It’s the politics, stupid!

The basic theory is very simple: Institutions are primarily responsible for economic development, world-wide and throughout history. Most common are “extractive” institutions which prevent development; “inclusive” institutions which permit persons to use their talents, to let them exploit productivity improvements and allocate the fruits of such efforts to these persons, promote development. Daron Acemoglu (MIT) and James Robinson (Harvard) have painstakingly argued this in a pathbreaking and impressive new book “Why Nations Fail. The Origins of Power, Prosperity and Poverty”, Profile Books, London 2012. This basic idea about the importance of institutions is complemented by Joseph Schumpeter’s idea of the necessity of “creative destruction” as the driver of technological development.

Societies which form inclusive political and social institutions, enabling inclusive economic institutions, become rich, since they enable the flourishing of human talent and the search for self-improvement. Extractive institutions have throughout history and across the world led to stagnation, since the dominant stratum of society, be it a monarch or a group of aristocrats, uses its dominance to extract surplus from the population for its own self-enrichment, thus stifling innovation and technological change, out of feat that these could reduce their power of exploitation. Such societies still have very rich masters, but very poor populations. The latters’ interest in productivity improvements is zilch, since they are (rightly) afraid that the fruits of extra efforts will be appropriated by their masters. Stagnant of even declining national wealth is the result.

AR describe these patterns using examples from antiquity and throughout the world up to today. They describe ancient Rome and states in the Congo, the exploitation of the old Aztek and Maya cultures through Spain, the North American conquest and expansion towards the Pacific, the Ottoman Empire and England, the West African suppliers of slaves and the US South, Russia and the Soviet Union, Austria-Hungary and the “Arab Spring” – and many more. In all these examples they show development and stagnation, depending on the type of institutions existing or coming about. They talk about a number of “critical junctures”, significant events, which may enable or make necessary significant change. If these junctures meet inclusive institutions, or are used to form such institutions, they can become the springboard for positive development. However, if they go hand in hand with extractive institutions, stagnation is maintained, albeit in different form. Examples for such junctures are e.g. the black plague which reduced Europe’s population by around half. In Western Europe, this reduced labour supply increased the bargaining power of the remaining workers and led them to demand (and succeed) in having many of their feudal burdens (which in many instances required them to deliver up to 90% of their produce to their respective lords) reduced, while in Austria-Hungary, and Russia this led to the development of serfdom, tied to the land indentured labor. Serfs, like slaves, cannot move, cannot employ their various talents and thus have no incentive to work even more or think about productivity-enhancing techniques. Another critical juncture was the development of Atlantic and Indian trade which created a class of merchants with eventually significant stakes in reducing the monopoly power of the English king. Large agglomerations of Aztec and Maya populations were used by their Spanish explorer/exploiters to work them in mines and plantations. Where such population agglomerations were absent, different modes prevailed (Argentina, Chile). Another significant juncture was the “Glorious Revolution” of 1688 which removed the exploitative Stuarts and brought in William and Mary of Orange whose deal with the rebels was to create much more inclusive institutions, sharing power and wealth. This led to the arguably most critical juncture of all, the Industrial Revolution which established English pre-eminence of an industrial power until World War I. According to the authors, it was the liberty of Englishmen, their more participatory system, the budding rule of law and protection of property rights which enabled so many of them to make path-breaking inventions and innovations. Austria-Hungary and Russia did not – until much later and much less – build railroads and encourage innovation for fear that the dominant power of their monarchies might become threatened. Result: backwardness and poverty. Critical was also the Bolshevik Revolution which enabled growth by forcibly transferring massive resources from agriculture to manufacturing (with ensuing starvation to death of some 30 million peasants), but foundered eventually for lack of inclusive institutions and a disinterested population. In the end, the inability of the Soviet Union to adjust to the tripling of oil prices in 1973 led to its eventual demise.

The authors show the vast inventiveness of ruling elites to bend the rules of society and economy to their own advantage, throughout history and across the globe. They show in multiple examples that the best ideas are to no avail, unless they go hand in hand with inclusive political and economic institutions. It took the authors fifteen years of research to amass this stupendous amount of material. Very impressively, they use their knowledge in a way which reads like a novel – in very simple language. No tables, no footnotes inhibit the stream of knowledge transfer – even though they have read everything of relevance. 26 pages of bibliography and 17 pages of bibliographic essay show that this is a work of deep scientific analysis. 20 maps help the reader to grasp the authors’ ideas.

 Acemoglu and Robinson dismiss the more traditional explanations for successful development. They reject out of hand Jeffrey Sachs’ hypothesis of the importance of geography (why is North Korea dirt-poor and South Korea rich, why is Nogales in Arizona rich, its sister across the Mexican border in Sonora poor?), they refute the idea that it is the original richness in flora and fauna which determines long-term wealth. They dismiss the “ignorance” hypothesis by pointing out that many post-colonial African leaders studied in the rich West and employed a plethora of Western advisers, but frequently decided to maintain and strengthen the previous colonial extractive institutions, this time to their own personal benefit. They show that knowledge of good economics (whatever that may be, KB) is useless, unless it goes hand in hand with basic societal change which promotes participation, safety, property rights, instead of feeding the elites’ luxurious lifestyles (Mobutu).

 I would like to lodge two types of criticism towards this impressive book. One concerns the authors’ very dismissive assessment of developments in China. Consistent with their main thesis, they dismiss the idolisation of autocratic market developments. In their view, China’s path is not “sustainable” and will break down because of a lack of inclusive institutions. However, I think that 30 years of more than 10% growth, the lifting of more than 300 million persons out of abject poverty, is an impressive record. How much longer must this persist, in order to be classified as “sustainable”? I concur that China has many problems it must solve in the future, not least those connecting to this impressive past growth. But a closer assessment does show that China’s elites are aware of these problems and will loosen their grip on society slowly, hopefully not too slowly. It is clear that such change towards more inclusive institutions will reduce the power of the Communist party. The question to ask is whether the party will accept this and at what speed. I do think that this will happen and the fear of the authors that the party will prevent this loss of influence will not come to bear.

 Another weakness (if it may be called this in the face of this impressive book) is the lack of any analysis of the contemporary West. Yes, we have the freest and most inclusive institutions in history, yes, we have democracy and participation, we have material incentives and free movement of labor, we can work where our talents and efforts are cherished most (what about the unemployed?). But this freedom has been used by an exploitative financial sector which threatens the whole system. Is this a regression towards a more extractive society? Are new financial actors the new aristocrats who exploit the rest of the economy to their own benefit? Does this throw us back into quasi-feudal times where we all work in order to maintain and enrich the financial elite? These developments of the last 30 years have reversed all the gains in income distribution achieved since the end of WWII. At present we do not yet see any significant efforts to reduce the economic and political power of the financiers and investors. A new “creative destruction” is necessary to safeguard our wellbeing. Of course, there are a number of other points one could lodge against this book. But its main hypothesis is very convincing and amazingly argued with lots and lots of material. Economic betterment for the many is only possible if they can participate in political decision-making. Only then do they have an incentive to use their creativity and effort. The well-meaning monarch who dispenses the one or the other coin on the occasion of his anniversary, does not improve mankind. There are still too many of such monarchs. And: most of them are not even well-meaning.


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2 responses to “It’s the politics, stupid!

  1. Andreas Breitenfellner

    According to another theory it was low (not high) oil prices that contributed to the collapse of the Soviet Union:

    • kurtbayer

      Andreas: I was talking about the inability of the S.U. to react to the tripling of oil prices in 1973. Of course, this was not the only reason for the collapse of the S.U., but strengthens the authors’ thesis that extractive institutions a la S.U. impede initiative, adjustment and innovation

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