Why are some countries rich and others poor? Why, despite the passage of nearly two hundred years since the Industrial Revolution, are some countries still struggling to provide basic necessities while others indulge in conspicuous consumption?

Why Nations Fail: The Origins of Power, Prosperity, and Poverty attempts to answer this question. It was written in 2012 by Daron Acemoglu, Killian Professor of Economics at MIT, and James A. Robinson, Pearson Professor of Global Conflict Studies at the University of Chicago.

Why Nations Fail
By Daron Acemoglu and James A. Robinson
Currency, New York, 2012

The main argument in Why Nations Fail is that differences in wealth and prosperity between nations are driven primarily by differences in their political and economic institutions. Not by differences in geography, or natural resources, or culture, or education, but by differences in institutions.  Over time, sometimes centuries, small institutional differences can result in dramatic divergences between countries.

OK, let’s dive in and unpack this.

Inclusive and Extractive Institutions

Acemoglu and Robinson define two types of political and economic institutions: inclusive and extractive.

They start with economic institutions, the rules and structures that determine how an economy works and the incentives it provides to motivate people.  Inclusive economic institutions:

“… are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish. To be inclusive, economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provide a level playing field in which people can exchange and contract; it also must permit the entry of new businesses and allow people to choose their careers.” [p. 74-75]

They call the opposite type of institutions extractive because they are “designed to extract income and wealth from one subset of society to benefit a different subset.” [p. 76]

Political institutions play a pivotal role too. The authors say that:

“Political institutions determine who has power in society and to what ends power can be used.” [p. 80]

Inclusive political institutions have two qualities.  First, they are pluralistic, that is, power is distributed broadly in society and there are constraints on the use of that power. Second, they are sufficiently centralized so that the state can enforce law and order, provide basic public services, and support economic activity. Without enough centralization, a society will descend into chaos.

The authors call political institutions extractive when they do not have both pluralism and sufficient centralization. North Korea is centralized but lacks pluralism. Somalia is pluralistic but lacks centralization. Both are extractive.

The US and Canada, Western Europe, Australia, Japan, South Korea and Botswana are all examples of societies with inclusive political and economic institutions.  Russia, most of Africa, much of South and Central America, and North Korea all have extractive institutions.  (I’ll come to China in a moment.)

Circles: Virtuous and Vicious

Acemoglu and Robinson argue there’s a feedback loop between political and economic institutions.  

In inclusive societies, that feedback loop forms a virtuous circle. Inclusive political institutions provide laws, and services and security that enable economic activity, especially risk taking and technological innovation, which the authors say (and I agree) is the main source of long-term economic growth. When the economic institutions are inclusive, growth is shared broadly. More people become more prosperous and they now have a stake in the proper functioning of society. They demand more representation and more inclusiveness in the nation’s political institutions and they form broad coalitions to achieve their goals. 

In extractive societies, the feedback loop becomes a vicious circle. The political institutions are structured to protect the interests and security of an elite few. There’s no desire for innovation because the “creative destruction” caused by new technologies threatens the businesses and livelihoods of the elite. So they structure economic institutions to stifle or prevent innovation. Economic growth eventually slows or even goes into reverse. Meanwhile, since so much of society’s economic wealth is concentrated in the hands of a few, there is a huge incentive to control the political institutions. This leads to in-fighting among rival factions within the elites – a cycle of coups with one elite group replacing another – illustrating the Iron Law of Oligarchy. Of course, these coups only reinforce the extractive institutions and bring no benefit to society as a whole.

The authors claim that the rich countries of the world almost always have inclusive political and economic institutions, and poor ones have extractive institutions. 

“The Contingent Path of History”

A natural question, then, is why haven’t more poor countries adopted inclusive institutions?  And a related question is how did the rich countries develop inclusive institutions in the first place?

Acemoglu and Robinson devote most of the book to answering these questions.

The short answer is luck.

Well, they call it “the contingent path of history” but that’s just an academic-sounding euphemism for luck.

They explore an impressive range of countries and time periods, including the Spanish conquest of South America, the founding of the American colonies, the Meiji Restoration in Japan, the devastating destruction caused by colonialism and the slave trade in Africa, and perhaps most importantly the origins of the Industrial Revolution in Great Britain. A truly astonishing amount of research has gone into this book.

They focus on the centuries-long transformation of Great Britain from a society built on extractive institutions to an inclusive one, because it was Britain the led the world into the Industrial Revolution and became one of the first modern inclusive, prosperous nations. They describe how a series of events starting with the Black Death, which is estimated to have killed nearly half the population of Europe, and including the victory of the British Navy over the Spanish Armada, the consequent rise of trans-Atlantic trade, the Glorious Revolution and the beginnings of the Industrial Revolution all contributed to the development of inclusive institutions in Britain.

None of these things were inevitable, they could have happened in Peru, or anywhere else really.

And that’s kind of a dismal conclusion because it means there is no recipe for making a poor country rich. First of all, in poor countries with extractive institutions, the powerful elites have no interest in evolving at all. And the transformation cannot be forced from the outside, for example by reforms dictated by the International Monetary Fund, or by foreign aid. It must come from within the country, with change rooted in local conditions, local history and starting from existing local institutions.  

While there’s no magic formula, and nothing is inevitable, the authors note that the common thread among those nations that have successfully evolved is empowerment: gradually spreading political and economic power to larger segments of society. It can take decades.

Here’s an example: According to gapminder.org, in 1965, per capita GDP in Egypt and South Korea was virtually identical: $2,320 in Egypt and $2310 in South Korea. South Korea adopted inclusive institutions after the Korean War while Egypt has remained a dictatorship, with a brief interruption during the Arab Spring. By 2018, per capita GDP in Egypt had grown to $11,800. But South Korea’s per capita GDP had shot up to $42,900. Even Botswana, which had per capita GDP of $989 in 1965 has surpassed Egypt with per capita GDP in 2018 of $17.800.

		Per Capita GDP
	Egypt	South Korea	Botswana
1965	$2,320	$2,310	$989
2018	$11,800	$42,900	$17,800

What About China?

China seems to be an anomaly. While there’s no questions its institutions have been extractive in the past, today you’d have to say that it seems to defy the authors’ model. Prosperity has been increasing since shortly after the death of Mao Zedong when China shifted towards a market-based economy. Yet the Chinese Communist Party is still in complete control of the country. In fact, under Xi Jinping, the Party seems to be extending its control. In other words, China has extractive political institutions yet, on the surface at least, inclusive economic ones.

The authors maintain that China is a fully extractive regime, that there are no secure property rights, for example. If a wealthy businessperson is not fully aligned with the Communist Party, their property can be confiscated, and they can be jailed or even executed.

They also assert that the impressive growth in China cannot be maintained, that inevitably, it must succumb to the stifling effects of its extractive institutions. 

I don’t agree. First it seems contradictory that Acemoglu and Robinson would say that there’s nothing inevitable about inclusive institutions evolving from extractive ones, yet at the same time maintain the inevitability of stalling growth. I’ve no doubt that growth in China will slow down, but that’s just because exponential growth is always temporary, as Vaclav Smil writes in his monumental book Growth (review). And I don’t see any signs of the Communist Party losing any of its power or control. History may prove the authors right, but it could take a very long time.

Unsolicited Feedback

Frankly, Why Nations Fail was a tough book to get through. It’s 462 pages long, dry, dense and kind of depressing.

I was familiar with some of the ideas in this book. They’re not the only authors to note the importance of institutions, laws and property rights. Michael Mandelbaum makes similar points in his historical book The Ideas That Conquered the World (review). So does economist Hernando de Soto in The Other Path, his study of the informal or underground economy of Peru (it’s is a terrific book, which I read it long before I started blogging.)

Why Nations Fail is as much about history as politics and economics. I learned about the histories of places and times that I knew nothing about and filled in some gaps in areas I was familiar with. A lot of this history is pretty dismal, especially the effects of colonialism on Africa and Southeast Asia. The British in particular, while they developed inclusive institutions at home, were utterly ruthless in establishing extractive institutions in most of their colonies.

This brings me to my first concern with the book. The main argument is that poor nations are poor because of their institutions, but that’s not the only cause of poverty. Nations can become poor because they are invaded, colonized, or just dominated by other nations. In other words, extractive institutions could be imposed upon them. The book shows how European colonialism in Africa left a legacy that many countries there are still recovering from. In South and Central America, Spain originally established extractive institutions in their colonies, but the US propped up many of them during the Cold War. Who knows how these places might have developed if left to themselves?  Similarly China’s Belt and Road initiative involves massive investments in the infrastructure of developing countries. It remains to be seen what impact this will have on their institutions and their prosperity.

Although the authors don’t say this explicitly, it’s pretty clear that inclusive and extractive institutions are not binary; they exist on a continuum. You could look at the US today and conclude that its institutions are actually quite extractive: they favor the wealthy and protect their interests at the expense of the poor and the non-white. More alarming, the trajectory in the US appears to be towards more extractive institutions. In fact, in every country there will always be tensions between incumbents and challengers in both the economic and political spheres. I do agree that more inclusive institutions provide better ways to mediate these tensions.

My strongest criticism of the book is that there is no analysis of the role played by the environment in economic and political development. The book was published in 2012 – that’s plenty recent enough for concerns about climate change to have been well understood. So how do environmental factors influence the trajectories of institutional development? Why Nations Fail doesn’t discuss this at all. In fact, there isn’t even a mention of the environment anywhere in the book.  

Climate change will put pressure on all nations, rich and poor. It will exacerbate conflicts between and within nations. It’s generally recognized, for example, that Syrian Civil War was at least partially caused by draught and crop failure brought on by climate change.  Syria has now fallen into chaos. I suspect other countries with extractive institutions will suffer the same fate as rival factions battle for control of water and other critical resources. That said, it’s not going to be easy for countries with inclusive institutions either, but they at least have mechanisms for resolving conflict without bloodshed. 

Ultimately, the message of Why Nations Fail is quite sobering. Countries are poor because they are built on extractive political and economic institutions. It’s very hard for them to break out of the vicious circle and develop the inclusive institutions they need to become more prosperous. They need a lot of time and a lot of luck.

This was a long one. Thanks for reading.