Monday, September 10, 2012

Why Nations Fail - The Origins of Power, Prosperity, and Poverty by Daron Acemoglu and James Robinson

Acemoglu and Robinson's Why Nations Fail is a thrilling read. It proposes answers to grand questions: Why are some nations rich? Why are others poor? Why are there such great disparities? Their theory is seductive -- yet it ultimately fails to give much guidance as to what can be done.

The key to prosperity, in the authors' view, can be found in a nation's political and economic institutions. The operative distinction is whether these institutions are extractive or inclusive. The most successful countries will have inclusive political and economic institutions; the most desperate will be afflicted with extractive institutions. Prescriptions seem tantalizingly accessible at first: simply replace extractive institutions with inclusive ones. But this is not so easy, Acemoglu and Robinson caution.

Labeling the 'bad' institutions extractive (as opposed to the more symmetrical 'exclusive') is a nice turn of phrase. Economists use the term extractive to describe economies that exploit endowments of valued natural resources, such as oil, gold or Mr. Kurtz's ivory, that are literally extracted. But the authors intend to characterize the relationship between the elites and the masses; elites 'extract' power and wealth from human resources through oppressive political and economic institutions.

In proposing an institutional account of prosperity, Acemoglu and Robinson reject cultural and geographic explanations. There is nothing peculiar about Northern European Protestantism (despite Weber's assertion) that suits it to the accumulation of wealth -- and folks living in temperate climes are not more industrious (or if they are -- they are not more likely to be successful). Technology is also non-determinative -- as opportunities for technological progress are frequently rejected by extractive states. Inclusive states -- the authors argue -- tend to be more receptive to new technologies, and hence enjoy the welfare gains innovation throws off.

It is a nation's institutions that matter. But despite the focus on institutions, institutions themselves (of the excellent inclusive variety) cannot assure prosperity unless a nation also possesses an adequate degree of 'centralization.' Acemoglu and Robinson do not clearly develop the notion of centralization -- and there seems to be some lingering tension between inclusivity (which diffuses power) and centralization (which focuses it). Centralization does seem to be a prior-in-time characteristic to the development of inclusive institutions in the examples explored in the book -- there exists a centralized nation that precedes the evolution of an inclusive, and so perhaps wealthy, nation.

The authors document the presence of extractive institutions in poor nations and inclusive institutions in rich ones. They describe vicious and virtuous cycles, respectively. These cycles describe both the reinforcement of tendencies between political and economic institutions, as well as a nation's trajectory over time. Of course, there should be more to the theory that this -- or we would find most nations tending toward one or the other pole (depending on the character of their historic institutions), with rare reversals of national fortunes.

In fact, the authors acknowledge, there are mixed cases -- and the most important one is today's China, which displays stunning recent growth that is restricted by extractive political and economic institutions. The authors are sanguine about China's emergence as a superpower; rather they predict that China has or will soon reach inclusivity limits imposed by its elites in order to maintain extractive conditions. In the long run, the authors believe, authoritarian regimes will falter -- and they cite the Soviet Union as the prime example. Of course, China may change institutional course, unleashing a process of creative destruction (and reallocating wealth and power within Chinese society) that might keep China growing. But in the absence of institutional change, they view a Chinese slowdown as an inevitability. We'll see.

In many other examples, where the historical record is more complete, the authors make more persuasive cases. They offer illustrations where former European colonies retain the extractive institutional legacies of their former masters. Far too frequently newly independent states have been captured by indigenous elites that prefer to maintain their holds on power by permitting an opening of civic life that would bring both greater wealth and more dynamic politics.

The authors are quite modest as to claims of their theory's predictive power -- there are many contingencies that could push China (or any other state) toward or away from wealth-inducing inclusive institutions. Yet the authors are quite confident of the power of their theory in accounting for many historic cases of wealthy and impoverished nations. To admit the theory cannot predict is to concede that it fails to fully capture the causes of wealth; at best it can serve to identify necessary elements. But without knowing more of how these elements (inclusive institutions) interplay with other, yet unidentified factors, leaves the reader with some doubts as to how complete a theory this really is.

Why Nations Fail is longlisted for the 2012 Financial Times and Goldman Sachs Business Book of the Year Award.

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