growth cannot occur without a relatively overquali¯ed labor force, i.e., without a high level of human capital relative to income. Barro and Sala-I-Martin (1995) develop several versions of a model with physical and human capital in which the growth rate depends on the balance between the two capital stocks. To capture these aspects, our model can be extended as follows. The technology is now given by yt = At f(kt ), where the scale factor At = at kt is interpreted as the ratio between human capital (a) and physical capital in the country. Our previous analysis has predicted how the level of physical capital is a®ected by colonization. We will now study how changes in physical capital a®ect the balance At , under the assumption that human 21 See, in particular, Lucas (1988) and Azariadis and Drazen (1990). See Barro and Lee (1993). Economic historians, for example Fieldhouse (1986), have also documented the critical shortage of human skills that characterized Black Africa at the end of the colonial period. 23 See Barro (1991). 22 14 capital is not a®ected by colonization. This simplifying assumption will then be removed in the next subsection. 5.1 The impact of colonization on the human/physical capital balance Assume for now that human capital evolves according to its own dynamic law, say, at+1 = j(at ), which is una®ected by colonization. The augmented production function we have postulated displays an external e®ect. It is well-known that, depending on the shape of At , this technology can produce a variety of dynamic patterns, including poverty traps, unbounded growth, and multiplicity of equilibria 24 . We will consider a speci¯c threshold e®ect. This feature ensures that even a small variation of the scale factor, provided it occurs within the relevant range, will result in a radical modi¯cation of the properties of equilibrium. Let the scale factor take a value ®1 for k < k¤ and a value ®2 < ®1 for k ¸ k¤ , where k¤ is a critical value of k. The dynamics will display two possible steady states for total capital k as well as for local capital h. Assume now that the economy before colonization is endowed with a human to physical capital ratio of ®1 . For ù0 (x) > ¡1, k suddenly increases as an e®ect of foreign investment while human capital will tend to fall behind. For a su±ciently large gap, At will jump to its lower value. In other words, colonization can provoke an imbalance between human and physical which can delay the development process, since \too rapid" modernization can create a chronic shortage of the human factor. By the time t¤ at which x is withdrawn, the local component of physical capital may have in fact grown large enough to keep the value of the ratio at its lower level. According to this scenario, even after colonization ends and foreign investment ceases, the country will bear the consequences of its colonial inheritance for a protracted period of time. 5.2. The direct impact of colonization on human capital One could of course argue that human capital was itself a®ected directly by colonization. Not only because education and health were in°uenced by the policies of the colonial admin24 See Azariadis and Drazen (1990) and Boldrin (1992). 15 istrations 25 , but also because the notion of human capital could meaningfully be extended to include intangible factors such as self-esteem, national pride, and entrepreneurship. Accordingly, the dynamic law governing the evolution of human capital can be modi¯ed to allow for such a direct in°uence. Assume, for example, that the evolution of human capital is subject to the same kind of long-lasting distortions which a®ect the production process, i.e., at+1 = (1 ¡ ±)j(at ). Under this formulation, even with decolonization and the withdrawal of foreign investment it will be harder for the country to jump above the critical value of the scale factor At . 6. Conclusion We have built a dynamic model with capital accumulation which describes the economy of an underdeveloped country before colonization takes place, during colonial domination, and after decolonization occurs. Within modern growth theory, this represents the ¯rst attempt to understand the historical causes of today's underdevelopment. Even if the model is highly stylized, it shows how colonization can promote output growth but at the same time depress living standards in the colonies. It also predicts that decolonization may deliver disappointing, or even disastrous, economic performances. The issue of colonialism is a complex one. While we have isolated in this paper a few key elements, direct foreign investment, direct exploitation and human capital, which capture the essence of its economic nature, our setup could be expanded to consider other important factors such as natural resources, technical progress, international trade, as well as political economy considerations. This is in our agenda for future research. 25 The practice of forced labor and the neglect of public education, for example, certainly exerted a negative e®ect, even though in the late-colonial era the attitude of most colonial regimes did change signi¯cantly. See Oliver and Fage (1962). 16 REFERENCES Azariadis, C. and Drazen, A. (1990), Threshold Externalities in Economic Development, Quarterly Journal of Economics 55, 501-526. Bairoch, P. (1993), Economics and World History. Myths and Paradoxes, Harvester Wheatsheaf, Hemel Hempstead. Barro , R.J. 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