WHY NATIONS FAIL
Recently 3 economists (Daron Acemoglu, Simon Johnson, and James Robinson) were awarded the Nobel Prize for their research into how the nature of institutions helps explain why some countries become rich and others remain poor. Interesting “stuff” for my Economics blog, so I decided to write a piece on it. The subject also concerns Governance, which is on the Topics I spend time writing about but also give masterclasses on.
The Nobel Committee praised the trio for explaining why “societies with a poor rule of law and institutions that exploit the population do not generate growth or change for the better.”
Why Are Some Nations Poor and Other Rich?
Why do some nations enjoy prosperity while others remain trapped in poverty? This age-old question has been the subject of countless debates, economic theories, and political discussions. While there are many factors that contribute to the wealth or poverty of nations, the works of Daron Acemoglu, Simon Johnson, and James Robinson—specifically in their book Why Nations Fail—provide a framework to understand this issue. These economists argue that the fundamental driver of national prosperity or poverty is the nature of a country’s institutions. According to them, inclusive institutions lead to wealth, while extractive institutions lead to poverty.
Furthermore the economists hold that, political power shapes economic outcomes. When political institutions are inclusive, they create economic systems that benefit the majority. When power is concentrated in the hands of elites, the economy is structured to serve their interests.
In this blog, I will dive into their ideas, exploring the economic, political, and historical reasons why some nations have developed rich economies while others remain underdeveloped. I leave it up to the reader of this blog to ponder on what type of institutions, and political and economic mechanisms we have on Curacao and if this is one of the causes of our social-economic situation.
The Importance of Institutions
The central argument proposed by Acemoglu c.s., is that institutions—both political and economic—are the key determinant of a nation’s prosperity. Their work moves away from earlier theories that emphasized geography, culture, or even individual leadership as the primary factors driving economic growth. Instead, they focus on the structure and design of a country’s institutions, and by extension the type of people that hold power in these institutions.
They make a critical distinction between two types of institutions: inclusive and extractive.
| INCLUSIVE INSTITUTIONS | EXTRACTIVE INSTITUTIONS |
| Inclusive institutions are those that encourage participation in economic activities by the broadest possible segment of society. They are characterized by a rule of law that applies equally to all, the protection of private property, and economic policies that incentivize innovation and entrepreneurship. Inclusive political institutions are those that distribute power broadly and provide checks and balances on rulers, ensuring accountability and limiting the potential for abuse.
Countries that have inclusive institutions tend to experience sustained economic growth. The United States, Western Europe, and Japan are often cited as examples of nations with inclusive institutions. These nations provide their citizens with opportunities to pursue education, start businesses, and own property, all which fuel economic dynamism and social mobility. |
Extractive institutions, on the other hand, are designed to benefit a small elite at the expense of the broader population. These institutions concentrate political power in the hands of a few, enabling them to extract wealth from the rest of society. Economic policies in extractive institutions do not incentivize innovation or entrepreneurship because the benefits of such activities are often appropriated by the ruling class.
Many nations that are poor today, such as those in Sub-Saharan Africa or parts of Latin America, suffer from extractive institutions. These nations have historically been ruled by small elites, often remnants of colonial regimes, who use their control of political power to enrich themselves while keeping the general population in poverty. |
The Historical Roots of Wealth and Poverty
One of the most compelling aspects of their work is how they explore the historical roots of institutions and their long-term effects on national development. Their research indicates that the origins of current institutions often trace back to specific historical events and decisions that have had lasting consequences. Historical Contingency Matters. The authors argue that historical events and “critical junctures” (e.g., wars, revolutions, colonization) can set nations on different trajectories by altering their institutions, for better or worse.
Colonialism’s Lasting Legacy
Colonialism played a significant role in shaping the institutions of many modern nations. The authors argue that the type of colonialism imposed by European powers often determined whether a nation would end up with inclusive or extractive institutions.
In regions where European settlers could live comfortably, such as the United States, Canada, and Australia, colonizers tended to establish inclusive institutions. Settlers had an interest in creating societies with a stable rule of law, property rights, and a degree of political participation. These nations, after independence, carried forward these inclusive institutions, which eventually became the foundation of their modern prosperity.
In contrast, in regions where European settlers faced high mortality rates—such as much of Africa, Latin America, and parts of Asia—colonizers established extractive institutions designed to exploit the local population and resources. European powers imposed centralized and authoritarian structures that allowed them to extract wealth without investing in local development. After these countries gained independence, the newly established local elites often maintained or even intensified the extractive nature of these institutions, preventing long-term economic development.
An interesting aspect of their theory is what Acemoglu c.s. call the “reversal of fortune.” They show that many regions that were wealthy before European colonization, such as India and Latin America, are now relatively poor, while regions that were relatively poor before colonization, such as North America and Australia, are now wealthy. This reversal is explained by the institutions imposed during colonization. Where inclusive institutions were established, these societies became wealthy; where extractive institutions were imposed, poverty persisted.
Why Don’t Nations Change?
Given that inclusive institutions promote prosperity, one might ask why nations with extractive institutions don’t simply reform. Why don’t the elites in these countries change the system to benefit the majority?
Acemoglu, Johnson, and Robinson argue that the problem lies in the political dynamics that maintain extractive institutions. Those in power under extractive regimes have little incentive to change the system, as they benefit enormously from the wealth they can extract from the rest of society. Reforms that would lead to inclusive institutions would reduce their power and wealth, making them less likely to willingly implement such changes.
In many cases, elites actively resist reforms, even at the cost of long-term economic development. They may limit access to education, stifle innovation, and use violence to suppress opposition, all to maintain the status quo. The result is a vicious cycle in which extractive institutions persist and economic stagnation continues.
Critical Junctures and the Role of Revolution
Although extractive institutions are highly resistant to change, Acemoglu, Johnson, and Robinson argue that critical junctures—moments of crisis or significant change—can provide opportunities for nations to shift from extractive to inclusive institutions. Wars, revolutions, economic crises, or the collapse of a regime can create openings for reforms that would otherwise be impossible.
For example, the Revolution of 1688 in England was a critical juncture that led to the establishment of more inclusive political institutions. The revolution limited the power of the monarchy and established a system of checks and balances, setting the stage for the Industrial Revolution and Britain’s eventual rise as a global economic power.
Similarly, the collapse of the Soviet Union in 1991 created a critical juncture for Eastern European nations, many of which transitioned from extractive communist regimes to more inclusive political and economic systems.
However, not all critical junctures lead to positive change. The authors also point out examples where revolutions or crises have reinforced extractive institutions rather than replacing them. The Arab Spring, for instance, led to the fall of several authoritarian regimes, but in many cases, new extractive elites emerged to take their place, preventing the establishment of inclusive institutions and economic development.
Geography, Culture, and Other Factors
While the authors of Why Nations Fail place institutions at the center of their analysis, they do not completely dismiss other factors like geography and culture. They argue that these elements can influence the types of institutions that emerge, but they are not the ultimate determinants of a nation’s wealth or poverty.
For example, Geography can shape the economy by determining access to trade routes or natural resources, but the wealth derived from these advantages will still depend on the institutions in place. A country with extractive institutions is unlikely to use its natural resources to benefit the general population, while a country with inclusive institutions will find ways to use those resources to promote broad-based economic growth.
Culture, too, can play a role in shaping institutions, but it is not deterministic. While some cultural values, such as a strong work ethic or trust in others, may support the development of inclusive institutions, cultures are not static, and they can change over time. The authors argue that culture often evolves in response to the institutions that are in place rather than being the primary driver of economic outcomes.
The Role of International Aid and Foreign Intervention
Another important aspect of their analysis is the role of foreign intervention in shaping institutions. Acemoglu, Johnson, and Robinson are critical of foreign aid programs that attempt to impose economic reforms without addressing the underlying political institutions. They argue that such interventions often fail because they do not change the extractive nature of the political system. One could argue here, the role the Netherlands plays in the institutional development of Curacao (and for that matter all the former Netherlands Antilles), through its financial and technical aid programs, under their supervision.
For example, international aid may provide funds for infrastructure projects or education, but if the political elites in a country continue to extract wealth for themselves, the benefits of these programs will not be widely shared. In some cases, foreign aid can even reinforce extractive institutions by providing resources that elites can use to maintain their power.
Similarly, foreign interventions that seek to impose democracy or market reforms without addressing the underlying political dynamics are unlikely to succeed. The authors point to examples like Iraq and Afghanistan, where attempts to create new political systems through foreign intervention have not led to inclusive institutions or long-term economic development.
And next….
The work of Daron Acemoglu, Simon Johnson, and James Robinson provides a framework for understanding why some nations are rich and others are poor. Their focus on the role of institutions—whether inclusive or extractive—offers a comprehensive explanation for the patterns of global wealth and poverty that we see today.
While geography, culture, and other factors can influence a nation’s development, it is the nature of its political and economic institutions that ultimately determines its success or failure. Countries with inclusive institutions can harness the talents and energies of their people, leading to sustained economic growth and prosperity. In contrast, countries with extractive institutions remain trapped in cycles of poverty, as elites continue to extract wealth at the expense of the broader population.
Understanding this dynamic is essential for policymakers, scholars, and anyone interested in promoting global development. While changing institutions is a complex and often difficult process, the research of Acemoglu, Johnson, and Robinson provides valuable insights into how such changes can occur and why they are so.
The explanations given above should be enough for us to ponder our own situation here in Curacao. The first question being: What type of institutions do we have? I would also like to refer to an earlier blog (O-1) “KAOS TA UN TRAPI”.
Dieudonne (Neetje) van der Veen is financieel en management bedrijfsadviseur. Zijn werk en ervaring liggen vooral op het gebied van financieel management en structurering van bedrijven in nood en Governance on Planning & Control-cycli.
De heer van der Veen heeft een masterdiploma bedrijfseconomie (Erasmus Universiteit Rotterdam), is Registeraccountant (Koninklijke Nederlandse Beroepsorganisatie van Accountants), CFE (Certified Fraud Examiner) en CICA (Certified Internal Control Auditor).
