Written by Ryan McGuine //
In October, economists Daron Acemoglu, Simon Johnson, and James Robinson (often collectively referred to as AJR) were awarded the Nobel Prize in Economic Sciences “for studies of how institutions are formed and affect prosperity.” All three recipients have worked on many topics beyond the institutions literature, and Acemoglu in particular has a reputation for publishing and being cited widely. However, this post will focus on the subject of their nomination.
The Solow Model of economic growth explains income differences between countries by the accumulation of physical capital (tools and equipment) and human capital (educational level), and rate of technological progress. However, Nobel laureate Douglass North wrote that rather than driving economic growth, factor accumulation and technological progress are economic growth.
The factors that actually cause growth are sometimes referred to as fundamental causes of growth, and include geography, culture, and institutions. Mr North defines institutions as “the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction.” It is intuitive in some sense that institutions might play a role in a country’s economic growth – structures like private property rights, democracy, and legal frameworks shape the incentives for mutually beneficial interactions between people.
In one of their most famous papers, AJR used patterns of European colonization to illustrate this point. Europeans moved to colonies like America and Australia in large numbers due to their temperate climates and low disease burden, where they established institutions involving mass participation in economic and political activities. However, the disease burden was higher in places like Nigeria or Pakistan, so Europeans allowed military brass and business people to rule without much oversight in exchange for mineral or agricultural exports. They argue that the differences between inclusive institutions in the former and extractive institutions in the latter explain a large part of income differences today.
Mr Acemoglu and Mr Robinson have published a number of books accessible by the general public, expanding on the narratives of institutional development. For example, in Why Nations Fail, the pair uses case studies across borders like America and Mexico or North and South Korea to suggest that inclusive and extractive institutions create self-reinforcing cycles that last decades and produce stark income differences. And in The Narrow Corridor, they argue that strong states and strong societies are both necessary for liberty and prosperity to thrive, but things go wrong when one comes to dominate the other.
Like any academic research, criticism abounds for the work surrounding institutions and growth. Some critics point out that a concept so ambiguous is difficult to evaluate quantitatively, and there are issues regarding the accuracy of historical data. Additionally, there are incentives to tweak the outcomes when money is involved, as was demonstrated by the high profile case of the World Bank’s Doing Business Index. Finally, authors may mean a range of things when discussing institutions – “good institutions” may mean anything from independent central banking to private property rights, from free and fair elections to a consistent regulatory environment for businesses
Even allowing that good institutions are important, though, it is not clear that adopting western-style institutions is good development advice. Many countries adopt western-looking institutions, but fail to undergo catch-up growth predicted by the Solow Model’s prediction. Other critics have questioned whether good institutions are necessary for growth. In the European colonial example, it may have been the early Americans’ human capital that drove its economic growth, or their frequent trade of technology and ideas with Europe. China meanwhile took off economically despite poor institutions, and has improved them over time as markets have improved.
With this decision, the Nobel Committee broke their recent trend of awarding the prize to practically useful empirical work, instead honoring cultural influence in economics. Whatever one’s opinion on that aspect, AJR have certainly influenced the field, and their popular writing is a major reason this author is interested in development topics.