In the first of our two-part series, we delve into the groundbreaking work of Daron Acemoglu, Simon Johnson of the Massachusetts Institute of Technology, and James Robinson of the Chicago University, commonly known as the AJR trio. Their research sheds light on the vast disparities in prosperity across nations and underscores the critical role institutions play in fostering economic progress.
Jacob Svensson, the chairman of the Economics Prize Committee, highlighted the significance of their work, noting, “Reducing the vast differences in income between countries is one of our times greatest challenges, and the laureates have demonstrated the importance of societal institutions for achieving this.” The foundational research by AJR dates back to 2002 with their influential research paper “Colonial Origins of Comparative Development” (COCD). A decade later, in 2012, they further elaborated on this theme in their famous book titled, “Why Nations Fail: The Origins of Power, Prosperity, and Poverty.”.
The fundamental question that AJR dealt with was, “Why are some countries that were wealthy in the medieval period now impoverished, while others that had been poor have grown rich?" This question resonates well with the case of India, whose industrial production in the 18th century was higher than that of the USA. However, 77 years after its independence, India’s industrial output is still below 20% of the USA. AJR noted that the richest 20% of countries today are 30 times wealthier than the poorest 20%.
AJR propounded the concept that the existence of institutions is a key determinant of development. They defined institutions as “direct and enforceable constraints on the exercise of economic power.”. The institutions evolve over a period to balance the exercise of power between various groups, limit the overuse of powers, and ensure that in the long run growth-enhancing mechanisms such as property rights are protected. This would allow investments, entrepreneurship, and growth to thrive. Their insights strived on the notion that geographical advantages and availability of capital alone never shape development. They asserted that the quality and inclusivity of institutions are important factors of economic success.
AJR cited the example of the city of Nogales, which is split by the US-Mexico border, in support of their thesis. The northern part is in Arizona, USA, while the southern part is in Sonora, Mexico. Despite the city being in two different countries, it is geographically the same place. The people have common ancestors, similar origins, culture and food habits, and climate as well. Regardless of these striking similarities, the southern part is poorer than the northern one. The setup of institutions in the USA is strong. People are assured about the existence of laws that protect their property and investments. People feel more secure in the USA and have the right to remove politicians they don’t like, and hence are wealthier and live a better life. Contrarily, crime and corruption are at their peak in Mexico, and the atmosphere is not conducive for business to flourish. While the people are empowered with some civil rights, challenging and removing corrupt politicians remains a distant dream. This example illustrates how similar populations living in identical geographic and cultural conditions experience vastly different economic outcomes based primarily on the institutions governing them.
AJR links the existence of the institutions to the policies of the colonial powers established in the erstwhile colonies. At one point, the European Colonial powers ruled 80% of the world. However, they didn’t treat each colony in the same way. In colonies like India, Brazil, Mexico, and a large part of Africa, the local population outnumbered the European settlers. Europeans faced resistance in such places, and they struggled to maintain firm control. But once they were at the helm of affairs, they resorted to exploitative techniques to suppress the local people and ensure benefits for their home country. The system they established was exploitative and benefitted the colonial powers at the expense of the local populations. In the post-World War II era, after securing independence, the new governments in these countries struggled to dismantle these unjust systems left behind by their colonial masters.
On the other side, the colonies like Canada, the US, Australia, New Zealand, Singapore, and Hong Kong had smaller populations, due to which the European settlers facilitated overcoming labour shortages in these regions. They didn’t face any resistance from the ethnic populations, and the institutions they set were more inclusive and benefitted everyone since there wasn’t much they could exploit. As a result, these countries went on to prosper.
(Tomorrow: In the second part of this exploration, we will uncover how historical precedents influenced the formation of inclusive versus extractive institutions across regions, shaping the trajectory of post-colonial development.)
(The author is a Chartered Accountant and works at Authomotive Division of Mahindra and Mahindra Limited. Views personal.)
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