Sunday, May 12, 2013

“Why nations fail” – A great book about the origins of economic prosperity

Daron Acemoglu and James A. Robinson have asked themselves the question “Why are some nations rich and some others poor?” Their short answer is “Inclusive political and economic institutions”.

The book is written very vividly and its clear language makes it accessible to both experts and nonprofessionals. Even though it is not exactly structured this way, the authors discuss three topics: Economic theories that cannot explain economic prosperity (1), theory proposed by the authors (2), and undermining historical references and contemporary examples (3).

(1) The geographic, cultural, and ignorance hypotheses cannot explain economic prosperity.

The geographic hypotheses says that poor countries are poor and rich countries are rich because of geographical differences. This belief doesn't withstand historical and current examples such as:
  • Most African countries are poor, Botswana is rich.
  • Singapore and Malaysia are significantly richer than their neighbors.
  • Regions at the border between Mexico and the United States (The authors offer the example of the divided city of Nogales.) share the same geographic patterns but their wealth bears no resemblance.
In addition, the geographical hypotheses cannot explain why the wealth of specific countries (Examples include China and Japan.) changes over time.

According to the cultural hypothesis, religion, beliefs, values, and ethics are linked to prosperity. “Some populations simply lack a good work ethic.”
The authors raise two main arguments against this hypothesis:
First, cultural patterns are oftentimes identical in frontier regions, although the economic performance of the states involved can differ substantially. Mexico and the USA as well as North and South Korea serve as examples here.
Second, by definition, cultural patterns change only slowly. As a consequence, they cannot explain rapid growth such as the development China experiences today.

Followers of the ignorance hypothesis say that poverty exists because some rulers simply don't know how to make their country rich.
Acemoglu and Robinson argue that ignorance can, at best, explain a small part of world inequality: “It’s not ignorance but oftentimes political strategy to sustain an undemocratic regime that is at the origin of wrong economic policies.”
In addition, the ignorance hypothesis can only explain poverty, not prosperity.

(2) Inclusive political and economic institutions make nations wealthy.

Acemoglu and Robinson argue that, to prosper in the long run, countries need inclusive economic and political institutions.

Inclusive economic institutions create a level playing field for and encourage every citizen to participate in economic activities. They are characterized by
  • secure private property rights,
  • an efficient legal system,
  • the availability of basic public services and infrastructure,
  • efficient markets and freedom of trade,
  • encouraging investment,
  • technological evolution,
  • and a high level of eduction.
    What matters most is that these institutions are available for everybody, not just for the elite of a country.

Most important for inclusive political institutions is a pluralistic society: Political power should be distributed widely and checks and balances among institutions should prevail. On the other hand, to dispose of political power at all, a state must be sufficiently centralized.

As opposed to inclusive institutions, extractive institutions are designed to extract income and wealth from a subset of society to benefit a different subset.

History shows that extractive institutions cannot create incentives for people to make their countries thrive in the long run. Also, they rarely exploit the talent pool of a society efficiently. Temporary economic growth is, however, possible under extractive institutions if they direct resources in the right direction, e.g. towards high-productivity activities. Ultimately, growth under extractive institutions is, nevertheless, doomed to slow down. The reason is that people under extractive institutions will not save, invest, or innovate, simply because they have no incentive to do so.

Why do not all countries in the world adopt inclusive institutions then? The reason is linked to the lack of innovation that arranges the elite of a country. Obviously, innovation leads to creative destruction. In other words, it replaces the old by the new and, thereby, creates winners and loosers and redistributes wealth. If you have power and money today, this is exactly what you want to avoid.

Over time, institutions can shift from inclusive to extractive and vice versa. Major historical events (“critical junctures”) play a major role here. In addition, political and economic institutions interact. For example, inclusive political institutions make the emergence and subsistence of inclusive economic institutions very likely (“virtuous circle”).

(3) Historical references and contemporary examples

To justify their above theory, the authors describe many relevant historical examples:

  • The consequences of a lack of political centralization are explained by a description of today's situation in countries such as Afghanistan, Columbia, Congo, Haiti, Nepal, Somalia, and Zimbabwe.
  • China today and the Soviet Union from 1928 until 1970 serve as examples to illustrate economic growth under extractive political institutions.
  • The break-down of the Roman empire and the economic decline of Venice in the 14th century illustrate how a shift from inclusive to extractive political institutions results in extractive economic institutions.
  • Two powerful stories describe the fear of creative destruction:
    The Roman emperor Tiberius killed the man who just showed him his invention of unbreakable glass instead of rewarding him because he feared the economic and social effects this invention might have.
    In 1589, William Lee presented his knitting machine to English Queen Elisabeth I and asked for a patent. Instead of obtaining it, the Queen responded “Thou aimest high, Master Lee. Consider thou what the invention could do to my poor subjects. It would assuredly bring to them ruin by depriving them of employment, thus making them beggars.”
  • Major critical junctures described in the book are the black death (and the related loss of the world's workforce) in the 14th century, the discovery and colonization of the Americas in the 14th century, the invention of the printing press by Johannes Gutenberg in Mainz in 1445, the French revolution in 1789, and the industrial revolution in England the 19th century.

The above list of examples is a personal choice; the book offers many other historical references.

What can I criticize? I found the book sometimes a bit repetitive. But that is definitely a minor aspect. Daron Acemoglu's and James A. Robinson's “Why nations fail” is, beyond any doubt, worth reading.

You can find a speech of one of the authors about the book here.