Economic growth and technological change are accompanied by what the great economist Joseph Schumpeter called creative destruction. They replace the old with the new. New sectors attract resources away from old ones. New firms take business away from established ones. New technologies make existing skills and machines obsolete.
Why Nations Fail
Wikipedia
https://en.wikipedia.org/wiki/Why_Nations_FailWhy Nations Fail
Why Nations Fail: The Origins of Power, Prosperity, and Poverty, first published in 2012, is a book by economists Daron Acemoglu and James A. Robinson. The book applies insights from institutional economics, development economics and economic history to understand why nations develop differently, with some succeeding in the accumulation of power and prosperity and others failing, via a wide range of historical case studies.
The authors also maintain a website (with a blog inactive since 2014) about the ongoing discussion of the book.
Context
The book is the result of a synthesis of many years of research by Daron Acemoglu on the theory of economic growth and James Robinson on the economies of Africa and Latin America, as well as research by many other authors. It contains an interpretation of the history of various countries, both extinct and modern, from the standpoint of a new institutional school. The central idea of many of the authors’ works is the defining role of institutions in the achievement of a high level of welfare by countries. An earlier book by the authors, The Economic Origins of Dictatorship and Democracy, is devoted to the same, but it did not contain a large number of various historical examples.
The authors enter into an indirect polemical dispute with the authors of other theories explaining global inequality: the authors of the interpretations of the geographical theory Jeffrey Sachs and Jared Diamond, representatives of the theory of ignorance of the elites Abhijit Banerjee and Esther Duflo, Seymour Martin Lipset and his modernization theory, as well as with various types of cultural theories: the theory of David Landes about the special cultural structure of the inhabitants of Northern Europe, the theory of David Fischer about the positive influence of British culture, with the theory of Max Weber about the influence of Protestant ethic on economic development. They most harshly criticized geographical theory as “unable to explain not only global inequality in general”, but also the fact that many countries have been in stagnation for a long time, and then at a certain point in time began a rapid economic growth, although their geographical position did not change.
Simon Johnson co-authored many of Acemoglu and Robinson’s works, but did not participate in the work on the book. For example, in a 2002 article, they showed through statistical analysis that institutional factors dominate culture and geography in determining the GDP per capita of different countries. And in the 2001 article they showed how mortality among European settlers in the colonies influenced the establishment of institutions and the future development of these territories.
Content
Conditions for sustainable development
Beginning with a description of Nogales, Arizona, and Nogales, Sonora, the authors question the reasons for the dramatic difference in living standards on either side of the wall separating the two cities. The book focuses on how some countries have managed to achieve high levels of prosperity, while others have consistently failed. Countries that have managed to achieve a high level of well-being have demonstrated stable high rates of economic growth for a long time: this state of the economy is called sustainable development. It is accompanied by a constant change and improvement of technologies — a process called scientific and technological progress. In search of the reasons why in some countries we observe this phenomenon, while others seem to have frozen in time, the authors come to the conclusion that for scientific and technological progress it is necessary to protect the property rights of wide strata of society and the ability to receive income from their enterprises and innovations (including from patents for inventions). But as soon as a citizen receives a patent, he immediately becomes interested in that no one else patented a more perfect version of his invention, so that he can receive income from his patent forever. Therefore, for sustainable development, a mechanism is needed that does not allow him to do this, because together with the patent he receives a substantial wealth. The authors come to the conclusion that such a mechanism is pluralistic political institutions that allow wide sections of society to participate in governing the country. In this example, the inventor of the previous patent loses, but everyone else wins. With pluralistic political institutions, a decision is made that is beneficial to the majority, which means that the inventor of the previous one will not be able to prevent a patent for a new invention and, thus, there will be a continuous improvement of technologies. The interpretation of economic growth as a constant change of goods and technologies was first proposed by Joseph Schumpeter, who called this process creative destruction. In the form of an economic model, this concept was implemented by Philippe Aghion and Peter Howitt in the Aghion–Howitt model, where the incentive for the development of new products is the monopoly profit from their production, which ends after the invention of a better product. Since only pluralistic political institutions can guarantee that the owners of existing monopolies, using their economic power, will not be able to block the introduction of new technologies, they, according to the authors, are a necessary condition for the country’s transition to sustainable development. Another prerequisite is a sufficient level of centralization of power in the country, because in the absence of this, political pluralism can turn into chaos. The theoretical basis of the authors’ work is presented in a joint article with Simon Johnson, and the authors also note the great influence of Douglass North‘s work on their views.
The authors support their position by analyzing the economic development of many modern and already disappeared countries and societies: the USA; medieval England and the British Empire; France; the Venetian Republic; the Roman Republic and the Roman Empire; Austria-Hungary; Russian Empire, USSR and modern Russia; Spain and its many former colonies: Argentina, Venezuela, Guatemala, Colombia, Mexico and Peru; Brazil; colonial period of the Caribbean region; Maya civilization; Natufian culture; the Ottoman Empire and modern Turkey; Japan; North Korea and South Korea; the Ming and Qing empires, and modern China; the sultanates of Tidore, Ternate and Bakan, the island state of Ambon and other communities on the territory of modern Indonesia, and the consequences of the impact of the Dutch East India Company on them; Australia; Somalia and Afghanistan; the kingdoms of Aksum and modern Ethiopia; South Africa, Zimbabwe and Botswana; the kingdoms of the Congo and Cuba, and the modern Democratic Republic of the Congo; the states of Oyo, Dahomey and Ashanti, and modern Ghana; Sierra Leone; modern Egypt and Uzbekistan. Reviewers unanimously note the wealth of historical examples in the book.
Contrasting two types of institutions
The decisive role for the development of countries, according to the authors, is played by institutions — a set of formal and informal rules and mechanisms for coercing individuals to comply with these rules that exist in society. Acemoglu and Robinson divide institutions into two large groups: Political and economic. The first regulate the distribution of powers between the various authorities in the country and the procedure for the formation of these bodies, and the second regulate the property relations of citizens. The concept of Acemoglu and Robinson consists in opposing two archetypes: the so-called. “extractive” (“extracting”, “squeezing”) and “inclusive” (“including”, “uniting”) economic and political institutions, which in both cases reinforce and support each other.
Inclusive economic institutions protect the property rights of wide sections of society (not just the elite), they do not allow unjustified alienation of property, and they allow all citizens to participate in economic relations in order to make a profit. Under the conditions of such institutions, workers are interested in increasing labour productivity. The first examples of such institutions are, for example, the commenda in the Venetian Republic and patents for inventions. The long-term existence of such economic institutions, according to the authors, is impossible without inclusive political institutions that allow wide sections of society to participate in governing the country and make decisions that are beneficial to the majority. These institutions that are the foundation of all modern liberal democracies. In the absence of such institutions, when political power is usurped by a small stratum of society, sooner or later it will use this power to gain economic power to attack the property rights of others, and, therefore, to destroy inclusive economic institutions.
Extractive economic institutions exclude large segments of the population from the distribution of income from their own activities. They prevent everyone except the elite from benefiting from participation in economic relations, who, on the contrary, are allowed to even alienate the property of those who do not belong to the elite. Examples include slavery, serfdom, and encomienda. In the context of such institutions, workers have no incentive to increase labour productivity, since all or almost all of the additional income will be withdrawn by the elite. Such economic institutions are accompanied by extractive political institutions that exclude large sections of the population from governing the country and concentrate all political power in the hands of a narrow stratum of society (for example, the nobility). Examples are absolute monarchies and various types of dictatorial and totalitarian regimes, as well as authoritarian regimes with external elements of democracy (constitution and elections), which are so widespread in the modern world, where power is supported by power structures: the army, the police, and dependent courts. The very fact that there are elections in a country does not mean that its institutions cannot be classified as extractive: competition can be dishonest, candidates’ opportunities and their access to the media are unequal, and voting is conducted with numerous violations, and in this case the elections are just a spectacle, the ending of which is known in advance.
Analysis of the economic development of different countries
Acemoglu and Robinson analyze the factors that contribute to the success or failure of states in their book. They argue that commonly cited explanations such as geography, climate, culture, religion, race, or the ignorance of political leaders are insufficient.
To support their thesis, the authors compare case studies of different countries. They highlight examples like
North and South Korea, where similar factors led to divergent economic outcomes. They also examine border cities to analyze the impact of institutional environments on prosperity.
The main argument of Acemoglu and Robinson is that
inclusive economic and political institutions are crucial for economic prosperity. Inclusive institutions allow for broad participation in decision-making and provide incentives for talent and creativity. On the other hand,
extractive institutions, which benefit a small elite, hinder economic growth.
The authors use historical examples, such as the Glorious Revolution in Great Britain, to illustrate the importance of democratic pluralism for economic development. They also discuss
China’s economic boom, attributing it to increasingly inclusive economic policies.
According to Acemoglu and Robinson, economic growth can lead to changes in political institutions. They caution that if China does not improve its political balance, it may face a collapse similar to the Soviet Union in the 1990s.
Theories
The book explores two main theories. The first theory examines the factors that drive democratic and dictatorial regimes. The second theory delves deeper into how democratic regimes foster economic growth, while dictatorial regimes hinder it.
Drivers of democracy
Acemoglu and Robinson’s theory on the driving forces behind democracy is based on their previous work in game theory. Their paper examines the historical democratization of Western Europe and Latin America and highlights the role of revolution threats and elite desires for economic redistribution in the transition to democracy.
The authors make several assumptions in their game theoretic model. They assume that society is divided into a rich class and a poor class, that regimes are either democratic or nondemocratic, and that people’s preferences are solely based on monetary redistribution. They also consider people’s concerns for future redistribution and the fluctuation of a country’s economic output. Additionally, individuals in society aim to maximize their own utility.
In their model, a country starts as a nondemocratic society where a small rich group controls the wealth and rules over the poor majority. The rich determine the taxation rate and the poor can either accept the redistribution offered or choose to revolt, which comes with a cost. The outcome of the game depends on the rich’s taxation proposal and the poor’s decision to revolt or not.
Democratization occurs when the rich voluntarily increase monetary redistribution and franchise to the poor to avoid revolution.
The analysis suggests that the constant threat of revolution motivates the wealthy to democratize. This theory aligns with a paper by Clark, Golder, and Golder, which discusses how governments decide whether to exploit or protect citizens based on the benefits, while citizens can choose to leave, stay loyal, or voice their concerns through protests. Similarly, this game also provides insights into how variables like exit payoff, cost of voicing and value of loyalty change state’s behavior as to whether or not to predate.
How democracy affects economic performance
The second part of the story in Why Nations Fail explores the connection between inclusive political institutions and economic growth. This idea was previously discussed in a paper by Acemoglu and Robinson titled Institutions as the Fundamental Cause for Long-Run Growth. Acemoglu and Robinson’s theory explains the varying levels of economic development in countries using a single framework.
Political institutions, like a constitution, determine the written distribution of political power, while the distribution of economic resources determines the actual distribution of political power. Both the written and actual distribution of political power impact economic institutions and how production is conducted. They also shape future political institutions. Economic institutions also determine the distribution of resources for the future. This framework is time-dependent, as today’s institutions determine tomorrow’s economic growth and institutions.
For example, before the Glorious Revolution, political power in Europe, particularly in England, was concentrated in the hands of the monarch. However, the increasing profits from international trade led to the emergence of a commercially engaged nobility and a rising merchant class. These groups played a significant role in the economy and contributed a substantial portion of tax income to the monarch. As a result, political and economic institutions began to favor the merchant class, eventually leading to the downfall of the monarchical system in England and the establishment of efficient economic institutions.
In another paper with Simon Johnson at Massachusetts Institute of Technology called The Colonial Origins of Comparative Development: An Empirical Investigation, the authors use a natural experiment in history to show that different institutions result in different levels of economic growth. They analyze the institutional choices made during the colonial period of several nations and their impact on present-day economic development. The study reveals that in countries where the disease environment made it difficult for colonizers to survive (high mortality rate), they established extractive regimes, resulting in poor economic growth today. Conversely, in regions with lower mortality rates, colonizers settled down and replicated institutions from their home countries, as seen in the successful colonization of Australia and the United States. Therefore, the mortality rate among colonial settlers hundreds of years ago has determined the economic growth of present-day post-colonial nations by setting them on divergent institutional paths.
The theory of interaction between political and economic institutions is further reinforced by Acemoglu, Johnson and Robinson in The Rise of Europe: Atlantic Trade, Institutional Change, and Economic Growth, which covers the economic rise of Europe after 1500. The paper shows that the Transatlantic trade after 1500 increased profits from trade and thus created a merchant class that was in a position to challenge monarchical power. Through regression analysis, the authors also reveal a significant interaction between the Atlantic Trade and political institutions. Specifically, the presence of an absolutist monarch hinders the economic impact of the Atlantic Trade. This explains why Spain, despite having access to the same trade, lagged behind England in economic development.
Acemoglu and Robinson have explained that their theory is largely inspired by the work of Douglass North, an American economist, and Barry R. Weingast, an American political scientist. In North and Weingast’s paper in 1989, Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-Century England, they conclude that historical winners shape institutions to protect their own interests. In the case of the Glorious Revolution, the winning merchant class established property rights laws and limited the power of the monarch, which essentially promoted economic growth. Later on, North, Wallis and Weingast call this law and order open access, in their 2009 paper Violence and the Rise of Open-Access Orders. With open access, equality and diversity in thought—societies are more able to flourish and prosper.
Whether it is North Korea, Sierra Leone, or Zimbabwe, well show that poor countries are poor for the same reason that Egypt is poor. Countries such as Great Britain and the United States became rich because their citizens overthrew the elites who controlled power and created a society where political rights were much more broadly distributed, where the government was accountable and responsive to citizens, and where the great mass of people could take advantage of economic opportunities.
Where was innovation to come from? We have argued that innovation comes from new people with new ideas, developing new solutions to old problems. In Rome the people doing the producing were slaves and, later, semi-servile coloni with few incentives to innovate, since it was their masters, not they, who stood to benefit from any innovation. As we will see many times in this book, economies based on the repression of labor and systems such as slavery and serfdom are notoriously noninnovative. This is true from the ancient world to the modern era. In the United States, for example, the northern states took part in the Industrial Revolution, not the South. Of course slavery and serfdom created huge wealth for those who owned the slaves and controlled the serfs, but it did not create technological innovation or prosperity for society.
All of this highlights several important ideas. First, growth under authoritarian, extractive political institutions in China, though likely to continue for a while yet, will not translate into sustained growth, supported by truly inclusive economic institutions and creative destruction. Second, contrary to the claims of modernization theory, we should not count on authoritarian growth leading to democracy or inclusive political institutions. China, Russia, and several other authoritarian regimes currently experiencing some growth are likely to reach the limits of extractive growth before they transform their political institutions in a more inclusive direction—and in fact, probably before there is any desire among the elite for such changes or any strong opposition forcing them to do so. Third, authoritarian growth is neither desirable nor viable in the long run, and thus should not receive the endorsement of the international community as a template for nations in Latin America, Asia, and sub-Saharan Africa, even if it is a path that many nations will choose precisely because it is sometimes consistent with the interests of the economic and political elites dominating them.