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 underdevelop-
ment 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

<100 100-199 200-299 300-499 500-999 1,000- 1,999 2,000-2,999 >3,000

<1 burma cambodia egypt zambia kuwait

india sudan ghana
somalia no.vietnam senegal
u.volta so.vietnam
chad niger

1-1.99 mali guinea morocco congo

burundi sierra leone
rwanda c.a.r.
dahomey

2-2.99 ceylon uganda philippines UK US

3-3.99 indonesia cameroon ivory coast algeria GERMANY

laos kenya no.korea malaysia
tanzania zaire tunisia
togo
nigeria

4-4.99 pakistan ITALY BELGIUM

mauritania FRANCE
NL

5-5.99 SPAIN

>6 so.korea taiwan gabon libya JAPAN

PORTUGAL

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 exis-
tence 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 in-
vestment 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 produc-
2
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 remu-
neration 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 individ-
uals 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 inelas-
tically 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 de-
veloping 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 colo-
nization, 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 invest-
ment 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 al-
lowed 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 pro-
duction 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
f (k) ¡ rx = f (Ã(x) ¹
+ x) ¡ f 0 (Ã(x) + x)x: (3)
14
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
f 0 ù0 (x)
when 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 repatri-
ated 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 progres-
sively 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¯tabil-
ity 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 colo-
nization experiences. We are referring not only to the presence of taxes that the colonizers
15
With the exception of the extreme case for which ù0 (x) < ¡1.
16
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.

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 de-
cisive 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 param-
eter in the e®ort to explain income disparities across countries, but without referring ex-
plicitly to colonial heritage.

12
 We consider now what happens to the economy of the colonies once they gain indepen-
dence. 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.
19
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.

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 con-
ditionally 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
at
technology is now given by yt = At f(kt ), where the scale factor 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).
22
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).

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 admin-
24
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. Ac-
cordingly, 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 with-
drawal 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
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