“Prosperity is all about political institutions and politics” – Daron Acemoglu
Daron Acemoglu is Elizabeth and James Killian Professor of Economics at the Massachusetts Institute of Technology. In 2005 he received the John Bates Clark Medal awarded to economists under forty judged to have made the most significant contribution to economic thought and knowledge. In 2010 Foreign Policy listed him as one of the top 100 global thinkers. Acemoglu talks to Truman Factor about Why Nations Fail: The Origins of Power, Prosperity, and Poverty, his latest book, co-authored with Harvard University political scientist and renowned expert on Latin America and Africa James Robinson.
The key to prosperity is in institutions, not in culture or in geography.
What led you to look for the genetics of economic growth in political institutions?
James Robinson and I have been working on economic development for almost 17 years. What made us start this research was the conviction that politics and economics could not be separated. For example, there is no coherent way of understanding why Africa is so underdeveloped without thinking about the politics of Africa and the politics of development. Why Nations Fail is our attempt to synthesize and extend our work in this area, while at the same time making it accessible to a broad audience. We thought especially making it accessible to a broad audience was important because much of the discussion on what makes some nations poor both in policy circles and in the popular press are just misguided. Some of them still emphasize factors such as geography or a nebulous notion of “national culture.” Some of them think that it’s all about enlightened leadership and good advice from policy experts.
But when you look at history and when you look at empirical evidence it is clear that the key to prosperity is in institutions, not in culture nor in geography. Moreover, history is also equally clear that bad institutions were in place not because of leaders’ mistakes but by design: because they played a useful political and economic role for the benefit of the politically powerful in society.
More explicitly, some types of economic institutions, which we call inclusive, provide incentives for investment and innovation and they provide a level playing field so that the majority of a nation’s population can deploy their talent. These economic institutions generate prosperity. But most societies are ruled not by ‘inclusive’ institutions but by extractive institutions, which create insecure property rights, don’t allow contracts, discourage innovation and technology adoption, and most importantly, instead of creating a level playing field, they create a very tilted playing field, advantaging a small segment of society, and sometimes even coercing people to work at low wages in occupations they shouldn’t be in, and banning them from occupations they wish to enter. We call these institutions extractive because they have been designed by the political powerful to extract resources from the majority of the population.
How are such bad institutions kept in place?
That’s where politics and political institutions come in. These extractive economic institutions are supported and kept in place by political institutions which concentrate political power in the hands of the elite so that they are able to create these economic institutions and maintain them, despite the fact that they are to the disadvantages of many in society. Without political institutions that are themselves extractive, concentrating power in the hands of the elite and putting no constraints on their exercise, extractive economic institutions would not survive. It is in this sense that we argue that prosperity is all about political institutions and politics.
Growing political inequality can pave the way for a reversal in the nature of political institutions, which is becoming a real danger for the United States today.
It would seem that there is somewhat of a paradoxical situation taking place today in societies with open political structures and advanced economies, as they are now experiencing widening social cleavages. What is causing this reversal?
I’m not sure that it is that paradoxical. Inclusive and open political systems generate innovation and growth, and this sometimes comes with greater inequality. Equally important, such systems are always under threat from narrow interest groups who want to gain more political power and turn that political power into economic advantage and wealth. The increase in inequality we are seeing in the United States and several European economies is the result of these two forces. First, we have new technologies and globalization increasing inequality. Second, we have important political changes that have made things more advantageous for the very rich, especially in the financial sector (for example, with implicit and explicit subsidies from the government for risk-taking).
Though they are not deeply paradoxical, these changes are nonetheless threatening to inclusive institutions. If economic inequality becomes very large, it also fuels further political inequality. We are seeing this very clearly in the United States, where the system is now much more in line with the wishes of the very wealthy at the expense of the rest of society. Such growing political inequality can pave the way for a reversal in the nature of political institutions, which is becoming a real danger for the United States today.
The genie is out of the bottle, people know that they can go to the street and protest, and bring down the extractive regimes.
The “Occupy Wall Street” movement in America seeks to denounce growing economic inequalities and the overtaking of political institutions by economic elites in the United States. What parallels are drawn between this movement and the “Arab Spring?”
There are important parallels. The social movements that sprang with the Arab Spring deposed of some of the most extractive regimes in the world. And these regimes in Egypt, Tunisia and Libya (and of course Syria) were the cause of their people’s poverty. So there is great hope. But the process we are witnessing in the Middle East and North Africa is a treacherous one. We explain in Why Nations Fail how many similar revolutions that came to power promising change ended up re-creating a similar extractive regime, sometimes with different people at the helm. This is because of the extractive nature of the institutions they inherit. The lack of constraints means that the new rulers have an opportunity to take over the extraction. Good institutions are those that create constraints preventing this type of behavior. But of course, they are absent at the moment in Egypt, Tunisia and Libya. So, for example, there is a real danger that in Egypt the military will re-create a system similar to that over which Mubarak ruled. Or the Muslim Brotherhood will try to re-create its own extractive regime. So there are great dangers. But there’s also room to be optimistic: the genie is out of the bottle, people know that they can go to the street and protest, and bring down the extractive regimes. This is very, very important.
The situation is not as bad in the United States of course. So protesters don’t have to fear for their life and they are not facing anything similar to the repression that those in Egypt, Tunisia, Libya and Syria faced. But they are playing a similar role of a grassroots movement challenging the political system from the outside. Grassroot movements of this type are hugely important and they are a very optimistic sign of the resilience of our societies in the face of the serious problems we are facing. They are a wake-up call and they will challenge the system. But ultimately, the grassroot movements cannot rule as grassroot movements. They have to become institutionalized (and this is part of the great challenge that the social protest movements in the Middle East and North Africa will face also).
An instructive example in this context comes from the United States. During the Gilded Age at the end of the 19th century, the United States was facing similar problems (huge economic inequality, politics captured by the rich elite, political institutions becoming weaker by the day). In response to this there developed grassroot movements such as the Populists and then later the Progressives. Their grievances and their protests are reminiscent to the Occupy movement or the Indignants in Spain. But notably, they did not just remain a protest movement. They became hugely influential, changing both economic and political institutions in the United States, when they influenced both of the mainstream parties. In fact, a series of very powerful presidents from both parties, Theodore Roosevelt, William Taft, and Woodrow Wilson, were essentially Progressives.
The real danger is when economic inequality spills onto the political inequality.
Free-markets are expected to thrive in an environment where political power has the proper checks and balances in place; however, the idea that too-free markets are to blame for the deterioration of the system is becoming widespread nowadays. Where should we focus the debate on markets and State: more regulation or increased political accountability and effective separation of powers?
Our view is that the greater dangers come from politics. Of course it’s important to have what we call “inclusive markets” rather than pure laissez-faire. For example, laissez-faire by itself does not guarantee that the population at large has access to good education, so that they are on a level playing field. Laissez-faire also does not stop the coercion of workers by powerful employers as was commonplace in the 19th century and is still commonplace in many parts of Asia, Central America and Africa today. So some degree of regulation is necessary for inclusive markets, which are the best guarantee for economic growth. But inclusive markets are not inconsistent with economic inequality. In fact, some degree of economic inequality is necessary for providing incentives for investment and innovation. The real danger is when that economic inequality spills onto the political inequality. Thus I’ve already mentioned, my fear about the United States is not that there is growing economic inequality, but that this is associated with growing political inequality and erosion of the quality of educational institutions and more and more favors from the politicians for the wealthy and economically powerful. That’s the sort of failure we have to be watchful for.
When institutions change, behavior will change.
You propose that neither culture nor geography determine economic success. However, some argue that the current crisis is exposing too-strong cultural differences within Europe, which are in fact fueling asymmetries and preventing the dream of a “United States of Europe” from becoming a reality. Is the problem really institutional?
Yes absolutely, it is institutional.
Obviously culture interpreted broadly is part of the political institutions. For example, what you expect from politicians and political parties will influence how people engage in politics. In emphasizing the primacy of politics and institutions over culture, we are emphasizing that things such as national cultures or ethnic cultures are second-order relative to institutional incentives. You cannot explain the poverty of Africa or Haiti with culture. Similarly, I don’t think you can explain why Greece and Spain are facing the problems that they are facing today with some sort of contrast of Germanic culture to the Mediterranean culture. In Greece, for example, people don’t work hard and evade taxes not because of their inherent values or some ethnic disposition to such behavior, but because the incentives that have been created. Politicians created a system in which work was not rewarded, tax evasion was easy, almost encouraged, and clientelistic transfer payments made entrepreneurship and innovation less attractive.
And the big difference between perspectives emphasizing institutions and culture is in this: if it is institutions that are at the root of these things, when institutions change, behavior will change. If it is culture, then not much will change in response to changes in incentives. So the institutional perspective is more optimistic. And we can see how this has worked out, for example, in China: Chinese “values” were very different under Mao’s cultural revolution. Look at them now. And I would hazard to guess that they would change further if China became politically more open and more democratic.
The same applies to Greece and Spain. Fix politics, improve institutions, undertake structural reforms that encourage investment and innovation and create a level playing field for the population at large, and the Greek and Spanish people will be as hard-working and as innovative as Northern Europeans.
Despite all of the resources that China is pouring into science and technology at the moment, its extractive political institutions will be an impediment to innovation.
So, much like it happened with the Soviet Union, would you say that the widely anticipated prospect of a Chinese economic and cultural surge in the world will be negated – or at least pushed quite far into the future – due to the very “extractive” nature of the regime that propelled its growth in the first place?
The Soviet Union is a typical example of growth under extractive institutions, based on using available technology and state-led mobilization of resources. After the Bolsheviks took over the highly inefficient agricultural economy from the Tsarist regime and started to use the power of the state to move people and resources into industry, the Soviet Union grew at then-unparalleled rates, achieving an average annual growth rate of over 6 percent between 1928 and 1960. Though there was much enthusiasm about Soviet growth at the time, it couldn’t and didn’t last. By the 1970s, the Soviets had produced almost all the growth that could be derived from moving people from agriculture into industry, and despite various incentives and bonuses, and even harsh punishments for failure, they could not generate innovation. The Soviet economy stagnated and then totally collapsed.
China’s growth today is another example of catch-up growth under extractive institutions (even though it’s economic institutions have made big strides towards greater inclusivity since Mao’s death). China has been growing thanks to the import of technology and its integration into the world economy (after three decades of very rapid growth, China still about 1/6 of the income per capita of the United States). Despite the important economic reforms in agriculture and some in industry that have been going on, it is still an extractive economy in which political power is very tightly controlled by the Communist Party, and this distorts economic decisions. These problems haven’t slowed down catch-up growth. But they will become much more of a formidable barrier when the low hanging fruit of catch-up growth are exhausted and China needs to start innovating. Here, despite all of the resources that China is pouring into science and technology at the moment, its extractive political institutions will be an impediment to innovation.
In other words, China may continue to grow in the near term, but the next stage of economic growth, generating genuine innovation, will be much more difficult unless its political institutions change to create an environment that rewards challenging established interests, technologies, firms and authority.
To be sure, China has more potential than the Soviet Union. Its growth has not come simply by government fiat, but also because it has reformed its economic institutions providing incentives to farmers and some firms (though having government connections still helps enormously, and challenging powerful firms can land you in jail or worse). China also had more technological catching up to do than the Soviet Union. But this potential will come to an end as well unless China radically transforms its institutions. This requires not only obvious steps such as introducing an independent judiciary, independent media, and more secure property rights for businesses, but truly inclusive political institutions which necessitate a fundamental political opening so that political power is more equally distributed and can underpin economic institutions that will create a level playing field and encourage and fully reward all sorts of innovation — and especially the disruptive kind.
Only regimes that are up to no good fear protest movements.
The Spanish government has recently introduced legislation to make “passive protests” a criminal act. In addition, this past weekend it suspended the Schengen Treaty to keep protesters at bay and guarantee social order during this week’s ECB summit in Barcelona. An example of “inclusive” political institutions turning “extractive”?
Yes this is a terrible idea. Inclusive regimes should not fear protest movements. Of course, lawlessness should be prevented, because it’s bad for the citizens, it’s bad for businesses. But peaceful protest movements are an essential life and blood. Only regimes that are up to no good fear protest movements. So this is a bad sign for Spain.
Where do you stand in the current debate over austerity as a path to exit the crisis in Europe?
Europe has serious problems. And the current climate of debt and austerity is making things worse. But ultimately Europe has a lot of promise: the European Union has created an integrated market with reasonable institutions, and there is tremendous human capital and innovative potential there. But also there are structural problems, some political and some economic in nature. Structural problems require bold structural reforms.
So overall Europe has great potential. But I’m not so sure about Greece, unless it undertakes fundamental reforms in its political system (which is absolutely riddled with corruption), product market, labor market and government sector employment. I also have worries about Spain and Portugal. This is because structural reforms are hard. They always create losers, especially from among the entrenched groups with political power. In Why Nations Fail we emphasize how politically powerful rich elites have been the biggest barrier to long-run economic growth. But other groups, for example entrenched trade unions and businesses protected from competition, will also be opposed to economic reforms, and in democracy, they can command significant power too.
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