Why Nations Fail: The Origins of Power, Prosperity, and Poverty

by Daron Acemoğlu

Each society functions with a set of economic and political rules created and enforced by the state and the citizens collectively. Economic institutions shape economic incentives: the incentives to become educated, to save and invest, to innovate and adopt new technologies, and so on. It is the political process that determines what economic institutions people live under, and it is the political institutions that determine how this process works.

Different patterns of institutions today are deeply rooted in the past because once society gets organized in a particular way, this tends to persist.

This persistence and the forces that create it also explain why it is so difficult to remove world inequality and to make poor countries prosperous.

It is about the effects of institutions on the success and failure of nations—thus the economics of poverty and prosperity; it is also about how institutions are determined and change over time, and how they fail to change even when they create poverty and misery for millions—thus the politics of poverty and prosperity.

Inclusive economic institutions require secure property rights and economic opportunities not just for the elite but for a broad cross-section of society.

We call such institutions, which have opposite properties to those we call inclusive, extractive economic institutions—extractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset.

Inclusive economic institutions also pave the way for two other engines of prosperity: technology and education. Sustained economic growth is almost always accompanied by technological improvements that enable people (labor), land, and existing capital (buildings, existing machines, and so on) to become more productive.

Politics is the process by which a society chooses the rules that will govern it.

Under absolutist political institutions such as those in North Korea and colonial Latin America, those who can wield this power will be able to set up economic institutions to enrich themselves and augment their power at the expense of society. In contrast, political institutions that distribute power broadly in society and subject it to constraints are pluralistic. Instead of being vested in a single individual or a narrow group, political power rests with a broad coalition or a plurality of groups.

We will refer to political institutions that are sufficiently centralized and pluralistic as inclusive political institutions. When either of these conditions fails, we will refer to the institutions as extractive political institutions.

inclusive economic institutions will neither support nor be supported by extractive political ones. Either they will be transformed into extractive economic institutions to the benefit of the narrow interests that hold power, or the economic dynamism they create will destabilize the extractive political institutions, opening the way for the emergence of inclusive political institutions. Inclusive economic institutions also tend to reduce the benefits the elites can enjoy by ruling over extractive political institutions, since those institutions face competition in the marketplace and are constrained by the contracts and property rights of the rest of society.

Economic growth and technological change are accompanied by what the great economist Joseph Schumpeter called creative destruction. They replace the old with the new.

Fear of creative destruction is often at the root of the opposition to inclusive economic and political institutions.

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.

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.

The main barrier to political centralization is again a form of fear from change: any clan, group, or politician attempting to centralize power in the state will also be centralizing power in their own hands, and this is likely to meet the ire of other clans, groups, and individuals, who would be the political losers of this process.

THE MOLUCCAN ARCHIPELAGO in modern Indonesia is made up of three groups of islands.

Whether power corrupts is debatable, but Lord Acton was certainly right when he argued that absolute power corrupts absolutely.

EL CORRALITO Argentina was in the grip of an economic crisis in late 2001. For three years, income had been falling, unemployment had been rising, and the country had accumulated a massive international debt. The policies leading to this situation were adopted after 1989 by the government of Carlos Menem, to stop hyperinflation and stabilize the economy. For a time they were successful.

The devaluation of Argentina Peso as the result of currency peg

What this episode illustrates is a micro version of the difficulty of implementing meaningful changes when institutions are the cause of the problems in the first place. In this case, it was not corrupt politicians or powerful businesses undermining institutional reform, but rather, the local health administration and nurses who were able to sabotage Seva Mandir’s and the development economists’ incentive scheme.