A Nobel prize for explaining why nations fail or succeed

Why some countries are rich while others are poor is a question that has been debated by economists for a long time now. Representational file image.
| Photo Credit: AP

The story so far: The 2024 Economics Nobel prize was awarded to U.S. economists Daron Acemoglu, Simon Johnson and James A. Robinson on Monday “for studies of how institutions are formed and affect prosperity.” The prize committee credited the winners for enhancing our understanding of the root causes of why countries fail or succeed.

Also read | Economics Nobel Winners 2024 and their studies on ‘how institutions are formed and affect prosperity’

What is the significance of the work of this year’s economics Nobel prize winners?

Why some countries are rich while others are poor is a question that has been debated by economists for a long time now. According to the Nobel committee, the richest 20% of countries in the world today are 30 times richer in terms of average income than the poorest 20%. Ever since the Industrial revolution led to the “Great Divergence” in living standards between the East and the West, various theories have been proposed to explain the huge difference in living standards in rich versus poor countries.

Some have blamed Western colonialism as the primary reason for the Western world’s prosperity even today. Other scholars have argued that disparities in natural resource endowment explains differences in economic prosperity across countries. Some others have argued that intelligence and even historical accidents could explain a nation’s fate.

The 2024 Nobel laureates, however, have argued that differences in the quality of economic and political institutions is what best explains the divergence in the economic fates of countries. This thesis is most famously elaborated in the 2012 book Why Nations Fail: The Origins of Power, Prosperity, and Poverty written by Daron Acemoglu and James A. Robinson, and also in the 2004 paper Institutions as a Fundamental Cause of Long-Run Growth, written together by all three of this year’s Nobel laureates.

Explore this year’s Nobel winners, and their achievements with this interactive guide

Why is the quality of institutions so important?

According to Douglass North, a Nobel laureate and a pioneer of New Institutional Economics, institutions are the “rules of the game” that define the incentives that human individuals face when dealing with each other. For example, institutions that stop the State from seizing the property of honest citizens would give ordinary citizens the incentive to work hard without the fear of expropriation and that in turn would lead to general economic prosperity. Institutions that legalize expropriation, on the other hand, would affect individual incentives negatively and cause economic stagnation.

Now, Acemoglu and Johnson argued in their book that institutions can either be “inclusive” or “extractive”. Inclusive institutions are characterized by secure private property rights and democracy while extractive institutions are marked by insecure private property rights and the lack of political freedom. They tried to empirically demonstrate that inclusive institutions lead to long-run economic growth and higher living standards while extractive institutions lead to economic degradation and poverty.

To this end, they studied the kinds of institutions that colonists set up in different colonies and the impact that this had on the long-term economic fate of these colonies. When a colonial power did not want to settle in a certain country for various reasons (such as higher mortality rates due to geography), it set up institutions that were extractive in nature and inimical to long-term economic growth. This may have been the case in India where the British set up institutions that were mostly devised to plunder the maximum resources within a short span of time rather than to promote long-term economic growth. But in countries where colonists wanted to settle for the long-run, they set up inclusive institutions that encouraged investment and long-term economic growth over short-term plunder. This may have been the case in the United States where the British set up inclusive institutions that promoted long-term economic prosperity.

It should be noted that institutions can also include factors like culture, which influence the more explicit “rules of the game” expressed by political and economic institutions.

If inclusive institutions are so good for growth, why don’t we have more of them?

The Nobel laureates have also shed light on why inclusive institutions, which are found to be extremely important for long-term economic growth, have not been adopted by more countries in the world. They attribute this to the different choices that rulers face in their respective countries. When the rulers of a country are able to safely extract sufficient resources for their personal gains through extractive institutions, the laureates argue, they have little reason to bring in political and economic reforms (or inclusive institutions) that can benefit the wider population over the long run. In such cases, extractive institutions may prevail for a really long time as long as the masses do not revolt against the status quo. But if there is a real threat of a popular uprising against extractive institutions, at least some rulers may decide to yield to popular demand and reluctantly set up more inclusive institutions which aid economic growth.

What’s special about the Nobel prize given to Acemoglu, Johnson, and Robinson?

The economics Nobel prize is usually awarded for ground-breaking academic research into topics that are of significant real-world importance. In the last two years, for instance, the Nobel prize was awarded to scholars who worked on important questions such as the gender pay gap and the fragility of the banking system. While these topics are no doubt important for economists to think about, they still do not delve deep enough into the more fundamental questions that economics as a discipline was founded to answer. This year’s Nobel prize corrects this flaw by bringing the world’s focus back onto the crucial topic of institutions, which determine the very “rules of the game” in any economy and thus affect literally everything that happens in it.