For many years it has been customary to say that institutions lie at the basis of different growth rates in different societies. But then the logical next question appears to be: What institutions are conducive to growth? One of the great strengths of this work is that it spells out what those institutions are. They turn out to be a familiar list: property rights, the rule of law, markets, competition, and a willingness to embrace creative destruction. But anyone wishing to claim a victory for laissez-faire would do well to ponder that they also include a strong state willing to, and capable of, providing an environment where contracting is secure, public goods are available, and critical externalities are internalized.
The authors’ basic thesis is that sustained economic progress results principally from having political and economic institutions that they characterize as “inclusive” rather than “extractive”. The terms constituted a problem for me. By “inclusive political institutions” they mean those in which political power rests with a broad coalition of groups, or “those that distribute political power widely in a pluralistic manner and [still] are able to achieve some amount of political centralization” (p.430). This is not the same as democracy, or rule by the majority, since although more democracy results in more inclusive institutions, one can envisage undemocratic institutions being fairly inclusive (as, they assert, in Britain in the eighteenth century) and minority rights being ruthlessly overridden under democracy (as, perhaps, in Venezuela today). But the opposite of “inclusive” is surely “absolutist” (those in which political power rests with a single individual), not “extractive”. Similarly, it is clear what one means by “extractive economic institutions”: those that “expropriate the resources of the many, erect entry barriers, and suppress the functioning of markets so that only a few benefit” (p.81), but quite unclear why their opposite is described as “inclusive” economic institutions. We shall use the term “inclusive” exclusively to refer to political institutions and “extractive” exclusively to refer to economic institutions. The core of their argument is that inclusive political institutions nurture growth and preclude extractive economic institutions. In other words, politics is key.
Extractive institutions are the historical norm, because usually those with the power to decide institutions find it advantageous to choose institutions that result in their personal enrichment. The problem rather is to explain how inclusive institutions have occasionally arisen. They explain this by historical accident (they describe it as a result of small differences caused by “historical drift” being magnified as a result of occasional “critical junctures”). They do not deny that growth is possible under non-inclusive institutions, but they assert that this growth is inherently limited, since they cannot conceive of the “creative destruction” that sooner or later will be necessary to sustained growth being allowed by an absolutist ruler. They establish all this by a very wide-ranging survey of historical developments, from which I learned a great deal[2], but at the end of the day one has to admit that their evidence is essentially anecdotal.
An important argument in the book is that the countries that industrialized in the nineteenth century were those that had already developed the inclusive institutions that are essential. Japan had, but China hadn’t. Western Europe had, but Eastern Europe hadn’t. The United States had, but Mexico hadn’t. Australia had, but the Ottoman Empire hadn’t. New Zealand had, but Africa hadn’t. I had always assumed that the reason Western Europe, the United States, and the white dominions industrialized early was that they had a dense network of personal contacts to Britain, on account of their being geographically and/or culturally close. (This leaves Japan as the great exception, which shows, so I argued, and will continue to argue, that development was possible when there was a ruler who knew about it and wanted it.) The idea that the Ottoman Empire failed to industrialize because its rulers knew how to industrialize but did not want to strikes me as implausible, to say the least. But the claim that Bechuanaland (the predecessor to Botswana) did not industrialize due to the malevolence of its leaders rather than because of ignorance runs directly counter to the story told in the book (pp. 404ff).
I am one of those who regard anecdotal evidence such as that presented in the book as quite legitimate, but it is not the only form of evidence. One should also supplement this by econometric evidence when it is available. It happens that there has been extensive econometric investigation of a closely-related topic, namely the (two-way) relationship between democracy and development. One of the findings of that literature is that the hypothesis (their hypothesis) that democracy favors development is ranked probable but far from a certainty[3]. Now Acemoglu and Robinson are careful to say that their theory is about inclusive political institutions, rather than democracy, as the generator of growth, and they emphasize the fact that the two concepts differ. Nevertheless, this appears to be the closest that the literature has come to a formal investigation of their hypothesis, and it is not favorable to it. At the very least one would have expected them to note that a similar hypothesis has been extensively investigated in the empirical literature and to explain why they do not consider the refutation of that hypothesis decisive.
When I first heard of the hypothesis that development and democracy were related (in the 1980s), I was told the then-conventional wisdom, which was that development was only possible under a dictatorial regime. The reason was supposed to be that only a benign dictator who did not have to worry about his re-election prospects could demand sacrifices, and the examples cited were characters like Park Cheung-hee in Korea, Chiang Kai-shek in Taiwan, and Augustin Pinochet in Chile. I therefore waited with baited breath for these examples to be discussed by Acemoglu and Robinson, to learn how they had managed to develop relatively inclusive institutions despite being dictators. Only in the Korean case was there a treatment: I learned that South Korea had relatively inclusive institutions–because it was supported by the United States! (Try telling that to a Central American.)
Another important set of econometric investigations has been by way of the cross-country studies. It strains credulity to believe that if Acemoglu and Robinson were right there would have been no successful attempt to introduce a variable representing political inclusiveness, and that it would not by now be mandatory to include such a variable in undertaking a cross-country regression.
Near the end of the book there is a moving account of how Brazil has become a far more inclusive society because of Lula. That Brazil has become a more inclusive society seems to me undeniable, and that Lula helped the process along is also easy to agree. But the growth rate of this transformed society is not much over half of what it was during the “Brazilian miracle” when the military ran the country. This does not present a problem for those of us who believe that other things matter besides growth, but presumably it does for those who believe that growth is a function of political arrangements.
Or, to take another case, consider China and India. China has grown like mad for three decades, which seems like a long time for a country that cannot possibly, according to their theory, enjoy sustained growth. Presumably the authors are still waiting for the collapse of Chinese growth that is inevitable according to their reasoning. In contrast, India ought to have grown far faster, since it has democratic institutions. Perhaps they believe that, despite its democracy, India does not enjoy inclusive institutions?
Thus the basic thesis of the book, that economic developments are very much pinned down by the politics of the situation, is at best unproven.
I take it that there is now general agreement that sustained development benefits from the sort of institutions that they discuss. The critical question is how to promote the development of such institutions. In an earlier paper (with a coauthor), they had outlined four possible reasons why institutions might differ between one country and another (Acemoglu, Johnson, and Robinson 2005; see footnote 1): because different institutions are socially efficient in different countries; because of different ideological views of the leaders; historical accidents; and because of political conflicts between those inclined to the “inclusive” view and those who put number 1 first. Their preference was clearly for the final reason, but they allowed a role for the others. This is in contrast to the book, where no room is allowed for differences in (e,g.) ideology.
It is this that I find unreasonable, and unproven. That there are cases in which a single dictator or a narrow oligarchy runs a country in its own interests strikes me as terrifyingly likely. (Think of Mobutu in Zaire.) That underdevelopment is always explained this way is a much stronger, and more dubious, proposition. None of the 50+ African countries, with the possible exceptions of Botswana and Mauritius, have come close to developed status since achieving independence. Why did the other countries not do comparably well? Were they all run by egomaniacs? Yes, sometimes economically-irrational actions were undertaken in the attempt to hang on to power, but this does not prove that the rulers chose to maximize their rents instead of developing their countries[4]. It is consistent with what many of us suspect is the normal case, mixed motives.
In chapter 2 the authors assert that there are three ways (apart from theirs) of explaining underdevelopment: geography, culture, and ignorance. The “ignorance hypothesis” is assertedly believed by most economists (one suspects they mean most Washington economists). Yes, it is quite true that the normal way of presenting advice is to assume that one is educating. For the information of the authors, many Washingtonians are well aware that not every ruler is dominated by a concern to do the best for his people. We are also aware of the need to consider political incentives. We nevertheless find it useful to present policy advice as though the “ignorance hypothesis” were valid:
(a) Because there are always some rulers who wish the best for their people, rather than being cynically concerned only for number one.
(b) Because we suspect that most rulers have mixed motives: they are concerned both to further development of their people, and to remain in office and enrich themselves (indeed, they seem to be remarkably good at convincing themselves that their remaining in office is for the benefit of the people)
(c) Because the ruled may also read the reports, and press their rulers to act on them.
Doubtless inclusive institutions are helpful to growth, but that they provide most of the picture seems emphatically not proven.
[1] One of the advantages of retiring is that one has time to read, and one of the most interesting things that I have read so far is the above book: Daron Acemoglu and James A. Robinson, Why Nations Fail: The Origins of Power, Prosperity, and Poverty (New York: Crown Business, 2012). I also read, or re-read, two of the scientific papers on which the book is based: “Institutions as a Fundamental Cause of Growth”, Ch. 6 in the Handbook of Growth Economics, 2005, and “The Colonial Origins of Economic Development: An Empirical Investigation”, American Economic Review, 2001, both of which were coauthored also by Simon Johnson. Because of the overlap with much of my own recent work, I have decided to write a review. But because of the lapse of time since the book was published, I cannot imagine that any reputable publisher would wish to include a review in his/her publication. Hence I have decided to post the review on the web in the first of what I anticipate will be an occasional series of blog posts.
[2] In particular, I learned a great deal about African history of which I was previously completely unaware. For example, I previously attributed the successful development of Botswana to their wise use of the income from diamonds in contrast to the foolishness of most countries that have great natural wealth in fighting over the spoils, in complete ignorance of the historical background of relatively pluralist government and the fact that the fast growth started before the diamond discovery.
[3] A recent summary of the literature is provided in Doucouliagos, Hristos, and Mehmet Ali Ulubaşoğlu. 2008. “Democracy and Economic Growth: A Meta-Analysis”, American Journal of Political Science, 52(1), 61-83.
[4] On pp.66-67 there is an account of how Nkrumah maladministered the Ghanaian economy so as to buy political support instead of nurturing growth, which he is asserted to have known how to do. After that, they recall how his successor Busia was kicked out by the military when he undertook a much-needed devaluation of the kwacha, which is also supposed to prove that the rulers knew how to nurture growth and failed to do so in order to line their own pockets. The logic escapes me.
