Why Nations Fail

Overall summary:

Developed countries are wealthy because of ‘inclusive economic institutions’ — Basically a combination of state and free market in which

1. The state creates incentives for people to invest and innovate — (through guaranteeing private property rights and enforcing contract law)
2. The state enables investment and growth through providing education and infrastructure, which private business uses, and
3. The state is controlled by its citizens, rather than monopolised by a small elite. Crucially, there needs to be a democratic principle at work in which people in politics establish institutions and laws which work for the majority of people, rather than just working to make them rich.
4. The state also needs to maintain a monopoly on violence.

The authors come to this conclusion through a number of comparative studies of countries which are in close geographical proximity to each other such as

• Mexico/ America
• South/ North Korea
• Botswana/ Zimbabwe

They argue that the only factor which can explain why one of these countries is poor and the other rich is because of the institutional infrastructure which has been established through the last few decades/ centuries.

In contrast to the above ‘inclusive economic institutions’ which encourage development, the authors suggest the opposite ‘extractive economic institutions’ (think corrupt dicator and his clique sucking money into a Swiss bank account) can generate growth in the short-term, but in the long term result in poverty.

They also suggest that there has been ‘a vicious circle’ at work in many underdeveloped countries over the last three to four centuries — With their globalised history starting off with extractive institutions established by a colonial power (typically built on already existing internal extractive institutions), which, on independence, became even more extractive under postolonial rulers, which in turn lead to civil war as competing factions fought for control over the extractive institutions — which then led to a decent into chaos and failed states. The authors see little hope for such countries.

In contrast, developing countries such as the US and the UK have benefitted from three to four centuries of a virtuous circle in which institutions have become gradually more inclusive, which has created increasing incentives for entrepeneurialism and economic growth.

Chapter 1

“The United States today is also far richer than . . . [third world countries] . . . because of the way its institutions, both economic and political, shape the incentives of businesses, individuals and politicians.”

“Each society functions with a set of economic and political rules created and enforced by the state and the citizens collectively. Economic institutions shape economic incentives; the incentives to become educated, to save and invest, to innovate and adopt new technologies and so on. It is the political process that determines what economic institutions people live under, and it is the political institutions that determine how this process works.”

“. . . it is politics and political institutions that determine what economic institutions a country has.”

Chapter 2

Three theories of development are offered, described and rejected in this chapter as valid explanations for world income/wealth inequality.

Geography Hypothesis

Culture Hypothesis

Ignorance Hypothesis

The first considers differing climate and factor endowments with particular attention to the view of Jared Diamond regarding initial plant and animal endowments.

The second is one that considers culture as a set of social norms and conventions and as such would seem to be a part of institutional analysis of change. Culture as manifest in religion and nationalism are rejected as useful explanations for change.

The final theory is considered and presented as the most dangerous of explanations. If only the “right” leader or elites can control society, then the ignorance of proper development policy can be overcome.

After reviewing these theories the chapter concludes with a call for economics to “understand how different types of policies and social arrangements affect economic incentives and behavior.”

Chapter 3

Acemoglu and Robinson use the Korean pennisula in their argument advancing institutions (political then economic) as the basis for economic change or lack of change.

To be inclusive, economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it must permit the entry of new businesses and allow people to choose their careers.”

The authors go on to argue that the list above: “ . . . all reply upon the state, the institution with the coercive capacity to impost order, prevent theft and fraud, and enforce contracts between private property.”

The authors might well have spent some time here discussing and distinquishing between formal institutions (state police power) and informal institutions (trust, adherence to the state, etc) to extend this point. The US experience, as that of other countries [advanced (open access or inclusive) and natural (extractive)] have indicated that the state is challenged in its effort to prevent theft and fraud, particularly in the face of informal institutional norms and conventions that encourage fraud.

After the public institutions and public works necessary for the defence of the society, and for the administration of justice, both of which have already been mentioned, the other works and institutions of this kind are chiefly those for facilitating the commerce of the society, and those for promoting the instruction of the people. The institutions for instruction are of two kinds: those for the education of youth, and those for the instruction of people of all ages. The consideration of the manner in which the expence of those different sorts of public, works and institutions may be most properly defrayed will divide this third part of the present chapter into three different articles.

“All economic institutions are created by society.”

The remainder of this chapter provides a useful analysis of the costs and benefits of creative destruction to society and the rent seeking behavior as agents in both inclusive and extractive societies acting to prevent private losses that inevitably result from this process.

Chapter 4

In a chapter that argues for the importance of path dependence through an examinination of history and, what the authors call, “small” differences, it is an odd choice to begin with an analysis of the Black Plague — a far from small difference.

However, the argument seems to be that, however small the distinctions may be between societies, there are moments in history — critical junctures — that offer the opportunity for a change in the path of development.

“The richly divergent patterns of economic development around the world hinge on the interplay of critical junctures and institutional drift. Existing political and economic institutions — sometimes shaped by a long process of institutional drift and sometimes resulting from divergent responses to prior critical junctures-create the anvil upon which future change will be forged.”(109–110)

In simple terms, is institutional drift a valid/useful mechanism to apply to understanding the process of economic change?

Chapter 5

. . .sustained growth requires technological change,”

Extractive institutions are so common in history because they have a powerful logic: they can generate some limited prosperity while at the same time distributing it into the hands of a small elite. For this growth to happen, there must be political centralization.”

Chapter 6

This key chapter analyzes the nature of institutional drift, critical junctures and the evolution toward or away from inclusive institutions.

Most societies have historically been and continue to be extractive in nature

Inclusiveness is fragile and easily can be reversed

Small institutional differences and critical junctures are ephemeral

The role of the “moral sense” and the dimly understood manner in which this sense develops seems to be a key variable in the movement toward inclusiveness.

Chapter 7

This chapter again seems to channel Schumpeter’s creative destruction — “Conflict over institutiosn and the distribution of resources has been pervasive throughout history.”(184)

The authors go on to examine England, the Glorious Revolution and the Industrial Revolution as an illustration of a “turning point” from extractive to inclusive institutions.

That is, the answer to Why England? sees to remain an open question and the institutional response presented in this chapter is one of a number of alternatives rather than the conclusion.

In any event, the overview in this chapter does connect political change and technological change in an interesting manner.

Chapter 8

This chapter concludes, in a section titled, Enduring Backwardness, with a further description of the role that extractive institutions play in incentivizing elites to reject emerging technologies, the process toward modernization and industrialization. A continuum of political institutions from absolutism to failed states (Somalia, Afganistan, etc) can lead to firmly entrenched extractive institutions.

“Inclusive political and economic institutions necessitate some degree of political centralization . . . .”

Chapter 9

Acemoglu and Robinson argue that the dual economy is an artifact of colonization and the process by which extractive institutions are imposed.

“World inequality today exists because during the nineteenth and twentieth centuries some countries were able to take advantage of the Industrial Revolution and the technologies and methods of organizations that it brought while others were unable to do so.” (271)

The authors argue that the “underdeveloped” societies were “unable” to participate in rising income and wealth due to growth as a result of extractive institutions (slavery is the example explored in this chapter) imposed by European colonization.

Chapter 10

It seems intuitive that inclusive institutions would serve to promote the exchange and the diffusion of technology, ideas, activity, and wealth. Acemoglu and Robinson see the roots of the initial divergence in world progress in the industrial revolution and the degree to which institutions in various parts of the world incentivized industrialization.

“Successful long-term development therefore requires a two-pronged push. It requires an industrialization drive, accompanied by the steady accumulation of human capital and institutional capabilities to sustain services-driven growth once industrialization reaches its limits. Without the industrialization drive, economic takeoff becomes quite difficult. Without sustained investments in human capital and institution-building, growth is condemned to peter out.

But this time-tested recipe has become a lot less effective these days, owing to changes in manufacturing technologies and the global context. First, technological advances have rendered manufacturing much more skill- and capital-intensive than it was in the past, even at the low-quality end of the spectrum. As a result, the capacity of manufacturing to absorb labor has become much more limited. It will be impossible for the next generation of industrializing countries to move 25% or more of their workforce into manufacturing, as East Asian economies did.

Second, globalization in general, and the rise of China in particular, has greatly increased competition on world markets, making it difficult for newcomers to make space for themselves. Although Chinese labor is becoming more expensive, China remains a formidable competitor for any country contemplating entry into manufactures.

Moreover, rich countries are unlikely to be as permissive towards industrialization policies as they were in the past. Policymakers in the industrial core looked the other way as rapidly growing East Asian countries acquired Western technologies and industrial capabilities through unorthodox policies such as subsidies, local content requirements, reverse engineering, and currency undervaluation. Core countries also kept their domestic markets open, allowing East Asian countries to export freely the manufactured products that resulted.”

Chapter 11

Chapter 10 points to the rule of law as a key emergent institution that once in place can lead to virtuous circles.

“Once in place, the notion of the rule of law not only kept absolutism at bay but also created a virtuous circle: . . .” (308)

The previous discussion in the book outlines why this key institution is a fragile one that can easily be overcome by special interests seeking extractive rather than inclusive institutions. And, importantly, Acemoglu and Robinson point out:

“While the virtuous circle creates a tendency for inclusive institutions to persiste, it is neither inevitable nor irreversible.” (309)

The authors conclude this chapter and introduce the next on vicious circles by asserting that while there is a strong tendency for both types of circles to be self reinforcing, the tension between the two is strong and if there is a tipping action it may well be in the direction of vicious circles.

Chapter 12

“. . . vicious circles create powerful forces toward the persistence of extractive institutions. History is not destiny, and vicious circles are not unbreakable. They create a powerful process of negative feedback, with extractive political institutions forging extractive economic institutions, which in turn create the basis for the persistence of extractive political institutions.” (365) This argument is developed via exemplification in this chapter with examples ranging from African countries to the American south. The chapter ends with the assertion that this vicious circle — “engender continuous infighting and civil wars” (366–7 due the motivation of special interest groups (the iron law of oligarchy) to snatch control of extractive institutions.

Chapter 13

Why nations fail today?

The short answer — extractive institutions which are the legacy of colonalism. I am not convinced — and while the authors use examples of European colonies that developed inclusive institutions — US and Australia in contrast to the majority of European colonies that evolved with extractive institutions, I was unable to detect the mechanism — what caused this difference? It seems that geography might be the answer -the US and Australia had large land masses that were quickly depopuluated of native populations — is that the mechanism? If so, going back to the 3 theories reviewed and rejected by Acemoglu and Robinson early in the book, isn’t this then evidence for geography as the key determinant?

Chapter 14

This chapter uses example to explore the possibilities and challenges of transition from extractive to inclusive institutional framework.

North, in his recent work, is pessimistic in his evaluation of the transition from natural state (extractive) to open access (inclusive) social order.

Chapter 15

The authors summarize their 2 part theory -

Distinction between extractive and inclusive institutions — the institutional component of their theory and —

Mechanism for the emergence of inclusion in a world historically characterized by extraction.

The theory seems to rest on the idea of circles — vicious ones that support extractive institutions (which tend to persist and can generate short term growth) and virtuous ones that support inclusive institutions.