How Inclusive Institutions Make The World Go Round
SY BSc Economics
Source: Indian express
What makes a country prosperous? Why are some countries rich, and why some fail to provide even the basic needs to their citizens? Why did the industrial revolution happen in England instead of France or Spain? These are some questions economists and political science experts have debated over since the dawn of free trade.
Authors Daron Acemoglu and James A. Robinson try to answer throughout the collection of research articles called “Why Nations Fail”. They attempt to establish an underlying theory for understanding wealth and power around the world and throughout history.
For decades developmental scientists and economists have had questions about why some countries are prosperous. Many explanations have also emerged. Some of the hypotheses blame the geographies of the country, some hold its culture responsible, and most rely on the ignorance theory. But the authors systematically question the viability of these theories and effectively disprove them with examples of countries that have broken these narrow moulds.
Geography and Culture and the Knowledge Problem
The first hypothesis states that tropical countries do not achieve high economic growth. This is disproved when we look at the economic success of Singapore or Japan as democratic nation states. The Second hypothesis views a country’s culture as the decisive factor in the country’s economic development. Still, this theory also does not hold water as the regions with the same culture have different financial circumstances like North and South Korea. The final hypothesis is the ignorance hypothesis, which states that the ruling class of a poor country is incompetent or ignorant, which is why the country is poor. By far, the ignorance hypothesis rules supreme among most economists and western policymaking circles. Still, a more careful examination of the theory reveals that it is not the ignorance of a leader but the political and economic incentive to please interest groups and extract resources for themselves that is the reason leaders of poor countries make bad economic choices. All of these theories do highlight parts of the problem but fail to give a general explanation.
Institutions, Institutions, Institutions
Through a story about two billionaires, one in America and one in Mexico, the authors present an elegant theory: Inclusive institutions.
The key to a nation’s success is inclusive political and economic institutions. From the Glorious Revolution in 1688, which gave parliament power from the monarchy to the Declaration of Independence in the United States to the growth of Botswana, it is perceptible that the most critical factor for a nation’s prosperity is its institutional structure. Inclusive structures prevent overexploitation of resources and give freedom to its citizens to flourish. Inclusive institutions are characterised by rights like access to education, freedom of expression, relatively free and competitive markets, and property rights. Countries that do not have inclusive institutions are called extractive. These are generally under authoritarian regimes like Venezuela under Hugo Chavez or Zimbabwe under Robert Mugabe. The extractive institutions in these countries are only made for a small elite to benefit from. These countries provide little incentive for education or business, no free market or have markets with high monopolies, and narrow income distribution.
Economic institutions vs Political Institutions
Any country has two separate institutions, political and economic. To achieve sustained growth, both of these should be inclusive. Sometimes there is growth in countries with extractive political institutions like China because they modify their economic institutions to become a little more inclusive, but that growth is not sustainable. Extractive countries do not have sustained development because any growth occurs by exploiting only existing technology as there is little incentive for innovations. There has to be technological change and creative destruction for sustained growth, and this type of change is impossible because the elites fear change and prevent free markets from emerging.
Critical Junctures: The Good, The Bad and The Ugly
Inclusive institutions emerge from critical junctures throughout history that can change. These junctures are essentially a turning point for society.
The start of pluralism in England happened because the plague had wiped out a significant proportion of the population. The labour class took advantage of this situation and demanded better pay and shorter hours; workers gained more power through this juncture. This occurrence was the birth of the prosperous merchants class, which opposed royal control on taxes and demanded liberalisation of trade, leading to free markets and private property. This would eventually lead to the transfer of power from the monarchy to a parliament.
Why did this only happen in England and not in France or Spain, which also had parliaments? Because the power of taxes was never given to the parliament in France or Spain and there was no chance for a free market to emerge.
A critical juncture is where there is a chance for a country’s institution to change. Although sometimes, this very juncture is when many prosperous nations turn their existing inclusive institutions into extractive. It is not always as good as the English revolution. Like in the case of Venice in the 14th century, when the elite class did not like the growing middle class, which was gaining their wealth through free trade, they stopped the entry of new people in business by setting up monopolies and substantial entry barriers. This act was the beginning of the end of Venice as the trade centre of the world and its affluence. Extractive institutions ultimately fail because for every elite ruling, there is a group waiting to take their place. The people who are in power, therefore, despise change. So many countries and kingdoms fail because of infighting between the ruling class. The Roman empire collapsed because the internal conflict gave outsiders a chance to seize power.
For growth, countries have to have a certain level of centralization because, without it, there will be no one to enforce the law. Only when a broad cross-section of society is involved in the decision-making process, and there is a certain degree of centralization, will there be growth.
Virtuous and Vicious Cycles and how we break them
Countries with extractive institutions plunge into a vicious cycle of poverty and exploitation, and countries that have inclusive institutions get into a virtuous cycle of growth and prosperity. Countries like the United States, Australia, or Canada give significant incentives for innovation and competitive markets which do their job. Countries like Zimbabwe or Sierra Leone, or North Korea manage to create just enough wealth for the elite to fight over and the citizens to aspire to become the next perpetrator.
However, there is a way to break this cycle by creating integrative institutions. Botswana, one of the poorest sub-Saharan countries at the time of its independence with only seven km of paved road and 22 graduates, is now the fastest-growing economy in Africa. It holds regular elections, has property rights, and there is access to education and medical care. It quickly established inclusive institutions. The leaders of Botswana chose to make institutions that did not just meet their greed but those which met society’s needs. In other words, the politics of a country matters as much for the economy as economics itself. What countries like the USA or Canada, or Switzerland can do is to help developing nations build more robust institutions. Foreign aid can be of help but is a temporary solution for an enduring problem.
This field of research is dense with history, politics, and competing theories. Every argument is presented with enough evidence to meet the burden of proof. For a subject as glum as this, Acemoglu and Robinson’s work is hugely captivating and enriching. Even though they are sometimes simplistic and vague in their policy advice, they do not fail to establish their theories. You will most probably come out as a new person when you read about institutions and origins of power without being isolated from economics. I have started to strive for a big change. Hopefully, so will you.
To read more on Acemoglu and Robinsons work please visit