Why Nations Fail: FROM THE WINNERS OF THE NOBEL PRIZE IN ECONOMICS: The Origins of Power, Prosperity and Poverty

by Daron Acemoğlu

It took the Virginia Company some time to recognize that its initial model of colonization did not work in Virginia, and it took a while, too, for the failure of the “Lawes Divine, Morall and Martiall” to sink in. Starting in 1618, a dramatically new strategy was adopted. Since it was possible to coerce neither the locals nor the settlers, the only alternative was to give the settlers incentives. In 1618 the company began the “headright system,” which gave each male settler fifty acres of land and fifty more acres for each member of his family and for all servants that a family could bring to Virginia. Settlers were given their houses and freed from their contracts, and in 1619 a General Assembly was introduced that effectively gave all adult men a say in the laws and institutions governing the colony. It was the start of democracy in the United States. It took the Virginia Company twelve years to learn its first lesson that what had worked for the Spanish in Mexico and in Central and South America would not work in the north. The rest of the seventeenth century saw a long series of struggles over the second lesson: that the only option for an economically viable colony was to create institutions that gave the colonists incentives to invest and to work hard.

The reason that the United States had a banking industry that was radically better for the economic prosperity of the country had nothing to do with differences in the motivation of those who owned the banks. Indeed, the profit motive, which underpinned the monopolistic nature of the banking industry in Mexico, was present in the United States, too. But this profit motive was channeled differently because of the radically different U.S. institutions. The bankers faced different economic institutions, institutions that subjected them to much greater competition. And this was largely because the politicians who wrote the rules for the bankers faced very different incentives themselves, forged by different political institutions. Indeed, in the late eighteenth century, shortly after the Constitution of the United States came into operation, a banking system looking similar to that which subsequently dominated Mexico began to emerge. Politicians tried to set up state banking monopolies, which they could give to their friends and partners in exchange for part of the monopoly profits. The banks also quickly got into the business of lending money to the politicians who regulated them, just as in Mexico. But this situation was not sustainable in the United States, because the politicians who attempted to create these banking monopolies, unlike their Mexican counterparts, were subject to election and reelection. Creating banking monopolies and giving loans to politicians is good bu...

The success and failure of specific groups notwithstanding, one lesson is clear: powerful groups often stand against economic progress and against the engines of prosperity. Economic growth is not just a process of more and better machines, and more and better educated people, but also a transformative and destabilizing process associated with widespread creative destruction. Growth thus moves forward only if not blocked by the economic losers who anticipate that their economic privileges will be lost and by the political losers who fear that their political power will be eroded.

Even though during the Republican period Rome built an impressive empire, and long-distance trade and transport flourished, much of the Roman economy was based on extraction. The transition from republic to empire increased extraction and ultimately led to the kind of infighting, instability, and collapse that we saw with the Maya city-states.

Another fascinating way to find evidence of economic growth is from the Greenland Ice Core Project. As snowflakes fall, they pick up small quantities of pollution in the atmosphere, particularly the metals lead, silver, and copper. The snow freezes and piles up on top of the snow that fell in previous years. This process has been going on for millennia, and provides an unrivaled opportunity for scientists to understand the extent of atmospheric pollution thousands of years ago. In 1990–1992 the Greenland Ice Core Project drilled down through 3,030 meters of ice covering about 250,000 years of human history. One of the major findings of this project, and others preceding it, was that there was a distinct increase in atmospheric pollutants starting around 500 BC. Atmospheric quantities of lead, silver, and copper then increased steadily, reaching a peak in the first century AD. Remarkably, this atmospheric quantity of lead is reached again only in the thirteenth century. These findings show how intense, compared with what came before and after, Roman mining was. This upsurge in mining clearly indicates economic expansion.

The fear of creative destruction is the main reason why there was no sustained increase in living standards between the Neolithic and Industrial revolutions. Technological innovation makes human societies prosperous, but also involves the replacement of the old with the new, and the destruction of the economic privileges and political power of certain people. For sustained economic growth we need new technologies, new ways of doing things, and more often than not they will come from newcomers such as Lee.

The Industrial Revolution started and made its biggest strides in England because of her uniquely inclusive economic institutions. These in turn were built on foundations laid by the inclusive political institutions brought about by the Glorious Revolution. It was the Glorious Revolution that strengthened and rationalized property rights, improved financial markets, undermined state-sanctioned monopolies in foreign trade, and removed the barriers to the expansion of industry. It was the Glorious Revolution that made the political system open and responsive to the economic needs and aspirations of society.

The reasoning of the Ming and Qing states for opposing international trade is by now familiar: the fear of creative destruction. The leaders’ primary aim was political stability. International trade was potentially destabilizing as merchants were enriched and emboldened, as they were in England during the era of Atlantic expansion.

NATIONS FAIL TODAY because their extractive economic institutions do not create the incentives needed for people to save, invest, and innovate. Extractive political institutions support these economic institutions by cementing the power of those who benefit from the extraction. Extractive economic and political institutions, though their details vary under different circumstances, are always at the root of this failure.