How nations grow, or why nations fail

A book published this year represents a breakthrough in the understanding of long term economic development of nation states. It presents a coherent analysis of why countries have large differences in income and economic welfare based on data, history and comparative experience. The evidence reported spans continents and historical times covering differences in cultures, countries, regions and climatic locations. For all these reasons, the book will be a classic on the subject.

“Why Nations Fail, the book.” The book is written by Daron Acemoglu, an economics professor at the Massachusetts Institute of Technology (M.I.T.), and James A. Robinson, a political science professor at Harvard University. The book distills the wide material and existing theories explaining economic development. It is particularly readable for lay men and social scientists alike. It offers a unique theory of how the process of high growth or decline happens in different settings – countries, empires, failed states, and successful nation states of today and the past.

The ideas spelled out in this book have been in circulation as published articles in economic journals that appeared in succession from the late 1990s and throughout the first decade of the 2000s. The common denominator of these papers which were written collaboratively by a number of young scholars is Daron Acemoglu who is the principal intellectual force behind the economic underpinnings of the studies.

All these writings are alternatively incorporated within the framework of the theory of modern economic growth that Acemoglu wrote in 2009. This latter book, however, is written for economic scholars who work at a high level of analytical difficulty. The American Economic Association recognized Daron Acemoglu with the John Bates Clark medal in 2005 as the economist under the age of 40 years who is adjudged to have made outstanding contributions to economic thought and knowledge.

“The main ideas.” Big differences in living standards across the world require an explanation. After reviewing the wide data of countries today against various theories offered to explain these differences, the old theories – those based on differences in geography, climate, culture and ethnicity – all fail to explain in the presence of convincing counter-examples.

Reviewing the historical experience of many countries, empires, and nation states that have been challenged and plagued by interactions among the institutions that surround them, no particular development path can be said to be predestined. Countries take different paths toward prosperity and poverty depending on how these institutions evolve and interact with the major factors that influence their future course.

A theory is therefore needed to explain these differences and to explain why some nations are prosperous while others fail and are mired in poverty. To be successful, the theory needs to explain the factors that create and retard prosperity and also to explain the historical origins that contribute to the unique path that is taken.

The book on Why Nations Fail offers such a theory. It seeks to explain the main outlines of economic and political development around the world since – I emphasize – the Neotlithic Revolution! The authors explain:

“A theory should enable us to focus on the parallels, sometimes at the expense of abstracting from many interesting details, but provides a useful and empirically well-grounded explanation for a range of processes while also clarifying the main forces at work.” (p. 429)

In offering such a theory, the book is replete with examples to emphasize analysis on two levels of practical applications. First, it makes a distinction between “extractive” and “inclusive” economic and political institutions. Essentially, this part of the book provides the authors with an institutional interpretation of history.

Second, the book provides an explanation of why inclusive institutions emerged in some parts of the world and not in others. This part of the book discusses the growth of open and highly dynamic economies set against others with poorer records.

“Defining critical terms.” All at once we encounter three distinct words with important meanings: exclusive, inclusive, institutions.

We start with “institutions.” Economics has a broader meaning for institutions. Institutions refer to rules, regulations, laws and policies that affect economic and political incentives. It is an article of faith in economics that individuals (economic agents) only take actions that are rewarded. There are economic and political institutions.

Institutions shape these rewards and therefore they are important in stimulating the actions of those who seek those rewards. Institutions are social choices taken by people collectively. Institutions tend to be persistent and stable and, for these reasons, are often difficult, although still liable, to change when they require change.

Now we combine these terms. “Inclusive economic institutions” enforce property rights, create a level playing field, and encourage investments and innovations. “Inclusive political institutions” distribute political power widely and are able to achieve an essential amount of political centralization that enables the state to establish law and order, the basis of secure property rights and an inclusive market economy.

“Extractive economic institutions” are organized to extract resources from the many by the few, fail to protect property rights or to provide incentives for economic activity. “Extractive political institutions” amass power into a few who then maintain and develop extractive economic institutions for their benefit and use the resources they obtain to cement their hold on political power.

“The interplay of economic and political forces.” Central to this theory of growth and decline is the link between political and economic institutions. Inclusive economic institutions and inclusive political institutions are mutually self-re-enforcing. This means that once in place together, they strengthen each other to make the country move toward sustained economic growth.

Inclusive economic institutions and inclusive political institutions when interacting well make possible “virtuous circles” that further encourage and cement the growth process. But it is also the case that extractive economic institutions and extractive political institutions can also work together to produce growth.

Thus, all economic and political power in the hands of a few under extractive rules is not necessarily incompatible with economic growth. It is in the interest of the elites to promote economic growth in order to have more to extract. However, extractive institutions are more prone to the development of “vicious circles” that bring in actions that are harmful to economic growth that lead the nation toward decline.

Moreover, the book warns that economic growth under extractive institutions is not sustainable. The reason for this is that economic growth requires innovation and innovation is destabilizing to power relations in politics as well as economics. As a result, power that grows under extractive conditions will likely be short-lived.

References: Daron Acemoglu and James A. Robinson, Why Nations Fail: The Origins of Power, Prosperity and Poverty, Crown Business, New York, 2012; Daron Acemoglu’s second book, Introduction to Modern Economic Growth, Princeton University Press, Princeton and Oxford, 2009.

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