Beyond Institutions: A Comprehensive Approach to Understanding Economic Disparities Among Nations.
This analysis, based on Prashanth Perumal’s article “A Nobel for Explaining Why Nations Fail” from The Hindu (October 16, 2024), explains how Nobel laureates Acemoglu, Robinson, and Johnson give a strong reason for why some countries are rich and others are poor. They focus on how different kinds of institutions, called inclusive and extractive, shape a country’s economy. However, their idea misses other important factors like geography, culture, and global influences, showing that we need a broader understanding to explain why nations succeed or fail.
The question of why some nations succeed economically while others remain trapped in poverty has fascinated scholars for centuries. Nobel laureates Daron Acemoglu, James A. Robinson, and Simon Johnson offer a compelling explanation based on the role of institutions in determining a country’s economic fate. Their theories, especially outlined in the book Why Nations Fail (2012) and other works, argue that institutions—both political and economic—shape the long-term prosperity of nations. Inclusive institutions, which encourage broad participation and fairness, lead to sustainable economic growth, while extractive institutions, which concentrate power and wealth in the hands of a few, often result in stagnation and poverty. Although their thesis provides important insights, it has its limitations, particularly in its narrow focus on institutions and its failure to fully account for other factors, such as geography and culture. In this essay, we first explore the Nobel laureates’ ideas, using examples from South Asia, before critically examining their limitations.
The Importance of Institutions in Economic Development
The primary argument put forth by Acemoglu, Robinson, and Johnson is that the success or failure of nations is fundamentally tied to the nature of their institutions. Inclusive institutions are those that provide security, promote democracy, and protect property rights. These systems encourage innovation, entrepreneurship, and broad-based participation in economic activities. In contrast, extractive institutions are designed to enrich a small elite while restricting opportunities for the majority of the population. They often undermine incentives for innovation and limit economic growth.
One example frequently cited by the laureates is the comparison between North and South Korea. Despite sharing the same cultural and geographic background, North Korea’s extractive political regime has resulted in widespread poverty, while South Korea’s inclusive institutions have driven rapid economic growth and technological advancement. Similarly, the divergent paths of the United States and Mexico in the 19th century underscore how inclusive institutions can foster innovation and long-term prosperity.
The laureates’ work builds on the foundation laid by earlier economists, such as Douglass North, who argued that institutions are the “rules of the game” that shape human behaviour. If individuals are assured that their property and rights are secure, they have more incentive to invest and work hard, leading to greater prosperity. However, if they fear expropriation by the state or other elites, their motivation to participate in economic activities diminishes.
Examples from South Asia: Inclusive vs. Extractive Institutions
The experiences of South Asia provide valuable examples of how institutions influence economic outcomes. After gaining independence in 1947, India established democratic institutions that promoted inclusive participation in political and economic life. Though economic growth was initially slow, the economic reforms of the 1990s, which included deregulation and privatisation, allowed for broader participation in the economy, resulting in rapid growth. This demonstrates the laureates’ argument that inclusive institutions are crucial for sustained development.
In contrast, Pakistan’s political instability and frequent periods of military rule have led to the establishment of extractive institutions. These systems have concentrated wealth and power in the hands of a small elite, stifling innovation and discouraging investment. As a result, Pakistan has struggled to achieve the same level of economic growth as India. Bangladesh, on the other hand, made significant strides in the 1990s by moving towards more inclusive institutions, particularly in the garment sector, leading to both economic growth and poverty reduction.
These examples from South Asia illustrate the Nobel laureates’ thesis that inclusive institutions are key to long-term economic development, while extractive institutions hinder progress. However, these cases also demonstrate the importance of other factors, such as political stability and external economic pressures, in shaping a nation’s success.
Criticism of the Institutional Thesis
Despite the laureates’ compelling arguments, their institutional thesis has drawn criticism for being overly simplistic. One major critique is that their theory focuses too narrowly on institutions as the primary drivers of economic success, while downplaying other critical factors such as geography, culture, and historical circumstances.
Geography, for instance, has played a significant role in shaping economic outcomes. The colonial strategies of European powers were often influenced by the geographical characteristics of the regions they controlled. In areas with dense populations, such as Mexico, colonists established extractive institutions to exploit local labour. In less densely populated areas like North America, more inclusive institutions were set up, promoting long-term economic growth. This geographical influence on institutional development suggests that the relationship between institutions and economic outcomes is more complex than the laureates’ theory acknowledges.
In addition, cultural factors have historically influenced the functioning of institutions. Social norms and historical legacies often shape how institutions operate and evolve over time. For example, deeply ingrained systems of hierarchy or patronage can persist even within formally inclusive institutions, limiting their effectiveness. Thus, a purely institutional analysis might overlook the important role that culture plays in shaping a nation’s economic trajectory.
The Short-Term Success of Extractive Institutions
Another important critique of the laureates’ thesis is its failure to account for the short-term economic successes that can occur under extractive regimes. While Acemoglu, Robinson, and Johnson emphasise the long-term inefficiencies of extractive institutions, historical evidence suggests that such systems can sometimes generate rapid economic growth, at least in the short run.
For instance, both Soviet Russia and Maoist China experienced periods of significant industrialisation and economic expansion under highly centralised, extractive regimes. However, these gains were not sustainable, and both countries eventually faced economic stagnation or collapse. This suggests that extractive institutions can, under certain conditions, foster rapid growth, even if such growth is not sustainable in the long term.
The Middle-Income Trap and Institutional Reform
A further limitation of the laureates’ thesis is its applicability to countries caught in the so-called “middle-income trap.” Many nations, such as Turkey and Chile, have achieved moderate economic success but struggle to transition to higher levels of prosperity. These countries often exhibit a mix of inclusive and extractive institutions, which allow for some growth but prevent the economy from reaching its full potential.
Acemoglu and his colleagues argue that deep institutional reform is necessary to escape the middle-income trap, but this is easier said than done. Elites who benefit from extractive institutions are often deeply entrenched and resistant to change. The global economic environment can also influence whether reforms succeed or fail, making institutional change a more complex process than the laureates’ theory suggests.
Conclusion
The Nobel laureates’ explanation of why nations succeed or fail based on the nature of their institutions offers a valuable framework for understanding the long-term economic trajectories of countries. Their distinction between inclusive and extractive institutions provides important insights into how political and economic systems shape development. Historical examples from South Asia and other regions demonstrate the validity of their thesis, particularly the importance of inclusive institutions in fostering growth and prosperity. However, their focus on institutions as the primary determinant of economic success overlooks other important factors such as geography, culture, and global dynamics. Furthermore, their thesis fails to fully account for the short-term economic gains that can occur under extractive regimes or the complexities of institutional reform in countries caught in the middle-income trap. Ultimately, while institutions are undoubtedly a crucial element in determining a nation’s economic trajectory, a more comprehensive theory of development would consider a broader range of factors. By integrating geography, culture, and global economic trends into the analysis, we can gain a fuller understanding of why some nations succeed while others fail.
