Why nations fail or succeed: what this year’s Economics Nobel winners worked on

Why are some nations rich and others poor? Why do some nations fail while others succeed in achieving prosperity? These are questions that have puzzled economists for decades.

Over the years, many explanations have been put forward — everything from biology to geographical location to climatic conditions to evolution has been offered as the reason why some nations have done better than others. Of course, since many nations that are relatively poor today weren’t so in the past (some were in fact, quite rich), any particular answer also depends on what time period is considered when analysing the question.

Yet the question itself remains relevant. As the Academy noted: “The richest 20 per cent of the world’s countries are now around 30 times richer than the poorest 20 per cent. Moreover, the income gap between the richest and poorest countries is persistent; although the poorest countries have become richer, they are not catching up with the most prosperous. Why?”

…And the answer

This year’s laureates in the economic sciences have demonstrated the importance of societal institutions for a country’s prosperity. By institutions, the laureates refer to the broad set of rules that govern the behaviour of individuals in a society or a country. “Societies with a poor rule of law and institutions that exploit the population do not generate growth or change for the better,” states the citation.

The three laureates have distinguished between inclusive and extractive institutions. An inclusive institutional framework refers to the existence of democracy, law and order, protection of property rights, etc.

By contrast, an extractive institutional framework typically refers to a lack of rule of law, of power being concentrated in the hands of a few (autocracy or dictatorship), and the associated risks of expropriation.

These two opposite types of institutional frameworks lead to very different incentives for people in an economy or society.

For instance, if people are assured that their property will not be taken away at will, or that their incomes and profits will be protected for generations, they tend to focus on boosting long-term growth and prosperity. In the absence of an inclusive institutional framework, the incentives collapse, undermining longer-term prosperity.

Available evidence

How do we know that the causality flows from the existence of institutions to economic prosperity and not the other way round? Moreover, how can one be sure that there is a causality at all? Further, rich countries are different from poor countries in many ways — not just in the type of institutions they have — and these differences could, in turn, be affecting both their institutions as well as their economic growth.

The laureates examined the European colonisation of large parts of the world, and summarised their findings in a paper titled ‘The Colonial Origins of Comparative Development: An Empirical Investigation’, which was first published in The American Economic Review in 2001.

They found that one important explanation for the current differences in prosperity is the political and economic systems that the colonisers introduced, or chose to retain, from the 16th century onward.

More precisely, they found that “in some colonies, the purpose was to exploit the indigenous population and extract natural resources to benefit the colonisers”, while in other cases, “the colonisers built inclusive political and economic systems for the long-term benefit of European settlers”.

This effect can be understood in relation to what happened in India under British rule. As the Academy notes, as late as the mid-18th century, industrial production in what is now India was higher than in the US. “This has changed fundamentally since the start of the nineteenth century, which speaks to the reversal primarily being a result of differences in institutions. The technical innovations sweeping across the world were only able (to) take hold in places where institutions had been established that would benefit the wider population,” it says.

Rationale for choices

Why did the colonisers choose to have one set of rules (institutions) in one colony and another set in another colony? The researchers found that the choice of institutions by the colonisers — regardless of who they were — was linked to their mortality.

If the chances of their being killed were high — either because the local population was large in numbers and capable of killing or because the region was home to diseases like malaria — the colonisers chose extractive institutions because they were unwilling to settle down in the colony. If instead the mortality rate was low, they chose inclusive institutions that gave people a say, an ability to build a future, and possibly even a fortune.

Present-day India

Independent India is run in accordance with its Constitution. It holds regular and fair elections, and has an independent judiciary and a vibrant mainstream and social media.

In 2013, soon after the release of Acemoglu and Robinson’s book Why Nations Fail: The Origins of Power, Prosperity, and Poverty, Arvind Subramanian, who later became India’s Chief Economic Advisor, wrote an article in American Interest, where he argued that neither India nor China fit this narrative.

That’s because China had grown quite rich despite not having any inclusive institutions, while India had barely grown notwithstanding all its inclusive institutions — and together these two countries accounted for a third of humanity.

The counter, as Subramanian noted in his piece, could be that China’s growth spurt is just a matter of the past three decades, and India could achieve its economic potential in the next three — even as China falters in the absence of inclusive institutions. To some extent, both these things have happened.

On Monday, Acemoglu was asked about the state of institutions in the US and the rest of the world. He said: “If you look at the data collected by international organisations such as Freedom House, V-Dem (Varieties of Democracy) or others, they show that institutions everywhere (in the world) are getting weaker and weaker. If you look at data from surveys that ask people their views about authoritarianism, dictatorship, democracy, and so on, you see that support for democracy is at an all time low… I think it is a time when democracies are going through a rough patch and it is crucial that they regain the high ground of better and cleaner governance and delivering the promise of democracy to a broad range of people”.