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

by Daron Acemoğlu

To Egyptians, the things that have held them back include an ineffective and corrupt state and a society where they cannot use their talent, ambition, ingenuity, and what education they can get. But they also recognize that the roots of these problems are political. All the economic impediments they face stem from the way political power in Egypt is exercised and monopolized by a narrow elite. This, they understand, is the first thing that has to change.

These different institutions create very disparate incentives for the inhabitants of the two Nogaleses and for the entrepreneurs and businesses willing to invest there. These incentives created by the different institutions of the Nogaleses and the countries in which they are situated are the main reason for the differences in economic prosperity on the two sides of the border.

Early Spanish and, as we will see, English colonists were not interested in tilling the soil themselves; they wanted others to do it for them, and they wanted riches, gold and silver, to plunder.

After an initial phase of looting, and gold and silver lust, the Spanish created a web of institutions designed to exploit the indigenous peoples. The full gamut of encomienda, mita, repartimiento, and trajin was designed to force indigenous people’s living standards down to a subsistence level and thus extract all income in excess of this for Spaniards. This was achieved by expropriating their land, forcing them to work, offering low wages for labor services, imposing high taxes, and charging high prices for goods that were not even voluntarily bought.

If the indigenous peoples could not be exploited, reasoned the Virginia Company, perhaps the colonists could. The new model of colonial development entailed the Virginia Company owning all the land.

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.

The clauses of the Fundamental Constitutions laid out a rigid social structure. At the bottom were the “leet-men,” with clause 23 noting, “All the children of leet-men shall be leet-men, and so to all generations.” Above the leet-men, who had no political power, were the landgraves and caziques, who were to form the aristocracy. Landgraves were to be allocated forty-eight thousand acres of land each, and caziques twenty-four thousand acres. There was to be a parliament, in which landgraves and caziques were represented, but it would be permitted to debate only those measures that had previously been approved by the eight proprietors.

all cases it proved to be impossible to force settlers into a rigid hierarchical society, because there were simply too many options open to them in the New World. Instead, they had to be provided with incentives for them to want to work. And soon they were demanding more economic freedom and further political rights.

The collapse of the Spanish state with the Napoleonic invasion created a constitutional crisis throughout colonial Latin America.

Ferdinand was forced to restore the Cádiz Constitution and recall the Cortes. This Cortes was even more radical than the one that had written the Cádiz Constitution, and it proposed abolishing all forms of labor coercion. It also attacked special privileges—for example, the right of the military to be tried for crimes in their own courts. Faced finally with the imposition of this document in Mexico, the elites there decided that it was better to go it alone and declare independence.

the motivation behind the Mexican declaration of independence was to protect the set of economic institutions developed during the colonial period, which had made Mexico, in the words of the great German explorer and geographer of Latin America Alexander von Humbolt, “the country of inequality.”

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.

Globalization made the large open spaces of the Americas, its “open frontiers,” valuable. Often these frontiers were only mythically open, since they were inhabited by indigenous peoples who were brutally dispossessed. All the same, the scramble for this newly valuable resource was one of the defining processes of the Americas in the second half of the nineteenth century. The sudden opening of this valuable frontier led not to parallel processes in the United States and Latin America, but to a further divergence, shaped by the existing institutional differences, especially those concerning who had access to the land.

you’re a Mexican entrepreneur, entry barriers will play a crucial role at every stage of your career. These barriers include expensive licenses you have to obtain, red tape you have to cut through, politicians and incumbents who will stand in your way, and the difficulty of getting funding from a financial sector often in cahoots with the incumbents you’re trying to compete against. These barriers can be either insurmountable, keeping you out of lucrative areas, or your greatest friend, keeping your competitors at bay. The difference between the two scenarios is of course whom you know and whom you can influence—and yes, whom you can bribe.

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.

This book will show that while economic institutions are critical for determining whether a country is poor or prosperous, it is politics and political institutions that determine what economic institutions a country has. Ultimately the good economic institutions of the United States resulted from the political institutions that gradually emerged after 1619. Our theory for world inequality shows how political and economic institutions interact in causing poverty or prosperity, and how different parts of the world ended up with such different sets of institutions.

Though institutions are the key to the differences between the two Nogaleses and between Mexico and the United States, that doesn’t mean there will be a consensus in Mexico to change institutions. There is no necessity for a society to develop or adopt the institutions that are best for economic growth or the welfare of its citizens, because other institutions may be even better for those who control politics and political institutions.

Because there is no such consensus, what rules society ends up with is determined by politics: who has power and how this power can be exercised.

While there is a lot of persistence in the patterns of prosperity we see around us today, these patterns are not unchanging or immutable. First, as we have already emphasized, most of current world inequality emerged since the late eighteenth century, following on the tails of the Industrial Revolution. Not only were gaps in prosperity much smaller as late as the middle of the eighteenth century, but the rankings which have been so stable since then are not the same when we go further back in history. In the Americas, for example, the ranking we see for the last hundred and fifty years was completely different five hundred years ago. Second, many nations have experienced several decades of rapid growth, such as much of East Asia since the Second World War and, more recently, China. Many of these subsequently saw that growth go into reverse.

The theory that hot countries are intrinsically poor, though contradicted by the recent rapid economic advance of countries such as Singapore, Malaysia, and Botswana, is still forcefully advocated by some, such as the economist Jeffrey Sachs. The modern version of this view emphasizes not the direct effects of climate on work effort or thought processes, but two additional arguments: first, that tropical diseases, particularly malaria, have very adverse consequences for health and therefore labor productivity; and second, that tropical soils do not allow for productive agriculture.

History illustrates that there is no simple or enduring connection between climate or geography and economic success.

Disease is largely a consequence of poverty and of governments being unable or unwilling to undertake the public health measures necessary to eradicate them. England in the nineteenth century was also a very unhealthy place, but the government gradually invested in clean water, in the proper treatment of sewage and effluent, and, eventually, in an effective health service. Improved health and life expectancy were not the cause of England’s economic success but one of the fruits of its previous political and economic changes.

Another influential version of the geography hypothesis is advanced by the ecologist and evolutionary biologist Jared Diamond. He argues that the origins of intercontinental inequality at the start of the modern period, five hundred years ago, rested in different historical endowments of plant and animal species, which subsequently influenced agricultural productivity.

Though Diamond’s thesis is a powerful approach to the puzzle on which he focuses, it cannot be extended to explain modern world inequality.

This technological gap persists today and reproduces itself on a bigger scale as new technologies, in particular those related to information technology, fuel further growth in many developed and some rapidly developing nations. Diamond’s thesis does not tell us why these crucial technologies are not diffusing and equalizing incomes across the world

It should also be clear that Diamond’s argument, which is about continental inequality, is not well equipped to explain variation within continents—an essential part of modern world inequality.

Is the culture hypothesis useful for understanding world inequality? Yes and no. Yes, in the sense that social norms, which are related to culture, matter and can be hard to change, and they also sometimes support institutional differences, this book’s explanation for world inequality. But mostly no, because those aspects of culture often emphasized—religion, national ethics, African or Latin values—are just not important for understanding how we got here and why the inequalities in the world persist.

there may be some marked differences in practices, norms, and values, though these are not causes but outcomes of the two places’ divergent development paths. For example, in surveys Mexicans typically say they trust other people less than the citizens of the United States say they trust others. But it is not a surprise that Mexicans lack trust when their government cannot eliminate drug cartels or provide a functioning unbiased legal system.

The real reason that the Kongolese did not adopt superior technology was because they lacked any incentives to do so. They faced a high risk of all their output being expropriated and taxed by the all-powerful king, whether or not he had converted to Catholicism. In fact, it wasn’t only their property that was insecure. Their continued existence was held by a thread.

Neither did the king have incentives to adopt the plow on a large scale or to make increasing agricultural productivity his main priority; exporting slaves was so much more profitable.

there is little relationship between religion and economic success.

The ignorance hypothesis differs from the geography and culture hypotheses in that it comes readily with a suggestion about how to “solve” the problem of poverty: if ignorance got us here, enlightened and informed rulers and policymakers can get us out and we should be able to “engineer” prosperity around the world by providing the right advice and by convincing politicians of what is good economics.

Inclusive economic institutions foster economic activity, productivity growth, and economic prosperity. Secure private property rights are central, since only those with such rights will be willing to invest and increase productivity.

The state is thus inexorably intertwined with economic institutions, as the enforcer of law and order, private property, and contracts, and often as a key provider of public services. Inclusive economic institutions need and use the state.

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.

All economic institutions are created by society.

Politics is the process by which a society chooses the rules that will govern it. Politics surrounds institutions for the simple reason that while inclusive institutions may be good for the economic prosperity of a nation, some people or groups, such as the elite of the Communist Party of North Korea or the sugar planters of colonial Barbados, will be much better off by setting up institutions that are extractive. When there is conflict over institutions, what happens depends on which people or group wins out in the game of politics—who can get more support, obtain additional resources, and form more effective alliances. In short, who wins depends on the distribution of political power in society.

The political institutions of a society are a key determinant of the outcome of this game.

There is obviously a close connection between pluralism and inclusive economic institutions. But the key to understanding why South Korea and the United States have inclusive economic institutions is not just their pluralistic political institutions but also their sufficiently centralized and powerful states.

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.

Extractive political institutions concentrate power in the hands of a narrow elite and place few constraints on the exercise of this power. Economic institutions are then often structured by this elite to extract resources from the rest of the society. Extractive economic institutions thus naturally accompany extractive political institutions.

This synergistic relationship between extractive economic and political institutions introduces a strong feedback loop: political institutions enable the elites controlling political power to choose economic institutions with few constraints or opposing forces.

The implication of course is that extractive political and economic institutions support each other and tend to persist.

When existing elites are challenged under extractive political institutions and the newcomers break through, the newcomers are likewise subject to only a few constraints. They thus have incentives to maintain these political institutions and create a similar set of economic institutions,

Economic rights without political rights would not have been trusted by the colonists, who had seen the persistent efforts of the Virginia Company to coerce them. Neither would these economies have been stable and durable. In fact, combinations of extractive and inclusive institutions are generally unstable. Extractive economic institutions under inclusive political institutions are unlikely to survive for long, as our discussion of Barbados suggests.

Nations fail when they have extractive economic institutions, supported by extractive political institutions that impede and even block economic growth.

why the politics of some societies lead to inclusive institutions that foster economic growth, while the politics of the vast majority of societies throughout history has led, and still leads today, to extractive institutions that hamper economic growth.

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.

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