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

by Daron Acemoğlu

Countries such as Great Britain and the United States became rich because their citizens overthrew the elites who controlled power and created a society where political rights were much more broadly distributed, where the government was accountable and responsive to citizens, and where the great mass of people could take advantage of economic opportunities.

Ottoman rule in Egypt was overthrown by Napoleon Bonaparte in 1798, but the country then fell under the control of British colonialism, which had as little interest as the Ottomans in promoting Egypt’s prosperity. Though the Egyptians shook off the Ottoman and British empires and, in 1952, overthrew their monarchy, these were not revolutions like that of 1688 in England, and rather than fundamentally transforming politics in Egypt, they brought to power another elite as disinterested in achieving prosperity for ordinary Egyptians as the Ottoman and British had been. In consequence, the basic structure of society did not change, and Egypt stayed poor.

It is indeed difficult for ordinary citizens to acquire real political power and change the way their society works. But it is possible, and we’ll see how this happened in England, France, and the United States, and also in Japan, Botswana, and Brazil. Fundamentally it is a political transformation of this sort that is required for a poor society to become rich.

The indigenous peoples had to give the encomendero tribute and labor services, in exchange for which the encomendero was charged with converting them to Christianity.

As the Spanish began their conquest of the Americas in the 1490s, England was a minor European power recovering from the devastating effects of a civil war, the Wars of the Roses.

As the United States began to experience the Industrial Revolution in the first half of the nineteenth century, Mexico got poorer.

The Industrial Revolution started in England. Its first success was to revolutionize the production of cotton cloth using new machines powered by water wheels and later by steam engines.

Just as the United States in the nineteenth century was more democratic politically than almost any other nation in the world at the time, it was also more democratic than others when it came to innovation. This was critical to its path to becoming the most economically innovative nation in the world.

If you were poor with a good idea, it was one thing to take out a patent, which was not so expensive, after all. It was another thing entirely to use that patent to make money.

While in 1818 there were 338 banks in operation in the United States, with total assets of $160 million, by 1914 there were 27,864 banks, with total assets of $27.3 billion. Potential inventors in the United States had ready access to capital to start their businesses. Moreover, the intense competition among banks and financial institutions in the United States meant that this capital was available at fairly low interest rates. The same was not true in Mexico. In fact, in 1910, the year in which the Mexican Revolution started, there were only forty-two banks in Mexico, and two of these controlled 60 percent of total banking assets. Unlike in the United States, where competition was fierce, there was practically no competition among Mexican banks. This lack of competition meant that the banks were able to charge their customers very high interest rates, and typically confined lending to the privileged and the already wealthy, who would then use their access to credit to increase their grip over the various sectors of the economy.

People in rich countries also drive on roads without potholes, and enjoy toilets, electricity, and running water in their houses.

Carlos Slim has the power to get what he wants. Bill Gates’s power is far more limited. That’s why our theory is about not just economics but also politics. 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.

World inequality, however, cannot be explained by climate or diseases, or any version of the geography hypothesis.

History illustrates that there is no simple or enduring connection between climate or geography and economic success. For instance, it is not true that the tropics have always been poorer than temperate latitudes.

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.

The average income of a Spaniard was probably less than double that of a citizen of the Inca Empire.

The story of Nogales highlights another major problem in adapting Diamond’s thesis: as we have already seen, whatever the drawbacks of the Inca and Aztec empires were in 1532, Peru and Mexico were undoubtedly more prosperous than those parts of the Americas that went on to become the United States and Canada. North America became more prosperous precisely because it enthusiastically adopted the technologies and advances of the Industrial Revolution. The population became educated and railways spread out across the Great Plains in stark contrast to what happened in South America.

Geography is also unlikely to explain the poverty of the Middle East for similar reasons. After all, the Middle East led the world in the Neolithic Revolution, and the first towns developed in modern Iraq. Iron was first smelted in Turkey, and as late as the Middle Ages the Middle East was technologically dynamic.

ignorance hypothesis, which asserts that world inequality exists because we or our rulers do not know how to make poor countries rich. This idea is the one held by most economists, who take their cue from the famous definition proposed by the English economist Lionel Robbins in 1935 that “economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”

Indeed, the most famous theoretical result in economics, the so-called First Welfare Theorem, identifies the circumstances under which the allocation of resources in a “market economy” is socially desirable from an economic point of view.

The ignorance hypothesis maintains that poor countries are poor because they have a lot of market failures and because economists and policymakers do not know how to get rid of them and have heeded the wrong advice in the past. Rich countries are rich because they have figured out better policies and have successfully eliminated these failures.

As the economist Abba Lerner noted in the 1970s, “Economics has gained the title Queen of the Social Sciences by choosing solved political problems as its domain.”

Nonetheless, available evidence confirms what we know from the all-too-often recurring famines: not only did industrial production fail to take off, but North Korea in fact experienced a collapse in agricultural productivity. Lack of private property meant that few people had incentives to invest or to exert effort to increase or even maintain productivity. The stifling, repressive regime was inimical to innovation and the adoption of new technologies.

Meanwhile, in the South, economic institutions encouraged investment and trade. South Korean politicians invested in education, achieving high rates of literacy and schooling. South Korean companies were quick to take advantage of the relatively educated population, the policies encouraging investment and industrialization, exports, and the transfer of technology. South Korea quickly became one of East Asia’s “Miracle Economies,” one of the most rapidly growing nations in the world.

Countries differ in their economic success because of their different institutions, the rules influencing how the economy works, and the incentives that motivate people.

In the South, by and large, you are free to open any business you like. In the North, you are not. In the South, you can hire workers, sell your products or services, and spend your money in the marketplace in whichever way you want. In the North, there are only black markets. These different rules are the institutions under which North and South Koreans live. 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 require secure property rights and economic opportunities not just for the elite but for a broad cross-section of society.

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.

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.

innovators of the Industrial Revolution and afterward, like Thomas Edison, were not highly educated, these innovations were much simpler than modern technology. Today technological change requires education both for the innovator and the worker. And here we see the importance of economic institutions that create a level playing field. The United States could produce, or attract from foreign lands, the likes of Bill Gates, Steve Jobs, Sergey Brin, Larry Page, and Jeff Bezos, and the hundreds of scientists who made fundamental discoveries in information technology, nuclear power, biotech, and other fields upon which these entrepreneurs built their businesses. The supply of talent was there to be harnessed because most teenagers in the United States have access to as much schooling as they wish or are capable of attaining.

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. There is obviously a close connection between pluralism and inclusive economic institutions.

Max Weber, who we met in the previous chapter, provided the most famous and widely accepted definition of the state, identifying it with the “monopoly of legitimate violence” in society.

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.

In Barbados, for example, the plantation system based on the exploitation of slaves could not have survived without political institutions that suppressed and completely excluded the slaves from the political process. The economic system impoverishing millions for the benefit of a narrow communist elite in North Korea would also be unthinkable without the total political domination of the Communist Party.

Industrial Revolution in England, which laid the foundations of the prosperity we see in the rich countries of the world today. It centered on a series of pathbreaking technological changes in steam power, transportation, and textile production. Even though mechanization led to enormous increases in total incomes and ultimately became the foundation of modern industrial society, it was bitterly opposed by many. Not because of ignorance or shortsightedness; quite the opposite. Rather, such opposition to economic growth has its own, unfortunately coherent, logic. Economic growth and technological change are accompanied by what the great economist Joseph Schumpeter called creative destruction. They replace the old with the new. New sectors attract resources away from old ones. New firms take business away from established ones. New technologies make existing skills and machines obsolete. The process of economic growth and the inclusive institutions upon which it is based create losers as well as winners in the political arena and in the economic marketplace. Fear of creative destruction is often at the root of the opposition to inclusive economic and political institutions.

So with the spread of the Industrial Revolution the aristocracies weren’t just the economic losers; they also risked becoming political losers, losing their hold on political power. With their economic and political power under threat, these elites often formed a formidable opposition against industrialization.

In the Austro-Hungarian and the Russian empires, where the absolutist monarchs and aristocrats had far more to lose, industrialization was blocked. In consequence, the economies of Austria-Hungary and Russia stalled. They fell behind other European nations, where economic growth took off during the nineteenth century.

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.

them. When there is a conflict, the wishes of all parties cannot be simultaneously met. Some will be defeated and frustrated, while others will succeed in securing outcomes they like. Who the winners of this conflict are has fundamental implications for a nation’s economic trajectory. If the groups standing against growth are the winners, they can successfully block economic growth, and the economy will stagnate.

Political centralization is likely only when one group of people is sufficiently more powerful than others to build a state. In Somalia, power is evenly balanced, and no one clan can impose its will on any other. Therefore, the lack of political centralization persists.

It is not geography, culture, or the ignorance of its citizens or politicians that keep the Congo poor, but its extractive economic institutions.

The central thesis of this book is that economic growth and prosperity are associated with inclusive economic and political institutions, while extractive institutions typically lead to stagnation and poverty.

complementary ways in which growth under extractive political institutions can emerge. First, even if economic institutions are extractive, growth is possible when elites can directly allocate resources to high-productivity activities that they themselves control. A prominent example of this type of growth under extractive institutions was the Caribbean Islands between the sixteenth and eighteenth centuries. Most people were slaves, working under gruesome conditions in plantations,

Another example is the economic growth and industrialization of the Soviet Union from the first Five-Year Plan in 1928 until the 1970s. Political and economic institutions were highly extractive, and markets were heavily constrained. Nevertheless, the Soviet Union was able to achieve rapid economic growth because it could use the power of the state to move resources from agriculture, where they were very inefficiently used, into industry.

The second type of growth under extractive political institutions arises when the institutions permit the development of somewhat, even if not completely, inclusive economic institutions.

Chinese economic growth today also has several commonalities with both the Soviet and South Korean experiences. While the early stages of Chinese growth were spearheaded by radical market reforms in the agricultural sector, reforms in the industrial sector have been more muted.

It is worth noting that political centralization is key to both ways in which growth under extractive political institutions can occur. Without some degree of political centralization, the planter elite in Barbados, Cuba, Haiti, and Jamaica would not have been able to keep law and order and defend their own assets and property.

Even though extractive institutions can generate some growth, they will usually not generate sustained economic growth, and certainly not the type of growth that is accompanied by creative destruction.

When both political and economic institutions are extractive, the incentives will not be there for creative destruction and technological change. For a while the state may be able to create rapid economic growth by allocating resources and people by fiat, but this process is intrinsically limited. When the limits are hit, growth stops, as it did in the Soviet Union in the 1970s. Even when the Soviets achieved rapid economic growth, there was little technological change in most of the economy, though by pouring massive resources into the military they were able to develop military technologies and even pull ahead of the United States in the space and nuclear race for a short while. But this growth without creative destruction and without broad-based technological innovation was not sustainable and came to an abrupt end.

At the turn of the fourteenth century, Europe had a feudal order, an organization of society that first emerged in Western Europe after the collapse of the Roman Empire. It was based on a hierarchical relationship between the king and the lords beneath him, with the peasants at the bottom. The king owned the land and he granted it to the lords in exchange for military services. The lords then allocated land to peasants, in exchange for which peasants had to perform extensive unpaid labor and were subject to many fines and taxes. Peasants, who because of their “servile” status were thus called serfs, were tied to the land, unable to move elsewhere without the permission of their lord, who was not just the landlord, but also the judge, jury, and police force. It was a highly extractive system, with wealth flowing upward from the many peasants to the few lords.