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

by Daron Acemoğlu

Inclusive economic institutions, such as those in South Korea or in the United States, are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish. To be inclusive, economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it also must permit the entry of new businesses and allow people to choose their careers.

Inclusive economic institutions foster economic activity, productivity growth, and economic prosperity.

To function well, society also needs other public services: roads and a transport network so that goods can be transported; a public infrastructure so that economic activity can flourish; and some type of basic regulation to prevent fraud and malfeasance. Though many of these public services can be provided by markets and private citizens, the degree of coordination necessary to do so on a large scale often eludes all but a central authority. The state is thus inexorably intertwined with economic institutions,

Economic institutions that create incentives for economic progress may simultaneously redistribute income and power in such a way that a predatory dictator and others with political power may become worse off.

Economic growth and technological change are accompanied by what the great economist Joseph Schumpeter called creative destruction.

It was the inclusive nature of markets that allowed people to allocate their talents to the right lines of business.

Modern Anglo-Saxon surnames such as Baker, Cooper, and Smith are direct descendants of hereditary occupational categories. Bakers baked, coopers made barrels, and smiths forged metals. But these categories were never as rigid as Indian caste distinctions and gradually became meaningless as predictors of a person’s occupation.

Because the Ottoman state failed to establish a stable order in these areas, property rights were far from secure, and there was a great deal of lawlessness and banditry as armed groups vied for local control. In Palestine, for example, the situation was so dire that starting in the late sixteenth century, peasants left the most fertile land and moved up to mountainous areas, which gave them greater protection against banditry.

The production of sugar based on gangs of slaves was certainly not “efficient,” and there was no technological change or creative destruction in these societies, but this did not prevent them from achieving some amount of growth under extractive institutions.

Though the policies of Stalin and subsequent Soviet leaders could produce rapid economic growth, they could not do so in a sustained way. By the 1970s, economic growth had all but stopped. The most important lesson is that extractive institutions cannot generate sustained technological change for two reasons: the lack of economic incentives and resistance by the elites.

The rulers of the Soviet Union would have had to abandon extractive economic institutions, but such a move would have jeopardized their political power. Indeed, when Mikhail Gorbachev started to move away from extractive economic institutions after 1987, the power of the Communist Party crumbled, and with it, the Soviet Union.

While Shyaam and his men did not introduce inclusive institutions to the eastern bank of the Kasai, some amount of economic prosperity is intrinsic to extractive institutions that achieve some degree of state centralization and impose law and order. Encouraging economic activity was of course in the interest of Shyaam and his men, as otherwise there would have been nothing to extract.

More important is that while sedentary life had pluses, it also had minuses. Conflict resolution was probably much harder for sedentary groups, since disagreements could be resolved less easily by people or groups merely moving away. Once people had built permanent buildings and had more assets than they could carry, moving away was a much less attractive option. So villages needed more effective ways of resolving conflict and more elaborate notions of property.

Syria and Palestine are relatively poor parts of the modern world, and the prosperity of Israel was largely imported by the settlement of Jewish people after the Second World War and their high levels of education and easy access to advanced technologies.

Extractive institutions are so common in history because they have a powerful logic: they can generate some limited prosperity while at the same time distributing it into the hands of a small elite. For this growth to happen, there must be political centralization. Once this is in place, the state—or the elite controlling the state—typically has incentives to invest and generate wealth, encourage others to invest so that the state can extract resources from them, and even mimic some of the processes that would normally be set in motion by inclusive economic institutions and markets.

The growth generated by extractive institutions is very different in nature from growth created under inclusive institutions, however. Most important, it is not sustainable. By their very nature, extractive institutions do not foster creative destruction and generate at best only a limited amount of technological progress. The growth they engender thus lasts for only so long.

As we argued earlier, without a centralized state to provide order and enforce rules and property rights, inclusive institutions could not emerge.

The reason Ethiopia is where it is today is that, unlike in England, in Ethiopia absolutism persisted until the recent past. With absolutism came extractive economic institutions and poverty for the mass of Ethiopians,

The lack of political centralization made it impossible for Somalia to benefit from the Industrial Revolution. In such a climate it would have been unimaginable to invest in or adopt the new technologies emanating from Britain, or indeed to create the types of organizations necessary to do so.

According to Lewis, many less-developed or underdeveloped economies have a dual structure and are divided into a modern sector and a traditional sector.

But even in these circumstances, couldn’t black Africans have made their way in the European, modern economy, started a business, or have become educated and begun a career? The government made sure these things could not happen. No African was allowed to own property or start a business in the European part of the economy—the 87 percent of the land.

At a stroke, Africans were banned from occupying any skilled job in the mining sector. This was the first incarnation of the famous “colour bar,” one of the several racist inventions of South Africa’s regime. The colour bar was extended to the entire economy in 1926, and lasted until the 1980s. It is not surprising that black Africans were uneducated; the South African state not only removed the possibility of Africans benefiting economically from an education but also refused to invest in black schools and discouraged black education.

Technological change is only one of the engines of prosperity, but it is perhaps the most critical one. The countries that did not take advantage of new technologies did not benefit from the other engines of prosperity, either.

example, in the polity of Nassau-Usingen, peasants were subject to 230 different payments, dues, and services. Dues included one that had to be paid after an animal had been slaughtered, called the blood tithe; there was also a bee tithe and a wax tithe.

Australia and the United States could industrialize and grow rapidly because their relatively inclusive institutions would not block new technologies, innovation, or creative destruction.

The institutional dynamics we have described ultimately determined which countries took advantage of the major opportunities present in the nineteenth century onward and which ones failed to do so. The roots of the world inequality we observe today can be found in this divergence. With a few exceptions, the rich countries of today are those that embarked on the process of industrialization and technological change starting in the nineteenth century, and the poor ones are those that did not.

British democracy was not given by the elite. It was largely taken by the masses, who were empowered by the political processes that had been ongoing in England and the rest of Britain for the last several centuries.

Inclusive economic institutions lead to a more equitable distribution of resources than extractive institutions. As such, they empower the citizens at large and thus create a more level playing field, even when it comes to the fight for power. This makes it more difficult for a small elite to crush the masses rather than to give in to their demands, or at least to some of them. The British inclusive institutions had also already unleashed the Industrial Revolution, and Britain was highly urbanized. Using repression against an urban, concentrated, and partially organized and empowered group of people would have been much harder than repressing a peasantry or dependent serfs.

This is the virtuous circle in action. Inclusive economic institutions provide foundations upon which inclusive political institutions can flourish, while inclusive political institutions restrict deviations away from inclusive economic institutions.

More important than the fate of these two acts was the general lesson from this episode. Inclusive political institutions not only check major deviations from inclusive economic institutions, but they also resist attempts to undermine their own continuation.

As we already mentioned in chapter 4, the German sociologist Robert Michels called it the iron law of oligarchy. The internal logic of oligarchies, and in fact of all hierarchical organizations, is that, argued Michels, they will reproduce themselves not only when the same group is in power, but even when an entirely new group takes control.

The essence of the iron law of oligarchy, this particular facet of the vicious circle, is that new leaders overthrowing old ones with promises of radical change bring nothing but more of the same. At some level, the iron law of oligarchy is harder to understand than other forms of the vicious circle.

Rich nations are rich largely because they managed to develop inclusive institutions at some point during the past three hundred years. These institutions have persisted through a process of virtuous circles. Even if inclusive only in a limited sense to begin with, and sometimes fragile, they generated dynamics that would create a process of positive feedback, gradually increasing their inclusiveness.

Once pluralism was enshrined, there was a tendency for the institutions to become more inclusive over time, even if this was a rocky and uncertain process.

In this, England was typical of virtuous circles: inclusive political institutions create constraints against the exercise and usurpation of power. They also tend to create inclusive economic institutions, which in turn make the continuation of inclusive political institutions more likely.

In a form that the sociologist Robert Michels would recognize as the iron law of oligarchy, the overthrow of a regime presiding over extractive institutions heralds the arrival of a new set of masters to exploit the same set of pernicious extractive institutions. The logic of this type of vicious circle is also simple to understand in hindsight: extractive political institutions create few constraints on the exercise of power, so there are essentially no institutions to restrain the use and abuse of power by those overthrowing previous dictators and assuming control of the state; and extractive economic institutions imply that there are great profits and wealth to be made merely by controlling power, expropriating the assets of others, and setting up monopolies.

There is yet another, even more destructive facet of the vicious circle, anticipated by our discussion of the Maya city-states in chapter 5. When extractive institutions create huge inequalities in society and great wealth and unchecked power for those in control, there will be many wishing to fight to take control of the state and institutions. Extractive institutions then not only pave the way for the next regime, which will be even more extractive, but they also engender continuous infighting and civil wars. These civil wars then cause more human suffering and also destroy even what little state centralization these societies have achieved. This also often starts a process of descent into lawlessness, state failure, and political chaos, crushing all hopes of economic prosperity, as the next chapter will illustrate.

BOTSWANA, CHINA, and the U.S. South, just like the Glorious Revolution in England, the French Revolution, and the Meiji Restoration in Japan, are vivid illustrations that history is not destiny. Despite the vicious circle, extractive institutions can be replaced by inclusive ones. But it is neither automatic nor easy. A confluence of factors, in particular a critical juncture coupled with a broad coalition of those pushing for reform or other propitious existing institutions, is often necessary for a nation to make strides toward more inclusive institutions. In addition some luck is key, because history always unfolds in a contingent way.

Journalist Richard McGregor reports that on the desk of the head of each of the biggest state companies in China stands a red phone. When it rings, it is the party calling with orders on what the company should do, where it should invest, and what its targets will be. These giant companies are still under the command of the party, a fact we are reminded of when the party decides to shuffle their chief executives, fire them, or promote them, with little explanation.

What happened in the central valley of Afghanistan is not an isolated incident. Many studies estimate that only about 10 or at most 20 percent of aid ever reaches its target. There are dozens of ongoing fraud investigations into charges of UN and local officials siphoning off aid money. But most of the waste resulting from foreign aid is not fraud, just incompetence or even worse: simply business as usual for aid organizations.

This is not to deny that, even beyond humanitarian aid, considerable good comes out of specific aid programs that build schools in areas where none existed before and that pay teachers who would otherwise go unpaid. While much of the aid community that poured into Kabul did little to improve life for ordinary Afghans, there have also been notable successes in building schools, particularly for girls, who were entirely excluded from education under the Taliban and even before.

One solution—which has recently become more popular, partly based on the recognition that institutions have something to do with prosperity and even the delivery of aid—is to make aid “conditional.” According to this view, continued foreign aid should depend on recipient governments meeting certain conditions—for example, liberalizing markets or moving toward democracy.

Also, it would be callous to cut the aid given to the neediest nations. Yes, much of it is wasted. But if out of every dollar given to aid, ten cents makes it to the poorest people in the world, that is ten cents more than they had before to alleviate the most abject poverty, and it might still be better than nothing.