Prosperity and poverty: the role of political and economic institutions

Daron Acemoglu, Simon Johnson, and James A. Robinson, authors of the book Why Nations Fail, are the 2024 winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. The prize, often referred to as the Nobel Prize in Economic Sciences, was awarded for their research into why some countries are rich and others poor. Their work explains how political and economic institutions determine the prosperity of nations. Institutions—the rules and systems that determine how a society functions—are key to understanding differences in prosperity and poverty, they argue.

What does their research entail?

Acemoglu, Johnson, and Robinson examine how institutions—the rules and systems that govern how a society operates—play a crucial role in the economic development of countries. They show that countries with strong, inclusive institutions develop better and create more wealth, while countries with weak, extractive institutions remain mired in poverty.

Inclusive and extractive institutions

In their research, they distinguish two types of institutions:

• Inclusive institutions: These are systems that give broad sections of the population the opportunity to participate in the economy and politics. People have property rights, can invest and develop their talents. There are political rights, such as free elections, and economic freedom, such as starting a business without fear of having property taken away. These institutions are 'inclusive' because they give everyone the chance to grow and contribute to society.
• Extractive Institutions: These are systems in which wealth and power are concentrated in the hands of a small elite, while most people have little freedom. In such societies, property rights are weak, corruption is high, and economic opportunity is limited. These institutions are designed to extract (or withdraw) wealth from society and concentrate it in the hands of the elite, without benefiting the broader population.

Settings during colonization

Acemoglu, Johnson, and Robinson studied in particular the political and economic institutions that European colonists introduced in the areas they colonized from the 16th century onwards. Depending on the circumstances in these areas, the colonists introduced different types of institutions:

1. Property Rights: In places where Europeans settled, such as North America and Australia, strong property rights were established. This gave people the security that what they built would remain theirs, which encouraged them to invest and work hard. This led to long-term economic growth.
2. Political rights: Political rights were also developed in these areas, such as the ability to elect or depose leaders. Although these societies were not fully democratic at first, citizens had much more influence and freedom than in other colonies.
3. Labor Systems: In areas with large indigenous populations, such as Latin America and parts of Africa, colonists often developed repressive systems. These extractive institutions were aimed at exploiting local people and resources, leading to long-term poverty and instability.
4. Corruption and Justice: Extractive societies often lacked a fair justice system, which fueled corruption and undermined trust in government. This made economic progress difficult for the broader population.

Why do inclusive institutions lead to prosperity?

Inclusive institutions promote economic growth and prosperity because they provide broad sections of the population with access to economic opportunities and political rights. In a society with inclusive institutions, people can invest freely, develop their capabilities, and benefit from their efforts. This promotes innovation, productivity, and entrepreneurship because individuals know that their property rights are protected and they can reap the rewards of their hard work. In addition, political rights, such as free elections, ensure that those in power are held accountable, which reduces corruption and increases trust in the system.

Why do extractive institutions lead to stagnation?

In extractive institutions, the opposite is true. These systems are designed to concentrate wealth in the hands of a small elite, often at the expense of the rest of the population. Most people have little economic freedom and property rights, and corruption is often widespread. This discourages investment and entrepreneurship, as there is no guarantee that people will profit from their efforts. Furthermore, extractive political institutions make it difficult to challenge the power of the elite, which perpetuates inequality and poverty. These institutions provide short-term gains for a few who hold power but hinder long-term growth.

Relevance of the research

1. Explaining Wealth Differences: The research by Acemoglu, Johnson, and Robinson provides a compelling explanation for the huge wealth differences between countries. It shows that wealth depends not only on natural resources or geographical location but, above all, on the nature of political and economic institutions.
2. Long-term impact of colonization: Their work shows that the political and economic institutions put in place hundreds of years ago continue to have a major impact on the prosperity of countries. Countries that developed inclusive institutions, such as the US and Canada, are much more prosperous than countries with extractive institutions, such as many parts of Africa and Latin America.
3. Possibility of change: While institutions are often long-lasting, these researchers’ work shows that change is possible. If countries can reform their extractive systems and develop more inclusive institutions, they can still achieve economic growth. This offers hope for countries currently struggling with corruption and poverty.

The Shift from Inclusive to Extractive Institutions in the US

The insights of Acemoglu, Johnson, and Robinson are also relevant to the current political situation in the world. Countries such as the United States, traditionally known for their inclusive institutions, are showing signs of a shift towards extractive institutions. Democratic rights are under pressure, and political and economic power is increasingly concentrated in the hands of a small elite.

In the US, we see attempts to manipulate elections, restrict press freedom, and politicize the judiciary. The growing gap between rich and poor and increasing polarization reinforce this shift, further weakening democratic foundations. Autocratic leaders like Donald Trump can accelerate this development, turning the US into a country with more extractive institutions, in which the elite is protected and the people have less influence.

Hope for change

Yet Acemoglu, Johnson, and Robinson show that change is possible. When citizens mobilize and pressure elites, inclusive institutions can be restored. This offers the prospect of a better future, but without this mobilization, the US risks sliding further into an autocratic, extractive system.