Reconsidering Why Some Nations Fail — and Others Prosper

Daron Acemoglu, Simon Johnson, and James Robinson won the Nobel Prize in Economics this year for their work on institutions and the causes of prosperity. In fact, I recently hosted Acemoglu and Johnson on my Hoover Institution podcast, prior to the announcement.

Many other economists over the years have discussed the role of institutions, including Barry Weingast and Avner Greif, as well as Douglass North, who famously called institutions “rules of the game” in work that won him a Nobel Prize in 1993. Institutional economics was a very theoretical field before Acemoglu, Johnson, and Robinson came along. Before the turn of the century, the big question in development economics was, "What is the fundamental cause of growth across countries?" Was it geography, as advocated by Jared Diamond in his 1997 book Guns, Germs, and Steel, which asks why cold countries are so rich and hot countries so poor? Was it culture, as suggested by Max Weber in his famous early-20th-century work The Protestant Ethic and the Spirit of Capitalism, which argued that Protestant countries are richer than Catholic countries? Or do institutions explain international differences in prosperity, which Acemoglu and Robinson argued in their 2012 bestseller Why Nations Fail?

Acemoglu, Johnson, and Robinson attempted to bring empirical rigor to the study of institutions in now-famous papers such as "The Colonial Origins of Comparative Development: An Empirical Investigation," published in 2001, and "Reversal of Fortune: Geography and Institutions In The Making of The Modern World Income Distribution," published in 2002. While these papers and the validity of their empirical design have been contested, Acemoglu, Johnson, and Robinson were the first to attempt to study the importance of institutions with new empirical tools that tease out cause and effect. Why Nations Fail summarizes many of these findings but goes further to outline many stories of institutions at work around the world. Take the natural experiment of Korea, for example. Since the early 1950s, the peninsula has been divided between the communist totalitarian north and the relatively capitalistic south (which didn't democratize until much later, in the 1990s). Capitalist South Korea prospered, while North Korea became poor.

Institutions do matter. The next important question is, "Which institutions matter most and why?" Institutions have a surprisingly malleable definition. They can be formal, as are laws (and the rule of law), regulations, property rights, and political systems, or they can be informal, as is trust. Almost any anthropological artifact can be considered an institution, which would render the concept much less useful. Acemoglu, Robinson, and Johnson put forward a distinction to help clarify which institutions matter most: inclusive versus extractive. Inclusive institutions are such things as evenly distributed property rights, or the rule of law, or democracy. Extractive ones include things such as slavery during the colonial period.

Some might criticize Acemoglu’s, Robinson’s, and Johnson’s stories of institutions for being indistinguishable from stories broadly about human capital or education, which might be the fundamental causes of growth. While European settlers to the Americas brought their institutions, for example, they also brought their human capital.

It's also not entirely clear that democracy causes growth, which Acemoglu and his co-authors claim to show by using various cross-country measures of democracy. As Andrei Shleifer and Ed Glaeser point out, by the end of the 20th century, the growth in GDP per capita of the East Asian “tigers” (Hong Kong, Singapore, South Korea, and Taiwan), under nondemocratic regimes, put them on par with Western countries such as the United States. Another study, conducted by Guillermo Vuletin, Julia Ruiz Pozuelo, and Amy Slipowitz, finds no clear evidence that real GDP rises after democratic transitions. A more recent paper by Max Miller finds that a country's stock market declines after it democratizes, perhaps because the stock market expects some redistribution. Suggesting that democratization and redistribution increase the size of the pie seems doubtful, flying in the face of Acemoglu’s and his co-authors’ claims about the growth benefits of “inclusive institutions.”

However, there's a good case to be made that regulation, particularly on firms, matters a lot for growth. The World Bank’s Doing Business index, which measures governmental barriers to firm entry and firm dynamics, is very well correlated with GDP per capita. We also have many historical examples of abrupt and major market reform, or “shock therapy,” as some people like to controversially call it: The growth of Eastern Europe after the collapse of the USSR, Deng Xiaoping’s reforms in China in the 1980s, P. V. Narasimha Rao’s reforms in India in the 1990s, the case of Chile after Augusto Pinochet, and now Javier Milei's Argentina offer examples of significant regulatory reforms that were followed by periods of growth. I would define these successful market reforms as instances in which countries adopted “liberal” (as opposed to “illiberal”) economic institutions rather than “inclusive” (as opposed to “extractive”) ones, as Acemoglu and his co-authors might define them.

Acemoglu’s, Johnson’s, and Robinson’s winning the Nobel Prize in Economics this year was a recognition of a great step forward for the field, bringing serious empirics to comparative development and highlighting that institutions matter for growth. The next goal should be to identify which institutions matter and why.