Book Review: Why Nations Fail
WhyNationsFailIn Why Nations Fail1 Daron Acemoglu & James Robinson maintain that it is the political and economic institutions that make the difference between success and failure of nations, rather than Adam Smith’s An enquiry into the nature and causes of the wealth of nations (1776), which was to shape economic theory for a long time. In short, a fascinating read which strikes a note of caution.

The book starts with an example, the city of Nogales, Arizona where people have an annual average income of USD 30,000. Most teenagers are in school, the population is healthy, life is safe. Further south meanwhile, in Sonora the average household income is USD 10.000, many teenagers do not go to school, infant mortality is high, roads are bad, crime is high.

How could 2 geographically close neighbourhoods be so different? There is no difference in geography, climate, ancestry. The authors sustain that the reason of the differences are the institutions on the 2 sides of the border that create very different incentives for their inhabitants. It is the political process that determines under which economic institutions people live.

Let’s take another example : the Conquistadores wanted to extract South America’s gold. They thus created a web of institutions designed to exploit the indigenous people, for their sole benefit.

Somewhat later, the English began their colonization of North America. The native Indians were few and unwilling to cooperate. There was no gold. The settlers thus realized they had to work to survive. The only option for a viable colony was to create institutions that gave the colonists incentives to work hard and invest.

This example and many others in the book are the basis of the theory that it is politics and political institutions that determine what economic framework a country has, which are crucial in determining if a country is rich or poor.

Extractive political and economic institutions concentrate power in the hands of a narrow elite, with few constraints on this power. Economic institutions are often structured by this elite to extract wealth from the rest of the society. The elite has little incentive to enforce secure property rights, provide basic public service, law and order etc. This is not conductive to sustained growth.

Inclusive political and economic institutions provide equal opportunities to all. Power is broadly distributed in society and prevents arbitrary. This creates a more equitable distribution of resources and the incentives that make a society prosperous. It follows that different institutions have different consequences for the wealth of a nation, how it is distributed and who has power.

Sustained economic growth is almost always accompanied by technological improvements that allow people and capital to become more productive.This is accompanied by creative destruction, which replaces the old with the new. New technologies make existing skills and machines obsolete. Creative destruction creates winners and losers.

Fear of this creative destruction is the main reason for the opposition to the inclusive political and economic institution. For example, in XIX century Europe, the traditional elites lived from agriculture, monopolies and entry barriers. They were clear economical and political losers in the industrialization, which they opposed. Growth is therefore only possible if the economic losers do not block it.

The central thesis of this book is that economic growth and prosperity are associated with inclusive economic and political institutions, while extractive institutions typically lead to stagnation and poverty.

Extractive system examples are plenty fold: former colonies, former communist countries, most of Africa.

Inclusive systems examples are the UK, which started the movement during the industrial revolution, the US, South Korea, Japan and most of Western Europe.

The move from extractive towards inclusive system starts at critical junctures which are historical turning points, such as the Great Plague (1350), which wiped out about half of the European population. The massive scarcity of labor created by the Great Plague shook the foundation of the feudal order. Another critical juncture was the start of the Atlantic trade, which led to greater pluralism in England, while strengthening monarchs in France and Spain. At such critical junctures, small differences in organization became very consequential for the future.

The world’s history is dominated by extractive systems, albeit with some early trials of inclusive institutions, such as those of the Republican Rome, or Venice, between 810 and 1324.

England was the first nation to move towards inclusive institutions, after the Glorious Revolution of 1688, which led the way to pluralism. Thereafter, the government guaranteed property rights (including patents) thereby stimulating innovation, and enforced law and order.

England was therefore ideally placed to take full advantage of the Industrial Revolution, while the other countries lagged behind.

The book further analyzes the histories of a large number of countries, to conclude that extractive political and economic systems can have growth, like the USSR between 1925 and the seventies, but cannot sustain it, as they cannot generate sustained technological change, because of the lack of economic incentive and resistance to change by the elites.

In China, the communist party is an extractive political institution. Property rights are not secure, creative destruction is centralized. The growth rests on cheap labor. The authors maintain that this will not bring sustained growth and is likely to run out of steam.

Similarly, foreign aid to Africa is a dismal failure as its nations have extractive political and economic systems which absorb most of the aid. Lack of property rights, law and order, secure legal system and dominance of an elite are the roots of poverty. Continued foreign aid should be made dependent on a move towards inclusive institutions.

The book is riveting. It however fails to mention the current critical junction (IT & globalization) and the causes of the current crisis.

Failure by governments to reduce their expenses and, consequently, their indebtedness is, in my view, criminal, as are the constant erosion of property rights, law and order, infrastructure and free media. Combined they push the system back towards extractive institutions.

In short, a fascinating read which strikes a note of caution.

Alexandre Paternotte de La Vaillée

1Why Nations Fail - The Origins of Power, Prosperity and Poverty, Daron Acemoglu & James A. Robinson, Faber & Faber, February 2013