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75Third Quarter 2012

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*Reprinted from Why Nations Fail: The Origins Of Power, Prosperity and Poverty. Copyright ©2012 by Daron Acemoglu and JamesRobinson. Published by Crown Archetype, a division of Random House, Inc.

b y d a r o n a c e m o g l u

a n d j a m e s a . r o b i n s o n NWhy Nations Fail

Nobel laureates (George Akerlof, Ken Arrow,

Gary Becker, Peter Diamond, Robert Solow)

have been lining up to blurb Why Nations

Fail – and for good reason. This new book by Daron

Acemoglu (MIT economist) and James A. Robinson

(Harvard political scientist) is an audacious attempt

to explain why the economic and political fortunes

of similarly endowed countries diverge so dramati-

cally. It integrates the best of economics, history and

political theory to build a simple yet powerful model,

a one-size-ts-most explanation for success and fail-

ure on a grand scale. And did I mention that Why … is

anecdote rich and easily accessible to non-specialists?

Here, we offer a rst taste free; you’ll be back for more. — Peter Passell

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76 The Milken Institute Review

In the summer of 1945, as the Second World Warwas drawing to a close, the Japanese colony in Korea began to collapse.

Within a month of Japan’s unconditional surrender in August, Korea was

divided at the 38th parallel into two spheres of inuence. The South was

administered by the United States. The North, by Russia.

The uneasy peace of the cold war was shat-tered in June 1950 when the North Koreanarmy invaded the South. Though initially theNorth Koreans made large inroads, capturingthe capital city, Seoul, by the autumn theywere in full retreat. It was then that HwangPyong-Won and his brother were separated.Hwang Pyong-Won managed to hide andavoid being drafted into the North Koreanarmy. He stayed in the South and worked as apharmacist. His brother, a doctor working inSeoul treating wounded soldiers from theSouth Korean army, was taken north as the

North Korean army retreated. Dragged apartin 1950, the Hwang brothers met again in2000 in Seoul for the rst time in 50 years, afterthe two governments nally agreed to initiatea limited program of family reunication.

As a doctor, Hwang Pyong-Won’s brotherhad ended up working for the air force, agood job in a military dictatorship. But eventhose with privileges in North Korea don’t dothat well. When the brothers met, Hwang

Pyong-Won asked about how life was northof the 38th parallel. He had a car, but hisbrother didn’t. “Do you have a telephone?” heasked his brother. “No,” said his brother. “Mydaughter, who works at the Foreign Ministry,has a phone, but if you don’t know the code

you can’t call.”Hwang Pyong-Won recalled how all the

people from the North at the reunion wereasking for money, so he offered some to hisbrother. But his brother said, “If I go back

with money the government will say, ‘Givethat money to us,’ so keep it.”

Hwang Pyong-Won noticed his brother’scoat was threadbare: “Take off that coat andleave it, and when you go back wear this one,”he suggested. “I can’t do that,” his brother re-plied. “This is just borrowed from the govern-ment to come here.” Hwang Pyong-Won re-called how, when they parted, his brother wasill at ease and always nervous as thoughsomeone were listening.

He was poorer than Hwang Pyong-Wonimagined. His brother said he lived well, but

Hwang Pyong-Won thought he looked awfuland was thin as a rake.The people of South Korea have living stan-

dards similar to those of Portugal and Spain.To the north, in the so-called Democratic Peo-ple’s Republic of Korea, living standards areakin to those of a sub-Saharan African coun-try, about one-tenth of average living stan-dards in South Korea. The health of NorthKoreans is in an even worse state; average

North Koreans can expect to live 10 years lessthan their cousins south of the 38th parallel.

These striking differences are not ancient.In fact, they did not exist prior to the end ofthe Second World War. But after 1945, the dif-ferent governments in the north and thesouth adopted very different ways of organiz-ing their economies.

South Korea was led, and its early eco-nomic and political institutions were shaped,by the Harvard- and Princeton-educated,

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staunchly anti-communist Syngman Rhee,with signicant support from the UnitedStates. Rhee was elected president in 1948.Forged in the midst of the Korean War andagainst the threat of communism spreadingsouth of the 38th parallel, South Korea wasno democracy.

Both Rhee and his equally famous succes-sor, General Park Chung-Hee, secured theirplaces in history as authoritarian presidents.But both governed a market economy whereprivate property was recognized. And after1961, Park effectively threw the weight of thestate behind rapid economic growth, chan-neling credit and subsidies to rms that weresuccessful.

The situation north of the 38th parallelwas different. Kim Il-Sung, a leader of anti-

Japanese communist partisans during theSecond World War, established himself as dic-tator by 1947 and, with the help of the SovietUnion, introduced a rigid form of centralplanning as part of the so-called Juche system.Private property was outlawed, and marketswere banned. Freedoms were curtailed not

only in the marketplace, but in every sphereof North Koreans’ lives – except for those whohappened to be part of the very small rulingelite around Kim Il-Sung and, later, his sonand successor Kim Jong-Il.

It should not surprise us that the economicfortunes of South and North Korea divergedsharply. Kim Il-Sung’s command economysoon proved to be a disaster. Detailed statis-tics are not released by North Korea, which isa secretive state to say the least. Nonetheless,

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available evidence conrms what we knowfrom the all-too-often recurring famines: notonly did industrial production fail to take off,but North Korea, in fact, experienced a col-lapse in agricultural productivity.

Lack of private property meant that fewpeople had incentives to invest or to exert ef-

fort to increase or even maintain productivity.The stiing, repressive regime was inimical toinnovation and the adoption of new technol-ogies. But Kim Il-Sung, Kim Jong-Il and theircronies had no intention of reforming thesystem, or introducing private property, mar-kets or private contracts, or changing eco-nomic and political institutions. North Koreacontinues to stagnate economically.

Meanwhile, in the south, economic insti-tutions encouraged investment and trade.

South Korean politicians invested in educa-tion, achieving high rates of literacy andschooling. South Korean companies werequick to take advantage of the relatively edu-cated population, as well as policies encour-aging investment and industrialization, ex-ports, and the transfer of technology. South

Korea quickly became one of East Asia’s “mir-acle economies,” one of the most rapidlygrowing in the world.

By the late 1990s, in just about half a cen-tury, South Korean growth and North Koreanstagnation led to a ten-fold gap between thetwo halves of this once-united country –imagine what a difference a couple of centu-ries could make. The economic disaster ofNorth Korea, when placed against the SouthKorean economic success, is striking: neither

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culture nor geography nor ignorance can ex-plain the divergent paths of North and SouthKorea. We have to look to institutions for an

answer.

extractive and inclusive

economic institutions

Countries differ in their economic success be-cause of their different institutions – the rulesinuencing how the economy works, and theincentives that motivate people. Imagineteenagers in North and South Korea, andwhat they expect from life. Those in theNorth grow up in poverty, without entrepre-

neurial initiative, creativity or adequate edu-cation to prepare them for skilled work. Muchof the education they do receive is pure pro-paganda, meant to shore up the legitimacy ofthe regime; there are few books, let alonecomputers. After nishing school, everyonehas to go into the army for ten years.

These teenagers know that they will not beable to own property, start a business or be-

come more prosperous even if many peopleengage illegally in private economic activitiesto make a living. They also know that theywill not have legal access to markets wherethey can use their skills or their earnings topurchase the goods they desire. They are evenunsure about what human rights they willenjoy.

Those in the south obtain a good educa-tion, and face incentives that encourage themto exert effort and excel in their chosen voca-

tion. South Korea is a market economy, builton private property. South Korean teenagersknow that, if successful as entrepreneurs or

workers, they can one day enjoy the fruitsof their investments and efforts; they canimprove their living standard, buying cars,houses and health care.

In the south the state supports economicactivity. So it is possible for entrepreneurs toborrow money from banks and nancial mar-kets, for foreign companies to enter into part-nerships with South Korean rms, for individ-uals to obtain mortgages to buy houses. In thesouth, by and large, you are free to open any

business you like. In the north, you are not. Inthe south, you can hire workers, sell yourproducts or services and spend your money inthe marketplace in whichever way you want.In the north, there are only black markets.

These different rules are the institutionsunder which North and South Koreans live.Inclusive economic institutions, such as thosein South Korea or in the United States, are the

ones that encourage participation by the greatmass of people in economic activities thatmake best use of their talents and skills andthat enable individuals to make their ownchoices. To be inclusive, economic institutionsmust feature secure private property, an unbi-ased system of law, and public services thatprovide a level playing eld in which peoplecan exchange and contract. They must alsopermit the entry of new businesses and allowpeople to choose their careers.

N orth Korean teenagers know that they will not beable to own property, start a business or become moreprosperous. They are even unsure of what human rightsthey will enjoy.

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The contrast between South and NorthKorea (and, as outlined in another chapter, be-tween the United States and Latin America)

illustrates a general principle. Inclusive eco-nomic institutions foster economic activity,productivity growth and prosperity. Secureprivate property rights are central, since onlythose with such rights will be willing to investand increase productivity. A businessman whoexpects his output to be stolen, expropriatedor entirely taxed away will have little incen-tive to work, let alone an incentive to under-take investment and innovation.

But such rights must exist for the majorityof people in society. In 1680 the English gov-

ernment conducted a census of the popula-tion of its West Indian colony of Barbados.The census revealed that, of the total popula-tion on the island of around 60,000, almost39,000 were African slaves who were theproperty of the remaining one-third of thepopulation. Indeed, they were mostly theproperty of the largest 175 sugar planters,who also owned most of the land.

These large planters had secure, enforce-able property rights over their land and evenover their slaves. If one planter wanted to sellslaves to another, he could do so and expect acourt to enforce the sale or any other contracthe wrote. Why? Of the 40 judges and justicesof the peace on the island, 29 of them werelarge planters. Also, the eight most senior mil-itary ofcials were all large planters.

Despite well-dened, secure property rightsand contracts for the island’s elite, Barbados

did not have inclusive economic institutions,since two-thirds of the population were slaveswith no access to education or economic op-

portunities, and no incentives to use their tal-ents or skills. Inclusive economic institutionsrequire secure property rights and economicopportunities, not just for the elite, but for abroad cross-section of society. Secure prop-erty rights, the law, public services and thefreedom to contract and exchange all rely onthe state, the institution with the coercive ca-pacity to impose order, to prevent theft andfraud, and to enforce private contracts.

To function well, society also needs otherpublic services: roads and a transport network

so that goods can be moved, a public infra-structure so that economic activity can our-ish, and some type of basic regulation to pre-vent fraud and malfeasance. Though many ofthese public services can be provided by mar-kets and private citizens, the degree of coordi-nation necessary to do so on a large scale ofteneludes all but a central authority. The state isthus inexorably intertwined with economic in-

stitutions as the enforcer of law and order, pri-vate property and contracts, and often as a keyprovider of public services. Inclusive economicinstitutions need and use the state.

The economic institutions of North Koreaor of colonial Latin America do not havethese properties. Private property is nonexis-tent in North Korea. In colonial Latin Amer-ica there was private property for Spaniards,but the property of the indigenous peopleswas highly insecure. In neither society were

Markets in slaves were, in fact, a part of the economicinstitutions systematically coercing the majority of thepopulation and robbing them of the right to choose theiroccupations and how they should utilize their talents.

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a r t r e s o u r c e , n y

the great majority of people able to make in-dependent economic decisions; they weresubject to mass coercion.

In neither society was the power of the stateused to provide critical public services thatpromoted prosperity. In North Korea, the statebuilt an education system to inculcate propa-ganda, but was unable to prevent famine. Incolonial Latin America, the state focused on

coercing indigenous peoples. In neither soci-ety was there a level playing eld or an unbi-ased legal system. In North Korea, the legal sys-tem is an arm of the ruling Communist Party,and in Latin America it was a tool of discrimi-nation against general population. We callsuch institutions, which have opposite proper-ties to those we call inclusive, “extractive” eco-nomic institutions – extractive because such

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institutions are designed to extract incomeand wealth from one portion of society tobenet a different portion.

engines of prosperity

Inclusive economic institutions create inclu-sive markets, which not only give people free-dom to pursue the vocations in life that bestsuit their talents but also provide a level play-ing eld that gives them the opportunity todo so. Those who have good ideas will be ableto start businesses, workers will choose activ-ities in which their productivity is greatest,

and less efcient rms can be replaced bymore efcient ones. Contrast how peoplechoose their occupations under inclusive mar-kets with colonial Peru and Bolivia, wheremany were forced to work in silver and mer-cury mines, regardless of their skills or wishes.Inclusive markets are not just free markets.

Barbados in the 17th century also hadmarkets. But in the same way that it lacked

property rights for all but the narrow planterelite, its markets were far from inclusive; mar-kets in slaves were, in fact, a part of the eco-nomic institutions systematically coercingthe majority of the population and robbingthem of the right to choose their occupationsand how they should utilize their talents.

Inclusive economic institutions also pavethe way for two other engines of prosperity:technology and education. Sustained eco-nomic growth is almost always accompanied

by technological improvements that enablepeople (labor), land and existing capital (build-ings, existing machines and so on) to become

more productive. Think of our great-great-grandparents who, just over a century ago, didnot have access to planes or automobiles ormost of the advanced health care we now takefor granted – not to mention indoor plumbing,air-conditioning, shopping malls, radio ormotion pictures, let alone information tech-nology, robotics or computer-controlled ma-chinery. And going back a few more genera-tions, technological know-how and living

standards were even more backward – so muchso that we would nd it hard to imagine howmost people struggled through life.

These improvements follow from scienceand from the efforts of entrepreneurs such asThomas Edison, who applied science to createprotable businesses. This process of innova-tion is made possible by economic institu-tions that encourage private property, uphold

contracts, create a level playing eld, and en-courage the creation of new businesses thatcan bring new technologies to life. It shouldtherefore be no surprise that it was the UnitedStates, not Mexico or Peru, that producedThomas Edison, and that it was South Korea,not North Korea, that today produces techno-logically innovative companies such as Sam-sung and Hyundai.

Intimately linked to technology are theskills of the work force acquired in schools, at

A ll economic institutions are created by society.Politics is the process by which a society chooses therules that will govern it. When there is conflict overinstitutions, what happens depends on which people orgroups win out in the game of politics.

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home and on the job. We are so much moreproductive than a century ago – not just be-cause of better technology embodied in ma-

chines but because of the greater know-howthat workers possess. All the technology inthe world would be of little use withoutworkers who knew how to use it.

But there is more to skills than just theability to run machines. The education of thework force generates the scientic knowledgeupon which progress is built. Many of the in-novators of the Industrial Revolution and af-terward, like Thomas Edison, were not highlyeducated, but these innovations were muchsimpler than technologies being producednow. Today, technological change requires ed-ucation both for the innovator and the worker.And here we see the importance of economicinstitutions that create a level playing eld.

The United States could produce (or at-tract from foreign lands) the likes of Bill Gates,Steve Jobs, Sergey Brin, Larry Page and Jeff

Bezos, and the hundreds of scientists whomade fundamental discoveries in informationtechnology, nuclear power, biotech and otherelds upon which these entrepreneurs builttheir businesses. The supply of talent wasthere to be harnessed because most teenagersin the United States have access to as muchschooling as they wish. Now imagine a differ-ent society – for example the Congo or Haiti,where a large fraction of the population has

no means of attending school, or where, ifthey manage to go to school, the quality ofteaching is lamentable, where teachers do notshow up for work, and even if they do, theremay be no books.

The low education level of poor countriesis a product of economic institutions that failto create incentives for parents to send theirchildren to school, and by political institu-tions that fail to induce the government tobuild and support schools that meet the

needs of parents and children. These nationspay a high price for the inadequate educationof their population and the lack of inclusive

markets. They fail to mobilize their nascenttalent. They have many potential Bill Gatesesand perhaps an Albert Einstein or two whoare now working as poor, uneducated farmers,coerced to do what they don’t want to do ordrafted into the army because they never hadthe opportunity to realize their life vocations.

The ability of economic institutions toharness the potential of inclusive markets, en-courage technological innovation, invest inpeople and mobilize the talents of a largenumber of individuals is critical for economicgrowth. Explaining why so many economicinstitutions fail to meet these simple objec-tives is the central challenge of this book.

extractive and inclusive political

institutions

All economic institutions are created by soci-

ety. Those of North Korea, for example, wereforced on its citizens by the communists whotook over the country in the 1940s, whilethose of colonial Latin America were im-posed by the Spanish conquistadors. SouthKorea ended up with very different economicinstitutions than North Korea because differ-ent people with different interests and objec-tives made the decisions about how to struc-ture society. In other words, South Korea had

different politics.Politics is the process by which a society

chooses the rules that govern it. Politics sur-rounds institutions for the simple reason that,while inclusive institutions may be good forthe economic prosperity of a nation, somepeople or groups, such as the elite of theCommunist Party of North Korea or thesugar planters of colonial Barbados, will bemuch better off with institutions that are ex-tractive in nature.

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When there is conict over institutions, theresolution depends on which people or groupswin out in the game of politics – who can getmore support, obtain additional resourcesand form more effective alliances. In short,who wins depends on the distribution of po-litical power in society.

The political institutions of a society are akey determinant of the outcome of this game.They are the rules that govern incentives inpolitics. They determine how the governmentis chosen and which part of the governmenthas the right to do what. Political institutionsdetermine who has power in society and towhat ends that power will be used.

If the distribution of power is narrow andunconstrained, then the political institutionsare absolutist, as exemplied by the monar-

chies reigning throughout the world duringmuch of history. Under absolutist political in-stitutions, such as those in North Korea andcolonial Latin America, the individuals whowield this power are able to set up economicinstitutions to enrich themselves and to aug-ment their power at the expense of society. In

contrast, political institutions that distributepower broadly and subject it to constraintsare pluralist in nature. Instead of being vestedin a single individual or a narrow group, po-litical power rests with a broad coalition or aplurality of groups.

There is obviously a close connection be-tween pluralism and inclusive economic in-stitutions. But the key to understanding whySouth Korea and the United States have inclu-sive economic institutions is not just their

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pluralist political institutions but also theirsufciently centralized and powerful states.

A telling contrast is with the East African

nation of Somalia. Political power in Somaliahas long been widely distributed – almostpluralistic. Indeed there is no real authoritythat can control or sanction what anyonedoes. Society is divided into deeply antago-nistic clans that lack the clout to dominateone another. The power of one clan is con-strained only by the guns of another. This dis-tribution of power leads not to inclusive in-stitutions but to chaos. And at the root of it isthe Somali state’s lack of central authority toenforce even minimal law and order, to sup-port economic activity, trade or even to pro-vide basic security to its citizens.

Max Weber [the late 19th-century sociolo-gist] provided a widely accepted denition ofthe state, identifying it with the “monopolyof legitimate violence” in society. Without

such a monopoly and the degree of central-ization that it entails, the state cannot play its

role as enforcer of law and order, let aloneprovide public services and regulate eco-nomic activity. When the state fails to achievesome degree of central authority, societysooner or later descends into chaos – as didSomalia.

We will refer to political institutions thatare sufciently centralized and pluralist as

“inclusive” political institutions. When eitherof these conditions fails, we will refer to theinstitutions as extractive.

There is strong synergy between economicand political institutions. Extractive politicalinstitutions concentrate power in the hands of

a narrow elite and place few constraints on theexercise of power. Economic institutions arethen often structured by the elite to extract re-sources from the rest of the society. Extractiveeconomic institutions thus naturally accom-pany extractive political institutions. In fact,they inherently depend on extractive politicalinstitutions for their survival.

By vesting power broadly, inclusive institu-tions tend to uproot economic institutionsthat expropriate the resources of the many, toerect entry barriers and to suppress the func-tioning of markets so that only a few benet.In Barbados, for example, the plantation sys-tem based on the exploitation of slaves couldnot have survived without political institu-tions that excluded the slaves from the politi-cal process. The economic system impover-

ishing millions for the benet of a tiny elite inNorth Korea would also be unthinkable with-

out the total political domination of the com-munist party.

This synergy between extractive economicand political institutions creates a strong feed-back loop: political institutions enable theelites controlling power to choose economicinstitutions with few constraints or opposingforces. They also enable the elites to structurepolitical institutions and their evolution. Ex-tractive economic institutions, in turn, enrichthe same elites, and their economic wealth

I n Barbados and Latin America, the colonists wereable to use their political power to impose economicinstitutions that made them huge fortunes at theexpense of the rest of the population.

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and power help to consolidate their politicaldominance.

In Barbados and Latin America, for exam-

ple, the colonists were able to use their politicalpower to impose economic institutions thatmade them huge fortunes at the expense ofthe rest of the population. The resources theseeconomic institutions generated enabledthese elites to build armies and police forcesto defend their absolute monopolies overpower. The implication, of course, is that ex-tractive political and economic institutionssupport each other and tend to persist.

There is, in fact, more to the synergy be-tween extractive economic and political insti-tutions. When existing elites are challengedunder extractive political institutions and thenewcomers break through, the newcomers arelikewise subject to few constraints. They thushave incentives to maintain these political in-stitutions and create a similar set of economicinstitutions, as Porrio Díaz and the elite sur-

rounding him did at the end of the 19th cen-tury in Mexico.Inclusive economic institutions, in turn,

are forged on foundations laid by inclusive po-litical institutions, which broadly distributepower and constrain its arbitrary exercise.These political institutions also make it harderfor others to usurp power and to underminethe foundations of inclusive institutions.Those controlling political power cannot eas-

ily use it to set up extractive economic institu-tions for their own benet. Inclusive economicinstitutions, in turn, create a more equitabledistribution of resources, facilitating the per-sistence of inclusive political institutions.

It was not a coincidence that, once the Vir-ginia Company [chartered in the early 17thcentury by King James I to settle a wedge ofwhat is now the mid-Atlantic region] gaveland and freedom from draconian contractsto the colonists it had previously tried to co-

erce, the General Assembly allowed the colo-nists to govern themselves. Economic rightswithout political rights would not have been

trusted by the colonists, who had experiencedthe persistent efforts of the Virginia Companyto coerce them. Neither would these econo-mies have been stable and durable.

In fact, combinations of extractive and in-clusive institutions are generally unstable. Ex-tractive economic institutions under inclu-sive political institutions are unlikely tosurvive for long, as our discussion of Barba-dos suggests.

Similarly, inclusive economic institutionswill neither support nor be supported by ex-tractive political ones. Either they will betransformed into extractive economic institu-tions to the benet of the narrow intereststhat hold power, or the economic dynamismthey create will destabilize the extractive po-litical institutions, opening the way for theemergence of inclusive political institutions.

Inclusive economic institutions also tend toreduce the benets the elites can enjoy by rul-ing over extractive political institutions sincethose institutions face competition in themarketplace and are constrained by the rightsof the rest of society.

why not always choose

prosperity?

Political and economic institutions, which are

ultimately the choice of society, can be inclu-sive and encourage economic growth. Or theycan be extractive and become impedimentsto economic growth. Nations fail when theyhave extractive economic institutions, sup-ported by extractive political institutions thatimpede economic growth. This means thatthe choice of institutions – that is, the politicsof institutions – is central to our quest for un-derstanding the reasons for the success andfailure of nations. We have to understand why

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the politics of some societies leads to inclu-sive institutions that foster economic growth,while the politics of the vast majority of soci-

eties throughout history has led to extractiveinstitutions that hamper economic growth.

It might seem obvious that everyoneshould have an interest in creating the type ofeconomic institutions that will bring pros-perity. Wouldn’t every citizen, every politi-cian – even predatory dictators – want tomake the country as wealthy as possible?

Consider the Kingdom of Kongo [the pre-

colonial state in west central Africa]. Thoughthis kingdom collapsed in the 17th century, itprovided the name for the modern countrythat became independent from Belgian rulein 1960. As an independent polity, Congo ex-perienced almost unbroken economic declineand mounting poverty under the rule of Jo-seph Mobutu between 1965 and 1997.

This decline continued after Mobutu wasoverthrown by Laurent Kabila. Mobutu cre-

ated a highly extractive set of economic insti-tutions. The citizens were impoverished, butMobutu and the elite surrounding him,known as Les Grosses Legumes (the Big Veg-etables), became fabulously wealthy. Mobutubuilt himself a palace at his birthplace, Gba-dolite, in the north of the country, with an air-port large enough to land a supersonic Con-corde jet, a plane he frequently rented fromAir France for travel to Europe. In Europe hebought castles and owned large tracts of the

Belgian capital of Brussels.Wouldn’t it have been better for Mobutu

to set up economic institutions that increased

the wealth of the Congolese rather than deep-ening their poverty? If Mobutu had managedto increase the prosperity of his nation, wouldhe not have been able to appropriate evenmore money, buy a Concorde instead of rent-ing one, have more castles and mansions, pos-sibly a bigger, more powerful army?

Unfortunately for the citizens of manycountries in the world, the answer is no. Eco-

nomic institutions that create incentives foreconomic progress may simultaneously redis-tribute income and power in such a way thata predatory dictator and others with politicalpower may end up worse off.

The fundamental problem is that there willnecessarily be conict over economic institu-tions. Different institutions have differentconsequences for the prosperity of a nation,how that prosperity is distributed and who

has power. The economic growth that can beinduced by institutions creates both winnersand losers.

This was clear during the Industrial Revo-lution in England, which laid the founda-tions for the prosperity we enjoy in richcountries of the world today. It centered on aseries of pathbreaking technological changesin steam power, transportation and textileproduction. Even though mechanization ledto enormous increases in total incomes and

The fundamental problem is that there will necessarilybe conflict over economic institutions. Differentinstitutions have different consequences for theprosperity of a nation, how that prosperity is distributedand who has power.

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other groups – of the landed aristocracy. InEngland, industrialization marched on de-spite the Luddites’ opposition because aristo-

cratic opposition was muted. In the Austro-Hungarian and the Russian empires, wherethe absolutist monarchs and aristocrats hadfar more to lose, industrialization was moreeffectively blocked. As a consequence, theeconomies of Austria-Hungary and Russiastalled. They fell behind other European na-tions, where economic growth took off dur-ing the 19th century.

The success and failure of specic groupsnotwithstanding, one lesson is clear: powerfulgroups often stand against economic prog-ress and against the engines of prosperity.Economic growth is not just a consequence ofmore and better machines, and more and bet-ter educated workers, but a transformative,destabilizing process associated with wide-spread creative destruction. Growth is thussustained only if it is not blocked by the eco-

nomic losers.Conict over scarce resources, income andpower translates into conict over the rules ofthe game – the economic institutions – thatdrive economic activity and determine whobenets from it. When there is a conict, thewishes of all parties cannot be simultaneouslymet. Some will be defeated and frustrated,while others will succeed in securing out-comes they like.

Who wins has fundamental implicationsfor a nation’s economic trajectory. If thegroups standing against growth are the win-ners, they can block change, and the economywill stagnate.

The logic of why the powerful would notnecessarily want to create the institutions thatpromote economic success extends easily tothe choice of political institutions. In an abso-lutist regime, some elites can wield power toset up the economic institutions they prefer.

Would they be interested in changing politicalinstitutions to make them more pluralist? Ingeneral no, since this would make it more dif-

cult – maybe impossible – for them to struc-ture economic institutions to further theirown interests.

Here again we see a ready source of conict.The people who suffer from the extractive eco-nomic institutions cannot expect absolutistrulers to change political institutions volun-tarily and to redistribute power. The only wayto alter these political institutions is to forcethe elite to create more pluralistic institutions.

In the same way that there is no inherentreason for political institutions to evolve to-ward pluralism, there is no natural tendencytoward political centralization. There wouldcertainly be incentives to create more central-ized state institutions in any society, particu-larly in those with no such centralizationwhatsoever. For example, in Somalia, if oneclan created a centralized state capable of im-

posing order on the country, this could leadto economic benets and make the clanricher.

What stops this? The main barrier to polit-ical centralization is again the fear of change:any clan attempting to centralize power inthe state will also be centralizing power in itshands, and this is likely to meet the ire ofthose who would lose in this process. Lack ofpolitical centralization means not only leads

to lack of law and order, but also an abun-dance of actors with sufcient powers to dis-rupt things. And the fear of their oppositionwill deter many would-be centralizers.

Political centralization is likely only whenone group is sufciently powerful to build astate over the opposition of other groups. InSomalia, power is evenly balanced, and noone clan can impose its will on any other.Therefore, the lack of political centralizationpersists. M

acemoglu 2012

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