Why Some Countries Are Rich And Some Poor And How Inclusive Institutions Can Make A Difference

Renowned economists, Daron Acemoglu (of MIT) and James A Robinson (now of University of Chicago) have written a sweeping account of world history for the general audience - Why Nations Fail: The Origins of Power, Prosperity and Poverty (2012). Their main objective is to answer the questions: Why is there inequality in the world? Why are some countries rich and some poor?

Many theories have been proposed in recent times to answer these questions. One is the geography hypothesis which claims that geographical differences lie behind the great divide between rich and poor countries. For instance, French political philosopher Montesquieu proposed that people in tropical countries tend to be lazy and lack inquisitiveness. Furthermore, such lazy people tend to be ruled by despots. That hot countries are intrinsically poor is still supported by economists such as Jeffrey Sachs. This, however, does not explain how Singapore, Malaysia and Botswana advanced in recent times.

The ecologist Jared Diamond suggested that intercontinental inequality originates in different historical endowment of plant and animal species which influenced agricultural productivity. Thus Africa did not have domesticable animals and hence remained backward. Acemoglu and Robinson state that while Diamond's thesis is powerful, it does not explain modern world inequality. Modern world inequality, according to them, is more due to "uneven dissemination and adoption of technologies".

Another explanation of world inequality is the culture hypothesis. Max Weber, the influential German sociologist, for instance, argued that it was the Protestant ethic that spurred the rise of modern industrial society in Western Europe. Thus Africans are poor because they lack such an ethic and are superstitious and are resistant to Western technologies.

Acemoglu and Robinson debunk the culture hypothesis as well. By giving an example of the former Kingdom of Kongo, they show that the Kongolese did not adopt the technologies like the plough because they lacked incentives to do so. All their output was being expropriated and taxed by the king and there were no property rights. The authors state: "Neither did the king have incentives to adopt the plow on a large scale or to make increasing agricultural productivity his main priority; exporting slaves was so much more profitable."

Furthermore, none of the economic successes of East Asia have anything to do with the Protestant ethic.

Finally, some people have bought into the ignorance hypothesis which states that the rulers of poor countries just do not know how to make their countries rich. The authors show that countries are not poor because their rulers are ignorant but that their priorities lie elsewhere.

What then is the cause of inequality? Acemoglu and Robinson have a thesis: "Countries differ in their economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people."

Thus countries which have inclusive institutions (those that have secure property rights, an unbiased system of law, public services and the freedom to contract and exchange) will prosper while countries that have extractive institutions (which are "designed to extract incomes and wealth from one subset of society [the masses] to benefit a different subset [the governing elite]") will deteriorate.

To support this thesis, the authors present accounts from world history - from the rise and fall of the Roman Empire to the disappearance of the Mayas to the French Revolution and the Glorious Revolution to the rise of Japan and China. It proves to be a mind-blowing intellectual expedition.

What about India? Can India's status as a developing country be explained by their thesis? The authors contend that the "uniquely hereditary caste system " and "strong form of absolutism under the Mughal rulers" were serious impediments to the development of inclusive economic institutions in India. "By the nineteenth century, things were even less hospitable for industrialization as India became an extractive colony of the English."

This has been extended to post-Independence times by Abhijit V Banerjee and Esther Duflo in their book Poor Economics (2011): "[Countries like India] inherited from the colonial period a set of institutions that were put in place by colonial rulers not for the development of the country but to maximize the extraction of resources for the benefit of the colonial powers. After decolonization, the new rulers found it convenient to hold on to the same extractive institutions and use them for their own benefit, thereby setting off a vicious cycle....[F]ormer colonies where the disease environment prevented large-scale settlements by Europeans tended to have worse institutions during colonial times (because they were naturally picked for being exploited from afar), and these bad institutions continued after decolonization."

Why do extractive institutions persist for long? Why don't the rulers take steps to make them more inclusive? The greatest fear that rulers have is that of "creative destruction" (the concept introduced by the great economist Joseph Schumpeter) that would make them irrelevant or worse deprived of their assets. It is this fear, according to the authors, that force the rulers to maintain the status quo.

Acemoglu and Robinson take on the currently fashionable "modernization theory" which states that inclusive institutions will emerge as a by-product of the growth process as citizens become richer and more educated. The authors disagree citing the examples of China, Gabon, Saudi Arabia and Venezuela that modernisation does not mean that the country will grow more inclusive. Hence these countries may not be able to sustain their prosperity.

Acemoglu and Robinson contend that there is no easy or sure-fire way to make countries more inclusive. You just "can't engineer prosperity". Hence they are wary of claims by many economists that massive foreign aid alone will solve the problem. Inclusive economic and political reforms are needed to break out of the cycle of poverty. Empowerment on a large scale can be a way of accomplishing this. Media can go a long way in bringing about the empowerment.

When it was released in 2012, Why Nations Fail was met with a furore of debate and discussion. There were also criticisms of the book. Jeffrey Sachs, for instance, criticised the book's unidimensional approach and stated: "[Acemoglu and Robinson] have ... promulgated a simplistic explanation of why countries have succeeded or failed. The evidence suggests that economic development is a multi-dimensional dynamic process, in which political, institutional, technological, cultural and geographic factors all play a role." Jared Diamond's review, while largely positive, commented that "inclusive institutions, while not the overwhelming determinant of prosperity that [the authors] claim, are an important factor. Perhaps they provide 50 percent of the explanation for national differences in prosperity." Bill Gates, in his blog, called the book "a major disappointment" and found the analysis "vague and simplistic". Gates, of course, is a strong believer in aid.

The criticisms notwithstanding, this is a very important book and it will definitely contribute to the ongoing economic debate on inequality and how to approach it.