The bottom line is “some countries are rich, and others are poor.”
The real question, “why?”
Daron Acemoglu and James A. Robinson try to give a definite answer to this question in their popular and heavily discussed book.
“Why Nations Fail,” writes Jared Diamond, “should be required reading for politicians and anyone concerned with economic development."
It should also be required reading for those who want to understand why some nations are prosperous and others are poverty-stricken.
Not many people want to put an end to inequality and corruption, but those that do, should really do more than just scratch the surface.
Let’s get down to it!
In Why Nations Fail, Daron Acemoglu and James A. Robinson set before themselves a very ambitious task: to pinpoint the real reasons why some countries are rich and prosperous, and why others are poor and suffering.
In all of the fifteen chapters, they lay out a thought-provoking theory which, if not something more, has incited a lively discussion among the most famous economists, intellectuals, and political thinkers of the XXI century.
Let’s see what the fuss is all about.
It isn’t difficult to guess that Why Nations Fail isn’t the first book to try to get to the bottom of the “rich vs. poor countries” quandary.
It is even easier to suppose so before they presenting the theory, because Acemoglu and Robinson try to point to the faults of other people’s explanations of the problem.
They group them into several categories, which we’ll further group into three.
According to the geography hypothesis – most eloquently demonstrated by Jared Diamond in Guns, Germs, and Steel – some nations were merely lucky enough to form countries on locations blessed with a pleasant climate.
There’s a reason why the poorest countries in the world are located in tropical regions, and why the wealthiest can be found in cooler climatic zones.
Simply put, diseases are more likely to develop in the tropical zones of central Africa and America, and, thus, it is only natural to expect from a Zambian to be far less productive than a Norwegian.
However, ask Acemoglu and Robinson, then why are neighboring countries such as North Korea and South Korea so different?
Moreover, why is Singapore so prosperous, even though it is located in the tropical climate zone.
According to the culture hypothesis, some people are just more inclined to work than others because of their cultural and religious heritage.
Most of the developed countries, for example, went through the Protestant Reformation.
And, as any Protestant knows, work is a religious duty, and everyone should embrace it. So it’s only natural to expect that a country with a Protestant past should be far more prosperous than one with, say, Confucian values.
That happens because the latter thinks that humanity, loyalty, and honesty are much more important than work and success. Also, economics is, well, to quote Thomas Carlyle once again, a dismal science.
However, this once again fails to explain why North Korea is one of the poorest countries in the world, and South Korea one of the most developed ones.
According to the final group of explanations, the ignorance hypothesis, North Korea is less developed than South Korea because of the ignorance of the ruling elites.
In other words, the people who ruled North Korea were incompetent and, instead of solving problems, they merely created more. The rulers of South Korea, on the contrary, understood the root of the problems and tried to solve them.
This does explain some things, but it doesn’t apply to every case.
A few case studies provided by Acemoglu and Robinson – such as, for example, Ghana – show that it is not the ignorance of political leaders that causes the economic decline of countries. The conclusion was that those leaders have very shrewd understanding that this decline also leads to their personal economic evolution.
And that’s fundamentally the main point of Acemoglu-Robinson study.
Developed countries foundations are mostly inclusive, with uncorrupted economic and political institutions. Developing countries, on the other hand, suffer because of extractive institutions.
Let’s analyze both of them in detail.
In essence, inclusive – or integrative – institutions are those which allow large groups of people to have a say in political and economic decision-making.
Inclusive institutions give individual members of a society access to high-quality education and allow them to choose freely the profession they like.
They also incentivize them to be creative and challenge the status quo.
And this is especially important because providing and leveraging a relatively fair playing ground to the talented enables them to benefit by helping other people.
Bill Gates and Jeff Bezos' products made the lives of many people easier, and so they became the wealthiest people in the world. However, Carlos Jesus Slim in Mexico earned his money by exploiting the monopoly in landline telephony.
The extractive institutions in Mexico allowed him to prosper and become rich without providing his countrymen additional value. Integrative institutions would almost never allow this.
And how do inclusive institutions come about?
Well, interestingly enough, in many cases, merely by accident.
Consider the example of the Glorious Revolution of 1688 in England. In less than a century, this revolution would lead to the Industrial Revolution which would eventually change the world in ways nothing before it ever did, practically marking the beginning of the rich-versus-poor debate, as argued in A Farewell to Alms.
And it all started because of the plague. The plague, you see, had led to the deaths of so many people that the ones who survived had to work for five and still received the paycheck for one.
So, they rebelled, and the attempt to meet their demands eventually led to the establishment of economic institutions that guaranteed the protection of private property and, with it, introduced actual free market policies.
The rest is history.
Extractive institutions are – you’ve guessed it – the very opposite of inclusive institutions.
Acemoglu and Robinson call them extractive because they believe that the characteristic that defines these institutions is their inclination to extract wealth from those who are not part of them.
Therefore, in countries ruled by extractive institutions, there are always two classes. The first one, the elite, always in a position to repress the other one.
The only way for those who are not in power to prosper in a country governed by extractive institutions is to join the vicious circle, i.e., to become part of the elite and prevent others from doing it.
Extractive institutions disincentivize people from taking part in the political and economic processes of a country. Keeping the status quo is the simple reason behind this.
Now, don’t get Acemoglu and Robinson wrong. They firmly believe that in addition to inclusive institutions, centralized political power is a must if you want to create a wealthy and prosperous country.
However, there’s a limit to how centralized it should be since the economic processes are too complicated for one to be able to predict the results.
For example, in the time of Stalin, the centrally planned economy of the USSR decided to reward workers with bonuses as high as a third of their paycheck for exceeding the assigned quotas.
This did the trick for a while, and the USSR became the second largest economy in the world. However, in retrospect, it also disincentivized these workers to think outside the box, which prevented the process of creative destruction (Schumpeter).
Then again, extractive institutions fear innovation and creative destruction, since these forces usually lead to them losing their power.
So, they suffocate them and, in doing so, cause the failure of their countries.
Now, Acemoglu and Robinson are capable of explaining many things through their framework, but, even at first glance, China is a curious case.
Even though it is still an authoritarian country, China’s economy is growing at such a rapid pace that many have started wondering if we’re living the last years of American dominance.
So how did China succeed to become the second largest economy of the world despite the fact of still being a communist country ruled by extractive institutions?
Well, according to the authors, the main reasons for this are the inclusive policies advocated by Deng Xiaoping, whose economic reforms opened China’s economy to the world and as well as reorienting it internally towards market-based economic programs.
However – and this is the more exciting part of Acemoglu-Robinson analysis – their model predicts that, unless China furthers the inclusiveness of its institutions, its growth will steeply drop over the next decade.
What we may be seeing is just another case of the 1970s Soviet Union. Back then, the relocation of labor from the agricultural sector to the manufacturing industry worked wonders, but twenty years later, the USSR collapsed.
Something similar may happen to China as well unless the country improves its political and economic inclusiveness. Now, that’s a bold prediction.
The central thesis in Why Nations Fail is that economic prosperity depends on the inclusiveness of the political and economic institutions of a country.
In other words, the country is supposed to be better off the more people make political and economic decisions.
Inclusive institutions flourish because they change. And they change because they allow people to freely choose their professions and also allow the market to guide the country on a prosperous path through its invisible hand.
Extractive regimes, in contrast, are more interested in keeping the status quo, since it is the status quo that allows them to remain in power.
However, the status quo means no innovation nor creative destruction. That’s the main reason why some nations have never attained wealth and never will.
One more thing, though: a powerful, centralized government is always essential, because without it, as the case of Somalia shows, neither the free market nor anything else really works.
Libertarians would, of course, beg to differ.
According to Acemoglu and Robinson, the history of democracy is the history of revolutions prevented.
They think that all societies must begin as non-democratic regimes in which elites rule through extractive governments.
However, at some point, the ruled realize, to quote Marx, “The workers have nothing to lose but their chains.” And this is when they start pondering whether revolution is the optimal escape from their doom.
Since a revolution would cost the rich all of their benefits, the rich act so that they lose only some of them. Namely, they propose minor taxation rates and appropriate measures that won’t necessarily lead to revolution. In turn, this causes redistribution, which helps some of the ruled ones move vertically upward.
And this works until it doesn’t anymore – when the process restarts.
Thus, democratization happens when the rich try to avoid revolution by willingly increasing monetary redistribution and making some of the poor richer.
In time, this leads to the inclusion of many, and to the transformation of extractive institutions to inclusive ones.
Inclusive economic and political institutions do not emerge by themselves. They are often the outcome of significant conflict between elites resisting economic growth and political change and those wishing to limit the economic and political power of existing elites.
Interestingly enough, the analysis above implicitly suggests that foreign aid will more often do a disservice to a country rather than helping it.
In simpler terms, if a country is ruled by extractive institutions, foreign aid will rarely reach the intended addressees and will be used by the elites to corrupt even more people interested in defending the status quo.
An excellent example of this process is Afghanistan, a country that, despite billions of dollars in foreign aid, hasn’t prospered in almost two decades after the fall of the Taliban!
Why Nations Fail is both an engaging and thought-provoking read.
As we pointed out earlier, Jared Diamond, who has found many faults with the central thesis of developing countries operate, wants to put several things into perspective to help us see the big picture.
And we share his enthusiasm!
The key findings of the book may be a bit reductive and constraining, but it is nevertheless one which will be debated for many decades.
And what more can you ask from a book?
If you are interested in social and economic development, you should definitely check out Capital in the Twenty First Century. In it, you’ll find out what drives the economy and how our lives are impacted by social events.
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