Why Nations Fail

As we delve further into the twenty-first century, the BRIC and MINT countries are converging with those that have sat atop the heap for so long. They are leaving many nations and billions of people behind. But why is this so? Why did the industrial revolution kick off in England and take only select countries with it? Why were Japan and South Korea able to leave their region in the dust during the twentieth century, and how has Nigeria recently stormed past it’s neighbours? Why is China now set to become king of the mountain, not so long after Mao dragged it to such drastic lows? Why are some countries poor while others prosperous, some successful while others not, and why do these fortunes ebb and flow? In short, what is the magic ingredient? There are many books out there with a claim to answer. Their theories range from the geographic to the cultural. Daron Acemoglu and James Robinson have yet another to add to the pile; for them, the secret sauce is creative destruction. And the differences between success or failure is the presence or absence of institutions that foster it.

“Countries differ in their economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people.”

Creative Destruction is an idea popularised by the economist Joseph Schumpeter to refer to a process of incessant industrial revolution, of innovations pushing out the antiquated. It is records making way for cassettes, CD’s bowing before Mp3 players. Why Nations Fail is built on the premise that this innovation, this creative destruction, is a necessary ingredient in the success of a country. And further, for a nation to harness creative destruction requires a certain amount of freedom, transparency and protection for it’s citizens. According to Acemoglu and Robinson, these are features of society that are granted or restricted by it’s institutions. So-called “inclusive institutions” are markets, laws and norms that protect and incentivise innovation and productivity. They foster creative destruction and are the building blocks of a successful society. On the other hand, “extractive institutions” are ones that protect and enrich the elite, that dis-incentivise productivity and innovation. They hinder creative destruction and are a recipe for a failed nation. 

“The fear of creative destruction is the main reason why there was no sustained increase in living standards between the Neolithic and Industrial revolutions. Technological innovation makes human societies prosperous, but also involves the replacement of the old with the new, and the destruction of the economic privileges and political power of certain people.”

Viewing the world through this prism gives Acemoglu and Robinson an explanation for where we are, and where we are going. The countries that today enjoy a high standard of living are those that have established multi-party democracies, transparency and protection through the rule of law and independent judiciaries, and incentives through free markets and patents (etc). On the other hand, countries that have seen dictatorships and despots, entrenched elites, disruptive monopolies and subsidies, and few political rights; have failed, are in the process of failing, or will soon do so. Acemoglu and Robinson explain that the Industrial Revolution kicked off in Britain because the citizens had already achieved hard won restrictions on the elite. Power was distributed and new protections in areas such as patents rewarded innovation and productivity. Pioneers like James Watt – famous for his steam engine — were not shut out by a rent-seeking aristocracy. Further, the efforts of these pioneers to secure their gains ensured a virtuous cycle, a promulgation of new institutions to further codify gains. According to Acemoglu and Robison, Britain hosted the Industrial Revolution because it’s inclusive institutions had already made way for the mother of creative destruction, and creative destruction begat even more creative destruction.

“The striking thing about the evidence on patenting in the United States is that people who were granted patents came from all sorts of backgrounds and all walks of life, not just the rich and the elite.” 

The authors use compelling examples and “experiments” to back up their claims — most notably, the difference between Nogales, Arizona and Nogales, Sonora; a city that straddles the border between the United States and Mexico. This one city provides a seemingly perfect “natural experiment” of the institution thesis; as geography, culture, and ethnicity are the same on both sides of the fence. Arguably, it is only recent history, which has resulted in differing institutions, that have caused the diverging living standards for the two Nogales. But there is more. Other examples trotted up by the authors include East and West Germany, Spanish South America – where the indigenous population were exploited to cash in on an abundance of natural resources, and English North America – where a scant aboriginal population and minimal natural resources forced the English to transplant and incentivise a European population. West Germany is still footing the bill for the shambles that was East Germany. The inhabitants of Spanish South America were turned into chattel, while the new inhabitants of North America progressed and built institutions to protect their growing status. More examples come in the analysis of East and Western Europe – where Western Europe had largely managed to reign in their monarchs and elites, much of Eastern Europe carried the burdens of Serfdom and Feudalism well into the twentieth century. While industry promulgated in the West, Eastern Lords bound their subjects and continued personally profitable agrarian economies. Most compelling for me was an exploration of Australia – where a scarcity of labour similar to North America forced the English to incentivise immigrants. The Convicts and settlers went on to build institutions to secure what they had gains in a similar fashion to their brothers elsewhere, institutions that are the foundations of modern Australia. Through numerous examples, Acemoglu and Robinson show that the countries that have succeeded have done so by following an economic ideal of productivity and innovation over monopoly and rent seeking, and they have done so not out of economic rationality, but political necessity.

“World inequality today exists because during the nineteenth and twentieth centuries some nations were able to take advantage of the industrial revolution and the technologies and methods of organization that it brought while others were unable to do so”

Why Nations Fail is a book that kicked up a storm of debate in the academic and development communities. The reviews written by the authors of other theories are enlightening, as are the responses of Acemoglu and Robinson. However, there are also major flaws in this work. One look at the book jacket, at those who have lent their names to promote it, raises questions. They are a remarkably homogenous bunch. People like Niall Ferguson – who even utilises some similar examples in his book, Civilisation. And, I’ll be honest, I tore through this book, loving it the entire way. It’s message appealed to me. But of course people like Niall Ferguson and myself love it. It offers a theory that takes a very Eurocentric view of the world, and then works backwards. Democracy and much of the social and political norms cherished in the West are taken as given and as ideal, and then ascribed major roles in past success. Niall Ferguson, myself, and everyone else on that jacket have a natural predilection to this theory. Our innate biases are towards the institutions that have allowed us to prosper and thrive in our wonderful, Western societies. But can liberalism really be the only path to success? The cloud overhanging all of this is the lack of real explanation of what’s going on in places like China – a nation ravaged by extractive institutions if there ever was one, yet with an economy growing pell mell and a massive savings rate. If anything, success is simply too complicated for such a grand unified theory. However, and whether you agree with their theory or not, Acemoglu and Robinson have produced a fantastic book. A great read. This is one of those library books that I really wish I had bought. From the moment I started reading it, I have wanted to share it with all and sundry. I have my doubts, but I highly recommend it. At the very least it will provoke debate and introspection.

“Nations fail today because their extractive economic institutions do not create the incentives needed for people to save, invest, and innovate.”